1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 1996 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 (517) 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 - $6.00 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] The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $37,628,000 as of March 14, 1997. The number of shares outstanding of the registrant's Common Stock ($6 par value) was 783,921 as of March 14, 1997. 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 Part III Shareholders to be held April 23, 1997
2 PART I ________________________________________________________________________________ ITEM 1. BUSINESS ________________________________________________________________________________ GENERAL IBT Bancorp, Inc. (the Corporation) is a registered bank holding company incorporated under Michigan law in September 1988. The Corporation has three subsidiaries: Isabella Bank and Trust, IBT Financial Services, and IBT Agency. Its principal subsidiary, Isabella Bank and Trust has eleven banking offices located throughout Isabella County, northeastern Montcalm County, and southern Clare County, all of which are located in central Michigan. IBT Financial Services is a full service retail brokerage offering stocks, bonds and mutual funds to individuals. IBT agency is authorized to sell life insurance, casualty insurance, and fixed and variable annuities. The principal city in which the Corporation operates is Mount Pleasant, which has a population of approximately 23,500. Central Michigan University, with enrollment of 16,000 students, is the area's largest employer and provides a stable source of employment and income. Mount Pleasant, as a result of having a large state supported university within its boundaries and being centrally located between 4 cities of similar size, has a sizable retail shopping industry. Mt. Pleasant is also the base for the state's oil and gas production; Michigan is the 12th largest producer of oil and gas in the United States. Other economic activity in Isabella County includes farming, light industrial manufacturing and gaming at the Saginaw Chippewa Indian Tribe Reservation. The area's unemployment rate is approximately 2.8% and the average household income is $34,500. 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. The Bank is a community bank and focuses on providing high-quality, personalized service at a fair price. Based on deposits maintained by all financial institutions, the Bank's market share exceeded 50% of the total for Isabella County in both 1996 and 1995. The Bank offers 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 charge card loans. Other financial related products include trust services, stocks, investment securities, bond, mutual fund sales, 24 hour banking service locally and nationally through shared automatic teller machines, and safe deposit box rentals. LENDING The Bank limits lending activity to its local market and has not purchased any loans from the secondary market. The Bank does not make loans to fund leveraged buyouts, has no foreign corporate or government loans, and no corporate debt securities. The general 2
3 lending philosophy of the Bank is to avoid concentrations to individuals and business segments. The following table sets forth the composition of the Bank's loan portfolio, as of December 31, 1996. LOANS BY MAJOR LENDING CATEGORY: (in thousands) Amount % ------ - Real Estate: One to four family residential $ 82,692 38.4 Commercial and other 43,707 20.3 Construction & Land Development 11,599 5.3 -------- ---- Total Real Estate 137,998 64.0 Commercial: Farmland & Agricultural Prod. 7,695 3.5 State and political subdivisions 3,372 1.6 Commercial and other 29,001 13.5 -------- ---- Total Commercial 40,068 18.6 Personal: Credit Cards 1,941 0.9 Student Loans 4,166 2.0 Other 31,281 14.5 -------- ------ Total Personal 37,388 17.4 TOTAL $215,454 100.00 ======== ====== First and second residential mortgages are the single largest category of loans (38.4% of total loans). The Bank 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 judgement 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. The Corporation has a policy that these loans may not exceed 5% of its total assets. The Bank's 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 Bank's loans have a loan-to-value ratio of less than 80%. When underwriting residential real estate loans, the Bank evaluates the borrower's ability to make monthly payments and the value of the property securing the 3
4 loan. The Bank requires that the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower's gross income and that all debt servicing does not exceed 36% of income. In addition to the above requirements, the Bank reviews credit reports and verifies employment, income, and financial information. Appraisals are performed by independent appraisers. The Bank requires an escrow account for taxes and insurance on all 15 and 30 year fixed rate mortgages. All mortgage loan requests are reviewed by a mortgage loan committee; loans in excess of $200,000 require the approval of either the Bank's Board of Directors or its loan committee. Construction and land development loans consisted solely 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 as 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 loans equaled 18.6% of the Bank's loan portfolio at December 31, 1996. Repayment of commercial loans is often dependent upon the successful operation and management of a business; thus, these loans generally involve greater risk than other types of lending. The Bank minimizes its risk by limiting the amount of loans to any one borrower to $2.5 million. Borrowers with credit needs of more than $2.5 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 Bank 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 Bank requires annual financial statements, prepares cash flow analysis, and reviews credit reports. All commercial loan requests require the approval of two senior loan officers if the amount exceeds $100,000. Loan requests in excess of $175,000 require the approval of either the Bank's Board of Directors or its loan committee. Consumer loans granted by the Bank include automobile loans, second mortgages, secured and unsecured personal loans, credit cards, student loans, and overdraft protection. The Bank does not offer revolving home equity loans nor does it purchase dealer paper. Loan amortization is generally for a period of up to 4 years; except home improvement loans, which are amortized for up to 10 years. The Bank places underwriting emphasis on a borrower's ability to pay rather than collateral value. Except for student loans, no installment loans are sold in the secondary market. All student loans are sold on the secondary market upon reaching a payout status. 4
5 SUPERVISION AND REGULATION The Corporation is subject to supervision and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. 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.) The Bank is chartered by the State of Michigan and is supervised and regulated by the Financial Institutions Bureau of the State of Michigan. The Bank is a member of the Federal Reserve System, its deposits are insured by the Federal Deposit Insurance Corporation to the extent provided by law, and is a member of the Federal Home Loan Bank of Indianapolis. (See Regulation below) The Corporation's non-banking subsidiary, IBT Financial Services, Inc., is a broker-dealer, registered 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. The Bank's non-banking subsidiary, IBT Agency, is a licensed insurance agency and is subject to regulation by the Michigan Insurance Bureau. PERSONNEL As of December 31, 1996, the Corporation had one full-time employee, the Bank had 146 full-time equivalent employees, IBT Financial Services had three full-time employees, and IBT Agency has a dual employee arrangement with IBT Financial Services. The Corporation and the Bank provide 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 law suits in which the Bank is periodically involved, such as claims to enforce liens, condemnation proceedings on making and servicing of real property loans and other issues incident to the Bank's business. However, neither the Corporation nor the Bank is involved in any material pending litigation. REGULATION The earnings and growth of the banking industry and therefore the earnings of the Corporation and the earnings of the Bank 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 5
6 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 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 Bank cannot be predicted. THE CORPORATION The Corporation, as a bank 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 bank 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 subsidiary. Under the BHC Act, bank holding companies such as the Corporation are prohibited, with certain limited exceptions, from engaging in activities other than those of banking or of managing or controlling banks and from acquiring or retaining direct or indirect ownership or control of voting shares or assets of any company which is not a bank or bank holding company, other than subsidiary companies furnishing services to or performing services for its subsidiaries, and other subsidiaries engaged in activities which the Federal Reserve Board determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under the BHC Act, bank holding companies may not (subject to certain limited exceptions) directly or indirectly acquire the ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company, including a bank or bank holding company, without the prior written approval of the Federal Reserve Board. The BHC Act prohibits the Federal Reserve Board (subject to certain limited exceptions) from approving the acquisition, by a bank holding company, such as the Corporation, the principal banking operations of which are conducted in one state, of control of a bank or bank holding company conducting its principal banking operations in another state, unless the statutory laws of the state in which are conducted the principal banking operations of the bank holding company or bank to be acquired, explicitly authorize such an acquisition. Under existing Michigan law and with the approval of the Commissioner of the Michigan Financial Institutions Bureau, a Michigan-based bank and bank holding company (such as the Corporation) may now be acquired by a bank holding company located in any state, if the laws of such state would grant Michigan-based banks or bank 6
