SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 2002 ----------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from to ----------- ----------- Commission File Number: 0-18415 ------- IBT BANCORP, INC. ----------------- (Exact name of registrant as specified in its charter) Michigan 38-2830092 -------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) identification No.) 200 East Broadway Street, Mt. Pleasant, Michigan 48858 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (989) 772-9471 -------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - ---------------------------- ------------------------------------------ Securities registered pursuant to Section 12(g) of the Act: Common Stock - No 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 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. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [X] Yes [ ] No The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $151,823,000 as of March 3, 2003. The number of shares outstanding of the registrant's Common Stock (no par value) was 4,337,807 as of March 3, 2003. DOCUMENTS INCORPORATED BY REFERENCE (Such documents are incorporated herein only to the extent specifically set forth in response to an item herein.) Documents Part of Form 10-K Incorporated into --------- ----------------------------------- IBT Bancorp, Inc. Proxy Statement for its Annual Meeting of Shareholders Part III to be held April 29, 2003 1
PART I ITEM 1. BUSINESS GENERAL IBT Bancorp, Inc. (the Corporation) is a registered financial services holding company incorporated in September 1988 under Michigan law. The Corporation has seven subsidiaries: Isabella Bank and Trust, Farmers State Bank, IBT Financial Services, IBT Title, IBT Loan Production, IBT Personnel, LLC, and Financial Group Information Services. Isabella Bank and Trust has sixteen banking offices located throughout Isabella County, northeastern Montcalm County, and southern Clare County, all of which are located in central Michigan. Farmers State Bank of Breckenridge has three offices located in Gratiot and Saginaw Counties. IBT Financial Services is a full service retail brokerage and insurance agency offering stocks, bonds, mutual funds, life insurance, casualty insurance, and fixed and variable annuities. IBT Title provides title insurance, abstract searches, and closes loans in Isabella, Montcalm, and Mecosta Counties. IBT Loan Production originates residential real estate mortgages. Its principal products are 15 and 30 year fixed rate loans. All loans originated are sold with servicing to Isabella Bank and Trust. IBT Personnel, LLC, is an employee leasing company. Financial Group Information Services provides computer services to the Corporation's other subsidiaries. All employees of the Corporation are employed by IBT Personnel and leased to each individual subsidiary. The principal city in which the Corporation operates is Mount Pleasant, which has a population of approximately 26,000. Markets served include Isabella, Gratiot, Mecosta, southwestern Midland, western Saginaw, northern Montcalm, and southern Clare. The area includes significant agricultural production, light manufacturing, retail, gaming and tourism, and two universities with enrollment of approximately 30,000 students. The area unemployment rate is approximately 5.0% and average household income is $38,000. COMPETITION The Corporation competes with other commercial banks, many of which are subsidiaries of other bank holding companies, savings and loan associations, finance companies, credit unions, and retail brokerage firms. Its subsidiary banks are community banks and focus on providing high-quality, personalized service at a fair price. The banks offer a broad array of banking services to businesses, institutions, and individuals. Deposit services offered include checking accounts, savings accounts, certificates of deposit, and direct deposits. Lending activity includes loans made pursuant to lines of credit, real estate loans, consumer loans, student loans, and credit card loans. Other financial related products include trust services, title insurance, stocks, investment securities, bonds, mutual fund sales, 24 hour banking service locally and nationally through shared automatic teller machines, and safe deposit box rentals. LENDING The subsidiary banks limit lending activities to local markets and have not purchased any loans from the secondary market. They do not make loans to fund leveraged buyouts, they have no foreign corporate or government loans, and limited corporate debt securities. The general lending philosophy is to avoid concentrations to individuals and business segments. The following table sets forth the composition of the banks loan portfolio as of December 31, 2002. 2
<Table> <Caption> LOANS BY MAJOR LENDING CATEGORY (in thousands) Amount % --------- --------- <S> <C> <C> Residential real estate One to four family residential $ 162,435 40.2% Construction & land development 21,537 5.3 --------- --------- Total 183,972 45.5 Commercial Commercial real estate 86,509 21.4 Farmland & agricultural production 54,788 13.5 Commercial and other 40,433 10.0 --------- --------- Total 181,730 44.9 Other individual Other personal 36,602 9.1 Credit cards 2,176 0.5 --------- --------- Total 38,778 9.6 --------- --------- TOTAL $ 404,480 100.0% ========= ========= </Table> First and second residential mortgages are the single largest category of loans (45.5% of total loans). The Corporation, through its subsidiary banks, offers 3 and 5 year fixed rate balloon mortgages with a maximum 30 year amortization, and 15 and 30 year amortized fixed rate loans. Fixed rate loans with an amortization greater than 15 years are sold upon origination to the Federal Home Loan Mortgage Association. Fixed rate residential mortgage loans with an amortization of 15 years or less may be held for future sale or sold upon origination. Factors used in determining when to sell these mortgages include management's judgment about the direction of interest rates, the Corporation's need for fixed rate assets in the management of its interest rate sensitivity, and overall loan demand. Currently all loans with a fixed maturity over 7 years are sold. The Corporation has a policy that these loans may not exceed 10% of its total assets. Lending policies generally limit the maximum loan-to-value ratio on residential mortgages to 95% of the lower of appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan-to-value ratios in excess of 80%. The majority of the loans have a loan-to-value ratio of less than 80%. Underwriting criteria for residential real estate loans include: evaluation of the borrower's ability to make monthly payments, the value of the property securing the loan, the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower's gross income, all debt servicing does not exceed 36% of income, acceptable credit reports, verification of employment, income, and financial information. Appraisals are performed by independent appraisers. Escrow accounts for taxes and insurance are required on all loans with loan-to-value ratio in excess of 80%. All mortgage loan requests are reviewed by a mortgage loan committee; loans in excess of $250,000 require the approval of either the subsidiary bank's Board of Directors or its loan committee. Construction and land development loans consist mostly of 1 to 4 family residential properties. These loans have a 6 to 9 month maturity and are made using the same underwriting criteria as residential mortgages. Loan proceeds are disbursed in increments as construction progresses and inspections warrant. Construction loans are either converted to permanent loans at the completion of construction or are paid off from financing through another financial institution. Commercial lending, which includes loans for farmland and agricultural production, state and political subdivisions, commercial real estate, and commercial operating loans equaled 44.9% of the Corporation's loan portfolio at December 31, 2002. Repayment of commercial loans is often dependent upon the successful 3
operation and management of a business; thus, these loans generally involve greater risk than other types of lending. The Corporation minimizes its risk by generally limiting the amount of loans to any one borrower to $5.0 million at its subsidiary banks. Borrowers with credit needs of more than $5.0 million are serviced through the use of loan participations with other commercial banks. All commercial real estate loans require loan-to-value limits of less than 80%. Depending upon the type of loan, past credit history, and current operating results, the Corporation may require the borrower to pledge accounts receivable, inventory, and fixed assets. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and proprietorships. In addition, the Corporation requires annual financial statements, prepares cash flow analysis, and reviews credit reports. Consumer loans granted include automobile loans, secured and unsecured personal loans, credit cards, student loans, and overdraft protection. Loan amortization is generally for a period of up to 6 years; except home improvement loans, which are amortized for up to 10 years. The underwriting emphasis is on a borrower's ability to pay rather than collateral value. Except for student loans, no installment loans are sold to the secondary market. All student loans are sold to the secondary market upon reaching a payout status. SUPERVISION AND REGULATION The Corporation is subject to supervision and regulation by the Securities and Exchange Commission under the Securities Act of 1933 and 1934 and by the Federal Reserve Board under the Financial Services Holding Company Act of 2000. A bank holding company and its subsidiaries are able to conduct only the business of commercial banking and activities closely related or incidental to it. (See Regulation below.) Isabella Bank and Trust and Farmers State Bank are chartered by the State of Michigan. The banks are members of the Federal Reserve System, their deposits are insured by the Federal Deposit Insurance Corporation to the extent provided by law. The Banks are members of the Federal Home Loan Bank of Indianapolis. The banks and IBT Loan Production are supervised and regulated by the Michigan Office of Financial and Insurance Services, Division of Financial Institutions (OFIS) and the Federal Reserve Board. (See Regulation below.) IBT Financial Services, Inc., is a registered broker-dealer and insurance agency and subject to regulation by the Securities and Exchange Commission under federal securities laws. This subsidiary is also subject to regulation under state securities laws and regulation by the OFIS. IBT Title, Inc., a non-banking subsidiary of IBT Bancorp, Inc., is a licensed title insurance agency and is subject to regulation by the OFIS, as well as the Federal Real Estate Settlement Procedures Act. IBT Title owns a membership interest in a similar title insurance agency, FSSB Title, LLC. PERSONNEL As of December 31, 2002, the Corporation had two full-time employees, Isabella Bank and Trust had 167, Farmers State Bank of Breckenridge had 51, IBT Financial Services had two, IBT Title had nineteen, IBT Loan Production had one, and Financial Group Information Services had ten. The Corporation provides group life, health, accident, disability and other insurance programs for employees and a number of other employee benefit programs. The Corporation believes its relationship with its employees to be good. LEGAL PROCEEDINGS There are various claims and lawsuits in which the Corporation's subsidiary banks are periodically involved, such as claims to enforce liens, condemnation proceedings on making and servicing of real property loans and other 4
issues incidental to the bank's business. However, neither the Corporation nor the banks are involved in any material pending litigation. AVAILABLE INFORMATION The Corporation does not maintain a website. Consequently, the Corporation's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Definitive Proxy Statements, Current Reports on Form 8-K and amendments to those reports are not available on a Corporation website. The Corporation will provide paper copies of its reports to the SEC free of charge upon request of a shareholder. The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Corporation (CIK #0000842517) and other issuers that file electronically with the SEC. REGULATION The earnings and growth of the banking industry and therefore the earnings of the Corporation and of the Banks are affected by the credit policies of monetary authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. Treasury securities, changes in the discount rate on member bank borrowing, and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve System have had a significant effect on the operating results of commercial banks and related financial service providers in the past and are expected to continue to do so in the future. The effect of such policies upon the future business and earnings of the Corporation and the banks cannot be predicted. THE CORPORATION The Corporation, as a financial services holding company, is regulated under the Bank Holding Company Act of 1956, as amended ("BHC Act"), and is subject to the supervision of the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). The Corporation is registered as a financial services holding company with the Federal Reserve Board and is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board requires. The Federal Reserve Board may also make inspections and examinations of the Corporation and its subsidiaries. Prior to March 13, 2000, a bank holding company generally was prohibited under the BHC Act from acquiring the beneficial ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the Federal Reserve Board's prior approval. Also, prior to March 13, 2000, a bank holding company generally was limited to engaging in banking and such other activities as determined by the Federal Reserve Board to be closely related to banking. Under the Gramm-Leach-Bliley Act of 1999 ("GLB Act"), beginning March 13, 2000, an eligible bank holding company may elect to become a financial holding company and thereafter affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. The GLB Act defines "financial in nature" to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; activities that the Federal Reserve Board has determined to be closely related to banking; and other activities that the Federal Reserve Board, after consultation with the Secretary of the Treasury, determines by regulation or order to be 5
financial in nature or incidental to a financial activity. No Federal Reserve Board approval is required for a financial holding company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as defined in the GLB Act or as determined by the Federal Reserve Board. A bank holding company is eligible to become a financial holding company if each of its subsidiary banks and savings associations is well capitalized under the prompt corrective action provisions of the Federal Deposit Insurance Act ("FDI Act"), is well managed and has a rating under the Community Reinvestment Act (CRA) of satisfactory or better. If any bank or savings association subsidiary of a financial holding company ceases to be well capitalized or well managed, the Federal Reserve Board may require the financial holding company to divest the subsidiary. Alternatively, the financial holding company may elect to conform its activities to those permissible for bank holding companies that do not elect to become financial holding companies. If any bank or savings association subsidiary of a financial holding company receives a CRA rating of less than satisfactory, the financial holding company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations. The Corporation became a financial holding company effective March 13, 2000. It continues to maintain its status as a bank holding company for purposes of other Federal Reserve Board regulations. Under Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support its subsidiaries. This support may be required at times when, in the absence of such Federal Reserve Board policy, the Corporation would not otherwise be required to provide it. Under Michigan law, if the capital of a Michigan state chartered bank (such as the Corporation's bank subsidiaries) has become impaired by losses or otherwise, the Commissioner of the Office of Financial and Insurance Services may require that the deficiency in capital be met by assessment upon the Bank's stockholders pro rata on the amount of capital stock held by each, and if any such assessment is not paid by any stockholder within 30 days of the date of mailing of notice thereof to such stockholder, cause the sale of the stock of such stockholder to pay such assessment and the costs of sale of such stock. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. This priority would apparently apply to guarantees of capital plans under the Federal Deposit Insurance Corporation Improvement Act of 1991. On July 30, 2002, the President of the United States signed the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") into law. The Sarbanes-Oxley Act provides for sweeping changes dealing with corporate governance, accounting policies and disclosure requirements for public companies, and also for their directors and officers. Section 302 of the Sarbanes-Oxley Act, entitled "Corporate Responsibility for Financial Reports" required the SEC to adopt numerous new rules to implement the requirements of the Sarbanes-Oxley Act. These requirements include new financial reporting requirements and rules concerning corporate governance, among other new requirements. New rules, which took effect August 29, 2002, require a company's chief executive and chief financial officers to certify certain financial and other information included in the company's quarterly and annual reports. The rules also require these officers to certify that they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the company's disclosure controls and procedures; that they have made certain disclosures to the auditors and to the audit committee of the board of directors about 6
