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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2002 Commission file number 2-78178
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Southern Michigan Bancorp, Inc.
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(Exact name of registrant as specified in its charter)
Michigan 38-2407501
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
51 West Pearl Street, Coldwater, Michigan 49036
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code -- (517) 279-5500
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Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, $2.50 Par Value - 1,866,425 shares at July 31, 2002 (including
shares held by ESOP)
PART 1 - FINANCIAL INFORMATION
ITEM 1. Financial Statements.
CONDENSED CONSOLIDATED BALANCE SHEETS
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
June 30 December 31
2002 2001
-----------------------------
(Unaudited) (A)
(In thousands, except share
and per share data)
ASSETS
Cash and cash equivalents $ 13,894 $ 23,432
Securities available for sale 49,142 61,531
Loans, net of allowance for loan losses of $2,267 (2001 - $2,065) 229,234 210,470
Premises and equipment, net 7,456 7,868
Other assets 13,031 13,795
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TOTAL ASSETS $ 312,757 $ 317,096
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LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest bearing $ 39,771 $ 40,515
Interest bearing 213,072 220,568
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252,843 261,083
Accrued expenses and other liabilities 4,347 4,943
Federal funds purchased 4,000 --
Long-term borrowings 24,820 24,000
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286,010 290,026
Common stock subject to repurchase obligation in ESOP,
shares outstanding - 101,476 in 2002 (98,549 in 2001) 1,634 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--1,866,435 shares (2001 - 1,920,651)
Outstanding--1,764,959 shares (2001 -1,822,102) 4,413 4,555
Additional paid-in capital 8,778 9,652
Retained earnings 11,835 11,528
Accumulated other comprehensive income, net of tax 590 400
Unearned Employee Stock Ownership Plan shares (503) (588)
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TOTAL SHAREHOLDERS' EQUITY 25,113 25,547
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 312,757 $ 317,096
===========================
(A) The balance sheet at December 31, 2001 has been derived from the audited
consolidated financial statements at that date.
See notes to unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
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(In thousands, except per share amounts)
Interest income:
Loans, including fees $ 4,190 $ 4,669 $ 8,234 $ 9,602
Securities:
Taxable 338 643 776 1,212
Tax exempt 238 194 490 396
Other 1 2 1 36
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Total interest income 4,767 5,508 9,501 11,246
Interest expense:
Deposits 1,131 2,175 2,351 4,484
Other 460 429 893 884
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Total interest expense 1,591 2,604 3,244 5,368
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NET INTEREST INCOME 3,176 2,904 6,257 5,878
Provision for loan losses 375 225 650 600
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NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,801 2,679 5,607 5,278
Non-interest income:
Service charges on deposit accounts 347 263 610 523
Trust fees 143 128 291 271
Net gain on sales of securities -- 27 4 33
Net gain on sales of loans 143 290 395 494
Earnings on life insurance policies 59 54 110 107
Loss on viatical settlement contracts (283) (283)
Other 169 74 289 270
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578 836 1,416 1,698
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Non-interest expense:
Salaries and employee benefits 1,484 1,257 2,959 2,560
Occupancy 194 199 404 419
Equipment 305 308 661 571
Professional and outside services 145 159 340 258
Advertising and marketing 38 64 72 113
Other 685 651 1,355 1,280
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2,851 2,638 5,791 5,201
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INCOME BEFORE INCOME TAXES 528 877 1,232 1,775
Federal income taxes 186 221 327 445
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NET INCOME 342 656 905 1,330
Other comprehensive income, net of tax: 288 16 190 461
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COMPREHENSIVE INCOME $ 630 $ 672 $ 1,095 $ 1,791
======================================================
Basic and Diluted Earnings Per Common Share $ 0.18 $ 0.34 $ 0.48 $ 0.69
======================================================
Dividends Declared Per Common Share $ 0.16 $ 0.15 $ 0.32 $ 0.30
======================================================
See notes to unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
Six Months Ended
June 30
2002 2001
------------------------------
(In thousands)
OPERATING ACTIVITIES
Net income $ 905 $ 1,330
Adjustments to reconcile net income to net