7 holding companies the right to acquire one or more banks or bank holding companies located in such state under conditions which are not unduly restrictive. Under the Michigan statute, the Commissioner of the Michigan Financial Institutions Bureau must not approve any such transaction without first determining among other things that the other state's law satisfies the reciprocity requirement imposed by the Michigan statute. Most states have adopted legislation that permits out-of-state bank holding companies to acquire local banks and bank holding companies subject, in most cases, to reciprocity requirements. Under Federal Reserve Board policy, the Corporation is expected to act as a source of financing strength to its subsidiary bank and to commit resources to support its subsidiary. 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 subsidiary) has become impaired by losses or otherwise, the Commissioner of the Michigan Financial Institutions Bureau 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. Certain additional information concerning regulatory guidelines for capital adequacy and other regulatory matters is presented herein under the caption "Capital" on pages 21 and 22, and "Note I - Commitments and Other Matters" and "Note J - Regulatory Capital Matters" on page 40 and 41, respectively. ISABELLA BANK & TRUST The Bank is subject to regulation and examination primarily by the Michigan Financial Institutions Bureau. As an insured state bank, which is a member of the Federal Reserve Bank of Chicago, the subsidiary is also subject to regulation and examination by the FDIC and the Federal Reserve. 7
8 The agencies and federal and state law 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 Bank is 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 Bank is also affected by various regulatory requirements and policies, such as the requirement to maintain adequate capital above regulatory guidelines. Recently enacted legislation will 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. These regulations and restrictions may limit the Corporation's ability to obtain funds from the Bank for its cash needs, including payment of dividends and operating expenses. The activities and operations of the Bank are also subject to other federal and state laws and regulations, including usury and consumer credit laws, the Federal Trust-in-Lending Act, Truth-in-Saving and Regulation Z of the Federal Reserve Board and the Federal Bank Merger Act. 8
9 ITEM 2. PROPERTIES The Corporation's offices are located in the main office building of the Bank. The Bank owns and operates all of its 12 facilities, which are located in Isabella, Montcalm and Clare counties in the State of Michigan. The Corporation's facilities current, planned, and best use is for transacting commercial and retail banking 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, 1996. Year Net Facility Approximate Book Value Opened Sq. Footage 12/31/96 (1) --------- ----------- ----------- Main Office: 200 East Broadway (2) Mt. Pleasant, Michigan 1903 27,640 247,747 Main Office Extension: Customer Service Center 139 East Broadway Mt. Pleasant, Michigan 1985 16,736 585,963 Isabella County Branch Offices: 1416 East Pickard (3) Mt. Pleasant, Michigan 1983 1,450 551,451 2133 South Mission (6) Mt. Pleasant, Michigan 1976 1,560 444,426 200 South University (4) Mt. Pleasant, Michigan 1964 1,795 66,688 1402 West High Mt. Pleasant, Michigan 1973 2,150 49,734 401 East Main Street (5) Blanchard, Michigan 1911 6,561 32,745 500 East Wright Avenue Shepherd, Michigan 1980 1,830 207,419 3388 N. Woodruff Road 1975 5,400 97,928 Weidman, Michigan 9
10 Year Net Facility Approximate Book Value Opened Sq. Footage 12/31/96 (1) -------- ----------- ----------- 1867 Winn Road Beal City, Michigan 1977 1,100 56,355 Montcalm County Branch Office: 313 W. Bridge Street (6) Six Lakes, Michigan 1966 1,527 470,089 Clare County Branch Office: 532 N. McEwan Street Clare, Michigan 1993 7,300 500,527 (1) includes land and buildings (2) substantially remodeled in 1986 (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 ITEM 3. LEGAL PROCEEDINGS The Corporation and the Bank are not involved in any material pending legal proceedings. The Bank, because of the nature of its business, is 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 1996 to a vote of security holders through the solicitation of proxies or otherwise. 10 r
11 EXECUTIVE OFFICERS OF REGISTRANT Pursuant to instruction G(3), the following information is included as an unnumbered item under Part I of this report in lieu of being included in the Proxy Statement for the Annual Shareholders Meeting to be held on April 23, 1997. The names, ages, corporate positions, and years of service of the executive officers of the Corporation are as follows: YEARS OF NAME AGE POSITION SERVICE ---- --- -------- -------- David W. Hole 59 President and CEO 37 Mary Ann Breuer 57 Secretary 37 Dennis P. Angner 41 Treasurer 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDERS' MATTERS 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, 1995 through December 31, 1996 there were, so far as management knows, 40 sales of the Corporation's common stock. These sales involved 21,156 shares, as adjusted for a 10 percent stock dividend paid in March of 1996. 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 $48.00 per share in the fourth quarter of 1996, and the lowest price was $38.18 per share in the first quarter of 1995. The following is a summary of all known transfers since January 1, 1995. All of the information has been adjusted to reflect the stock dividend referred to above. Number of Number of Low High Date Sales Shares Bid Bid ---- --------- --------- --- ---- 1995: First Quarter 2 1,940 $38.18 $38.18 Second Quarter 6 1,004 38.18 39.55 Third Quarter 8 2,099 38.18 40.00 Fourth Quarter 6 736 40.00 40.00 1996: First Quarter 3 1,317 $45.00 $45.00 Second Quarter 8 12,857 45.00 46.00 Third Quarter 6 1,062 45.00 48.00 Fourth Quarter 1 141 48.00 48.00 The following table sets forth the cash dividends paid for the following quarters, adjusted for the 10 percent stock dividend. 1996 1995 ---- ---- First Quarter $0.24 $0.22 Second Quarter 0.24 0.22 Third Quarter 0.24 0.22 Fourth Quarter 0.80 0.66 ----- ----- Total $1.52 $1.32 ===== ===== IBT Bancorp's authorized stock consists of 4,000,000 shares, of which 783,457 shares are issued with a par value of $6 per share. As of year end 1996, there were 842 shareholders of record. 11
12 ITEM 6. SELECTED FINANCIAL DATA SUMMARY OF SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) <TABLE> <CAPTION> 1996 1995 1994 1993 1992 INCOME STATEMENT DATA: ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> Total interest income $ 21,698 $ 19,852 $ 17,991 $ 17,901 $ 18,350 Net interest income 11,741 10,855 10,280 9,737 9,150 Provision for loan losses 500 475 475 400 360 Net income 3,340 2,958 2,802 2,607 2,291 BALANCE SHEET DATA: End of period assets $298,742 $281,505 $263,203 $249,367 $233,690 Daily average assets 289,308 265,860 255,399 240,342 223,767 Daily average deposits 259,240 238,761 230,598 217,954 203,870 Daily average loans/net 196,783 177,109 159,556 142,970 132,081 Daily average equity 26,954 24,313 22,316 19,892 17,873 PER SHARE DATA: (1) Net income $ 4.30 $ 3.85 $ 3.70 $ 3.50 $ 3.14 Cash dividends 1.52 1.32 1.24 1.13 1.04 Book value (at year end) 35.74 33.36 29.49 27.59 25.17 FINANCIAL RATIOS: Shareholders' equity to assets 9.37% 9.17% 8.56% 8.34% 7.98% Net income to average equity 12.39 12.17 12.56 13.10 12.82 Cash dividend payout to net income 35.60 34.27 33.67 32.15 33.36 Net income to average assets 1.15 1.11 1.10 1.08 1.02 </TABLE> <TABLE> <CAPTION> 1996 1995 Fourth Third Second First Fourth Third Second First ------ ----- ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> <C> <C> QUARTERLY OPERATING RESULTS: Total interest income $5,593 $5,498 $5,343 $5,264 $5,175 $5,093 $4,904 $4,680 Interest on deposits 2,569 2,506 2,422 2,460 2,402 2,305 2,208 2,082 Net interest income 3,024 2,992 2,921 2,804 2,773 2,788 2,696 2,598 Provision for loan losses 132 128 123 117 124 121 117 113 Noninterest income 580 556 550 504 538 509 478 446 Noninterest expense 2,302 2,232 2,179 2,083 2,060 2,048 2,121 2,099 Net income 828 853 847 812 811 821 692 634 PER SHARE OF COMMON STOCK: (1) Net income $ 1.06 $ 1.10 $ 1.09 $1.05 $ 1.05 $ 1.07 $ 0.90 $ 0.83 Cash dividends 0.80 0.24 0.24 0.24 0.66 0.22 0.22 0.22 Book value 35.74 35.23 34.27 33.67 33.36 32.79 31.84 30.61 </TABLE> (1) Retroactively restated in 1995 for the 10% stock dividend declared on January 16, 1996, and paid in March 1996 12
13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of the financial condition and results of operations for the Corporation. This discussion and analysis is intended to provide a better understanding of the financial statements and statistical data included elsewhere herein. TABLE 1. DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY; INTEREST RATE AND INTEREST DIFFERENTIAL (Dollars in Thousands) The following schedules present the daily average amount outstanding for each major category (at historical cost) 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. <TABLE> <CAPTION> 1996 1995 1994 ---- ---- ---- 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: Loans $199,277 $17,690 8.88 % $179,355 $15,972 8.91 % $161,669 $14,079 8.71% Taxable investment 46,505 3,280 7.05 43,329 2,660 6.14 52,435 2,803 5.35 securities Nontaxable investment 15,524 788 5.08 16,271 1,258 7.73 16,467 1,311 7.96 securities Federal funds sold 7,983 419 5.25 7,564 422 5.58 6,771 276 4.08 Other 431 27 6.26 336 20 5.95 336 20 5.95 -------- ------- ---- -------- ------- ---- ------- ------- ---- TOTAL EARNING ASSETS 269,720 22,204 8.23 246,855 20,332 8.24 237,678 18,489 7.78 NON EARNING ASSETS: Allowance for loan losses (2,494) ( 2,247) (2,113) Cash and due from banks 11,136 10,945 10,375 Premises and equipment 5,449 5,218 4,786 Accrued income and other assets 5,497 5,089 4,673 -------- -------- -------- TOTAL ASSETS $289,308 $265,860 $255,399 ======== ======== ======== INTEREST BEARING LIABILITIES: Interest bearing demand deposits $ 39,876 1,091 2.74 % $ 42,010 1,277 3.04 % $ 40,318 1,052 2.61% Savings deposits 68,667 2,165 3.15 63,825 1,865 2.92 70,128 1,834 2.62 Time deposits 114,279 6,701 5.86 100,064 5,855 5.85 89,010 4,825 5.42 -------- ------- ---- -------- ------- ---- ------- ------- ---- TOTAL INTEREST BEARING LIABILITIES 222,822 9,957 4.47 205,899 8,997 4.37 199,456 7,711 3.87 NONINTEREST BEARING LIABILITIES AND SHAREHOLDERS' EQUITY: Demand deposits 36,418 32,862 31,142 Other 3,114 2,786 2,485 Shareholders' equity 26,954 24,313 22,316 -------- -------- -------- TOTAL LIABILITIES AND EQUITY $289,308 $265,860 $255,399 ======== ======== ======== NET INTEREST INCOME (FTE) $12,247 $11,335 $10,778 ======= ======= ======= NET YIELD ON INTEREST EARNING ASSETS (FTE) 4.54% 4.59% 4.53% ===== ====== ==== </TABLE> 13