the company's controls and procedures; and that they have included information in their quarterly and annual filings about their evaluation and whether there have been significant changes to the controls and procedures or other factors which would significantly impact these controls subsequent to their evaluation. See Certifications on page 62 for such certifications of the financial statements and other information for this 2002 Form 10-K. See Item 14, "Controls and Procedures" for the Corporation's evaluation of disclosure controls and procedures. The Corporation is also filing as an exhibit to this report a certificate called for under Section 906 of the Sarbanes-Oxley Act. Certain additional information concerning regulatory guidelines for capital adequacy and other regulatory matters is presented herein under the caption "Capital" on pages 22-23 and "Note K - Commitments and Other Matters" and "Note M - Regulatory Capital Matters" on pages 46, 47, and 48, respectively. SUBSIDIARY BANKS The banks are subject to regulation and examination primarily by the Office of Financial and Insurance Services. As insured state banks, which are members of the Federal Reserve Bank of Chicago, the subsidiaries are also subject to regulation and examination by the FDIC and the Federal Reserve. The agencies and federal and state laws extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits and the safety and soundness of banking practices. Banking laws and regulations also restrict transactions by insured banks owned by a bank holding company, including loans to and certain purchases from the parent holding company, non-bank and bank subsidiaries of the parent holding company, principal shareholders, officers, directors and their affiliates, and investments by the subsidiary banks in the shares or securities of the parent holding company (or any of the other non-bank or bank affiliates), acceptance of such share or securities as collateral security for loans to any borrower. The banks are also subject to legal limitations on the frequency and amount of dividends that can be paid to the Corporation. For example, a Michigan state bank may not declare a cash dividend or a dividend in kind except out of net profits then on hand after deducting all losses and bad debts, and then only if it will have a surplus amounting to not less than 20% of its capital after the payment of the dividend. Moreover, a Michigan state bank may not declare or pay any cash dividend or dividend in kind until the cumulative dividends on its preferred stock, if any, have been paid in full. Further, if the surplus of a Michigan state bank is at any time less than the amount of its capital, before the declaration of a cash dividend or dividend in kind, it must transfer to surplus not less than 10% of its net profits for the preceding half-year (in the case of quarterly or semi-annual dividends) or the preceding two consecutive half-year periods (in the case of annual dividends). The payment of dividends by the Corporation and the banks is also affected by various regulatory requirements and policies, such as the requirement to maintain adequate capital above regulatory guidelines. Federal laws impose further restrictions on the payment of dividends by insured banks which fail to meet specified capital levels. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, payment of dividends by a bank may be prevented by the applicable federal regulatory authority if such payment is determined, by reason of the financial condition of such bank, to be an unsafe and unsound banking practice. The Federal Reserve Board and the FDIC have issued policy statements providing that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. 7
These regulations and restrictions may limit the Corporation's ability to obtain funds from its subsidiary banks for its cash needs, including payment of dividends and operating expenses. The activities and operations of the banks are also subject to other federal and state laws and regulations, including usury and consumer credit laws, the Federal Truth-in-Lending Act, Truth-in-Saving and Regulation Z of the Federal Reserve Board and the Federal Bank Merger Act. ITEM 2. PROPERTIES The Corporation's offices are located in the main office building of the Isabella Bank and Trust. Isabella Bank and Trust owns 15 branches and leases one and Farmers State Bank owns three branches. IBT Title owns one office, and leases one. The Corporation's facilities current, planned, and best use is for conducting its current activities with the exception of approximately 8% of the main office, and 45% of the Clare office, which is leased to tenants. In management's opinion, each facility has excess capacity and is in good condition. The following table sets forth the location of the Corporation's offices, as well as certain additional information relating to those offices as of December 31, 2002. <Table> <Caption> Year Approximate Net Facility Square Book Value Opened Footage 12/31/02(1) -------- ----------- ------------ <S> <C> <C> <C> Isabella Bank and Trust Main Office 200 East Broadway(2) Mt. Pleasant, Michigan 1903 27,640 $ 380,801 Main Office Extension(2) Customer Service Center 139 East Broadway Mt. Pleasant, Michigan 1985 19,136 $ 1,021,241 Operations Center 2750 Three Leaves Drive Mt. Pleasant, Michigan 2001 15,000 $ 1,462,302 Isabella County Branch Offices 1416 East Pickard(3) Mt. Pleasant, Michigan 1983 1,450 $ 454,296 2133 South Mission(6) Mt. Pleasant, Michigan 1976 1,560 $ 326,420 </Table> 8
<Table> <Caption> Year Approximate Net Facility Square Book Value Opened Footage 12/31/02(1) -------- ----------- ------------- <S> <C> <C> <C> 200 South University(4) Mt. Pleasant, Michigan 1964 1,795 $ 52,554 1402 West High Mt. Pleasant, Michigan 1973 2,150 $ 49,734 401 East Main Street(5) Blanchard, Michigan 1911 6,561 $ 16,458 500 East Wright Avenue Shepherd, Michigan 1980 1,830 $ 201,052 3388 N. Woodruff Rd. Weidman, Michigan 1975 5,40 $ 69,672 1867 Winn Road Beal City, Michigan 1977 1,100 $ 44,742 Montcalm County Branch Office 313 W. Bridge Street(6) Six Lakes, Michigan 1966 1,527 $ 360,342 Clare County Branch Offices 532 N. McEwan Street Clare, Michigan 1993 7,300 $ 326,434 1125 N. McEwan Street Clare, Michigan 1997 525 $ 382,905 Mecosta County Branch Offices 220 W. Wheatland Street Remus, Michigan 1998 4,273 $ 290,803 240 E. Northern Avenue Barryton, Michigan 1998 4,273 $ 234,257 8529 - 100th Avenue(8) Stanwood, Michigan 1998 2,665 $ 17,437 IBT Title Isabella County 209 E. Broadway Mt. Pleasant, Michigan 1998 2,640 $ 205,556 </Table> 9
<Table> <Caption> Year Approximate Net Facility Square Book Value Opened Footage 12/31/02(1) -------- ----------- ------------- <S> <C> <C> <C> Mecosta County 119 Michigan Avenue Big Rapids, Michigan 1999 1,700 $ 40,833 Clare County 404 N. McEwan Clare, Michigan 2001 1,450 $ 20,496 Farmers State Bank of Breckenridge Main Office 1967 13,700 $ 734,491 316 E. Saginaw Breckenridge, Michigan Ithaca Branch 1402 E. Center Ithaca, Michigan 1991 2,387 $ 246,301 Hemlock Branch(9) 16490 Gratiot Hemlock, Michigan 1994 1,840 $ 928,079 </Table> (1) includes land and buildings (2) remodeled in 2001 (3) substantially remodeled in 1990 (4) partially remodeled in 1986 and 1988 (5) substantially remodeled in 1976 and partially remodeled in 1986 (6) substantially remodeled in 1992 and 1996 (7) substantially remodeled in 1985 and 1993 (8) leased facilities (9) substantially remodeled in 2002 3. LEGAL PROCEEDINGS The Corporation and its banks are not involved in any material pending legal proceedings. The banks, because of the nature of their business, are at times subject to numerous pending and threatened legal actions which arises out of the normal course of their business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 2002 to a vote of security holders through the solicitation of proxies or otherwise. 10
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDERS' MATTERS COMMON STOCK AND DIVIDEND INFORMATION There is no established market for the Corporation's common stock or public information with respect to its market price. There are occasional sales by shareholders of which the management of the Corporation is aware. From January 1, 2001 through December 31, 2002 there were, so far as management knows, 196 sales of the Corporation's common stock. These sales involved 103,587 shares. The prices were reported to management in only some of the transactions and management cannot confirm the prices which were reported during this period. The highest known price paid for the Bank's stock was $35.00 per share in the fourth quarter of 2002, and the lowest price was $27.27 per share in the first quarter of 2001. The following is a summary of all known transfers since January 1, 2001. All of the information has been adjusted to reflect the 10% stock dividend paid on February 28, 2002. <Table> <Caption> Number of Number of Low High Date Sales Shares Bid Bid - -------------- --------- --------- --------- ---------- <S> <C> <C> <C> <C> 2001 First Quarter 28 14,972 $ 27.27 $ 30.91 Second Quarter 21 14,019 28.18 29.09 Third Quarter 22 10,472 29.09 29.09 Fourth Quarter 12 11,081 29.09 30.45 2002 First Quarter 27 6,022 32.00 34.00 Second Quarter 31 29,213 33.00 33.00 Third Quarter 31 11,538 33.00 33.00 Fourth Quarter 24 6,270 33.00 35.00 </Table> The following table sets forth the cash dividends paid for the following quarters, adjusted for the 10% stock dividend paid on February 28, 2002. <Table> <Caption> 2002 2001 --------- --------- <S> <C> <C> First Quarter $ 0.10 $ 0.09 Second Quarter 0.10 0.09 Third Quarter 0.10 0.09 Fourth Quarter 0.30 0.28 --------- --------- TOTAL $ 0.60 $ 0.55 ========= ========= </Table> IBT Bancorp's authorized common stock consists of 10,000,000 shares, of which 4,336,283 shares are issued and outstanding as of December 31, 2002. As of year end 2002, there were 1,700 shareholders of record. 11
ITEM 6. SELECTED FINANCIAL DATA SUMMARY OF SELECTED FINANCIAL DATA (1) (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) <Table> <Caption> 2002 2001 2000 1999 1998 --------- --------- --------- --------- --------- <S> <C> <C> <C> <C> <C> INCOME STATEMENT DATA Total interest income $ 38,161 $ 40,798 $ 38,754 $ 35,445 $ 33,651 Net interest income 22,905 21,538 20,352 19,224 17,601 Provision for loan losses 1,025 770 565 509 531 Net income 6,925 6,066 5,431 5,244 4,701 BALANCE SHEET DATA End of year assets $ 652,717 $ 592,143 $ 540,897 $ 503,596 $ 485,983 Daily average assets 623,507 566,547 516,145 493,606 451,668 Daily average deposits 549,970 494,847 452,664 441,566 405,291 Daily average loans/net 390,613 399,239 380,392 332,083 300,794 Daily average equity 59,540 54,787 50,506 45,482 41,670 PER SHARE DATA(2) Net income $ 1.61 $ 1.42 $ 1.28 $ 1.25 $ 1.14 Cash dividends 0.60 0.55 0.49 0.45 0.44 Book value (at year end) 14.63 3.30 11.31 11.13 10.75 FINANCIAL RATIOS Shareholders' equity to assets 9.71% 9.60% 9.60% 9.35% 9.09% Net income to average equity 11.63 11.07 10.75 11.53 11.28 Cash dividend payout to net income 37.33 38.36 38.30 36.80 37.94 Net income to average assets 1.11 1.07 1.05 1.06 1.04 </Table> <Table> <Caption> 2002 2001 --------------------------------------------- --------------------------------------------- Quarterly Operating Results: 4th 3rd 2nd 1st 4th 3rd 2nd 1st --------- --------- --------- --------- --------- --------- --------- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Total interest income $ 9,530 $ 9,731 $ 9,433 $ 9,467 $ 9,996 $ 10,256 $ 10,338 $ 10,208 Interest expense 3,581 3,754 3,850 4,071 4,358 4,876 4,985 5,041 Net interest income 5,949 5,977 5,583 5,396 5,638 5,380 5,353 5,167 Provision for loan losses 487 188 162 188 275 167 166 162 Noninterest income 2,750 2,213 1,572 1,568 1,990 1,558 1,464 1,186 Noninterest expenses 6,279 5,227 4,648 4,618 5,573 4,446 4,395 4,280 Net income 1,499 2,063 1,749 1,614 1,376 1,680 1,622 1,388 Per Share of Common Stock:(2) Net income $ 0.35 $ 0.48 $ 0.41 $ 0.38 $ 0.32 $ 0.39 $ 0.37 $ 0.34 Cash dividends 0.30 0.10 0.10 0.10 0.28 0.09 0.09 0.09 Book value 14.63 14.86 14.02 13.51 13.30 13.39 12.92 12.57 </Table> (1) 2000 and prior years presented were restated for the merger in August 2000 with FSB Bancorp, which was accounted for as a pooling of interests. (2) Retroactively restated for the 10% stock dividend paid on February 28, 2002. 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IBT BANCORP FINANCIAL REVIEW (All dollars in thousands) The following is management's discussion and analysis of the financial condition and results of operations for IBT Bancorp (the Corporation). This discussion and analysis is intended to provide a better understanding of the financial statements and statistical data included elsewhere in the Annual Report. CRITICAL ACCOUNTING POLICIES: The Corporation's significant accounting policies are set forth in Note 1 of the Consolidated Financial Statements. Of these significant accounting policies, the Corporation considers its policies regarding the allowance for loan losses and servicing assets to be its most critical accounting policies. The allowance for loan losses requires management's most subjective and complex judgment. Changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Corporation has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Corporation's assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers which is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Corporation's allowance for loan losses and related matters, see Provision for Loan Losses and Allowance for Loan Losses. Servicing assets are recognized when loans are sold with servicing retained. Servicing assets are amortized in proportion to and over the period of estimated future net servicing income. The fair value of servicing assets is estimated by discounting the future cash flows at estimated future current market rates for the expected life of the loans. The Corporation uses industry prepayment statistics in estimating the expected life of the loan. Management periodically evaluates servicing assets for impairment. For purposes of measuring impairment, the rights are stratified based on original term to maturity. The amount of impairment recognized is the amount by which the servicing asset for a stratum exceeds its fair value. 13
TABLE 1. DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY; INTEREST RATE AND INTEREST DIFFERENTIAL The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. This schedule also presents an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a fully taxable equivalent (FTE) basis using a 34% tax rate. Nonaccruing loans, for the purpose of the following computations, are included in the average loan amounts outstanding. Federal Reserve and Federal Home Loan Bank Equity holdings are included in Other Investments. <Table> <Caption> 2002 2001 2000 ----------------------------- ----------------------------- ----------------------------- Tax Average Tax Average Tax Average Average Equivalent Yield/ Average Equivalent Yield/ Average Equivalent Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS Loan $396,234 $ 31,554 7.96% $404,586 $ 35,118 8.68% $380,392 $ 33,333 8.76% Taxable investment securities 94,383 4,197 4.45 54,171 2,993 5.53 62,581 3,666 5.86 Nontaxable investment securities 45,663 2,864 6.27 34,748 2,481 7.14 29,914 2,194 7.33 Federal funds sold 26,364 423 1.60 23,827 897 3.76 2,731 170 6.22 Other investments 2,735 165 6.03 2,626 180 6.85 2,256 173 7.67 -------- -------- -------- -------- -------- -------- -------- -------- -------- TOTAL EARNING ASSETS 565,379 39,203 6.93 519,958 41,669 8.01 477,874 39,536 8.27 NONEARNING ASSETS Allowance for loan losses (5,621) (5,347) (4,939) Cash and due from banks 24,236 21,052 18,253 Premises and equipment 14,983 12,461 10,385 Accrued income and other assets 24,530 18,423 14,572 -------- -------- -------- TOTAL ASSETS $623,507 $566,547 $516,145 ======== ======== ======== INTEREST BEARING LIABILITIES Interest bearing demand deposits $ 98,478 1,406 1.43 $ 81,260 1,955 2.41 $ 68,017 1,987 2.92 Savings deposits 135,792 2,201 1.62 121,202 3,258 2.69 122,610 3,908 3.19 Time deposits 247,182 10,971 4.44 235,481 13,465 5.72 206,849 12,032 5.82 Borrowed funds 13,960 678 4.86 10,712 582 5.43 7,158 475 6.64 -------- -------- -------- -------- -------- -------- -------- -------- -------- TOTAL INTEREST BEARING LIABILITIES 495,412 15,256 3.08 448,655 19,260 4.29 404,634 18,402 4.55 NONINTEREST BEARING LIABILITIES AND SHAREHOLDERS' EQUITY Demand deposits 59,518 56,904 55,188 Other 9,037 6,201 5,817 Shareholders' equity 59,540 54,787 50,506 -------- -------- -------- TOTAL LIABILITIES AND EQUITY $623,507 $566,547 $516,145 ======== ======== ======== NET INTEREST INCOME (FTE) $ 23,947 $ 22,409 $ 21,134 ======== ======== ======== NET YIELD ON INTEREST EARNING ASSETS (FTE) 4.24% 4.31% 4.42% ======== ======== ======== </Table> RESULTS OF OPERATIONS The Corporation achieved record net income for the sixteenth consecutive year in 2002 with net earnings of $6,925 versus $6,066 in 2001. Two key measures of earnings performance commonly used in the banking industry are return on average assets and return on average shareholders' equity. Return on average assets measures the ability of a corporation to profitably and efficiently employ its resources. The Corporation's return on average assets was 1.11% in 2002, 1.07% in 2001, and 1.05% in 2000. Return on average equity indicates how effectively a corporation is able to generate earnings on capital invested by its shareholders. The Corporation's return on average shareholders' equity was 11.63% in 2002, 11.07% in 2001, and 10.75% in 2000. 14