cash from operating activities:
Provision for loan losses 650 600
Earnings on life insurance policies (110) (107)
Loss on viatical settlement contracts 283 --
Depreciation 449 430
Amortization of intangible assets 51 59
Net realized gain on sales of securities (4) (33)
Net realized loss on disposal of fixed assets 23 --
Net change in:
Loans held for sale 1,689 970
Other assets 442 1,163
Accrued expenses and other liabilities (637) (280)
Reduction of obligation under ESOP 85 --
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Net cash from operating activities 3,826 4,132
INVESTING ACTIVITIES
Proceeds from sales of securities available for sale 254 2,125
Proceeds from maturities of securities available for sale 16,927 12,988
Purchases of securities available for sale (4,500) (15,051)
Net change in loans (21,103) 8,268
Proceeds from sale of premises and equipment 58
Purchase of premises and equipment (118) (1,126)
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Net cash from investing activities (8,482) 7,204
FINANCING ACTIVITIES
Net change in deposits (8,240) (381)
Net change in federal funds purchased 4,000 (4,000)
Proceeds from long-term borrowings 820 --
Repayments of long-term borrowings (2,000)
Common stock repurchased and retired (856) (7)
Cash dividends paid (606) (621)
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Net cash from financing activities (4,882) (7,009)
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Net change in cash and cash equivalents (9,538) 4,327
Cash and cash equivalents at beginning of period 23,432 18,489
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,894 $ 22,816
==============================
See notes to unaudited condensed consolidated financial statements.
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
June 30, 2002
NOTE A -- BASIS OF PRESENTATION
The accompanying year-end balance sheet data was derived from audited
consolidated financial statements, but does not include all disclosures required
by generally accepted accounting principles.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on Form
10-K for the year ended December 31, 2001.
Basic earnings per common share is net income divided by the weighted average
number of common shares outstanding during the period. ESOP shares are
considered outstanding for this calculation unless unearned. Diluted earnings
per common share includes the dilutive effect of additional potential common
shares issuable under stock options. Earnings and dividends per share are
restated for all stock splits and dividends through the date of issue of the
financial statements.
The basic and diluted weighted average common shares outstanding for the three
and six month period ended June 30, 2002 and 2001 were:
For the 3 months ended For the 6 months ended
6/30/02 6/30/01 6/30/02 6/30/01
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Basic 1,851,225 1,924,879 1,876,404 1,925,002
Diluted 1,851,432 1,925,008 1,876,765 1,925,063
Reclassifications: Some items in the prior year consolidated financial
statements have been reclassified to conform with the current year presentation.
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FINANCIAL CONDITION
During the first six months of 2002, cash and cash equivalents decreased 40.7%
or $9,538,000. In addition, securities available for sale decreased by 20.1% or
$12,389,000 during this same time period. These funds were primarily used to
fund additional loans.
Gross loans have increased by 8.9% in the first six months of 2002. The increase
has occurred primarily in the commercial loan portfolio. Mortgage loans have
increased slightly while installment loans continue to decline. There were
$174,000 in loans held for sale as of June 30, 2002.
In assessing the adequacy of the allowance for loan losses, management reviews
the characteristics of the loan portfolio in order to determine the overall
quality and risk profile. Some factors considered by management in determining
the level at which the allowance is maintained include a continuing evaluation
of those loans identified as being subject to possible problems in collection,
results of examinations by regulatory agencies, current economic conditions and
historical loan loss experience. The allowance for loan losses is being
maintained at a level, which in management's opinion, is adequate to absorb
probable incurred loan losses in the loan portfolio as of June 30, 2002.
The allowance for loan losses was $2,267,000 or .98% of gross loans, including
loans held for sale, at June 30, 2002. As of December 31, 2001, the allowance
for loan losses was $2,065,000 or .97% of gross loans, including loans held for
sale. As of June 30, 2002, loans past due 90 days or more or on non-accrual have
decreased by a total of $289,000 or 10.7% from December 31, 2001. Despite this
decrease, the allowance has remained stable to account for increased volume in
the commercial loan area as well as increases in the allowance allocations for
specific loan credits.