14 RESULTS OF OPERATIONS The Corporation achieved record net income for the tenth consecutive year in 1996 with earnings of $3,340,198, a 12.9% increase over 1995. Earnings per share were $4.30, an increase of $0.45 over 1995 and $0.60 over 1994. 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 bank to profitably and efficiently employ its resources. The Corporation's return on average assets equaled 1.15% in 1996, 1.11% in 1995, and 1.10% in 1994. Return on average equity indicates how effectively a bank is able to generate earnings on capital invested by its shareholders. The Corporation's return on average shareholders' equity equaled 12.39% in 1996, 12.17% in 1995, and 12.56% in 1994. NET INTEREST INCOME The Corporation derives the majority of its 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. 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. In accordance with Statement of Financial Accounting Standards (SFAS) No. 91, interest income includes loan fees of $754,000 in 1996; $601,000 in 1995; and $639,000 in 1994. 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 (Dollars in Thousands) 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> 1996 Compared to 1995 1995 Compared to 1994 ------------------------------------ ------------------------------- 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 $ 1,769 $ (51) $1,718 $1,569 $ 324 $1,893 Taxable investment securities 205 415 620 (526) 383 (143) Nontaxable investment securities (55) (415) (470) (15) (38) (53) Federal funds sold 23 (26) (3) 35 111 146 Other 6 1 7 -------- ------- ------ ------ ------ ------- TOTAL CHANGES IN INTEREST INCOME 1,948 (76) 1,872 1,063 780 1,843 CHANGES IN INTEREST EXPENSE: Interest bearing demand deposits (63) (123) (186) 46 179 225 Savings deposits 147 153 300 (173) 204 31 Time deposits 834 12 846 628 402 1,030 -------- ------- ------ ------ ----- ------ TOTAL CHANGES IN INTEREST EXPENSE 918 42 960 501 785 1,286 -------- ------- ------ ------ ----- ------ NET CHANGE IN FTE NET INTEREST INCOME $1,030 $ (118) $ 912 $ 562 $ (5) $ 557 ======== ======= ====== ====== ====== ====== </TABLE> 14
15 NET INTEREST INCOME (CONTINUED) Changes in net interest income from period to period result from changes in the average balances (volume) of interest earning assets and interest bearing liabilities and the average rate earned and paid on such assets and liabilities. As shown in Tables 1 and 2, when comparing 1996 to 1995 fully taxable equivalent (FTE) interest income increased $912,000 or 8.0%. A 9.3% increase in interest earning assets provided $1,948,000 of FTE interest income. The majority of this growth was funded by an 8.2% increase in interest bearing deposits, resulting in $918,000 of additional interest expense. Overall, changes in volume resulted in $1,030,000 of additional FTE interest income. The average FTE interest rate earned on assets decreased by 0.01%, decreasing FTE interest income by $76,000 and the average rate paid on deposits increased by 0.10%, increasing interest expense by $42,000. The net change related to interest rates earned and paid was a $118,000 reduction in FTE net interest income. The Corporation's FTE net interest yield as a percentage of average earning assets equaled 4.54% during 1996 versus 4.59% in 1995. The 0.05% decrease in the net interest yield was primarily a result of the Corporation's increasing reliance on higher cost deposits such as certificates of deposit and money market accounts to fund asset growth. The percentage of assets funded with these deposits increased from 46.8% in 1995 to 49.6%. Management expects the Corporation's reliance on higher cost deposits to fund asset growth to continue. In addition to changes in asset and liability mix, changes in rates have an impact on the Corporation's interest income. Management expects interest rates to remain steady during 1997. Based on this expectation and the Corporation's asset and liability repricing characteristics, management calculates that the Corporation's FTE net interest margin as a percentage of average assets will not change significantly in 1997. Due to the many factors that can affect net interest income, interest income cannot be predicted with any certainty. Net interest income increased $557,000 to $11.3 million in 1995 from $10.8 million in 1994. As shown in Tables 1 and 2, in 1995 (FTE) interest income increased $1,063,000, from a 3.9% increase in the volume of average earning assets. The growth of interest earning assets was funded primarily by a 3.2% increase in interest bearing deposits that resulted in additional interest expense of $501,000. Overall, the Corporation earned an additional $562,000 in FTE interest income as a result of volume. The average rate earned in 1995 increased by 46 basis points, increasing FTE interest income by $780,000 and the average rate paid on deposits increased by 50 basis points, increasing interest expense by $785,000. The net result of increased interest rate earned and paid reduced FTE net interest income by $5,000. PROVISION FOR LOAN LOSSES The viability of any financial institution is ultimately determined by its management of credit risk. Total loans outstanding represent 80.5% of the Corporation's total year end deposits, and is the Corporation's single largest concentration of risk. Inevitably, poor operating performance may result in the failure to control this credit risk. Given the importance of maintaining sound underwriting practices, both the Board of Directors and senior management spend a large portion of their time and effort in loan review. 15
16 PROVISION FOR LOAN LOSSES (CONTINUED) 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, 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 15.8% in 1996 and 6.9% in 1995. The allowance for loan losses as a percentage of total outstanding loans at year end 1996 was 1.22% compared to 1.21% at December 31, 1995. The Corporation's net charged off loans as a percentage of average loans decreased to 0.06% in 1996 from 0.17% in 1995. The decline in net charged off loans is attributable to the strong economic conditions in our principal markets. TABLE 3. SUMMARY OF LOAN LOSS EXPERIENCE ----------------------------------------- (Dollars in Thousands) The following is a summary of loan balances at the end of each period and their daily average balance, changes in the allowance for possible 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 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> Amount of loans outstanding at the end of period $215,454 $185,996 $173,939 $154,608 $139,092 ======== ======== ======== ======== ======== Average amount of loans outstanding for the period $199,277 $179,355 $161,669 $144,905 $133,859 ======== ======== ======== ======== ======== Summary of changes in allowance: Allowance for loan losses - January 1 $ 2,248 $ 2,083 $ 1,854 $ 1,686 $ 1,553 Loans charged off: Commercial and agricultural 166 334 375 350 308 Real estate mortgage 36 4 5 10 26 Installment 173 161 181 123 141 -------- -------- -------- ------- --------- TOTAL LOANS CHARGED OFF 375 499 561 483 475 Recoveries: Commercial and agricultural 146 109 247 158 132 Real estate mortgage 2 19 1 Installment 102 80 66 74 115 -------- -------- --------- ------- --------- TOTAL RECOVERIES 248 189 315 251 248 -------- -------- --------- ------- --------- Net charge offs 127 310 246 232 227 Provision charged to income 500 475 475 400 360 -------- -------- --------- ------- --------- ALLOWANCE FOR LOAN LOSSES - DECEMBER 31 $ 2,621 $ 2,248 $ 2,083 $ 1,854 $ 1,686 ======== ======== ========= ======= ======== Ratio of net charge offs during the year to average loans outstanding 0.06% 0.17% 0.15% 0.16% 0.17% ==== ==== ==== ==== ==== Ratio of the allowance for loan losses to loans outstanding at year end 1.22% 1.21% 1.20% 1.20% 1.21% ==== ==== ==== ==== ==== </TABLE> 16
17 As shown in Table 4, the percentage of loans classified as nonperforming by the Corporation as of December 31, 1996 and 1995 equaled 0.25% and 0.46% of total loans, respectively. The Bank's policy, including a loan impaired under SFAS No. 114, is 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, it is determined 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. Restructured loans are loans whose terms have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower. TABLE 4. NONPERFORMING LOANS ----------------------------- (Dollars in Thousands) The following loans are all the credits which require classification for state or federal regulatory purposes. December 31 1996 1995 1994 1993 1992 Nonaccrual loans $ $ 262 $ 347 $ 205 $ 122 Accruing loans past due 90 days or more 441 590 183 303 508 Restructured loans 107 19 280 ----- ----- ------ ----- ----- TOTAL NONPERFORMING LOANS $ 548 $ 852 $ 530 $ 527 $ 910 ===== ===== ====== ===== ===== As of December 31, 1996, 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. In management's opinion, the allowance for loan losses is adequate as of December 31, 1996. Management has allocated, as shown in Table 5, the allowance for loan losses to the following categories: 42.4% to commercial and agricultural loans; 14.6% to real estate loans; 35.4% to installment loans; and 7.6% unallocated. The above allocation is not intended to imply limitations on usage of the allowance. The entire allowance is available for any future loans without regard to loan type. TABLE 5. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES ----------------------------------------------------- (Dollars in Thousands) 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 1996 1995 1994 ---- ---- ---- % of Each % of Each % of Each Category Category Category Allowance to Total Allowance to Total Allowance to Total Amount Loans Amount Loans Amount Loans ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> Commercial and agricultural $1,110 18.60% $1,079 18.06% $ 915 19.01% Real estate mortgage 384 64.05 278 62.22 249 60.91 Installment 928 17.35 707 19.72 706 20.08 Impaired loans 5 50 Unallocated 199 179 163 ------ ------- ------ ------- ------- ------- TOTAL $2,621 100.00% $2,248 100.00% $ 2,083 100.00% ====== ======= ====== ======= ======= ======= <CAPTION> December 31 1993 1992 ---- ---- % of Each % of Each Category Category Allowance to Total Allowance to Total Amount Loans Amount Loans ------ ----- ------ ----- <S> <C> <C> <C> <C> Commercial and agricultural $ 745 21.94% $ 667 22.53% Real estate mortgage 318 60.97 317 62.37 Installment 644 17.09 567 15.10 Impaired loans Unallocated 147 135 ------- ------- ------- ------- TOTAL $ 1,854 100.00% $ 1,686 100.00% ======= ======= ======= ======= </TABLE> 17