NET INTEREST INCOME The Corporation derives the majority of its gross income from interest earned on loans and investments, while its most significant expense is the interest cost incurred for funds used. Net interest income is the amount by which interest income on earning assets exceeds the interest cost of deposits and borrowings. Net interest income is influenced by changes in the balance and mix of assets and liabilities and market interest rates. Management exerts some control over these factors, however, Federal Reserve monetary policy and competition have a significant impact. Interest income includes loan fees of $1,524 in 2002, $1,425 in 2001; and $957 in 2000. For analytical purposes, net interest income is adjusted to a "taxable equivalent" basis by adding the income tax savings from interest on tax-exempt loans and securities, thus making year-to-year comparisons more meaningful. TABLE 2. VOLUME AND RATE VARIANCE ANALYSIS The following table details the dollar amount of changes in FTE net interest income for each major category of interest earning assets and interest bearing liabilities and the amount of change attributable to changes in average balances (volume) or average rates. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. <Table> <Caption> 2002 Compared to 2001 2001 Compared to 2000 Increase (Decrease) Due to Increase (Decrease) Due to -------------------------------- -------------------------------- Volume Rate Net Volume Rate Net -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> CHANGES IN INTEREST INCOME Loans $ (713) $ (2,851) $ (3,564) $ 2,103 $ (318) $ 1,785 Taxable investment securities 1,878 (674) 1,204 (473) (200) (673) Nontaxable investment securities 711 (328) 383 346 (59) 287 Federal funds sold 87 (561) (474) 819 (92) 727 Other investments 7 (22) (15) 27 (20) 7 -------- -------- -------- -------- -------- -------- TOTAL CHANGES IN INTEREST INCOME 1,970 (4,436) (2,466) 2,822 (689) 2,133 CHANGES IN INTEREST EXPENSE Interest bearing demand deposits 357 (906) (549) 351 (383) (32) Savings deposits 356 (1,413) (1,057) (44) (606) (650) Time deposits 642 (3,136) (2,494) 1,640 (207) 1,433 Other borrowings 163 (67) 96 205 (98) 107 -------- -------- -------- -------- -------- -------- TOTAL CHANGES IN INTEREST EXPENSE 1,518 (5,522) (4,004) 2,152 (1,294) 858 -------- -------- -------- -------- -------- -------- NET CHANGE IN FTE NET INTEREST INCOME $ 452 $ 1,086 $ 1,538 $ 670 $ 605 $ 1,275 ======== ======== ======== ======== ======== ======== </Table> 15
As shown in Tables 1 and 2, when comparing year ending December 31, 2002 to 2001, fully taxable equivalent (FTE) net interest income increased $1,538 or 6.9%. An increase of 8.7% in average interest earning assets provided $1,970 of FTE interest income. The majority of this growth was funded by a 10.4% increase in interest bearing liabilities, resulting in $1,518 of additional interest expense. Overall, changes in volume resulted in $452 in additional FTE interest income. The average FTE interest rate earned on assets decreased by 1.08%, decreasing FTE interest income by $4,436, and the average rate paid on deposits decreased by 1.21%, decreasing interest expense by $5,522. The net change related to interest rates earned and paid was a $1,086 increase in FTE net interest income. The Corporation's FTE net yield as a percentage of average earning assets decreased 0.07%. The decrease was primarily the result of a significant change in the mix of assets and funding sources. Average investment securities as a percentage of total earning assets, increased 7.7% to 24.8% in 2002, while loans, the Corporation's highest yielding assets, decreased 7.7% to 70.1%. The change in mix resulted in a 0.23% decrease in the FTE net yield on interest earning assets. The funding of interest earning assets was done primarily through a 10.4% increase in the percentage of average earning assets funded by interest bearing liabilities. The increased utilization of interest bearing liabilities in funding earning assets resulted in a 0.04% decrease in the FTE net yield on interest earning assets. Net interest income increased $1,275 to $22,409 in 2001 from $21,134 in 2000. As shown in Tables 1 and 2, in 2001 (FTE) interest income increased $2,822, from an 8.8% increase in the volume of average earning assets. The growth of interest earning assets was funded primarily by a 10.9% increase in interest bearing liabilities that resulted in additional interest expense of $2,152. Overall, the Corporation earned an additional $670 in FTE interest income as a result of increased volume. The average rate earned in 2001 decreased by 0.26%, decreasing FTE interest income by $689, and the average rate paid on deposits decreased by 0.26%, decreasing interest expense by $1,294. The net change related to interest rates earned and paid was a $605 increase in FTE net interest income. PROVISION FOR LOAN LOSSES The viability of any financial institution is ultimately determined by its management of credit risk. Total loans outstanding represent 72.0% of the Corporation's total year end deposits and is the Corporation's single largest concentration of risk. Inevitably, poor operating performance may result from the failure to control credit risk. Given the importance of maintaining sound underwriting practices, the Banks' Boards of Directors and senior management teams spend a large portion of their time and effort in loan review. The provision for loan losses is the amount added to the allowance for loan losses on a monthly basis. The allowance for loan losses is management's estimation of potential future losses inherent in the loan portfolio, and is maintained at a level considered by management to be adequate to absorb potential future losses. Evaluation of the allowance for loan losses and the provision for loan losses is based on a continuous review of the changes in the type and volume of the loan portfolio, reviews of specific loans to evaluate their collectibility, past and recent loan loss history, financial condition of borrowers, the amount of impaired loans, overall economic conditions, and other factors. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, that may be subject to significant change. As shown in Table 3, total loans outstanding increased 1.7% in 2002 and decreased 1.4% in 2001. The provision for loan losses in 2002 was $1,025, a $255 increase from 2001 and a $460 increase from 2000. The 2002 provision for loan losses was increased as a result of increases in net charged-off loans of $442 and loans classified as nonperforming of $2,484. The majority of the increase in nonperforming loans is related to one farm credit which was in the process of liquidation at year end. Management does not expect any significant additional losses related to this credit. The allowance for loan losses as a percentage of total outstanding loans was 1.38% at both December 31, 2002, and 2001. The Corporation's net charged off loans as a percentage of average loans was 0.23% in 2002 and 0.11% in 2001. 16
TABLE 3. SUMMARY OF LOAN LOSS EXPERIENCE The following is a summary of loan balances at the end of each year and their daily average balances, changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, and additions to the allowance which have been expensed. <Table> <Caption> December 31 ------------------------------------------------------------------ 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> Amount of loans outstanding at the end of year $ 404,480 $ 397,864 $ 403,679 $ 355,846 $ 318,914 ========== ========== ========== ========== ========== Average gross loans outstanding for the year $ 396,234 $ 404,586 $ 380,392 $ 332,083 $ 300,794 ========== ========== ========== ========== ========== Summary of changes in allowance Allowance for loan losses - January 1 $ 5,471 $ 5,162 $ 4,622 $ 4,412 $ 4,112 Loans charged off Commercial and agricultural 506 271 65 221 252 Real estate mortgage 236 70 58 78 70 Personal 460 351 295 347 297 ---------- ---------- ---------- ---------- ---------- TOTAL LOANS CHARGED OFF 1,202 692 418 646 619 Recoveries Commercial and agricultural 140 35 172 86 255 Real estate mortgage 18 41 64 92 13 Personal 141 155 157 169 120 ---------- ---------- ---------- ---------- ---------- TOTAL RECOVERIES 299 231 393 347 388 Net charge offs 903 461 25 299 231 Provision charged to income 1,025 770 565 509 531 ---------- ---------- ---------- ---------- ---------- ALLOWANCE FOR LOAN LOSSES - DECEMBER 31 $ 5,593 $ 5,471 $ 5,162 $ 4,622 $ 4,412 ========== ========== ========== ========== ========== Ratio of net charge offs during the year to average loans outstanding 0.23% 0.11% 0.01% 0.09% 0.08% ========== ========== ========== ========== ========== Ratio of the allowance for loan losses to loans outstanding at year end 1.38% 1.38% 1.28% 1.30% 1.38% ========== ========== ========== ========== ========== </Table> As shown in Table 4, the percentage of loans classified as nonperforming by the Corporation as of December 31, 2002 and 2001 was 1.19% and 0.64% of total loans, respectively. Average nonperforming loans for the peer group was 0.87%. The peer group is a composite of financial information of all bank holding companies with assets between $500 million and $1 billion; there were 330 bank holding companies in the Corporation's peer group for the period indicated. The Banks' policies, including a loan considered impaired under Statement of Financial Accounting Standards (SFAS) No. 118, are to transfer a loan to nonaccrual status whenever it is determined that interest should be recorded on the cash basis instead of the accrual basis because of a deterioration in the financial position of the borrower, or a determination that payment in full of interest or principal cannot be expected, or the loan has been in default for a period of 90 days or more, unless it is both well secured and in the process of collection. 17
TABLE 4. NONPERFORMING LOANS The following loans are all the credits which require classification for state or federal regulatory purposes: <Table> <Caption> December 31 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> Nonaccrual loans $ 2,484 $ 1,346 $ 382 $ 945 $ 274 Accruing loans past due 90 days or more 1,840 1,219 1,484 618 1,130 Restructured loans 479 -- -- -- -- ---------- ---------- ---------- ---------- ---------- TOTAL NONPERFORMING LOANS $ 4,803 $ 2,565 $ 1,866 $ 1,563 $ 1,404 ========== ========== ========== ========== ========== NONPERFORMING LOANS AS % OF LOANS 1.19% 0.64% 0.46% 0.44% 0.44% ========== ========== ========== ========== ========== </Table> As of December 31, 2002, there were no other interest bearing assets which required classification. Management is not aware of any recommendations by regulatory agencies which, if implemented, would have a material impact on the Corporation's liquidity, capital, or operations. Management's internal analysis of the estimated range for the allowance was $2,900 to $7,300 as of December 31, 2002. In management's opinion, the allowance for loan losses of $5,593 is adequate as of December 31, 2002. Management has allocated, as reflected in Table 5, the allowance for loan losses to the following categories: 33.4% to commercial and agricultural loans; 29.5% to real estate loans; 30.0% to installment loans; and 7.1% unallocated. The above allocation is not intended to imply limitations on usage of the allowance. The entire allowance is available to fund loan loss without regard to loan type. TABLE 5. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The allowance for loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories: <Table> <Caption> December 31 2002 2001 2000 1999 1998 ------------------ ------------------ ------------------ ------------------ ------------------ % of Each % of Each % of Each % of Each % of Each Category Category Category Category Category Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allowance to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------- -------- ------- -------- ------- -------- ------- -------- ------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial and agricultural $ 1,868 29.5% $ 2,081 26.9% $ 1,301 26.6% $ 1,502 26.9% $ 1,473 27.3% Real estate mortgage 1,649 57.0 1,408 59.7 1,559 60.0 1,232 59.8 1,171 58.4 Installment 1,679 13.5 1,577 13.4 1,923 13.4 1,555 13.3 1,467 14.3 Unallocated 397 -- 405 -- 379 -- 333 -- 301 -- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- TOTAL $ 5,593 100.0% $ 5,471 100.0% $ 5,162 100.0% $ 4,622 100.0% $ 4,412 100.0% ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= </Table> 18
NONINTEREST INCOME Noninterest income consists of trust fees, service charges on deposit accounts, fees for other financial services, gain on the sale of mortgage loans, title insurance revenue, and other. As is the case for many financial institutions, management believes fee income is increasingly important as a source of net earnings and expects this trend to continue. There was a $1,905 or 30.7% increase in fees earned from these sources during 2002. Significant changes during 2002 include a $643 increase from the sale of title insurance and related services, a $161 increase in overdraft fees, a $138 increase in mortgage servicing fees, and a $711 increase in gains on the sale of real estate mortgages. During 2002, the Corporation had an average investment of $9.5 million in bank-owned life insurance, a $5.0 million increase over 2001. The average net rate earned on the investment was approximately 5.0% and, because of their tax free accumulation of earnings, they have a taxable equivalent rate of 7.6%. The rates on these contracts are adjustable annually on their anniversary date. The investment is placed with five separate insurance companies with S&P ratings of AA+ or better. The increase in other income due to this investment was $245. Included in noninterest income is a $1,762 gain from the sale of $192,407 in mortgages during 2002 versus a $1,051 gain on the sale of $126,814 during 2001. The Corporation has established a policy that all 30-year fixed rate mortgage loans will be sold. During 2002, most 15-year fixed rate mortgage loans granted were sold on the secondary market. These loans were sold without recourse, with servicing retained. Noninterest income increased $1,793 in 2001 when compared to 2000. Significant changes in 2001 include a $539 increase in revenue from IBT Title, a $162 increase in overdraft fees, a $36 increase in mortgage servicing fees, a $953 increase in gains on the sale of residential real estate mortgages, a $39 decrease in service charges on deposit accounts, and a $41 decrease in brokerage commissions. NONINTEREST EXPENSES Noninterest expenses increased $2,077 or 11.1% during 2002. Noninterest expense net of noninterest income divided by average total assets equalled 2.03% in 2002, 2.21% in 2001, and 2.38% in 2000. The decrease in the 2002 ratio was primarily a result of the $711 increase in the gains on the sale of real estate mortgages, and a $561 decline in the amortization of intangibles. The largest component of noninterest expenses is salaries and employee benefits, which increased $1,517 or 15.5%. Salaries increased $916 due to increases in staffing and normal merit and promotional salary increases. Employee benefits increased $601 in 2002. A significant portion of the increase was related to a 28.7% increase in medical insurance expenses, an 86.6% increase in pension expense, and a 33.8% increase in the Corporation's voluntary contribution to the ESOP. Footnote G in the Corporation's Notes to Consolidated Financial Statements include the required disclosures regarding the benefit obligations, plan assets, and funding status of the Corporation's Defined Pension Benefit Plan. Over the last three years the plan has experienced an accumulated loss of $1,060 on the Plan's investments. The entire loss is related to the general decline in market value of stock equity investments. Over the same time period, the actuarial assumption for the long term rate of return on the assets held by the Plan should have produced a return of $1,161. Essentially, the actual loss combined with the change in actuarial assumptions related to the benefit obligation has produced a $2,119 underfunding of the Plan's assets as of December 31, 2002. This shortfall will significantly increase the Corporation's pension expense in future periods. The Corporation's Board of Directors has been discussing its options and plans to make a decision on how to address the shortfall in 2003. Occupancy and furniture and equipment expenses increased $461 or 14.2% in 2002. The majority of this increase is related to building depreciation, property taxes, service contracts and equipment depreciation. The amortization of acquisition intangibles decreased $561 as a result of the adoption of SFAS No. 142. All other operating expenses increased $660. The most significant increases are related to director fees, audit and examiner fees, and donations. The Corporation contributed approximately $750 to the Isabella Bank and Trust Community Foundation. 19