There were no significant fixed asset commitments as of June 30, 2002.
Total deposits decreased by $8,240,000 or 3.2% during the first six months of
2002. To provide an additional source of funding for loan growth the Company
borrowed $4 million of federal funds purchased at June 30, 2002.
During the first six months of 2002, the Company repurchased approximately
$856,000 worth of stock and retired it. This resulted in total shareholders'
equity decreasing from December 31, 2001.
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CAPITAL RESOURCES
The Federal Reserve Board (FRB) has adopted 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 8.0 percent. In
addition, a bank holding company must maintain a minimum ratio of Tier 1 capital
equal to 4.0 percent of risk-weighted assets. Tier 1 capital includes common
shareholders' equity, qualifying perpetual preferred stock and minority interest
in equity accounts of consolidated subsidiaries less intangible assets.
As a supplement to the risk-based capital requirements, the FRB has also adopted
leverage capital ratio requirements. The leverage ratio requirements establish a
minimum ratio of Tier 1 capital to total assets less intangible assets of 3
percent for the most highly rated bank holding companies. All other bank holding
companies are required to maintain additional Tier 1 capital yielding a leverage
ratio of 4 percent to 5 percent, depending on the particular circumstances and
risk profile of the institution.
The following table summarizes the Company's capital ratios as of June 30, 2002
and December 31, 2001:
June 30, 2002 December 31, 2001
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Tier 1 risk-based capital ratio 10.5% 11.1%
Total risk-based capital ratio 11.4% 12.0%
Leverage ratio 8.1% 8.3%
The above table indicates that the Company's capital ratios are above the
regulatory minimum requirements.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income increased by 6.4% or $379,000 for the six month period ended
June 30, 2002 compared to the same period in 2001. Higher priced deposits
matured during the last part of 2001 reducing interest costs which in turn
increased the net interest income. This reduction in interest expense offset a
15.5% decrease in gross interest income which declined primarily as a result of
the prime rate being lower during the first six months of 2002 as compared to
the first six months of 2001.
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Provision for Loan Losses
The provision for loan losses is based on an analysis of outstanding loans. In
assessing the adequacy of the allowance for loan losses, management reviews the
characteristics of the loan portfolio in order to determine the overall quality
and risk profile. Some factors considered by management in determining the level
at which the allowance is maintained include a continuing evaluation of those
loans identified as being subject to possible problems in collection, results of
examinations by regulatory agencies, current economic conditions and historical
loan loss experience.
Despite lower levels of nonperforming loans and lower net charge-offs, the
provision for loan losses for the six months ended June 30, 2002 is $50,000
higher than the provision for the six months ended June 30, 2001. For the three
month period ending June 30, 2002, the provision is $150,000 higher than the
prior year comparable period. The provision has increased during both of these
periods primarily to account for commercial loan growth and to provide for
increases in allowance allocations for specific loan credits.
Non-interest Income
Non-interest income decreased $282,000 for the six month period ending June 30,
2002 compared to the same period in 2001. The primary reason for the decrease in
non-interest income is the $283,000 loss on viatical settlement contracts during
the three months ended June 30, 2002. In mid-July the Company received new
information regarding its life insurance investments in eight viatical
settlement contracts. A letter was received from the Treasurer of the State of
Florida Department of Insurance. The letter stated that the company servicing
the Company's viatical settlement contracts has advised the Department that they
do not have sufficient funds to pay premiums on policies that are supporting the
investments. Management has been in contact with the Florida Department of
Insurance as well as legal counsel to do everything possible to protect the
Company's investments. For the three months ended June 30, 2002, the Company
recorded a $283,000 loss on the $283,000 carrying value of these investments.
This loss is based on management's inability at this time to verify continuing
value for these investments.
Service charges on deposit accounts increased $87,000 due to the variable nature
of the fees assessed, based on customer account balances for business accounts.