18 NONINTEREST INCOME Noninterest income consists of trust fees, deposit service charges, and fees for other financial services. Noninterest income increased $219,000 or 11.1% in 1996 when compared to 1995. The most significant changes were a $65,000 increase in automatic teller machine fees, a $48,000 gain on the sale of $2.9 million in student loans, a $44,000 increase in brokerage fees, and a $28,000 decrease in trust fees. In December 1996, a major contract for providing ATM services was not renewed. During 1996, services provided under this contract generated $300,000 in revenue. The decline in revenue is expected to be partially offset by decreases in ATM operating cost, depreciation expense, and additional interest income due to a substantial decrease in vault cash. In anticipation of this event, the Bank offset the majority of its 1996 net earnings related to this contract through the establishment and funding of a charitable foundation. Included in other operating income is a $120,000 gain from the sale of $18.8 million in mortgages during 1996 versus a $73,000 gain on the sale of $8.1 million for 1995. The Corporation has established a policy that all 30-year amortized fixed rate mortgage loans will be sold. During 1996, all 15 and 30 year fixed rate mortgage loans granted were sold on the secondary market. These loans were sold without recourse, with servicing retained. The gain on sale in 1996 was calculated under the provisions of SFAS No. 122. For further information regarding SFAS No. 122, refer to Note A, Business and Significant Accounting Policies, and Note C, Loans, of the audited financial statements. Total noninterest income increased $185,000 or 10.4% in 1995 when compared to 1994. The most significant changes were a $111,000 increase in automatic teller machine fees, a $51,000 increase in overdraft charges, a $44,000 increase in brokerage fees, and a $14,000 decrease in trust fees. NONINTEREST EXPENSES Controlling noninterest expenses is important to maintain adequate and satisfactory profitability. Noninterest expenses declined from 3.13% of average assets in 1995 to 3.04% in 1996. The largest component of noninterest expense is salaries and employee benefits, which increased $373,000 or 8.8%. The majority of this increase was related to normal merit and promotional salary increases and the addition of three full-time equivalent employees. Salaries and benefits equaled 1.59% of average assets during 1996, 1995 and 1994. Occupancy and furniture and equipment expenses increased $215,000 or 13.7% in 1996. The majority of this increase was associated with a $30,000 increase in automatic teller machine operating costs, a $60,000 increase in computer operations expenses, a $66,000 increase in depreciation, and a $32,000 increase in building repairs. Other noninterest expenses decreased $121,000, or 4.8%. The most significant change was a decrease in FDIC insurance premiums from $272,000 in 1995 to $2,000 in 1996. Federal legislation approved in September 1996 requires commercial banks to assist in the repayment of debts issued by the Savings Association Insurance Fund. These debts were authorized by Congress in prior years as part of the savings and loan industry bailout. FDIC insurance premium expense for 1997 is expected to increase by approximately $34,000 as a result of this legislation. Additional significant changes in other operating expenses included increases in donations of $108,000, State of Michigan single business tax of $35,000, printing and office supplies of $95,000, marketing of $46,000, and a decrease in other real estate expense of $138,000. The majority of the increase in donations is related to establishment of a charitable foundation by the Bank. Noninterest expense increased $476,000 or 6.1% in 1995 when compared with 1994. Salaries and employee benefits increased $174,000 or 4.3%. The majority of this increase was related to normal merit and promotional salary increases and the addition of the brokerage subsidiary. Occupancy and furniture and equipment expenses increased $243,000 or 18.2% in 1995. The majority of this increase was associated with automatic teller machine operating costs, computer operations, and furniture and equipment depreciation. Other noninterest expenses increased $58,000, a 2.4% increase. The most significant change was a decrease in FDIC insurance premiums effective June 1, 1995 from 23 cents per hundred dollars in deposits to 4 cents. FDIC expense decreased $229,000 in 1995. Significant increases in other operating expenses included legal expenses, other losses, armored car services, and other real estate expenses. 18
19 FEDERAL INCOME TAXES Federal income tax expense for 1996 was $1,295,000 or 27.9% of pre-tax income compared to $1,065,000 and 26.5% in 1995 and $936,000 and 25.0% in 1994. The increase in tax expense as a percentage of income is attributable to a decrease in non-taxable 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 E, Federal Income Taxes. ANALYSIS OF CHANGES IN THE STATEMENT OF CONDITION Total assets were $298.7 million at December 31, 1996, an increase of $17.2 million or 6.1% over year end 1995. Asset growth was primarily funded by a $14.6 million increase in deposits and a $2.2 million 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 activity 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 1996, the Corporation's net holding of investment securities decreased $5.6 million. The proceeds from the reduction in investment securities were invested in loans. 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, long term U.S. government and agency notes, and mortgage backed securities. The mortgage backed securities are issues of the Federal Home Loan Mortgage Corporation and pay regular monthly amortized principal and interest. These investments have less than 10 years to final maturity. 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 ------------------------------ (Dollars in Thousands) The following is a schedule of the carrying value of investment securities available for sale and held to maturity: <TABLE> <CAPTION> December 31 Available for sale: 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> U.S. Treasury and U.S. government agencies $37,905 $43,723 $42,275 States and political subdivisions 12,579 12,898 14,988 ------- ------- ------- $50,484 $56,621 $57,263 ======= ======= ======= <CAPTION> Held to maturity 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> U.S. Treasury and U.S. government agencies $4,163 $3,852 $2,693 States and political subdivisions 3,963 4,796 3,493 Other securities 1,369 336 336 ----- ------ ------ $9,495 $8,984 $6,522 ====== ====== ====== </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. Other securities consist solely of Federal Reserve Bank Stock. 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, collateralized mortgage obligations, zero coupon bonds, nongovernment agency asset backed securities, corporate bonds, and structured notes. 19
20 The following is a schedule of maturities of each category of investment securities (at book value) and their weighted average yield as of December 31, 1996. The weighted average interest rates have been computed on a fully taxable equivalent basis, based on amortized cost. The rates shown on securities issued by states and political subdivisions are stated on a taxable equivalent basis using a 34% tax rate. TABLE 7. SCHEDULE OF MATURITIES OF INVESTMENT SECURITIES AND ------------------------------------------------------------- WEIGHTED AVERAGE YIELDS ----------------------- (Dollars in Thousands) <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 $12,564 5.92% $24,435 6.28% $ 906 6.50% States and political subdivisions 4,770 8.09 6,103 7.49 1,706 7.40 ------- ------- ------ TOTAL $17,334 6.51% $30,538 6.53% $2,612 7.09% ======= ======= ====== Held to maturity: U.S. Treasury and U.S. government agencies $ $ 3,481 6.38% $ 540 8.28% $ 142 8.49% States and political subdivisions 2,160 6.60% 562 7.69 1,241 7.50 Other securities 1,369 7.08 ------- ------- ------ ------ TOTAL $ 2,160 6.60% $ 4,043 6.56% $1,781 7.74% $1,511 7.21% ======= ======= ====== ====== </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 ------------------------ (Dollars in Thousands) <TABLE> <CAPTION> December 31 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> Commercial and agricultural $ 40,068 $ 33,585 $ 33,062 $ 33,926 $ 31,336 Real estate mortgage 137,998 115,718 105,953 94,264 86,749 Installment 37,388 36,693 34,924 26,418 21,007 --------- --------- --------- --------- --------- TOTAL LOANS $215,454 $185,996 $173,939 $154,608 $139,092 ======== ======== ======== ======== ======== </TABLE> Total loans increased $29.5 million in 1996. The increase was primarily in commercial operating loans, commercial real estate loans, and residential mortgages. Loan growth was funded solely from new deposits and the liquidation of investments. During 1996, a total of 5,819 new loans were granted for a total of $114.6 million. 20
21 DEPOSITS Total deposits were $267.6 million at year end 1996, a 5.8% increase over 1995. Average deposits increased 8.6% in 1996 and 3.5% in 1995. During 1996, average noninterest bearing deposits increased 10.8%, interest bearing demand deposits decreased 5.1%, savings deposits increased 7.6%, and time deposits increased 14.2%. Time deposits over $100,000 as a percentage of total deposits equaled 5.2% and 3.9% as of December 31, 1996 and 1995, respectively. TABLE 9. AVERAGE DEPOSITS -------------------------- (Dollars in Thousands) <TABLE> <CAPTION> 1996 1995 1994 Amount Rate Amount Rate Amount Rate ------ ----- ------- ---- ------- ----- <S> <C> <C> <C> <C> <C> <C> Noninterest bearing demand deposits $ 36,418 $ 32,862 $ 31,142 Interest bearing demand deposits 39,876 2.74% 42,010 3.04% 40,318 2.61% Savings deposits 68,667 3.15 63,825 2.92 70,128 2.62 Time deposits 114,279 5.86 100,064 5.85 89,010 5.42 -------- -------- --------- TOTAL $259,240 $238,761 $230,598 ======== ======== ======== </TABLE> TABLE 10. MATURITIES OF TIME CERTIFICATES OF DEPOSIT OVER $100,000 ------------------------------------------------------------------- (Dollars in Thousands) <TABLE> <Caption December 31 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Maturity: Within 3 months $ 5,095 $2,043 $2,105 Within 3 to 6 months 2,825 1,504 1,363 Within 6 to 12 months 418 2,138 759 Over 12 months 5,666 4,174 3,604 -------- ------ ------ TOTAL $14,004 $9,859 $7,831 ======== ====== ====== </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 Bank's trust department also offers a variety of financial products in addition to traditional estate services. Competition from other financial institutions in Isabella County has an impact on both the amount of and the cost of deposits. Isabella County has a population of less than 60,000 people and is serviced by eight financial institutions with 24 locations. This competition results in a higher cost of funds than would otherwise exist. Generally, deposit rates in Isabella County are higher than in the major metropolitan areas in the state. Currently, the Bank's market share of deposits in Isabella County is slightly in excess of 50%. CAPITAL The capital of the Corporation consists solely of common stock, capital surplus, retained earnings, and unrealized net gains on securities available for sale. Total capital increased approximately $2.2 million in 1996. The Corporation offers a dividend reinvestment and employee stock purchase plan. Under the provisions of the Plan, the Corporation issued 9,966 shares of common stock generating $432,000 of capital during 1996, and 9,000 common shares generating $369,000 of capital in 1995. 21