Noninterest expense increased $2,018 or 12.1% in 2001. During 2001, salaries and benefits increased $1,196, occupancy and furniture and equipment expenses increased $270, all other operating expenses increased $465, and the amortization of the deposit based intangible increased by $87. FEDERAL INCOME TAXES Federal income tax expense for 2002 was $2,286 or 24.8% of pre-tax income compared to $2,205 or 26.7% of pre-tax income in 2001 and $2,084 or 27.7% in 2000. The decrease in income tax expense as a percentage of income in 2002 is attributable to an increase in nontaxable municipal income as a percentage of the Corporation's pretax net income. A reconcilement of federal income tax expense and the amount computed at the federal statutory rate of 34% is found in Note F, Federal Income Taxes, in the accompanying consolidated financial statements. ANALYSIS OF CHANGES IN THE STATEMENT OF FINANCIAL CONDITION Total assets were $652,717 at December 31, 2002, an increase of $60,574 or 10.2% over year end 2001. Asset growth was primarily funded by a $45,215 increase in deposits, a $6,161 increase in borrowings, and a $6,629 increase in shareholders' equity. A discussion of changes in balance sheet amounts by major categories follows. INVESTMENT SECURITIES The primary objective of the Corporation's investing activities is to provide for safety of the principal invested. Secondary considerations include the need for earnings, liquidity, and the Corporation's overall exposure to changes in interest rates. During 2002, the Corporation's net holdings of investment securities increased $53,673. Table 6 shows the carrying value of investment securities available for sale and held to maturity. Securities held to maturity, which are stated at amortized cost, consist mostly of local municipal bond issues, and U.S. Agencies. Securities not classified by management as held to maturity are classified as available for sale and are stated at fair value. TABLE 6. INVESTMENT PORTFOLIO The following is a schedule of the carrying value of investment securities available for sale and held to maturity: <Table> <Caption> December 31 2002 2001 2000 ---------- ---------- ---------- <S> <C> <C> <C> Available for sale U.S. Treasury and U.S. government agencies $ 90,974 $ 53,047 $ 40,978 States and political subdivisions 64,607 47,141 36,186 Commercial paper 2,328 2,330 350 ---------- ---------- ---------- TOTAL $ 157,909 $ 102,518 $ 77,514 ========== ========== ========== Held to maturity U.S. Treasury and U.S. government agencies $ 74 $ 148 $ 1,060 States and political subdivisions 1,662 3,306 6,637 Other securities -- -- 602 ---------- ---------- ---------- TOTAL $ 1,736 $ 3,454 $ 8,299 ========== ========== ========== </Table> Excluding those holdings of the investment portfolio in U.S. Treasury and U.S. government agency securities, there were no investments in securities of any one issuer which exceeded 10% of shareholders' equity. The Corporation has a policy prohibiting investments in securities that it deems are unsuitable due to their inherent credit or market risks. Prohibited investments include stripped mortgage backed securities, zero coupon bonds, nongovernment agency asset backed securities, and structured notes. 20
The following is a schedule of maturities of each category of investment securities (at carrying value) and their weighted average yield as of December 31, 2002: TABLE 7. SCHEDULE OF MATURITIES OF INVESTMENT SECURITIES AND WEIGHTED AVERAGE YIELDS <Table> <Caption> Maturing --------------------------------------------------------------------------------------- After One After Five Year But Years But Within Within Within After One Year Five Years Ten Years Ten Years Amount Yield Amount Yield Amount Yield Amount Yield -------- -------- -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Available for sale U.S. Treasury and U.S. government agencies $ 18,198 4.44% $ 61,849 3.55% $ -- --% $ -- --% States and political Subdivisions 10,860 3.13 28,091 3.97 20,921 4.48 4,735 4.41 Mortgage backed 267 5.93 270 5.94 4,459 5.35 5,931 9.63 Corporate & other Securities 1,017 4.71 1,311 4.62 -- -------- -------- -------- -------- -------- -------- -------- -------- Total $ 30,342 3.99% $ 91,521 3.70% $ 25,380 4.63% $ 10,666 7.30% Held to maturity States and political subdivisions $ 50 4.50% $ 1,612 4.79% $ -- --% $ -- --% Mortgage backed -- -- 74 5.76 -- -- -- -- -------- -------- -------- -------- -------- -------- -------- -------- Total $ 50 4.50% $ 1,686 4.83% $ -- --% $ -- --% ======== ======== ======== ======== ======== ======== ======== ======== </Table> Loans The largest component of earning assets is loans. The proper management of credit and market risk inherent in loans is critical to the financial well-being of the Corporation. To control these risks, the Corporation has adopted strict underwriting standards. The standards include prohibitions against lending outside the Corporation's defined market area, lending limits to a single borrower, and strict loan to collateral value limits. The Corporation also monitors and limits loan concentrations extended to volatile industries. The Corporation has no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category in Table 8. TABLE 8. LOAN PORTFOLIO <Table> <Caption> December 31 2002 2001 2000 1999 1998 -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> Commercial $ 66,326 $ 58,424 $ 60,301 $ 55,247 $ 48,204 Agricultural 53,223 48,523 47,298 40,449 38,766 Real estate mortgage 230,409 237,650 242,042 212,724 186,413 Installment 54,522 53,267 54,038 47,426 45,531 -------- -------- -------- -------- -------- TOTAL LOANS $404,480 $397,864 $403,679 $355,846 $318,914 ======== ======== ======== ======== ======== </Table> Total loans increased $6,616 in 2002. The increase was primarily in commercial and agricultural loans. As of December 31, 2002, as a percentage of total loans, commercial loans were 16.4%, agricultural were 13.1%, real estate mortgages were 57.0%, and installments were 13.5%. 21
DEPOSITS Total deposits increased $45,215 and were $561,456 at year end 2002, an 8.8% increase over 2001. Average deposits increased 9.3% in 2002 and in 2001. During 2002, average noninterest bearing deposits increased 4.6%, interest bearing demand deposits increased 21.2%, savings deposits increased 12.0%, and time deposits increased 5.0%. Time deposits over $100 as a percentage of total deposits equaled 12.5% and 11.5% as of December 31, 2002 and 2001, respectively. TABLE 9. AVERAGE DEPOSITS <Table> <Caption> 2002 2001 2000 ------------------- ------------------- ------------------- Amount Rate Amount Rate Amount Rate -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> Noninterest bearing demand deposits $ 59,518 $ 56,904 $ 55,188 Interest bearing demand deposits 98,478 1.43% 81,260 2.41% 68,017 2.92% Savings deposits 135,792 1.62 121,202 2.69 122,610 3.19 Time deposits 247,182 4.44 235,481 5.72 206,849 5.82 -------- -------- -------- TOTAL $540,970 $494,847 $452,664 ======== ======== ======== </Table> TABLE 10. MATURITIES OF TIME CERTIFICATES OF DEPOSIT OVER $100,000 <Table> <Caption> December 31 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Maturity Within 3 months $ 21,900 $ 22,259 $ 13,217 Within 3 to 6 months 15,928 11,418 7,250 Within 6 to 12 months 18,624 11,496 7,418 Over 12 months 13,858 14,252 10,627 -------- -------- -------- TOTAL $ 70,310 $ 59,425 $ 38,512 ======== ======== ======== </Table> Within the banking industry there is agreement that competition from mutual funds and annuities has had a significant impact on deposit growth. In response, the Corporation's subsidiaries now offer mutual funds and annuities to its customers. The Corporation's trust department also offers a variety of financial products in addition to traditional estate services. CAPITAL The capital of the Corporation consists solely of common stock, capital surplus, retained earnings, and accumulated other comprehensive income. Total capital increased approximately $6,629 in 2002. The Corporation offers a dividend reinvestment and employee stock purchase plan. Under the provisions of these Plans, the Corporation issued 52,473 shares of common stock generating $1,524 of capital during 2002, and 32,623 shares of common stock generating $971 of capital in 2001. The Board of Directors authorized management to repurchase up to $2.0 million of common stock shares. A total of 18,786 shares were repurchased in 2002 at an average price of $32.95 per share. Accumulated other comprehensive income increased $525 and consists of $1,887 increase in unrealized gain on available for sale investment securities reduced by a loss of $1,362 related to the recognition of an additional minimum pension liability. The Federal Reserve Board's current recommended minimum primary capital to assets requirement is 6.0%. The Corporation's primary capital to assets, which consists of shareholders' equity plus the allowance for loan losses less acquisition intangibles, was 10.0% at year end 2002. There are no commitments for significant capital expenditures. 22
The Federal Reserve Board has established a minimum risk based capital standard. Under this standard, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. The minimum standard is 8%, of which at least 4% must consist of equity capital net of goodwill. The following table sets forth the percentages required under the Risk Based Capital guidelines and the Corporation's values at December 31, 2002: Percentage of Capital to Risk Adjusted Assets: <Table> <Caption> Required IBT Bancorp ----------- ----------- <S> <C> <C> Equity Capital 4.00% 13.94% Secondary Capital 4.00 1.25 ----------- ----------- Total Capital 8.00% 15.19% =========== =========== </Table> IBT Bancorp's secondary capital includes only the allowance for loan losses. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources. The Federal Reserve also prescribes minimum capital requirements for the Corporation's subsidiary Banks. At December 31, 2002, the Banks exceeded these minimums. For further information regarding the Banks' capital requirements, refer to Note M of the Financial Statements, Regulatory Capital Matters. LIQUIDITY Liquidity management is designed to have adequate resources available to meet depositor and borrower discretionary demands for funds. Liquidity is also required to fund expanding operations, investment opportunities, and payment of cash dividends. The primary sources of the Corporation's liquidity are cash and cash equivalents and available for sale investment securities. As of December 31, 2002 and 2001, cash and cash equivalents equaled 8.3% and 9.4%, respectively, of total assets. Net cash provided from operations was $6,124 in 2002 and $2,145 in 2001. Net cash provided by financing activities equaled $49,491 in 2002 and $42,489 in 2001. The Corporation's investing activities used cash amounting to $56,640 in 2002 and $17,597 in 2001. The accumulated effect of the Corporation's operating, investing, and financing activities on cash and cash equivalents was a $1,025 decrease in 2002 and a $28,425 increase in 2001. In addition to cash and cash equivalents, investment securities available for sale are another source of liquidity. Securities available for sale equaled $157,909 as of December 31, 2002 and $102,518 as of December 31, 2001. In addition to these primary sources of liquidity, the Corporation has the ability to borrow in the federal funds market and at both the Federal Reserve Bank and the Federal Home Loan Bank. The Corporation's liquidity is considered adequate by the management of the Corporation. INTEREST RATE SENSITIVITY Interest rate sensitivity management aims at achieving reasonable stability in the net interest margin through periods of changing interest rates. Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative sensitivity to a change in interest rates. One tool used by management to measure interest rate sensitivity is gap analysis. As shown in Table 11, the gap analysis depicts the Corporation's position for specific time periods and the cumulative gap as a percentage of total assets. 23
Investment securities and other investments are scheduled according to their contractual maturity. Nonvariable rate loans are included in the appropriate time frame based on their scheduled amortization. Variable rate loans are included in the time frame of their earliest repricing. Of the $404,480 in total loans, $67,424 are variable rate loans. Time deposit liabilities are scheduled based on their contractual maturity except for variable rate time deposits in the amount of $1,588 which are included in the 0 to 3 month time frame. Money market accounts reprice monthly and are included in the 0 to 3 month time frame. Passbook savings, statement savings, and NOW accounts have no contractual maturity date and are believed to be predominantly noninterest rate sensitive by management. These accounts have been classified in the gap table according to their estimated withdrawal rates based upon management's analysis of deposit runoff over the past five years. Management believes this runoff experience is consistent with its expectation for the future. As of December 31, 2002, the Corporation had $64,704 more in liabilities than assets maturing within one year. A negative gap position results when more liabilities, within a specified time frame, mature or reprice than assets. TABLE 11. INTEREST RATE SENSITIVITY The following table shows the time periods and the amount of assets and liabilities available for interest rate repricing as of December 31, 2002. For purposes of this analysis, nonaccrual loans and the allowance for loan losses are excluded. <Table> <Caption> 0 to 3 4 to 12 1 to 5 Over 5 Months Months Years Years ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Interest Sensitive Assets Fed funds sold $ 25,850 $ -- $ -- $ -- Investment securities 4,892 25,500 93,208 36,045 Loans 115,153 50,299 215,889 20,655 ---------- ---------- ---------- ---------- TOTAL $ 145,895 $ 75,799 $ 309,097 $ 56,700 ========== ========== ========== ========== Interest Sensitive Liabilities Borrowed funds $ 3,169 $ 94 $ 6,375 $ 8,155 Time deposits 49,905 82,822 118,476 59 Savings 80,993 4,373 36,772 13,755 Interest bearing demand 58,000 7,042 41,446 4,707 ---------- ---------- ---------- ---------- TOTAL $ 192,067 $ 94,331 $ 203,069 $ 26,676 ========== ========== ========== ========== Cumulative gap $ (46,172) $ (64,704) $ 41,324 $ 71,348 Cumulative gap as a % of assets (7.07)% (9.91)% 6.33% 10.98% </Table> 24
TABLE 12. LOAN MATURITY AND INTEREST RATE SENSITIVITY The following table shows the maturity of commercial and agricultural loans outstanding at December 31, 2002. Also provided are the amounts due after one year, classified according to the sensitivity to changes in interest rates. <Table> <Caption> Due in 1 Year 1 to 5 Over 5 or Less Years Years Total --------- --------- --------- --------- <S> <C> <C> <C> <C> Commercial and agricultural $ 57,089 $ 58,884 $ 3,576 $ 119,549 ========= ========= ========= ========= Interest Sensitivity: Loans maturing after one year which have: Fixed interest rates $ 45,050 $ 3,385 Variable interest rates 13,834 191 --------- --------- TOTAL $ 58,884 $ 3,576 ========= ========= </Table> ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Corporation's primary market risks are interest rate risk and, to a lesser extent, liquidity risk. The Corporation has no foreign exchange risk, holds limited loans outstanding to oil and gas concerns, holds no trading account assets, nor does it utilize interest rate swaps or derivatives in the management of its interest rate risk. Any changes in foreign exchange rates or commodity prices would have an insignificant impact, if any, on the Corporation's interest income and cash flows. Interest rate risk ("IRR") is the exposure of the Corporation's net interest income, its primary source of income, to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method in which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to the Corporation's earnings and capital. The Federal Reserve, the Corporation's primary Federal regulator, has adopted a policy requiring the Board of Directors and senior management to effectively manage the various risks that can have a material impact on the safety and soundness of the Corporation. The risks include credit, interest rate, liquidity, operational, and reputational. The Corporation has policies, procedures and internal controls for measuring and managing these risks. Specifically, the IRR policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to the Board of Directors. The Corporation uses several techniques to manage IRR. The first method is gap analysis. Gap analysis measures the cash flows and/or the earliest repricing of the Corporation's interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the imbedded repricing options contained in assets and liabilities. A substantial portion of the Corporation's assets are invested in loans and mortgage backed securities. These assets have imbedded options that allow the borrower to repay the balance prior to maturity without penalty. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current interest rate for residential mortgages, the level of sales of used homes, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in the Corporation's cash flows from these assets. Investment securities, other than those that are callable, do not have any significant imbedded options. Savings and checking deposits may generally be withdrawn on request without prior notice. The timing of cash flow from these deposits is estimated based on historical experience. Time deposits have penalties which discourage early withdrawals. 25