Offsetting this increase was a $99,000 decrease in the net gain on sales of
loans during the same period. Despite rates remaining low, many current
homeowners have already taken advantage of the low rate interest environment and
have refinanced their mortgages. Thus the level of loan refinancing activity is
lower in 2002 as compared to 2001.
-8-
Other non-interest income for the three and six months ending June 30, 2002
compared to the same period in 2001 has increased due to increases in ATM income
and other miscellaneous income.
Non-interest Expense
Non-interest expenses increased by $590,000 for the six month period ended June
30, 2002 compared to the same period in 2001. During the six months ended June
30, 2002, salaries and employee benefits expense increased $399,000 compared to
the same period in 2001. After the first quarter of 2001, the Company hired
additional staff in Battle Creek to focus on this targeted market. The Company
also hired additional mortgage originators who are paid commissions for work
generated. The commissions for the first six months of 2002 have exceeded the
commissions for the same time period in 2001 by over $133,000. The cost of
employee benefits increased in 2002 as health insurance costs have increased and
more employees have participated in the plan. In addition to salaries and
employee benefits increasing, the Company saw an increase in legal and other
fees related to the resolution of a lawsuit during the first quarter of 2002.
Changes in Management
In December of 2001, the President and CEO of the Company and Southern Michigan
Bank & Trust, announced his retirement effective December 31, 2002. An extensive
search for a replacement began with a goal to have a replacement in place by mid
year. In June of 2002, John Castle was named CEO of both The Company and
Southern Michigan Bank & Trust. Since that time, Kurt Miller has been named
President of both organizations and Mary Guthrie has been named VP & Senior
Trust Officer.
New Accounting Pronouncements
On January 1, 2002, the Company adopted a new accounting standard which
addresses accounting for goodwill and intangible assets arising from business
combinations. Identifiable intangible assets must be separated from goodwill.
Identifiable intangible assets with finite useful lives are amortized under the
new standard, whereas goodwill resulting from business combinations, both
amounts previously recorded and future amounts purchased, cease being amortized.
Annual impairment testing is required for goodwill with impairment being
recorded if the carrying amount of goodwill exceeds its implied fair value. The
Company's current intangible assets resulted from branch acquisitions. Current
interpretations by the Financial Accounting Standards Board (FASB) requires the
continued amortization of the core deposit intangibles and the unidentified
intangibles resulting from branch acquisitions. However, the FASB is
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reconsidering their interpretation and it is possible that in the future there
may no longer be a requirement to amortize the unidentified intangibles
resulting from branch acquisitions. Adoption of this standard on January 1, 2002
did not have a material effect on the Company's financial statements.
Intangible assets subject to amortization are as follows:
June 30, 2002 December 31, 2001
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Gross Accumulated Gross Accumulated
Description Amount Amortization Amount Amortization
- ----------- ---------- ------------ ---------- ------------
Core deposit intangibles $ 559,000 $ 389,000 $ 559,000 $ 370,000
Unidentified intangibles 938,000 350,000 938,000 318,000
---------- ---------- ---------- ----------
Total $1,497,000 $ 739,000 $1,497,000 $ 688,000
Amortization expense for the first six months of 2002 and 2001 was $51,000 and
$59,000. Estimated annual amortization expense for the next five years is:
2002 $102,000
2003 102,000
2004 102,000
2005 102,000
2006 96,000
In August 2001, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 143, "Accounting for Asset Retirement Obligations" which will be
adopted by the Company on January 1, 2003. The new accounting standard addresses
accounting for obligations associated with the retirement of tangible,
long-lived assets and requires a liability to be recognized for the fair value
of any such obligations. Adoption of this standard on January 1, 2003 is not
expected to have a material effect on the Company's consolidated financial
position or results of operations.