22 Since year end 1993, equity capital growth has averaged 10.5% annually versus average annual asset growth of 6.4%. The principal sources of capital growth are retained earnings and cash dividends reinvested. As a result of the differential between internal capital growth and asset growth since 1993, the equity to asset ratio has increased by 1.03% and return on equity has decreased by approximately .50%. The Board of Directors has determined that the Corporation's capital ratio of 9.37% is sufficient and is reviewing options to stabilize the capital ratio at a level below 10.0%. Options being considered include acquisitions, branch expansion, a common stock repurchase program, and a curtailment of the dividend reinvestment plan combined with an increase in cash dividend payouts. The Board may act on any one or all of these options in 1997. Any actions taken in regard to a common stock repurchase plan or curtailment of the dividend reinvestment plan will be preceded by an announcement to the Corporation's shareholders. There are no commitments for significant capital expenditures. The Federal Reserve Board's current recommended mini-mum primary capital to average assets requirement is 6.0%. The Corporation's primary capital to average assets, which consists of shareholders' equity plus the allowance for loan losses, was 10.49% at year end 1996. 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 bank 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, 1996: Percentage of Capital to Risk Adjusted Assets: Required IBT Bancorp -------- ----------- Equity Capital 4.00% 15.26% Secondary Capital 4.00 1.25 ---- ----- Total Capital 8.00% 16.51% ==== ===== *IBT Bancorp's secondary capital includes only the allowance for loan losses. entage 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 bank, Isabella Bank and Trust. At December 31, 1996, Isabella Bank and Trust exceeded these minimums. For further information regarding Isabella Bank and Trust's capital requirements, refer to Note J, 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, 1996 and 1995, cash and cash equivalents equaled 5.1% and 7.7% of total assets, respectively. Net cash provided from operations was $5.7 million in 1996 and $3.2 million in 1995. Net cash provided by financing activities equaled $13.9 million in 1996 and $14.0 million in 1995. The Corporation's investing activities consumed $26.1 million in 1996 and $13.5 million in 1995. The accumulated effect of the Corporation's operating, investing, and financing activities on cash and cash equivalents was a $6.6 million decrease in 1996 and a $3.7 million increase in 1995. 22
23 LIQUIDITY (CONTINUED) In addition to cash and cash equivalents, investment securities available for sale are another source of liquidity. Securities available for sale equaled $50.5 million as of December 31, 1996 and $56.6 million at year end 1995. In addition to these primary sources of liquidity, the Corporation has the ability to borrow in the federal funds market and at the Federal Reserve Bank. The Corporation did not borrow from either of these secondary sources during 1996 or 1995. 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. 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 $215.5 million in total loans, $19.8 million are variable rate loans. Time deposit liabilities are scheduled based on their contractual maturity except for variable rate time deposits in the amount of $1.1 million 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, 1996, the Corporation had $11.6 million 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. In addition to the GAP analysis, the Corporation utilizes a computer simulation to project interest margins into the future. These projections are based on the repricing characteristics and cash flows of the Corporation's interest earning assets and interest bearing deposits. By using different prepayment assumptions and interest rate and balance sheet scenarios, the Corporation can measure the effect of changes in interest rates on its net intererst margin and adjust its position to minimize any change. The GAP and interest rate risk reports are reviewed regularly by the Corporation's Asset and Liability Management Committee. The Corporation does not use interest rate swaps or derivatives in the management of interest rate risk. 23
24 TABLE 11. INTEREST RATE SENSITIVITY ----------------------------------- (Dollars in Thousands) The following table shows the time periods and the amount of assets and liabilities available for interest rate repricing as of December 31, 1996. For purposes of this analysis, nonaccrual loans, the allowance for loan losses, and the market value adjustment on investment securities available for sale are included in nonearning assets. <TABLE> <CAPTION> 0 to 3 4 to 12 1 to 5 Over 5 Months Months Years Years Total -------- -------- -------- ------- -------- <S> <C> <C> <C> <C> <C> INTEREST SENSITIVE ASSETS: Federal funds sold $ 3,175 $ 3,175 Investment securities 3,819 $16,481 $ 34,430 $ 5,065 59,795 Loans 41,609 35,171 131,403 7,271 215,454 Nonearning 20,318 ------- ------- -------- ------- -------- TOTAL $48,603 $51,652 $165,833 $12,336 $298,742 ------- ------- -------- ------- -------- INTEREST SENSITIVE LIABILITIES: Time deposits $19,627 $36,436 $60,483 $ 1,352 $117,898 Savings 39,268 2,210 11,909 14,556 67,943 Interest bearing demand 10,803 3,530 15,462 10,090 39,885 Noninterest bearing 73,016 ------- ------- -------- ------- -------- TOTAL $69,698 $42,176 $87,854 $25,998 $298,742 ------- ------- ------- ------- -------- Cumulative gap $(21,095) $(11,619) $66,360 $52,698 Cumulative gap as a % of assets (7.06)% (3.89)% 22.21% 17.64% </TABLE> TABLE 12. LOAN MATURITY AND INTEREST SENSITIVITY ------------------------------------------------- (Dollars in Thousands) The following table shows the maturity of commercial and agricultural loans outstanding at December 31, 1996. 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 $25,588 $13,406 $1,074 $40,068 ======= ======= ====== ======= Interest Sensitivity: Loans maturing after one year which have: Fixed interest rates $12,300 $1,048 Variable interest rates 1,106 26 ------- ------ TOTAL $13,406 $1,074 ======= ====== </TABLE> 24
25 IMPACT OF INFLATION The majority of assets and liabilities of financial institutions are monetary in nature. Generally, changes in interest rates have a more significant impact on earnings of the Corporation than inflation. Although influenced by inflation, changes in rates do not necessarily move in either the same magnitude or direction as changes in the price of goods and services. Inflation does impact the growth of total assets, creating a need to increase equity capital at a higher rate to maintain an adequate equity to assets ratio, which in turn reduces the amount of earnings available for cash dividends. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements of the registrant and reports of independent auditors are set forth on pages 26 through 42 of this report: Reports of Independent Auditors Consolidated Balance Sheet Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of 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 12 of this report. 25
26 Report of Independent Auditors Board of Directors and Shareholders IBT Bancorp We have audited the accompanying consolidated balance sheet of IBT Bancorp and subsidiaries as of December 31, 1996, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the year 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 audit. We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides 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 and subsidiaries as of December 31, 1996, and the consolidated results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. As described in Note A to the consolidated financial statements, in 1996 IBT Bancorp and subsidiaries changed their method of accounting for originated mortgage servicing rights. Saginaw, Michigan February 6, 1997 Rehmann Robson P.C. 26
27 ANDREWS, HOOPER & PAVLIK, P.L.C. REPORT OF INDEPENDENT AUDITORS Board of Directors IBT Bancorp We have audited the accompanying consolidated statement of financial position of IBT Bancorp and subsidiaries as of December 31, 1995 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the two years in the period ended December 31, 1995. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of IBT Bancorp and subsidiaries at December 31, 1995 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. ANDREWS HOOPER & PAVLIK, P.L.C. February 2, 1996 27
28 CONSOLIDATED BALANCE SHEETS DECEMBER 31 <TABLE> <CAPTION> 1996 1995 ---- ---- <S> <C> <C> ASSETS Cash and demand deposits due from banks -- Note I $ 11,944,739 $ 15,299,222 Federal funds sold 3,175,000 6,400,000 ------------ ------------ CASH AND CASH EQUIVALENTS 15,119,739 21,699,222 Investment securities -- Note B Securities available for sale (Amortized cost of $50,299,984 in 1996 and $55,849,730 in 1995) 50,483,580 56,621,213 Securities held to maturity (Fair value of $9,509,025 in 1996 and $9,058,737 in 1995) 9,495,293 8,984,422 ------------ ------------ TOTAL INVESTMENT SECURITIES 59,978,873 65,605,635 Loans -- Notes C and H Commercial 40,067,951 33,584,662 Real estate mortgage 137,997,951 115,717,820 Installment 37,388,521 36,693,646 ------------ ------------ TOTAL LOANS 215,454,423 185,996,128 Less allowance for loan losses -- Note C 2,620,570 2,248,184 ------------ ------------ NET LOANS 212,833,853 183,747,944 Premises and equipment -- Note A 5,622,955 5,150,853 Accrued interest receivable 2,059,236 2,075,387 Other assets 3,126,946 3,226,281 ------------ ------------ TOTAL ASSETS $298,741,602 $281,505,322 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing $ 41,922,878 $ 39,620,454 NOW accounts 39,885,743 39,882,893 Certificates of deposit and other savings 171,835,681 163,642,277 Certificates of deposit over $100,000 14,004,225 9,859,419 ------------ ------------ TOTAL DEPOSITS 267,648,527 253,005,043 Accrued interest and other liabilities 3,092,659 2,695,270 ------------ ------------ TOTAL LIABILITIES 270,741,186 255,700,313 Shareholders' Equity -- Note I Common stock -- $6 par value: 4,000,000 shares authorized; 783,457 shares issued and outstanding (703,248 shares at December 31, 1995) 4,700,741 4,219,489 Capital surplus 13,261,911 10,220,114 Retained earnings 9,916,593 10,856,229 Unrealized gain on securities available for sale, net of taxes of $62,000 in 1996 and $262,000 in 1995 121,171 509,177 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 28,000,416 25,805,009 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $298,741,602 $281,505,322 ============ ============ See notes to consolidated financial statements. </TABLE> 28