The second technique used in the management of IRR is to combine the projected cash flows and repricing characteristics generated by the gap analysis, the interest rates associated with those cash flows to project future interest income. By changing the amount and timing of the cash flows and the repricing interest rates of those cash flows, the Corporation can project the effect of changing interest rates on its interest income. Based on the projections prepared for the year ended December 31, 2002 the Corporation's net interest income would decrease during a period of decreasing interest rates. The following tables provide information about the Corporation's assets and liabilities that are sensitive to changes in interest rates as of December 31, 2002 and 2001. The Corporation has no interest rate swaps, futures contracts, or other derivative financial options. The principal amounts of assets and time deposits maturing were calculated based on the contractual maturity dates. Savings and NOW accounts are based on management's estimate of their future cash flows. QUANTITATIVE DISCLOSURES OF MARKET RISK <Table> <Caption> Fair Value 2003 2004 2005 2006 2007 Thereafter Total 12/31/02 -------- -------- -------- -------- -------- ---------- -------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Rate sensitive assets Other interest bearing assets $ 25,950 -- -- -- -- -- $ 25,950 $ 25,950 Average interest rates 1.25% -- -- -- -- -- 1.25% Fixed interest rate securities $ 30,393 $ 50,671 $ 23,853 $ 12,169 $ 6,514 $ 36,045 $159,645 $159,712 Average interest rates 4.00% 3.77% 3.32% 4.06% 4.17% 4.76% 4.01% Fixed interest rate loans $ 98,028 $ 86,180 $ 83,675 $ 27,107 $ 21,906 $ 20,160 $337,056 $338,585 Average interest rates 7.80% 7.69% 7.40% 7.57% 7.07% 5.89% 7.49% Variable interest rate loans $ 45,756 $ 9,646 $ 4,541 $ 3,297 $ 3,689 $ 495 $ 67,424 $ 67,424 Average interest rates 6.13% 6.11% 5.95% 5.95% 5.52% 5.30% 6.07% Rate sensitive liabilities Borrowed funds $ 3,263 $ 1,094 $ 94 $ 5,094 $ 93 $ 8,155 $ 17,793 $ 18,507 Average interest rates 0.88% 5.07% 5.23% 5.08% 5.20% 5.30% 4.41% Savings and NOW accounts $150,280 $ 20,646 $ 16,779 $ 13,749 $ 12,706 $ 32,928 $247,088 $247,088 Average interest rates 1.42% 1.25% 1.49% 1.57% 1.15% 0.91% 1.34% Fixed interest rate time deposits $131,911 $ 32,404 $ 37,843 $ 26,984 $ 20,473 $ 59 $249,674 $255,167 Average interest rates 3.08% 4.85% 5.79% 4.89% 4.61% 7.20% 4.04% Variable interest rate time deposits $ 816 $ 449 $ 9 -- $ 314 -- $ 1,588 $ 1,588 Average interest rates 2.03% 2.03% -- -- 3.82% -- 2.37% </Table> <Table> <Caption> Fair Value 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 -------- -------- -------- -------- -------- ---------- -------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Rate sensitive assets Other interest bearing assets $ 32,900 $ 100 -- -- -- -- $ 33,000 $ 33,000 Average interest rates 1.50% 1.85% -- -- -- -- 1.50% Fixed interest rate securities $ 31,156 $ 17,566 $ 17,533 $ 3,612 $ 8,209 $ 27,896 $105,972 $106,044 Average interest rates 4.57% 4.98% 4.55% 4.22% 4.68% 4.91% 4.72% Fixed interest rate loans $104,468 $ 75,855 $ 93,477 $ 34,622 $ 21,839 $ 15,776 $346,037 $343,501 Average interest rates 9.37% 8.42% 8.13% 8.30% 8.28% 7.53% 8.57% Variable interest rate loans $ 49,117 $ 2,158 $ 235 $ 186 $ 131 -- $ 51,827 $ 51,827 Average interest rates 7.25% 9.76% 7.41% 7.27% 7.00% -- 7.36% Rate sensitive liabilities Borrowed funds $ 251 -- $ 1,000 -- $ 5,000 $ 5,381 $ 11,632 $ 11,904 Average interest rates 2.00% -- 5.05% -- 5.08% 5.72% 5.31% Savings and NOW accounts $122,022 $ 19,950 $ 16,209 $ 13,170 $ 12,153 $ 30,276 $213,780 $213,780 Average interest rates 1.72% 1.85% 1.80% 2.32% 1.50% 1.39% 1.72% Fixed interest rate time deposits $141,602 $ 33,814 $ 19,952 $ 28,412 $ 15,406 $ 7 $239,193 $241,551 Average interest rates 5.37% 6.04% 5.95% 6.35% 6.67% 5.85% 5.71% Variable interest rate time deposits $ 900 $ 348 -- -- -- -- $ 1,248 $ 1,248 Average interest rates 4.09% 4.09% -- -- -- -- 4.09% </Table> 26
FORWARD LOOKING STATEMENTS This report contains certain 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 Corporation intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Corporation, are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Corporation's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Corporation and the subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Corporation's market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Corporation and its business, including additional factors that could materially affect the Corporation's financial results, is included in the Corporation's filings with the Securities and Exchange Commission. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements of the registrant and report of independent auditors are set forth on pages 30 through 52 of this report: Report of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary data regarding quarterly results of operations set forth under the table named "Summary of Selected Financial Data" on Page 13 of this report. 27
REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders IBT Bancorp Mt. Pleasant, Michigan We have audited the accompanying consolidated balance sheets of IBT Bancorp, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of changes in shareholders' equity, income, comprehensive income, and cash flows for the three years then ended. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial position of IBT Bancorp, Inc. and subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for the three years then ended in conformity with accounting principles generally accepted in the United States of America. REHMANN ROBSON P.C. Saginaw, Michigan January 31, 2003 28
CONSOLIDATED BALANCE SHEETS (Dollars in thousands) <Table> <Caption> DECEMBER 31 2002 2001 -------- -------- <S> <C> <C> ASSETS Cash and cash equivalents $ 28,587 $ 22,562 Federal funds sold 25,850 32,900 -------- -------- CASH AND CASH EQUIVALENTS 54,437 55,462 Investment securities Securities available for sale (amortized cost of $153,499 in 2002 and $100,969 in 2001) 157,909 102,518 Securities held to maturity (fair value of $1,803 in 2002 and $3,526 in 2001) 1,736 3,454 -------- -------- TOTAL INVESTMENT SECURITIES 159,645 105,972 Loans Agricultural 53,223 48,523 Commercial 143,957 128,098 Residential real estate mortgage 152,778 167,976 Installment 54,522 53,267 -------- -------- TOTAL LOANS 404,480 397,864 Less allowance for loan losses 5,593 5,471 -------- -------- NET LOANS 398,887 392,393 Premises and equipment 14,470 13,985 Bank-owned life insurance 9,810 9,038 Accrued interest receivable, net 4,897 4,961 Acquisition intangibles and goodwill, net 3,498 2,528 Other assets 7,073 7,804 -------- -------- TOTAL ASSETS $652,717 $592,143 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest bearing $ 63,106 $ 62,020 NOW accounts 111,195 86,676 Certificates of deposit and other savings 316,845 308,120 Certificates of deposit over $100 70,310 59,425 -------- -------- TOTAL DEPOSITS 561,456 516,241 Other borrowed funds 17,793 11,632 Accrued interest and other liabilities 10,011 7,442 -------- -------- TOTAL LIABILITIES 589,260 535,315 Shareholders' equity Common stock -- no par value; 10,000,000 shares authorized; 4,336,283 shares issued and outstanding (3,884,985 shares at December 31, 2001) 45,610 31,017 Retained earnings 16,299 24,788 Accumulated other comprehensive income 1,548 1,023 -------- -------- TOTAL SHAREHOLDERS' EQUITY 63,457 56,828 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $652,717 $592,143 ======== ======== </Table> The accompanying notes are an integral part of these consolidated financial statements. 29
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands) <Table> <Caption> YEAR ENDED DECEMBER 31 2002 2001 2000 ------------ ------------ ------------ <S> <C> <C> <C> NUMBER OF SHARES OF COMMON STOCK OUTSTANDING Balance at beginning of year 3,884,985 3,871,552 3,848,248 10% stock dividend 388,758 Issuance of common stock 81,326 37,434 23,304 Common stock repurchased (18,786) (24,001) ------------ ------------ ------------ BALANCE END OF YEAR 4,336,283 3,884,985 3,871,552 ============ ============ ============ COMMON STOCK Balance at beginning of year $ 31,017 $ 30,814 $ 30,322 10% stock dividend 12,829 -- -- Issuance of common stock 2,383 971 492 Common stock repurchased (619) (768) -- ------------ ------------ ------------ BALANCE END OF YEAR 45,610 31,017 30,814 RETAINED EARNINGS Balance at beginning of year 24,788 21,049 17,816 Net income 6,925 6,066 5,431 10% stock dividend (12,829) -- -- Cash dividends ($0.60 per share in 2002, $0.55 in 2001, and $0.49 in 2000) (2,585) (2,327) (2,198) ------------ ------------ ------------ BALANCE END OF YEAR 16,299 24,788 21,049 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year 1,023 67 (1,031) Unrealized gains on securities available for sale, net of income taxes and reclassification adjustment 1,887 956 1,098 Minimum pension liability adjustment, net of income taxes (1,362) -- -- ------------ ------------ ------------ BALANCE END OF YEAR 1,548 1,023 67 ------------ ------------ ------------ TOTAL SHAREHOLDERS' EQUITY END OF YEAR $ 63,457 $ 56,828 $ 51,930 ============ ============ ============ </Table> The accompanying notes are an integral part of these consolidated financial statements. 30
CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands except per share data) <Table> <Caption> YEAR ENDED DECEMBER 31 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> INTEREST INCOME Loans, including fees $ 31,527 $ 35,091 $ 33,470 Investment securities Taxable 4,362 3,173 3,839 Tax exempt 1,849 1,637 1,275 Federal funds sold and other 423 897 170 -------- -------- -------- TOTAL INTEREST INCOME 38,161 40,798 38,754 -------- -------- -------- INTEREST EXPENSE Deposits 14,578 18,678 17,927 Borrowings 678 582 475 -------- -------- -------- TOTAL INTEREST EXPENSE 15,256 19,260 18,402 -------- -------- -------- NET INTEREST INCOME 22,905 21,538 20,352 Provision for loan losses 1,025 770 565 -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 21,880 20,768 19,787 Noninterest income Trust fees 597 548 535 Service charges on deposit accounts 277 288 327 Other service charges and fees 1,807 1,686 1,530 Gain on sale of mortgage loans 1,762 1,051 98 Title insurance revenue 2,221 1,578 1,039 Other 1,439 1,047 876 -------- -------- -------- TOTAL NONINTEREST INCOME 8,103 6,198 4,405 NONINTEREST EXPENSES Salaries, wages, and employee benefits 11,307 9,790 8,594 Occupancy 1,422 1,201 1,025 Furniture and equipment 2,277 2,037 1,943 Amortization of acquisition intangibles 94 655 568 Charitable donations 815 490 130 Other 4,857 4,522 4,417 -------- -------- -------- TOTAL NONINTEREST EXPENSES 20,772 18,695 16,677 -------- -------- -------- INCOME BEFORE FEDERAL INCOME TAXES 9,211 8,271 7,515 Federal income taxes 2,286 2,205 2,084 -------- -------- -------- NET INCOME $ 6,925 $ 6,066 $ 5,431 ======== ======== ======== Net income per basic share of common stock $ 1.61 $ 1.42 $ 1.28 ======== ======== ======== </Table> The accompanying notes are an integral part of these consolidated financial statements. 31
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands) <Table> <Caption> YEAR ENDED DECEMBER 31 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> NET INCOME $ 6,925 $ 6,066 $ 5,431 -------- -------- -------- Other comprehensive income before income taxes Unrealized gains on securities available for sale Unrealized holding gains arising during year 2,861 1,440 1,661 Reclassification adjustment for realized (gain) loss included in net income (2) 8 4 Minimum pension liability adjustment (2,063) -- -- -------- -------- -------- Other comprehensive income before income taxes 796 1,448 1,665 Income taxes related to other comprehensive income 271 492 567 -------- -------- -------- Other comprehensive income 525 956 1,098 -------- -------- -------- COMPREHENSIVE INCOME $ 7,450 $ 7,022 $ 6,529 ======== ======== ======== </Table> The accompanying notes are an integral part of these consolidated financial statements. 32
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) <Table> <Caption> YEAR ENDED DECEMBER 31 2002 2001 2000 ---------- ---------- ---------- <S> <C> <C> <C> OPERATING ACTIVITIES Net income $ 6,925 $ 6,066 $ 5,431 Reconciliation of net income to net cash provided by operations Provision for loan losses 1,025 770 565 Provision for depreciation 1,647 1,197 1,155 Net amortization on investment securities 1,006 295 211 Amortization and impairment of mortgage servicing rights 994 390 139 Increase in cash surrender value of life insurance (472) (205) (166) Amortization of acquisition intangibles 94 655 568 Deferred income tax benefit (276) (277) (272) Gain on sale of mortgage loans (1,762) (1,051) (98) Proceeds from sale of mortgage loans 192,407 126,814 12,360 Loans originated for sale (195,776) (132,875) (12,261) Decrease (increase) in accrued interest receivable 64 92 (741) Increase in other assets (1,959) (1,461) (463) Increase in accrued interest and other liabilities 2,207 1,735 404 ---------- ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES 6,124 2,145 6,832 INVESTING ACTIVITIES Activity in available-for-sale securities Maturities, calls, and sales 40,019 24,935 23,341 Purchases (93,225) (48,479) (9,702) Activity in held-to-maturity securities Maturities and calls 1,386 4,537 5,832 Purchases -- -- (2,355) Net (increase) decrease in loans (2,388) 12,466 (50,575) Purchases of premises and equipment (2,107) (3,921) (2,025) Acquisition of title office (25) -- -- Purchase of cash value life insurance (300) (7,135) -- ---------- ---------- ---------- NET CASH USED IN INVESTING ACTIVITIES (56,640) (17,597) (35,484) FINANCING ACTIVITIES Net increase in noninterest bearing deposits 1,086 1,222 913 Net increase in interest bearing deposits 44,129 38,203 30,827 Net increase in borrowings 5,897 5,188 334 Cash dividends (2,585) (2,327) (2,198) Proceeds from issuance of common stock 1,583 971 492 Common stock repurchase (619) (768) -- ---------- ---------- ---------- NET CASH PROVIDED BY FINANCING ACTIVITIES 49,491 42,489 30,368 (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,025) 27,037 1,716 Cash and cash equivalents beginning of year 55,462 28,425 26,709 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS END OF YEAR $ 54,437 $ 55,462 $ 28,425 ========== ========== ========== Supplemental cash flow information: Federal income taxes paid $ 2,774 $ 2,670 $ 2,254 Interest paid 15,312 19,357 18,228 </Table> The accompanying notes are an integral part of these consolidated financial statements. 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS) NOTE A - BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION AND CONSOLIDATION: The consolidated financial statements include the accounts of IBT Bancorp (the "Corporation"), a Financial Services Holding company, and its wholly owned subsidiaries, Isabella Bank and Trust, Farmers State Bank of Breckenridge, IBT Title, IBT Financial Services, IBT Loan Production, and its majority owned subsidiary, IBT Personnel, LLC (79%). All intercompany transactions and accounts have been eliminated. NATURE OF OPERATIONS: IBT Bancorp is a Financial Service Holding Company offering a wide array of financial products and services in mid-Michigan. Its banking subsidiaries, Isabella Bank and Trust and Farmers State Bank of Breckenridge, offer banking services through 19 locations, 24-hour banking services locally and nationally through shared automatic teller machines, and direct deposits to businesses, institutions, and individuals. Lending services offered include commercial real estate loans and lines of credit, residential real estate loans, consumer loans, student loans, and credit cards. Deposit services include interest and noninterest bearing checking accounts, savings accounts, money market accounts, and certificates of deposit. Other related financial products include trust services, safe deposit box rentals, and credit life insurance. Active competition, principally from other commercial banks, savings banks and credit unions, exists in all of the Banks' principal markets. The Corporation's results of operations can be significantly affected by changes in interest rates or changes in the local economic environment. IBT Title does business under the names Isabella County Abstract and Title, Mecosta County Abstract and Title, IBT Title Clare, and Benchmark Title of Greenville. IBT Title provides title insurance, abstract searches, and closes real estate loans. IBT Financial Services is a full service retail brokerage company offering stocks, bonds, and mutual fund sales to individuals. IBT Loan Production is a mortgage loan origination company. Principal loan products include 15 and 30 year fixed rate mortgage loans. All loans originated are sold to Isabella Bank and Trust. IBT Personnel provides payroll services, benefit administration, and other human resource services to IBT Bancorp's subsidiaries. USE OF ESTIMATES: The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and foreclosed real estate, management obtains independent appraisals for significant properties. 34