On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This new accounting standard
establishes more restrictive requirements for the classification of assets as
"held for sale" and also expands the types of dispositions that are to be
accounted for as discontinued operations. Adoption of this standard on January
1, 2002 did not have a material effect on the Company's consolidated financial
position or results of operations
The FASB recently issued SFAS No. 145 and SFAS No. 146. SFAS No. 145 applies for
years beginning after May 14, 2002 and may be adopted sooner. SFAS No. 145
covers extinguishments of debt and leases, and includes some minor technical
corrections. Under previous accounting guidance, gains or losses from
extinguishments of debt were always treated as extraordinary
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items. Under SFAS No. 145 they will no longer be considered extraordinary,
except under very limited conditions. Upon adoption of SFAS No. 145, any prior
gains and losses from extinguishments of debt must be reclassified as ordinary
gains and losses. Under SFAS No. 145, if a capital lease is modified to become
an operating lease, it will be accounted for as a sale-leaseback, by following
the accounting guidance of SFAS No. 98, instead of being accounted for as a new
lease. SFAS No. 146 covers accounting for costs associated with exit or
long-lived asset disposal activities, such as restructurings, consolidation or
closing of facilities, lease termination costs or employee relocation or
severance costs. SFAS No. 146 replaces Emerging Issues Task Force (EITF) 94-3,
and is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002, and may be adopted sooner. A company may not restate
its previously issued financial statements. SFAS No. 146 requires exit or
long-lived asset disposal costs to be recognized as an expense when the
liability is incurred and can be measured at fair value, rather than at the date
of making a commitment to an exit or disposal plan. Management does not expect
the effects of the future adoptions of SFAS No. 145 and SFAS No. 146 to be
material to the Company's consolidated financial position or results of
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk and to a lesser
extent, liquidity risk. 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
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interest-bearing liabilities. In addition to reviewing the interest sensitivity
gap, the Company also analyzes projected changes in market interest rates and
the resulting effect on net interest income.
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. Certain portions of the Bank's liabilities may be short-term or due on
demand, while most of its assets may be invested in long-term loans or
investments. Accordingly, the Company seeks to have in place sources of cash to
meet short-term demands. These funds can be obtained by increasing deposits,
borrowing or selling assets. Also, Federal Home Loan Bank advances and
short-term borrowings provide additional sources of liquidity for the Company.
In June of 2002, the Board of directors of the Company approved an issuance of
trust preferred securities not to exceed $5,000,000. Management is reviewing
alternatives and may close a deal by the end of 2002. Proceeds will be used to
provide additional liquidity and capital for the Company.
There have been no significant changes in the distribution of the Company's
financial instruments that are sensitive to changes in interest rates during the
first six months of 2002.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities and Use of Proceeds.
None.
ITEM 3. Defaults Upon Senior Securities.
None.
-12-
ITEM 4. Submission of Matters to a Vote of Security Holders.
The annual Meeting of Shareholders of Southern Michigan Bancorp, Inc. was held
on April 15, 2002 at Southern Michigan Bank & Trust. The following items were
approved by the shareholders at the Annual Meeting:
a. Election of Marcia Albright, James P. Briskey and Nolan E. Hooker as
directors.
Marcia James Nolan
Albright Briskey Hooker
Number of votes for 1,751,840 1,790,967 1,753,280
Number of votes against 39,127 27,648 37,687
Number of votes abstained 0 0 0
Number of broker nonvotes 128,665 101,017 128,665
H. Kenneth Cole, William E. Galliers, James T. Grohalski, Gregory J.
Hull, Thomas E. Kolassa, James J. Morrison and Freeman E. Riddle
continued their terms as directors. Jane L. Randall retired from the
Board effective April 15, 2002.
b. Ratification of the selection of Crowe, Chizek and Company LLP as
Independent Auditors for 2002.
Number of votes for 1,437,173
Number of votes against 18,065
Number of votes abstained 150,003
Number of broker nonvotes 314,391
ITEM 5. Other Information.
None
ITEM 6. Exhibits and Reports on Form 8-K.
None.
-13-
SIGNATURES
Pursuant to the requirements 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.
------------------------------
(Registrant)
August 14, 2002 /s/ John H. Castle
- --------------- -------------------------------
Date John H. Castle, Chief
Executive Officer
/s/ James T. Grohalski
-------------------------------
James T. Grohalski, Chief
Financial Officer (Principal
Financial and Accounting Officer)
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