29 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY <TABLE> <CAPTION> Unrealized Net Gain (Loss) on Securities Total Common Capital Retained Available Shareholders' Stock Surplus Earnings For Sale Equity ----------- ----------- ---------- ------------ -------------- <S> <C> <C> <C> <C> <C> BALANCE AT JANUARY 1, 1994 $3,739,244 $ 7,710,415 $ 9,354,951 $ 889,040 $21,693,650 Net income for 1994 2,801,899 2,801,899 10% stock dividend 373,217 1,928,288 (2,301,505) Cash dividends paid -- $1.24 per share (943,469) (943,469) Issuance of 8,837 shares of common stock under dividend reinvestment plan 53,027 266,201 319,228 Change in unrealized loss on securities available for sale, net of $694,000 tax benefits (1,347,726) (1,347,726) ---------- ----------- ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1994 4,165,488 9,904,904 8,911,876 (458,686) 22,523,582 Net income for 1995 2,958,065 2,958,065 Cash dividends paid -- $1.32 per share (1,013,712) (1,013,712) Issuance of 9,000 shares of common stock under dividend reinvestment plan 54,001 315,210 369,211 Change in unrealized gain on securities available for sale, net of taxes of $498,000 967,863 967,863 ---------- ----------- ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 4,219,489 10,220,114 10,856,229 509,177 25,805,009 Net income for 1996 3,340,198 3,340,198 Cash dividends paid -- $1.52 per share (1,189,141) (1,189,141) 10% stock dividend 421,458 2,669,235 (3,090,693) Issuance of 9,966 shares of common stock under dividend reinvestment plan 59,794 372,562 432,356 Change in unrealized gain on securities available for sale, net of taxes of $200,000 (388,006) (388,006) ---------- ----------- ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1996 $4,700,741 $13,261,911 $ 9,916,593 $ 121,171 $28,000,416 ========== =========== =========== =========== =========== </TABLE> See notes to consolidated financial statements. 29
30 CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> <S> <C> <C> <C> YEAR ENDED DECEMBER 31 1996 1995 1994 ---- ---- ---- INTEREST INCOME Loans $17,589,379 $15,880,947 $13,990,446 Investment Securities Taxable: U.S. Treasury and U.S. government agencies 2,755,495 2,588,935 2,785,201 Other 146,915 70,667 38,912 Nontaxable: States and political subdivisions 787,954 868,887 900,857 ----------- ----------- ----------- TOTAL INTEREST ON INVESTMENT SECURITIES 3,690,364 3,528,489 3,724,970 Federal funds sold and other 418,591 442,244 275,518 ----------- ----------- ----------- TOTAL INTEREST INCOME 21,698,334 19,851,680 17,990,934 INTEREST EXPENSE ON DEPOSITS 9,957,039 8,996,712 7,711,291 ----------- ----------- ----------- NET INTEREST INCOME 11,741,295 10,854,968 10,279,643 Provision for loan losses -- Note C 500,000 475,000 475,000 ----------- ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 11,241,295 10,379,968 9,804,643 NONINTEREST INCOME Trust fees 329,413 357,138 370,724 Service charges on deposit accounts 281,240 297,636 288,894 Other service charges and fees 1,131,953 1,030,241 865,425 Other 438,888 300,457 278,664 Net realized gains (losses) on securities available for sale 8,061 (14,503) (18,215) ----------- ----------- ----------- TOTAL NONINTEREST INCOME 2,189,555 1,970,969 1,785,492 NONINTEREST EXPENSE Salaries, wages, and employee benefits 4,604,915 4,231,828 4,057,708 Occupancy 686,661 578,818 556,906 Furniture and equipment 1,104,166 996,606 775,387 Other 2,399,910 2,520,620 2,462,235 ----------- ----------- ----------- TOTAL NONINTEREST EXPENSE 8,795,652 8,327,872 7,852,236 ----------- ----------- ----------- INCOME BEFORE FEDERAL INCOME TAXES 4,635,198 4,023,065 3,737,899 Federal income taxes -- Note E 1,295,000 1,065,000 936,000 ----------- ----------- ----------- NET INCOME $ 3,340,198 $ 2,958,065 $ 2,801,899 =========== =========== =========== Net income per share -- Note A $4.30 $3.85 $3.70 ===== ===== ===== </TABLE> See notes to consolidated financial statements. 30
31 CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> YEAR ENDED DECEMBER 31 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> OPERATING ACTIVITIES -- NOTE G Interest and fees collected on loans and investments $ 21,953,938 $ 19,555,643 $ 18,211,278 Other fees and income received 2,082,301 1,958,544 1,826,564 Interest paid (9,987,503) (8,898,078) (7,729,080) Cash paid to suppliers and employees (6,916,070) (8,252,915) (7,431,480) Federal income taxes paid (1,474,500) (1,134,961) (964,000) ------------ ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 5,658,166 3,228,233 3,913,282 INVESTING ACTIVITIES Proceeds from maturities and sales of securities available for sale 24,663,892 26,997,081 32,295,051 Proceeds from maturities of securities held to maturity 3,095,371 4,407,685 876,273 Purchase of securities available for sale (18,070,826) (24,944,425) (19,833,945) Purchase of securities held to maturity (4,893,051) (6,834,606) (6,178,383) Net increase in loans (29,585,909) (12,367,647) (19,576,020) Purchase of premises and equipment (1,333,825) (754,235) (939,222) ------------ ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES (26,124,348) (13,496,147) (13,356,246) FINANCING ACTIVITIES Net increase in noninterest bearing deposits 2,302,424 4,075,859 4,330,638 Net increase in interest bearing deposits 12,341,060 10,525,994 7,729,125 Cash dividends (1,189,141) (1,013,712) (943,469) Proceeds from issuance of common stock 432,356 369,211 319,228 ------------ ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 13,886,699 13,957,352 11,435,522 (DECREASE) INCREASE IN CASH AND ------------ ------------ ------------ CASH EQUIVALENTS (6,579,483) 3,689,438 1,992,558 Cash and cash equivalents at beginning of year 21,699,222 18,009,784 16,017,226 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS END OF YEAR $ 15,119,739 $ 21,699,222 $ 18,009,784 ============= ============ ============ </TABLE> See notes to consolidated financial statements. 31
32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION AND CONSOLIDATION: The consolidated financial statements include the accounts of IBT Bancorp (the "Corporation") and its wholly owned subsidiaries, Isabella Bank and Trust (the "Bank"), IBT Agency, and IBT Financial Services. All intercompany transactions and accounts have been eliminated. NATURE OF OPERATIONS: IBT Bancorp is a registered bank holding company offering a wide array of financial products and services in mid Michigan. Its principal subsidiary, Isabella Bank and Trust, offers banking services through 11 locations 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. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the real estate in the Bank's principal market area. 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, 24-hour banking services locally and nationally through shared automatic teller machines, safe deposit box rentals, credit life insurance, and direct deposits. Active competition, principally from other commercial banks, savings banks and credit unions, exists in all of the Bank's principal markets. The Corporation's results of operations can be signficantly affected by changes in interest rates or changes in the local economic environment. IBT Financial Services is a full service retail brokerage offering stocks, bonds, and mutual fund sales to individuals. IBT Agency, an insurance agency, is authorized to sell life insurance, casualty insurance, and fixed and variable rate annuities. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans 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 losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. CASH AND CASH EQUIVALENTS: For purposes of the statement of cash flows, the Corporation considers cash, demand deposits due from banks, and federal funds sold as cash and cash equivalents. SECURITIES HELD TO MATURITY AND AVAILABLE FOR SALE: 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, reported as a separate component of shareholders' equity. 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. 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 evaluation 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. 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. 32
33 A summary of premises and equipment at December 31 follows: 1996 1995 Premises $ 6,052,005 $ 5,537,872 Equipment 5,004,068 5,509,394 ----------- ----------- 11,056,073 11,047,266 Less accumulated depreciation 5,433,118 5,896,413 ----------- ----------- Net premises and equipment $ 5,622,955 $ 5,150,853 =========== =========== INTEREST ON LOANS: Interest on loans is credited to income based upon the principal outstanding. The accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest. Loans are placed on nonaccrual status whenever the collectibility of principal or interest is considered doubtful. MORTGAGE SERVICING RIGHTS: In 1996, the Corporation adopted Statement of Financial Accounting Standard (SFAS) No. 122, Accounting for Mortgage Servicing Rights. SFAS No. 122 provides for the recognition of originated mortgage servicing rights ("OMSR") retained for loans sold by allocating total costs incurred between the loan and the servicing rights based on their relative fair values. Previously, the value of OMSR was not recognized as an asset when the related loan was sold. 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. SFAS No. 122 requires the establishment of a valuation allowance for the excess of book value of the capitalized MSR over 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. FEDERAL INCOME TAXES: Federal income taxes have been provided based on amounts reported in the statement of income (after the exclusion of nontaxable interest income) and include deferred federal income taxes on temporary differences between financial statement and income tax reporting. The Corporation and its subsidiaries file a consolidated federal income tax return on a calendar year basis. PER SHARE AMOUNTS: Net income per share amounts were computed by dividing net income by the weighted average number of shares outstanding. All per share amounts have been adjusted for the 10% stock dividend paid on March 15, 1996. The weighted average number of common shares outstanding were 777,619 in 1996, 767,878 in 1995; and 757,918 in 1994. NOTE B - 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 31,1996: Securities available for sale: U.S. Treasury and U.S. government agencies $37,759,549 $220,941 ($75,904) $37,904,586 States and political subdivisions 12,540,435 73,763 (35,204) 12,578,994 ----------- -------- --------- ----------- TOTAL $50,299,984 $294,704 ($111,108) $50,483,580 =========== ======== ========= =========== Securities held to maturity: U.S. Treasury and U.S. government agencies $ 4,163,442 $ 23,040 ($29,484) $ 4,156,998 States and political subdivisions 3,963,050 23,241 (3,065) 3,983,226 Other securities 1,368,801 1,368,801 ----------- -------- --------- ----------- TOTAL $ 9,495,293 $ 46,281 ($32,549) $ 9,509,025 =========== ======== ========= =========== </TABLE> 33