SIGNIFICANT GROUP CONCENTRATION OF CREDIT RISK. Most of the Corporation's activities are with customers located within the central Michigan area. A significant amount of its outstanding loans are secured by real estate or are made to finance agricultural production. Other than these types of loans, there is no significant concentration to any other industry or customer. CASH AND CASH EQUIVALENTS: For purposes of the consolidated statements of cash flows, the Corporation considers cash on hand, demand deposits due from banks, and federal funds sold as cash and cash equivalents. Generally, federal funds are sold for a one day period. The Corporation maintains deposit accounts in various financial institutions which at times may exceed FDIC insured limits or are not insured. Management believes the Corporation is not exposed to any significant interest rate or other financial risk as a result of these deposits. SECURITIES: Management determines the appropriate classification of debt securities at the time of purchase. Debt securities are classified as held to maturity when the Corporation has the positive intent and ability to hold the securities to maturity. Securities held to maturity are stated at amortized cost. Debt securities not classified as held to maturity are classified as available for sale and are stated at fair value with the unrealized gains and losses net of taxes excluded from earnings and reported in other comprehensive income. The amortized cost of debt securities classified as either held to maturity or available for sale is adjusted for amortization of premiums and accretion of discounts to maturity and is computed using a method that approximates the level yield method. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are determined to be other than temporary are reflected in earnings as realized losses. Gains or losses on the sale of securities available for sale are calculated using the adjusted cost for the specific securities sold. ALLOWANCE FOR LOAN LOSSES: Management determines the adequacy of the allowance for loan losses based on evaluations of the loan portfolio, past and recent loan loss experience, current economic conditions and other pertinent factors. The allowance is increased by a charge to income for provisions for loan losses. Loans deemed to be uncollectible are charged against the allowance for loan losses and subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses on loans classified as impaired is based on discounted cash flows using the loans initial interest rate or the fair value of the collateral for certain collateral dependent loans. LOANS AND RELATED INCOME: Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balance adjusted for any charge offs, the allowance for loans losses, and any deferred fees or costs on originated loans. Interest income on loans is accrued over the term of the loan based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in the opinion of management, the borrower may be unable to meet payments as scheduled. When the accrual of interest is discontinued, all uncollected accrued interest is reversed against interest income. The interest income on such loans is subsequently recognized only to the extent cash payment is received. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. For impaired loans not classified as nonaccrual, interest income continues to be accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the constant yield method. 35
MORTGAGE BANKING ACTIVITIES: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Gains or losses on sales of such loans are recognized at the time of sale and are determined by the difference between the net sales proceeds and the unpaid principal balance of the loans sold, adjusted for any yield differential, servicing fee, and servicing costs applicable to future years. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income. Mortgage servicing rights ("MSR") are amortized in proportion to, and over the period of, estimated net servicing income. To determine the fair value of MSR, the Corporation estimates the present value of future cash flows incorporating a number of assumptions including servicing income, cost of servicing, discount rates, and prepayment rates. The Corporation has established a valuation allowance for the excess of the book value of the capitalized MSR over the estimated fair value. For purposes of measuring impairment, the rights are stratified based on their predominant risk characteristics, primarily period of origination, interest rate, and current prepayment rates. PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less accumulated depreciation. For financial reporting purposes, the provision for depreciation is computed principally by the straight line method based upon the useful lives of the assets which generally range from 5 to 30 years. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur and major improvements are capitalized. Management annually reviews these assets to determine whether carrying values have been impaired. A summary of premises and equipment at December 31 follows: <Table> <Caption> 2002 2001 -------- -------- <S> <C> <C> Premises $ 12,194 $ 10,957 Equipment 15,479 14,585 -------- -------- 27,673 25,542 Less accumulated depreciation 13,203 11,557 -------- -------- NET PREMISES AND EQUIPMENT $ 14,470 $ 13,985 ======== ======== </Table> RESTRICTED INVESTMENTS: Included in other assets are restricted securities of $2,648 in 2002 and $2,582 in 2001. Restricted securities include the stock of the Federal Reserve Bank and the Federal Home Loan Bank and have no contractual maturity. BANK OWNED LIFE INSURANCE: The Corporation has purchased life insurance policies on key members of management. In the event of death of one of these individuals, the Corporation would receive a specified cash payment equal to the face value of the policy. Such policies are recorded at their cash surrender value. Increases in cash surrender value are reported as other noninterest income. CREDIT RELATED FINANCIAL INSTRUMENTS: In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under credit card arrangements, home equity lines of credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when funded. 36
FEDERAL INCOME TAXES: Federal income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of taxes currently due plus deferred income taxes. Deferred income taxes are recognized for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred income tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets or liabilities are recorded or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. As changes in income tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. PER SHARE AMOUNTS: Net income per share amounts were computed by dividing net income by the weighted average number of shares outstanding. The weighted average number of common shares outstanding were 4,292,467 in 2002, 4,266,174 in 2001; and 4,247,073 in 2000. ACQUISITION INTANGIBLES: Isabella Bank and Trust previously acquired branch facilities and related deposits in a business combination accounted for as a purchase. The acquisition of the branches included amounts related to the valuation of customer deposit relationships (core deposit intangibles). The deposit intangible is being amortized on the straight line basis over nine years, the expected life of the acquired relationship. RECLASSIFICATIONS: Certain amounts reported in the 2001 and 2000 consolidated financial statements have been reclassified to conform with the 2002 presentation. RECENT ACCOUNTING PRONOUNCEMENTS: In April 2002, the Financial Accounting Standards Board (SFAS) issued Statement of Financial Accounting Standards No. 145. Statement No. 145 requires that gains and losses from extinguishment of debt be classified as extraordinary items only if they meet the criteria defined in APB Opinion No. 30 which are that the event or transaction is both unusual in nature and infrequent in occurrence. Events considered unusual should have a high degree of abnormality and be clearly unrelated to the company's normal operations and infrequency is defined as not expected to recur in the foreseeable future. It is not expected that provisions of Statement No. 145 will have a material impact on the financial position or results of operations of the Corporation. In June 2002, FASB issued Statement of Financial Accounting Standards No. 146 which nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity" and as a result modified the criteria for measurement and recognition of costs associated with exiting an activity. The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002. It is not expected that provisions of Statement No. 146 will have a material impact on the financial position or results of operations of the Corporation. In October 2002, FASB issued Statement of Financial Accounting Standards No. 147 which amends FASB Statements No. 72 and 144, "Accounting for Certain Acquisitions of Banking or Thrift Institutions" and "Accounting for the Impairment or Disposal of Long-Lived Assets", respectively and FASB Interpretation No. 9, "Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution is Acquired in a Business Combination Accounted for by the Purchase Method". The provisions of this standard generally became effective October 1, 2002. IBT Bancorp adopted SFAS No. 142 on January 1, 2002. As a result, goodwill and other intangible assets were separately disclosed on the consolidated balance sheet and amortization of the goodwill ceased. Adoption of SFAS No. 147 did not have a significant impact on the Corporation's financial reporting. 37
In November 2002, FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" which addresses the disclosure to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. FIN 45 requires the guarantor to recognize a liability for the non-contingent component of the guarantee. This is the obligation to stand ready to perform in the event that specified triggering events or conditions occur. The initial measurement of this liability is the fair value of the guarantee at inception. The recognition of the liability is required even if it is not probable that payments will be required under the guarantee or if the guarantee was issued with a premium payment or as part of a transaction with multiple events. The initial recognition and measurement provisions are effective for all guarantees within the scope of FIN 45 issued or modified after December 31, 2002. The impact of adoption is not expected to have a significant impact on the Corporation's financial reporting. In December 2002, the FASB issued SFAS 148 "Accounting for Stock-Based Compensation - Transition and Disclosure", an amendment of FASB Statement No. 123", which is effective for years beginning after December 15, 2002. This Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirement of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reporting results. The Corporation has no stock-based compensation, and thus the adoption of SFAS 148 will have no impact on the Corporation's financial reporting. NOTE B - BUSINESS COMBINATION On July 1, 2002, the Corporation's subsidiary IBT Title completed the purchase of Benchmark Abstract and Title of Greenville, Michigan. The purchase was accounted for according to the FASB Statement No. 141. The purchase price of Benchmark was approximately $1.1 million, which was funded through the issuance of $800 of IBT Bancorp stock, $25 cash, and a note payable in the amount of $264. The purchase price was allocated $25 to premises and equipment and $1,064 to goodwill. Results of operations have not been significant. 38
NOTE C - INVESTMENT SECURITIES The following is a summary of securities available for sale and held to maturity: <Table> <Caption> Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> DECEMBER 31, 2002 Securities available for sale U.S. Treasury and U.S. government agencies $ 88,546 $ 2,428 $ -- $ 90,974 Corporate 2,284 44 -- 2,328 States and political subdivisions 62,669 1,960 (22) 64,607 ---------- ---------- ---------- ---------- TOTAL $ 153,499 $ 4,432 $ (22) $ 157,909 ========== ========== ========== ========== Securities held to maturity U.S. Treasury and U.S. government agencies $ 74 $ 1 $ -- $ 75 States and political subdivisions 1,662 66 -- 1,728 ---------- ---------- ---------- ---------- TOTAL $ 1,736 $ 67 $ -- $ 1,803 ========== ========== ========== ========== </Table> <Table> <Caption> Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> DECEMBER 31, 2001 Securities available for sale U.S. Treasury and U.S. government agencies $ 52,209 $ 908 $ (70) $ 53,047 States and political subdivisions 46,450 773 (82) 47,141 Commercial paper 2,310 20 -- 2,330 ---------- ---------- ---------- ---------- TOTAL $ 100,969 $ 1,701 $ (152) $ 102,518 ========== ========== ========== ========== Securities held to maturity U.S. Treasury and U.S. government agencies $ 148 $ 3 $ -- $ 151 States and political subdivisions 3,306 71 (2) 3,375 ---------- ---------- ---------- ---------- TOTAL $ 3,454 $ 74 $ (2) $ 3,526 ========== ========== ========== ========== </Table> The following table summarizes the fair value, realized gains, and realized losses on sales of securities available for sale. <Table> <Caption> 2002 2001 2000 ------ ------ ------ <S> <C> <C> <C> Fair value of securities sold on the date of sale $2,066 $3,165 $4,354 Gross realized gains U.S. Treasury and U.S. government agencies 2 4 -- Municipals -- -- 1 Gross realized losses U.S. Treasury and U.S. government agencies -- -- 5 Municipals -- 12 -- </Table> 39
The following table shows the amortized cost and estimated fair value of securities owned at December 31, 2002 by contractual maturity. Expected maturities will differ from contractual maturities because the issuers of securities may have the right to prepay obligations without prepayment penalty. <Table> <Caption> Available for Sale Held to Maturity Amortized Fair Amortized Fair Cost Value Cost Value ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Due within one year or less $ 27,957 $ 28,382 $ 495 $ 501 Due after 1 year thru 5 years 88,958 91,734 1,167 1,227 Due after 5 years thru 10 years 21,409 22,131 -- -- Due after 10 years 4,681 4,735 -- -- ---------- ---------- ---------- ---------- Subtotal 143,005 146,982 1,662 1,728 Mortgage backed securities 10,494 10,927 74 75 ---------- ---------- ---------- ---------- TOTAL $ 153,499 $ 157,909 $ 1,736 $ 1,803 ========== ========== ========== ========== </Table> Investment securities with a carrying value of approximately $10,359 and $8,537 were pledged to secure public deposits and for other purposes as necessary or required by law at December 31, 2002 and 2001, respectively. NOTE D - LOANS An analysis of changes in the allowance for loan losses follows: <Table> <Caption> 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Balance at beginning of year $ 5,471 $ 5,162 $ 4,622 Loans charged off (1,202) (692) (418) Recoveries 299 231 393 Provision charged to income 1,025 770 565 -------- -------- -------- BALANCE AT END OF YEAR $ 5,593 $ 5,471 $ 5,162 ======== ======== ======== </Table> The following is a summary of information pertaining to impaired loans at December 31: <Table> <Caption> 2002 2001 -------- -------- <S> <C> <C> Impaired loans without a valuation allowance $ 1,085 $ -- Impaired loans with a valuation allowance 1,639 544 -------- -------- Total impaired loans $ 2,724 $ 544 ======== ======== Valuation allowance related to impaired loans $ 103 $ 56 ======== ======== Average investment in impaired loans $ 2,968 $ 544 ======== ======== </Table> The average investment in impaired loans for the year ended December 31, 2000 was not significant. Interest income recognized on impaired loans was not significant during any of the three years ended December 31, 2002. No additional funds are committed to be advanced in connection with impaired loans. Certain directors and executive officers (including their families and companies in which they have 10% or more ownership) of the Corporation and the Banks were loan customers of the Banks. Total loans to these customers aggregated $7,721 and $9,248 at December 31, 2002 and 2001, respectively. During 2002, $5,858 of new loans were made and repayments totaled $7,385. 40