34 NOTE B (CONTINUED) <TABLE> <CAPTION> Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ----- <S> <C> <C> <C> <C> December 31, 1995: Securities available for sale: U.S. Treasury and U.S. government agencies $43,137,308 $619,228 ($33,583) $43,722,953 States and political subdivisions 12,712,422 188,389 (2,551) 12,898,260 ----------- -------- -------- ----------- TOTAL $55,849,730 $807,617 ($36,134) $56,621,213 =========== ======== ======== =========== Securities held to maturity: U.S. Treasury and U.S. government agencies $ 3,851,725 $ 49,936 ($188) $ 3,901,473 States and political subdivisions 4,796,496 31,665 (7,098) 4,821,063 Other securities 336,201 336,201 ----------- -------- -------- ----------- TOTAL $ 8,984,422 $ 81,601 $ (7,286) $ 9,058,737 =========== ======== ======== =========== </TABLE> The following table summarizes the fair value, realized gains, and realized losses on sales of securities available for sale: <TABLE> <CAPTION> 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Fair value of securities sold at the date of sale: $4,973,892 $3,970,078 $4,992,000 Gross realized gains: U.S. Treasury and U.S. government agencies 8,850 1,118 5,924 Gross realized losses: U.S. Treasury and U.S. government agencies 789 15,621 24,139 </TABLE> The following table shows the amortized cost and estimated fair value of securities owned at December 31, 1996 by contractual maturity. Expected maturities will differ from contractual maturities because the issuers of securities may have the right to prepay obligations without prepayment penalties. <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 $17,300,352 $17,333,727 $2,160,000 $2,162,973 Due after 1 year thru 5 years 28,438,193 28,595,333 561,979 567,781 Due after 5 years thru 10 years 1,704,892 1,706,084 1,241,071 1,252,472 Due after 10 years 1,368,801 1,368,801 ----------- ----------- ---------- ---------- 47,443,437 47,635,144 5,331,851 5,352,027 Mortgage backed securities 2,856,547 2,848,436 4,163,442 4,156,998 ----------- ----------- ---------- ---------- TOTAL $50,299,984 $50,483,580 $9,495,293 $9,509,025 =========== =========== ========== ========== </TABLE> Investment securities with a carrying value of approximately $4,019,000 and $2,712,000 were pledged to secure public deposits and for other purposes as necessary or required by law at December 31, 1996 and 1995, respectively. 34
35 NOTE C - LOANS An analysis of changes in the allowance for loan losses follows: 1996 1995 1994 ---- ---- ---- Balance at beginning of year $2,248,184 $2,083,216 $1,854,163 Loans charged off (375,561) (498,922) (560,809) Recoveries 247,947 188,890 314,862 Provision charged to income 500,000 475,000 475,000 ---------- ---------- ---------- BALANCE AT END OF YEAR $2,620,570 $2,248,184 $2,083,216 ========== ========== ========== The following table summarizes loans considered impaired under SFAS No. 114: <TABLE> <CAPTION> December 31 1996 1995 ---- ---- <S> <C> <C> Impaired loans which, as a result of charge-offs, do not have a specific allowance for loan loss $107,000 $221,000 Average investment in impaired loans 153,000 858,000 Interest income recognized on average impaired loans using cash basis method of income recognition 35,000 12,000 Loans classified as impaired and recorded on a nonaccrual basis 262,000 Impaired loans for which a specific allowance for loan loss has been allocated 41,000 Specific allowance for loan losses that have been allocated to impaired loan 5,000 </TABLE> Certain directors and executive officers (including their families and companies in which they have 10% or more ownership) of the Corporation and the Bank were loan customers of the Bank. Total loans to these customers aggregated $5,400,000 and $5,550,000 at December 31, 1996 and 1995, respectively. During 1996, $3,523,000 of new loans were made and repayments totalled $3,673,000. All such loans and commitments were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions and in the opinion of management do not involve more than normal risk of collectibility. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgages serviced for others was $48,744,000 at December 31, 1996. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and taxing authorities, and foreclosure processing. Loan servicing income is accounted for under the provisions of SFAS No. 122. Mortgage servicing rights of $35,000 were capitalized in 1996. The fair value of these rights was $27,000 at December 31, 1996 after amortization of $1,000 and recording a $7,000 impairment valuation allowance. Residential mortgages committed for sale were $906,000 as of December 31, 1996 and $285,000 as of December 31, 1995. NOTE D - FAIR VALUE OF FINANCIAL INSTRUMENTS The Corporation utilized 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 techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates 35
36 NOTE D - CONTINUED 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 sheet for cash and 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 Bank does not charge fees for lending commitments, thus it is not practicable to estimate the fair value of these instruments. The following sets forth the estimated fair value and recorded book balance of the Corporation's financial instruments as of December 31. <TABLE> <CAPTION> 1996 1995 ---- ---- Estimated Fair Recorded Book Estimated Fair Recorded Book Value Balance Value Balance -------------- ------------- -------------- ------------- <S> <C> <C> <C> <C> Cash and due from banks $ 11,944,739 $ 11,944,739 $ 15,299,222 $ 15,299,222 Federal funds sold 3,175,000 3,175,000 6,400,000 6,400,000 Investment securities 59,992,605 59,978,873 65,679,950 65,605,635 Net Loans 216,668,376 212,833,853 189,038,657 183,747,944 Accrued interest receivable 2,059,236 2,059,236 2,075,387 2,075,387 Deposits with no stated maturities 149,750,963 149,750,963 145,210,153 145,210,153 Deposits with stated maturities 117,583,681 117,897,564 107,331,341 107,794,890 Accrued interest payable 593,065 593,065 623,293 623,923 </TABLE> 36
37 NOTE E - 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> 1996 1995 ---- --- <S> <C> <C> Deferred tax assets: Allowance for loan losses $ 644,000 $ 526,000 Deferred directors fees 293,000 242,000 Employee benefit plans 254,000 265,000 Other 11,000 1,000 ---------- ---------- TOTAL DEFERRED TAX ASSETS 1,202,000 1,034,000 Deferred tax liabilities: Tax over book depreciation 142,000 159,000 Accretion on securities 112,000 91,000 Prepaid pension expense 206,000 166,000 Net unrealized gain on available for sale securities 62,000 262,000 Other 9,000 15,000 ---------- ---------- TOTAL DEFERRED TAX LIABILITIES 531,000 693,000 ---------- ---------- NET DEFERRED TAX ASSETS $ 671,000 $ 341,000 ========== ========== </TABLE> Components of the consolidated provision for income taxes are as follows: <TABLE> <CAPTION> 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Current $1,425,000 $1,162,000 $ 984,000 Deferred credit (130,000) (97,000) (48,000) ---------- ---------- ---------- PROVISION FOR INCOME TAXES $1,295,000 $1,065,000 $ 936,000 ========== ========== ========== </TABLE> The reconciliation of federal income tax and the amount computed at the federal statutory tax rate of 34% to income before federal income tax expense is as follows: <TABLE> <CAPTION> 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Income tax on pretax income $1,576,000 $1,368,000 $1,271,000 Effect of nontaxable interest income (334,000) (317,000) (324,000) Other 53,000 14,000 (11,000) ---------- ---------- ---------- PROVISION FOR INCOME TAXES $1,295,000 $1,065,000 $ 936,000 ========== ========== ========== </TABLE> The income tax effects on securities gains or (losses) were $3,000 in 1996, ($5,000) in 1995, and ($6,000) in 1994. 37
38 NOTE F - BENEFIT PLANS The Bank has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee's average compensation over their last 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 service to date but also for those expected to be earned in the future. The defined pension plan's assets are primarily invested in mutual funds. Defined benefit pension plan costs included the following components: <TABLE> <CAPTION> 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Service cost - benefits earned during the year $ 110,000 $ 83,000 $ 106,000 Interest cost on projected benefit obligation 263,000 235,000 228,000 Actual return on plan assets (229,000) (218,000) 24,000 Net amortization and deferral 17,000 7,000 (222,000) -------- --------- --------- Net periodic pension cost of defined benefit plan $ 161,000 $ 107,000 $ 136,000 ========= ========= ========= </TABLE> The following table sets forth the defined benefit pension plan funding status and a reconciliation to the amounts recognized in the Corporation's consolidated balance sheets at December 31: <TABLE> <CAPTION> 1996 1995 ---- ---- <S> <C> <C> Actuarial present value of benefit obligations: Vested benefits $3,085,000 $2,924,000 Nonvested benefits 18,000 11,000 ---------- ---------- Accumulated benefit obligation 3,103,000 2,935,000 Effect of projected future compensation levels 710,000 628,000 ---------- ---------- Projected benefit obligation for services rendered 3,813,000 3,563,000 Plan assets at fair value 3,409,000 3,060,000 ---------- ---------- Plan assets under projected benefit obligation (404,000) (503,000) Unrecognized cost related to plan amendment (prior service cost) 215,000 195,000 Unrecognized net loss from past experience different from that assumed and the effect of changes in assumptions 951,000 972,000 Unrecognized net transition asset being recognized over 17 years (155,000) (177,000) ---------- ---------- Prepaid pension cost included in other assets $ 607,000 $ 487,000 ========== ========== </TABLE> 38
39 NOTE F - BENEFIT PLANS (CONTINUED) Actuarial assumptions used in determining the projected benefit obligation and the net periodic pension cost: <TABLE> <CAPTION> 1996 1995 1994 ---- ---- ---- <C> <C> <C> <C> Weighted average discount rate 7.50% 7.25% 8.50% 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 Bank maintains a nonqualified supplementary retirement plan for officers to provide supplemental retirement benefits and preretirement death benefits to each participant. Insurance policies, designed primarily to fund preretirement benefits, have been purchased on the life of each participant with the Bank as the sole owner and beneficiary of the policies. Expenses related to this program are being recognized over the participants' expected years of service. The Bank maintains an employee stock ownership plan (ESOP) which covers substantially all of its employees. Contributions to the Plan are discretionary and are approved by the Board of Directors and recorded as compensation expense. Compensation expense related to this Plan for 1996, 1995 and 1994 was $70,000, $85,000 and $80,000 respectively. Total shares outstanding at December 31, 1996 and 1995 were 49,034 and 44,491 respectively, and were included in the computation of dividends and earnings per share in each of the respective years. NOTE G - CONSOLIDATED STATEMENTS OF CASH FLOWS The reconciliation of net income to net cash provided by operating activities is as follows: <TABLE> <CAPTION> Year Ended December 31 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Net Income $3,340,198 $2,958,065 $2,801,899 Reconcilement of net income to cash provided by operations: Provision for loan losses 500,000 475,000 475,000 Provision for depreciation 861,723 719,073 543,026 Net amortization on investment securities 243,488 20,137 171,486 Deferred income tax benefit (130,000) (97,000) (48,000) Decrease (increase) in: Accrued income receivable 16,151 (315,597) 49,487 Other assets 429,217 (950,365) (164,717) Increase in accrued interest and other liabilities 397,389 418,920 85,101 ---------- ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES $5,658,166 $3,228,233 $3,913,282 ========== ========== ========== </TABLE> 39