Residential mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgages serviced for others was $208,432 and $153,136 at December 31, 2002 and 2001, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and taxing authorities, and foreclosure processing. The following table summarizes the fair value of mortgage servicing rights included in other assets as of December 31: <Table> <Caption> 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Balance at beginning of year $ 402 $ 271 $ 140 Mortgage servicing rights capitalized 1,632 660 270 Accumulated amortization (885) (358) (139) Impairment valuation allowance (638) (171) -- -------- -------- -------- BALANCE AT END OF YEAR $ 511 $ 402 $ 271 ======== ======== ======== </Table> Residential mortgages committed for sale were $13,392 as of December 31, 2002 and $8,261 as of December 31, 2001. NOTE E - FAIR VALUE OF FINANCIAL INSTRUMENTS The Corporation utilizes quoted market prices, where available, to compute the fair value of its financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from the disclosure requirements. Accordingly, the aggregate of the fair value amounts presented are not necessarily indicative of the underlying value of the Corporation. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments. Cash and cash equivalents: The carrying amounts reported in the balance sheets for cash and demand deposits due from banks and federal funds sold approximate those assets' fair value. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are unavailable, fair values are based on quoted market prices of comparable instruments. Loans: Fair values for variable rate loans that reprice at least quarterly and have no significant change in credit risk are assumed to equal recorded book value. Fixed rate loans are valued using present value discounted cash flow techniques. The discount rate used in these calculations was the U.S. government bond rate for securities with similar maturities adjusted for servicing costs, credit loss, and prepayment risk. Deposit liabilities: Demand, savings, and money market deposits have no stated maturities and are payable on demand; thus their estimated fair value is equal to their recorded book balance. Fair values for variable rate certificates of deposit approximate their recorded book balance. Fair values for fixed rate certificates of deposit are determined using discounted cash flow techniques that apply interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Off-balance-sheet instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the counterparties' credit standings. The Corporation does not charge fees for lending commitments; thus it is not practicable to estimate the fair value of these instruments. 41
The following sets forth the estimated fair value and recorded book balance of the Corporation's financial instruments as of December 31. <Table> <Caption> 2002 2001 ------------------------------ ------------------------------ Estimated Fair Recorded Book Estimated Fair Recorded Book Value Balance Value Balance -------------- ------------- -------------- ------------- <S> <C> <C> <C> <C> ASSETS Cash and demand deposits due from banks $ 28,587 $ 28,587 $ 22,562 $ 22,562 Federal funds sold 25,850 25,850 32,900 32,900 Investment securities 159,712 159,645 106,044 105,972 Net loans 400,416 398,887 395,328 392,393 Accrued interest receivable 4,897 4,897 4,961 4,961 LIABILITIES Deposits with no stated maturities 310,194 310,194 275,800 275,800 Deposits with stated maturities 256,755 251,262 243,799 240,441 Borrowed funds 18,507 17,793 11,904 11,632 Accrued interest payable 1,037 1,037 1,093 1,093 </Table> NOTE F - FEDERAL INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Corporation's deferred tax assets and liabilities, included in other assets, as of December 31 are as follows: <Table> <Caption> 2002 2001 -------- -------- <S> <C> <C> Deferred tax assets Allowance for loan losses $ 1,175 $ 1,156 Deferred directors' fees 664 565 Employee benefit plans 608 424 Core deposit premium and acquisition expenses 245 362 Net unrealized loss on minimum pension liability 701 -- Other 225 154 -------- -------- TOTAL DEFERRED TAX ASSETS 3,618 2,661 -------- -------- Deferred tax liabilities Premises and equipment 222 278 Accretion on securities 73 56 Prepaid pension expense -- 639 Net unrealized gain on available-for-sale securities 1,498 526 Other 80 61 -------- -------- TOTAL DEFERRED TAX LIABILITIES 1,873 1,560 -------- -------- NET DEFERRED TAX ASSETS $ 1,745 $ 1,101 ======== ======== </Table> Components of the consolidated provision for income taxes are as follows for the year ended December 31: <Table> <Caption> 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Current $ 2,562 $ 2,482 $ 2,356 Deferred benefit (276) (277) (272) -------- -------- -------- PROVISION FOR FEDERAL INCOME TAXES $ 2,286 $ 2,205 $ 2,084 ======== ======== ======== </Table> 42
The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income taxes is as follows for the year ended December 31: <Table> <Caption> 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Income tax on pretax income $ 3,132 $ 2,812 $ 2,555 Effect of nontaxable income (846) (607) (471) -------- -------- -------- Provision for federal income tax $ 2,286 $ 2,205 $ 2,084 ======== ======== ======== </Table> NOTE G - BENEFIT PLANS The Corporation has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employees' average compensation over their best five years of service. The funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to services to date but also for those expected to be earned in the future. The defined pension plan's assets are invested primarily in common stocks. Changes in the projected benefit obligation and plan assets during each year, the funded status of the plan and a reconciliation to the amount recognized in the Corporation's consolidated balance sheets are summarized as follows at December 31: <Table> <Caption> 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Change in projected benefit obligation Benefit obligation January 1 $ 5,870 $ 5,130 $ 4,839 Service cost 297 271 188 Interest cost 425 384 352 Actuarial loss (gain) 634 305 (34) Benefits paid (277) (220) (215) -------- -------- -------- BENEFIT OBLIGATION, DECEMBER 31 $ 6,949 $ 5,870 $ 5,130 ======== ======== ======== Change in plan assets Fair value of plan assets, January 1 $ 5,259 $ 5,446 $ 5,230 Investment return (loss) (509) (439) (112) Corporation contribution 357 472 543 Benefits paid (277) (220) (215) -------- -------- -------- FAIR VALUE OF PLAN ASSETS, DECEMBER 31 $ 4,830 $ 5,259 $ 5,446 ======== ======== ======== Reconciliation of funded status Funded status $ (2,119) $ (611) $ 316 Unrecognized net transition asset (22) (44) (66) Unrecognized prior service cost 113 125 143 Unrecognized net loss from experience different than that assumed and effects of changes in assumptions 3,843 2,409 1,268 Adjustment to recognize additional minimum pension liability (2,176) -- -- -------- -------- -------- (ACCRUED LIABILITY) PREPAID PENSION COST $ (361) $ 1,879 $ 1,661 ======== ======== ======== </Table> An adjustment to record the additional minimum pension liability as of December 31, 2002 was established by the recording of an intangible pension asset of $113 and a charge to other comprehensive income of $2,063 in 2002. 43
Net pension expense consists of the following components for the year ended December 31: <Table> <Caption> 2002 2001 2000 ------ ------ ------ <S> <C> <C> <C> Service cost on benefits earned for services rendered during the year $ 297 $ 271 $ 188 Interest cost on projected benefit Obligation 425 384 352 Expected return on plan assets (409) (445) (436) Amortization of unrecognized transition asset (22) (22) (22) Amortization of unrecognized prior service cost 18 18 18 Amortization of unrecognized actuarial net loss 113 48 12 ------ ------ ------ NET PENSION EXPENSE $ 422 $ 254 $ 112 ====== ====== ====== </Table> Actuarial assumptions used in determining the projected benefit obligation and the net periodic pension cost are as follows for the year ended December 31: <Table> <Caption> 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> Weighted average discount rate 6.75% 7.50% 7.50% Rate of increase in future compensation 4.50% 4.50% 4.50% Expected long-term rate of return 8.00% 8.00% 8.00% </Table> The Corporation maintains a nonqualified supplementary retirement plan for officers to provide supplemental retirement benefits and death benefits to each participant. Insurance policies, designed primarily to fund death benefits, have been purchased on the life of each participant with the Corporation as the sole owner and beneficiary of the policies. Expenses related to this program for 2002, 2001, and 2000 were $41, $84, and $20, respectively, and are being recognized over the participants' expected years of service. The Corporation maintains an employee stock ownership plan (ESOP) and a profit sharing plan which cover substantially all of its employees. Contributions to the Plans are discretionary and are approved by the Board of Directors and recorded as compensation expense. Compensation expense related to the Plans for 2002, 2001, and 2000 was $196, $146, and $200, respectively. Total shares outstanding related to the ESOP at December 31, 2002 and 2001 were 166,139 and 152,107, respectively, and were included in the computation of dividends and earnings per share in each of the respective years. NOTE H - DEPOSITS At December 31, 2002, the scheduled maturities of time deposits were as follows: <Table> <Caption> YEAR AMOUNT ---- ------ <S> <C> 2003 132,003 2004 32,912 2005 37,852 2006 26,984 2007 21,452 Thereafter 59 </Table> 44
NOTE I - BORROWED FUNDS Borrowed funds at December 31 consist of the following obligations: <Table> <Caption> 2002 2001 -------- -------- <S> <C> <C> Federal Home Loan Bank advances $ 14,360 $ 11,381 Securities sold under agreements to repurchase 3,169 251 Unsecured note payable 264 -- -------- -------- $ 17,793 $ 11,632 ======== ======== </Table> The Federal Home Loan Bank borrowings are collateralized by a blanket lien on all qualified 1 to 4 family residential mortgage loans and U.S. Treasury and government agency securities equal to at least 160% of outstanding advances. Advances are also secured by FHLB stock owned by the Banks. The unsecured note payable has an imputed interest rate of 4.16% and is payable in annual installments of $60,000, including interest, through July 2007. Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreement to repurchase are reflected at the amount of cash received in connection with the transaction. The U.S. government agency securities underlying the agreements have a carrying value and a fair value of approximately $3,625 and $1,030 at December 31, 2002 and 2001, respectively. Such securities remain under the control of the Corporation. The Corporation may be required to pledge additional collateral based on the fair value of the underlying securities. The maturity and weighted average interest rates of FHLB advances at December 31 follow: <Table> <Caption> 2002 ------------------- AMOUNT RATE -------- -------- <S> <C> <C> Fixed rate advance due 2004 $ 1,000 5.05% Two year putable advance due 2006 5,000 5.08 Fixed rate advance due 2009 1,000 4.19 Fixed rate advance due 2010 2,360 6.62 One year putable advance due 2010 3,000 4.98 Fixed rate advance due 2012 2,000 4.90 -------- -------- TOTAL ADVANCES $ 14,360 5.22% ======== ======== </Table> <Table> <Caption> 2001 ------------------- AMOUNT RATE -------- -------- <S> <C> <C> Fixed rate advance due 2004 $ 1,000 5.05% Two year putable advance due 2006 5,000 5.08 Fixed rate advance due 2010 2,381 6.62 One year putable advance due 2010 3,000 4.98 -------- -------- TOTAL ADVANCES $ 11,381 5.26% ======== ======== </Table> 45
NOTE J - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Corporation is party to financial instruments with off-balance-sheet risk. These instruments are entered into in the normal course of business to meet the financing needs of its customers. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in a particular class of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Corporation uses the same credit policies in deciding to make these commitments as it does for extending loans to customers. Commitments to extend credit, which totaled $60,800 at December 31, 2002, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have variable interest rates, fixed expiration dates, or other termination clauses and may require the 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. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. At December 31, 2002, the Corporation had a total of $506 in outstanding standby letters of credit. Generally, these commitments to extend credit and letters of credit mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. The Corporation evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon the extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and other income producing commercial properties. NOTE K - COMMITMENTS AND OTHER MATTERS There were no material noncancelable lease commitments outstanding at December 31, 2002. Banking regulations require banks to maintain cash reserve balances in currency or as deposits with the Federal Reserve Bank. The Corporation's requirement was approximately $11,031 at December 31, 2002, and $8,709 at December 31, 2001. Banking regulations also limit the transfer of assets in the form of dividends, loans, or advances from the subsidiary Banks to the Corporation. At December 31, 2002, substantially all of the subsidiary Banks' assets were restricted from transfer to the Corporation in the form of loans or advances. Consequently, bank dividends are the principal source of funds for the Corporation. Payment of dividends without regulatory approval is limited to the current year retained net income plus retained net income for the preceding two years, less any required transfers to capital surplus. At January 1, 2003, the amount available for dividends without regulatory approval was approximately $1,373. The Corporation maintains a self-funded medical plan under which the Corporation is responsible for the first $50 per year of claims made by a covered individual. Medical claims are subject to a lifetime maximum of $2,000 per covered individual. Expenses are accrued based on estimates of the aggregate liability for claims incurred and the Corporation's experience. Expenses were $1,370 in 2002, $1,063 in 2001 and $634 in 2000. 46
The Corporation offers a dividend reinvestment and employee stock purchase plan. The dividend reinvestment plan allows shareholders to purchase previously unissued IBT Bancorp common shares. The employee stock purchase plan allows employees to purchase IBT Bancorp common stock through payroll deduction. The number of shares authorized for issuance under these plans are 150,000 with 14,538 shares unissued at December 31, 2002. During 2002, 2001 and 2000, 52,473 shares were issued for $1,524, 37,434 shares were issued for $971, and 23,304 shares were issued for $492, respectively, in cash pursuant to these plans. The subsidiary Banks of the Corporation have obtained approval to borrow up to $30,000 from the Federal Home Loan Bank (FHLB) of Indianapolis. Under the terms of the agreement, the Banks may obtain advances at the stated rate at the time of the borrowings. The Banks have agreed to pledge eligible mortgage loans and U.S. Treasury and governmental agencies as collateral for any such borrowings. Certain directors and executive officers and their related interests of the Corporation and the Banks were deposit customers of the Banks. Total deposits of these customers aggregate approximately $6,956 and $4,881at December 31, 2002 and December 31, 2001, respectively. NOTE L - OPERATING SEGMENTS The Corporation's reportable segments are based on legal entities that account for at least 10% of operating results. The accounting policies are the same as those discussed in Note A to the Consolidated Financial Statements. The Corporation evaluates performance based principally on net income and asset quality of the respective segments. A summary of selected financial information for the Corporation's reportable segments follows: <Table> <Caption> All Others Isabella Bank Farmers (Including and Trust State Bank Parent) Total ------------- ---------- ---------- --------- <S> <C> <C> <C> <C> 2002 Total assets $ 515,831 $ 126,850 $ 11,038 $ 653,719 Interest income 29,689 8,353 119 38,161 Net interest income 17,559 5,135 211 22,905 Provision for loan losses 650 375 -- 1,025 Net income 5,516 1,206 203 6,925 2001 Total assets $ 469,408 $ 116,903 $ 5,832 $ 592,143 Interest income 31,718 8,987 93 40,798 Net interest income 16,292 5,003 243 21,538 Provision for loan losses 500 270 -- 770 Net income (loss) 4,824 1,269 (27) 6,066 2000 Total assets $ 430,060 $ 106,699 $ 4,138 $ 540,897 Interest income 29,554 9,135 65 38,754 Net interest income 15,002 5,199 151 20,352 Provision for loan losses 265 300 -- 565 Net income (loss) 4,223 1,439 (231) 5,431 </Table> NOTE M - REGULATORY CAPITAL MATTERS The Corporation (on a consolidated basis) and its subsidiary banks, Isabella Bank and Trust and Farmers State Bank of Breckenridge ("Banks") are subject to various regulatory capital requirements administered by their primary regulator, the Federal Reserve Bank. Failure to meet minimum capital requirements can initiate mandatory and/or discretionary actions by the Federal Reserve. These actions could have a material effect on the Corporation's and Banks' financial statements. 47
Under the Federal Reserve's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Banks must meet specific capital guidelines that include quantitative measures of their assets, certain off-balance-sheet items, and capital, as calculated under regulatory accounting standards. The Banks' required capital is also subject to regulatory qualitative judgment regarding the Banks' interest rate risk exposure and credit risk. Prompt corrective action provisions are not applicable to bank holding companies. Measurements established by regulation to ensure capital adequacy require the Corporation and the Banks to maintain minimum total capital to risk weighted assets (as defined in the regulations), Tier 1 capital to risk weighted assets (as defined), and Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2002 and 2001, that the Corporation and the Banks met all capital adequacy requirements to which they are subject. As of December 31, 2002, the most recent notifications from the Federal Reserve Bank categorized the Banks as well capitalized. To be categorized as well capitalized, a bank must maintain total risk based capital, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There have been no conditions or events since the notifications that management believes has changed the Banks' category. The Corporation's and each Bank's actual capital amounts (in thousands) and ratios are also presented in the table. <Table> <Caption> Minimum To Be Well Capitalized Minimum Capital Under Prompt Corrective Actual Requirements Action Provisions ------------------- ------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> AS OF DECEMBER 31, 2002 Total capital to risk weighted assets Isabella Bank and Trust $ 40,385 12.9% $ 24,998 8.0% $ 31,247 10.0% Farmers State Bank of Breckenridge 12,957 14.2 7,284 8.0 9,106 10.0 Consolidated 62,030 15.2 32,670 8.0 N/A N/A Tier 1 capital to risk weighted assets Isabella Bank and Trust 36,525 11.7 12,499 4.0 18,748 6.0 Farmers State Bank of Breckenridge 11,811 13.0 3,642 4.0 5,463 6.0 Consolidated 56,919 13.9 16,335 4.0 N/A N/A Tier 1 capital to average assets Isabella Bank and Trust 36,525 7.4 19,856 4.0 24,820 5.0 Farmers State Bank of Breckenridge 11,811 9.6 4,912 4.0 6,140 5.0 Consolidated 56,919 9.2 24,795 4.0 N/A N/A AS OF DECEMBER 31, 2001 Total capital to risk weighted assets Isabella Bank and Trust $ 37,154 12.5% $ 23,867 8.0% $ 29,834 10.0% Farmers State Bank of Breckenridge 12,294 14.9 6,593 8.0 8,241 10.0 Consolidated 58,065 15.1 30,831 8.0 N/A N/A Tier 1 capital to risk weighted assets Isabella Bank and Trust 33,425 11.2 11,933 4.0 17,900 6.0 Farmers State Bank of Breckenridge 11,255 13.7 3,296 4.0 4,945 6.0 Consolidated 53,240 13.8 15,415 4.0 N/A N/A Tier 1 capital to average assets Isabella Bank and Trust 33,425 7.4 17,979 4.0 22,474 5.0 Farmers State Bank of Breckenridge 11,255 10.3 4,371 4.0 5,464 5.0 Consolidated 53,240 9.4 22,553 4.0 N/A N/A </Table> 48
NOTE N - PARENT COMPANY ONLY FINANCIAL INFORMATION CONDENSED BALANCE SHEET <Table> <Caption> December 31 2002 2001 -------- -------- <S> <C> <C> ASSETS Cash on deposit at subsidiary Banks $ 4,690 $ 5,861 Securities available for sale 1,497 588 Investments in subsidiaries 58,949 51,912 Premises and equipment 98 113 Other assets 1,722 1,157 -------- -------- TOTAL ASSETS $ 66,956 $ 59,631 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Other liabilities $ 3,553 $ 2,803 Shareholders' equity 63,403 56,828 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 66,956 $ 59,631 ======== ======== </Table> CONDENSED STATEMENTS OF INCOME <Table> <Caption> Year Ended December 31 2002 2001 2000 ------ ------ ------ <S> <C> <C> <C> Income Dividends from subsidiaries $3,325 $3,115 $4,700 Interest income 122 154 105 Management fee and other 292 245 6 ------ ------ ------ TOTAL INCOME 3,739 3,514 4,811 Expenses 824 680 563 ------ ------ ------ Income before income tax benefit and equity in undistributed earnings of subsidiaries 2,915 2,834 4,248 Federal income tax benefit 152 103 166 ------ ------ ------ 3,067 2,937 4,414 Undistributed earnings of subsidiaries 3,858 3,129 1,017 ------ ------ ------ NET INCOME $6,925 $6,066 $5,431 ====== ====== ====== </Table> CONDENSED STATEMENTS OF CASH FLOWS <Table> <Caption> Year Ended December 31 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> OPERATING ACTIVITIES Net income $ 6,925 $ 6,066 $ 5,431 Adjustments to reconcile net income to cash provided by operations Undistributed earnings of subsidiaries (3,858) (3,129) (1,017) Net amortization of securities -- 1 3 (Increase) decrease in interest receivable (2) 1 20 (Increase) decrease in other assets (1,947) (240) 3 Increase in accrued expenses 389 1,353 1,440 Provision for depreciation 20 19 19 Deferred income tax benefit 328 (401) (512) -------- -------- -------- NET CASH PROVIDED BY OPERATIONS 1,855 3,670 5,387 </Table> 49
<Table> <Caption> Year Ended December 31 2002 2001 2000 -------- -------- -------- <S> <C> <C> <C> INVESTING ACTIVITIES Proceeds from the maturities of investment securities available for sale 175 75 867 Purchases of investment securities available for sale (1,080) -- -- Investment in subsidiaries (495) -- (2,924) Purchases of equipment and premises (5) (39) (19) -------- -------- -------- NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (1,405) 36 (2,076) FINANCING ACTIVITIES Cash dividends (2,585) (2,327) 2,198) Issuance of common stock 1,583 971 492 Repurchase of common stock (619) (768) -- -------- -------- -------- NET CASH USED IN FINANCING ACTIVITIES (1,621) (2,124) (1,706) -------- -------- -------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,171) 1,582 1,605 Cash and cash equivalents at beginning of year 5,861 4,279 2,674 -------- -------- -------- CASH AND CASH EQUIVALENTS AT YEAR END $ 4,690 $ 5,861 $ 4,279 ======== ======== ======== </Table> NOTE O - GOODWILL AND OTHER INTANGIBLE ASSETS On January 1, 2002, the Corporation adopted the FASB Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets." Statement No. 142 addresses the reporting and other intangible assets subsequent to their acquisition. This Statement requires that goodwill be separately disclosed if material from other intangible assets on the consolidated balance sheet and that goodwill and intangible assets with indefinite useful lives no longer be amortized, but, instead, tested for impairment at least annually. The adoption of Statement No. 142 resulted in the reduction of goodwill amortization of $392 or $0.09 per share for 2002. As required by the Statement, intangible assets that do not meet the criteria for recognition apart from goodwill must be reclassified. As a result of the Corporation's analysis, no reclassifications were required as of December 31, 2002. Included in other assets on the accompanying consolidated balance sheets are the following amounts as of December 31: <Table> <Caption> 2002 2001 ------ ------ <S> <C> <C> Branch acquisition goodwill $2,036 $2,036 Title company goodwill 1,064 -- ------ ------ Total goodwill 3,100 2,036 Core deposit intangibles 398 492 ------ ------ $3,498 $2,528 ====== ====== </Table> The core deposit intangibles are being amortized on a straight-line basis over nine years. 50
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information concerning directors and certain executive officers of the Corporation, see "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Corporation's 2003 Annual Meeting Proxy Statement ("Proxy Statement") which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION For information concerning executive compensation, see "Executive Officers," "Report on Executive Compensation," "The Defined Benefit Pension Plan," "Compensation Committee Interlocks and Insider Participation," "Remuneration of Directors," and "Stock Performance" in the Proxy Statement which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS For information concerning the security ownership of certain owners and management, see "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement which is incorporated herein by reference. EQUITY COMPENSATION PLAN INFORMATION The following table provides information as of December 31, 2002, with respect to compensation plans under which common shares of the Corporation are authorized for issuance to directors, officers or employees in exchange for consideration in the form of goods or services. <Table> <Caption> Number of Securities Remaining Available for Future Issuance Number of Weighted Under Equity Securities to be Average Exercise Compensation Issued upon Price of Plans Exercise of Outstanding (Excluding Outstandings Options, Securities Options, Warrants, Warrants Reflected in and Rights and Rights Column(A)) Plan Category (A) (B) (C) - ------------- ------------------ ---------------- --------------- <S> <C> <C> <C> Equity compensation approved by Shareholders: None -- -- -- Equity compensation plans not approved by shareholders: 1984 deferred director fee plan 126,956 (1) (1) 1998 executive officer deferred salary plan 5,486 (2) (2) ------------------ Total 132,442 ================== </Table> 51
(1) Pursuant to the terms of the Deferred Director fee plan, directors of the Corporation and its subsidiaries are required to defer at least 25% of their earned board fees. Deferred fees are converted on a quarterly basis into stock units of the Corporation's common stock. The fees are converted to stock units based on the purchase price for a share of common stock under the Corporation's Dividend Reinvestment Plan. Stock units credited to a participant's account are eligible for stock and cash dividend as payable. Upon retirement from the board, a participant can convert one stock unit into one share of common stock. All authorized but unissued shares of common stock are eligible for issuance under this Plan. (2) The Executive Officer Deferred Salary Plan allows executive officers of the Corporation and its subsidiaries to defer up to 5% of their annual salary to purchase stock units. The mechanics of the plan operate exactly the same as the Deferred Director Fee Plan as discussed in (1) above. PART IV ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS For information concerning certain relationships and related transactions, see "Indebtedness of and Transactions with Management" in the Proxy Statement, which is incorporated herein by reference. ITEM 14. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Within ninety days prior to the filing date of this Annual Report on Form 10-K, the Corporation under the supervision and with the participation of its management, including its Chief Executive Officer/Chief Financial Officer, performed an evaluation of the Corporation's disclosure controls and procedures, in accordance with Rules 13a-14 and 13a-15 of the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer/Chief Financial Officer concluded that such disclosure controls and procedures are effective to ensure that material information relating to the Corporation, including its consolidated subsidiaries, is made known to him, particularly during the period for which the periodic reports are being prepared. CHANGES IN INTERNAL CONTROLS No significant changes were made in the Corporation's internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation performed pursuant to Rule 13a-15 of the Securities Act of 1934, referred to above. ITEMS 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements: The following consolidated financial statements of IBT Bancorp are incorporated by reference in Item 8: Report of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 52
2. Financial Statement Schedules: All schedules are omitted because they are neither applicable nor required, or because the required information is included in the consolidated financial statements or related notes. 3. Exhibits: 3(a) Amended Articles of Incorporation(1) 3(b) Amendment to the Articles of Incorporation(3) 3(c) Amendment to the Articles of Incorporation(5) 3(d) Amendment to the Articles of Incorporation(5) 3(e) Amended Bylaws(1) 3(f) Amendment to the Bylaws(2) 3(g) Amendment to the Bylaws(3) 3(h) Amendment to the Bylaws(6) 3(i) Amendment to the Bylaws(7) 3(j) Amendments to the Bylaws 10(a) Isabella Bank & Trust Executive Supplemental Income Agreement(3)* 10(b) Isabella Bank & Trust Deferred Compensation Plan(6)* 10(c) IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Directors(6)* 10(d) Isabella Bank and Trust Death Benefit Only Agreement(7)* 21 Subsidiaries of the Registrant 23 Consent of Rehmann Robson, P.C. Independent Auditors 99.01 Certification of Chief Executive Officer and Chief Financial Officer (b) During the three months ended December 31, 2002, the Corporation filed the following current report on Form 8-K: None (c) Exhibits: The response to this portion of Item 15 is submitted as a separate section of this report entitled, "Index to Exhibits" (d) Financial Statement Schedules: None 53
ITEM 15 (CONTINUED) (1) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 12, 1991, and incorporated herein by reference. (2) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 13, 1990, and incorporated herein by reference. (3) Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 26, 1994, and incorporated herein by reference. (4) Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 26, 1996, and incorporated herein. (5) Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 22, 2000, and incorporated herein. (6) Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 27, 2001, and incorporated herein. (7) Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 25, 2002, and incorporated herein. * Management's Contract or Compensatory Plan or Arrangement. 54
Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized. IBT BANCORP, INC. (Registrant) by: /s/ Dennis P. Angner Date: March 24, 2003 ------------------------------------- ---------------- Dennis P. Angner President and Chief Executive Officer Pursuant to the requirements of the Securities and 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. <Table> <Caption> Signatures Capacity Date - ---------- -------- ---- <S> <C> <C> /s/ L. A. Johns Chairman of the Board March 24, 2003 - --------------------------------------- and Director L. A. Johns /s/ Dennis P. Angner President and Chief March 24, 2003 - --------------------------------------- Executive Officer Dennis P. Angner (Principal Executive and Principal Financial Officer) and Director /s/ Richard J. Barz Director March 24, 2003 - --------------------------------------- /s/ Frederick L. Bradford Director March 24, 2003 - --------------------------------------- Frederick L. Bradford /s/ Gerald D. Cassel Director March 24, 2003 - --------------------------------------- Gerald D. Cassel /s/ James C. Fabiano Director March 24, 2003 - --------------------------------------- James C. Fabiano </Table> 55
<Table> <Caption> Signatures Capacity Date - ---------- -------- ---- <S> <C> <C> /s/ David W. Hole Director March 24, 2003 - --------------------------------------- David W. Hole /s/ Ronald E. Schumacher Director March 24, 2003 - --------------------------------------- Ronald E. Schumacher /s/ William J. Strickler Director March 24, 2003 - --------------------------------------- William J. Strickler /s/ Dean Walldorff Director March 24, 2003 - --------------------------------------- Dean Walldorff /s/ Herbert C. Wybenga Vice President and March 24, 2003 - --------------------------------------- Director Herbert C. Wybenga /s/ Dale Weburg Director March 24, 2003 - --------------------------------------- Dale Weburg </Table> 56
CERTIFICATIONS I, Dennis P. Angner, certify that: 1. I have reviewed this annual report on Form 10-K of IBT 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 me 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 my 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 6. The registrant's other certifying officers and I have indicated in this annual report whether or not 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 24, 2003 /s/ Dennis P. Angner ---------------- ----------------------------------------- President and CEO, Principal Executive Officer and Principal Financial Officer 57
IBT Bancorp FORM 10-K Index to Exhibits <Table> <Caption> Exhibit Form 10-K Number Exhibit Page Number ------ ------- ----------- <S> <C> <C> 3(j) Amendment to the Bylaws 59 21 Subsidiaries of the Registrant 60 23 Consent of Rehmann Robson P.C. 61 Independent Certified Public Accountants 99.01 Statement Pursuant to Title 18 - USC Section 1350 62 </Table> 58