40 NOTE H - 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 statements of financial position. 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 totalled $26,165,000 at December 31, 1996, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have 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, 1996, the Corporation had a total of $185,000 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 I - COMMITMENTS AND OTHER MATTERS There were no material noncancelable lease commitments outstanding at December 31, 1996. Included in other expenses are FDIC insurance premiums of approximately $2,000 in 1996, $272,000 in 1995, and $502,000 in 1994. Banking regulations require banks to maintain cash reserve balances in currency or as deposits with the Federal Reserve Bank. The Bank's requirement was approximately $3,800,000 at December 31, 1996 and $3,446,000 at December 31, 1995. Banking regulations also limit the transfer of assets in the form of dividends, loans, or advances from the Bank to the Corporation. At December 31, 1996, substantially all of the Bank's 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's retained net income plus retained net income for the preceding two years, less any required transfers to capital surplus. At January 1, 1997, the amount available for dividends without regulatory approval was approximately $2,540,000. The Corporation maintains a self-funded medical plan under which the Corporation is responsible for the first $30,000 per year of claims made by a covered individual and a maximum of $397,000. Claims in excess of these amounts are insured through an "excess loss" policy up to $1,000,000. Medical claims are subject to a lifetime maximum of $2,000,000 per covered individual. Certain directors and executive officers (including their families and companies in which they have 10% or more ownership) of the Corporation and the Bank were deposit customers of the Bank. Total deposits of these customers' aggregated approximately $3,701,000 at December 31, 1996. 40
41 NOTE J - REGULATORY CAPITAL MATTERS The Bank is subject to various regulatory capital requirements administered by its 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 Bank's financial statements. Under the Federal Reserve's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that include quantitative measures of the Bank's assets, certain off-balance sheet items, and capital, as calculated under regulatory accounting standards. The Bank's required capital is also subject to regulatory qualitative judgement regarding the Bank's interest rate risk exposure and credit risk. Measurements established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of capital to average assets, Tier 1 capital to risk weighted assets, and Tier 1 capital to average assets. Management believes, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 1996, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized. To be categorized as well capitalized, the Bank must maintain total risk based capital, Tier 1 risk based, and Tier 1 leverage ratio as set forth in the following table. There has been no condition or event since that notification that management believes has changed the institution's category. The Bank's actual capital amounts and ratios are also presented in the table (in thousands). <TABLE> <CAPTION> To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions ------ ----------------- ----------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> As of December 31, 1996: Total capital (to risk weighted assets) $28,485 15.62% $14,592 >8.0% $18,240 >10.0% Tier 1 capital (to risk weighted assets) 26,199 14.55 7,204 >4.0 10,807 > 6.0 Tier 1 capital (to average assets) 26,199 9.06 11,565 >4.0 14,456 > 5.0 </TABLE> 41
42 NOTE K - PARENT COMPANY ONLY FINANCIAL INFORMATION CONDENSED BALANCE SHEET 1996 1995 ---- ---- ASSETS Cash on deposit at subsidiary bank $ 1,464,287 $ 932,225 Investments in subsidiaries 26,405,285 24,705,266 Premises and equipment 133,730 158,710 Other assets 3,114 10,808 ----------- ----------- TOTAL ASSETS $28,006,416 $25,807,009 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Other liabilities $ 6,000 $ 2,000 Shareholders' equity 28,000,416 25,805,009 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $28,006,416 $25,807,009 =========== =========== CONDENSED STATEMENTS OF INCOME <TABLE> <CAPTION> Year Ended December 31 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> Income Dividends from subsidiary $1,400,000 $1,200,000 $ 950,000 Interest income 31,962 16,364 11,735 Other 6,000 6,000 6,000 ---------- ---------- ---------- TOTAL INCOME 1,437,962 1,222,364 967,735 Expenses 186,789 176,210 149,699 ---------- ---------- ---------- Income before income tax benefit and equity in undistributed earnings of subsidiary 1,251,173 1,046,154 818,036 Federal income tax benefit (51,000) (52,000) (44,000) ---------- ---------- ---------- 1,302,173 1,098,154 862,036 Undistributed earnings of subsidiaries 2,038,025 1,859,911 1,939,863 ---------- ---------- ---------- NET INCOME $3,340,198 $2,958,065 $2,801,899 ========== ========== ========== CONDENSED STATEMENTS OF CASH FLOWS <CAPTION> Year Ended December 31 1996 1995 1994 ---- ---- ---- <S> <C> <C> <C> OPERATING ACTIVITIES Interest on investments $ 32,027 $ 16,063 $ 11,735 Dividends from subsidiary 1,400,000 1,200,000 950,000 Cash paid to suppliers (144,180) (137,862) (176,566) Other operating activities 51,000 52,000 34,000 ---------- ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,338,847 1,130,201 819,169 INVESTING ACTIVITIES Investment in IBT Financial Services (50,000) (150,000) Purchase of equipment and premises (732) ( 15,420) ---------- ---------- ---------- NET CASH USED IN INVESTING ACTIVITIES (50,000) (150,732) (15,420) FINANCING ACTIVITIES Cash dividends (1,189,141) (1,013,712) (943,469) Issuance of common stock 432,356 369,211 319,228 ---------- ---------- ---------- NET CASH USED IN FINANCING ACTIVITIES (756,785) (644,501) (624,241) ---------- ---------- ---------- INCREASE IN CASH AND CASH EQUIVALENTS 532,062 334,968 179,508 Cash and cash equivalents at beginning of year 932,225 597,257 417,749 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT YEAR END $1,464,287 $ 932,225 $ 597,257 ========== ========== ========== </TABLE> 42
43 ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None PART III Part III incorporated by reference from the Corporation's Definitive Proxy Statement pursuant to instruction G(3). The Corporation will file with the SEC a definitive Proxy Statement pursuant to Schedule 14A involving the election of directors no later than 120 days after the close of the calendar year (April 30, 1997). PART IV ITEM 14. 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: Reports of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Income Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 2. Financial Statement Schedules: All schedules are omitted because they are neither applicable nor required, or because the required information is either included in the consolidated financial statements or related notes. 3. Exhibits: 3(a) Amended Articles of Incorporation* 3(b) Amendment to the Articles of Incorporation*** 3(c) Amended Bylaws* 3(d) Amendment to the Bylaws** 3(e) Amendment to the Bylaws*** 10(a) Isabella Bank & Trust Executive Supplemental Income Agreement***(1) 10(b) Isabella Bank & Trust Deferred Compensation Plan****(1) 21 Subsidiaries of the Registrant 43
44 ITEM 14 (CONTINUED) 23(a) Consent of Rehmann Robson, P.C., Independent Certified Public Accountants 23(b) Consent of Andrews, Hooper & Pavlik, P.L.C., Independent Certified Public Accountants 27 Financial Data Schedule (b) No reports on Form 8-K were filed for the quarter ended December 31, 1996. (c) The index to exhibits is on page 44 of this report. (d) There are no financial statement schedules filed with this report. * Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 12, 1991, and incorporated herein by reference. ** Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 13, 1990, and incorporated herein by reference. *** Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 26, 1994, and incorporated herein by reference. **** Previously filed as an Exhibit to IBT Bancorp, Inc. Form 10-K, dated March 26, 1996, and incorporated herein. (1) Management's Contract or Compensatory Plan or Arrangement. 44
45 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/David W. Hole Date: March 5, 1997 ------------------------------ David W. Hole President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Capacity Date ---------- -------- ---- /s/ L. A. Johns Chairman of the Board March 5, 1997 - ---------------------------------- and Director L. A. Johns /s/ James R. Bigard Director March 5, 1997 - ---------------------------------- James R. Bigard /s/ Frederick L. Bradford Director March 5, 1997 - ---------------------------------- Frederick L. Bradford /s/ Gerald D. Cassel Director March 5, 1997 - ---------------------------------- Gerald D. Cassel /s/ James C. Fabiano Director March 5, 1997 - ---------------------------------- James C. Fabiano /s/ Ronald E. Schumacher Director March 5, 1997 - ---------------------------------- Ronald E. Schumacher 45
46 Signatures Capacity Date ---------- -------- ---- /s/ Robert O. Smith Director March 5, 1997 - ---------------------------------- Robert O. Smith /s/ Dean Walldorff Director March 5, 1997 - ---------------------------------- Dean Walldorff /s/ David W. Hole President March 5, 1997 - ---------------------------------- Chief Executive Officer David W. Hole and Director (Principal Executive Officer) /s/ Dennis P. Angner Treasurer March 5, 1997 - ---------------------------------- (Principal Financial Officer) Dennis P. Angner 46
47 IBT Bancorp FORM 10-K Index to Exhibits Exhibit Form 10-K Number Exhibit Page Number - ------- ------- ----------- 21 Subsidiaries of the Registrant 48 23(a) Consent of Rehmann Robson P.C. 49 Independent Certified Public Accountants 23(b) Consent of Andrews, Hooper & Pavlik, P.L.C. 50 Independent Certified Public Accountants 27 Financial Data Schedule 51 47