UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended September 30, 2006 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) <TABLE> <S> <C> Michigan 38-2830092 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) identification No.) </TABLE> <TABLE> <S> <C> 200 East Broadway, Mt. Pleasant, MI 48858 (Address of principal executive offices) (Zip code) </TABLE> (989) 772-9471 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report) 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 whether the registrant is a large accelerated filer, an accelerated file, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check One). Large accelerated filer [ ] Accelerated Filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock no par value, 6,307,881 as of October 18, 2006 1
IBT BANCORP, INC. Index to Form 10-Q <TABLE> <CAPTION> Page Numbers ------------ <S> <C> PART I FINANCIAL INFORMATION Item 1 Condensed Consolidated Financial Statements 3-11 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 11-21 Item 3 Quantitative and Qualitative Disclosures About Market Risk 22-23 Item 4 Controls and Procedures 24 PART II OTHER INFORMATION Item 1A Risk Factors 25 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 25 Item 6 Exhibits 26 Signatures 27 Exhibit 31(a) 29 Exhibit 31(b) 30 Exhibit 32 31 </TABLE> 2
PART I - FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS IBT BANCORP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> September 30 December 31 (dollars in thousands) 2006 2005 ------------ ----------- <S> <C> <C> ASSETS Cash and demand deposits due from banks $ 25,693 $ 30,825 Securities available for sale (amortized cost of $194,833 in 2006 and $185,688 in 2005) 193,268 183,406 Mortgage loans available for sale 656 744 Loans Agricultural 49,640 49,424 Commercial 206,149 179,541 Personal 26,947 28,026 Residential real estate mortgage 240,411 226,251 -------- -------- TOTAL LOANS 523,147 483,242 Less allowance for loan losses 7,129 6,899 -------- -------- NET LOANS 516,018 476,343 Other assets 53,537 50,336 -------- -------- TOTAL ASSETS $789,172 $741,654 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest bearing $ 74,031 $ 73,839 NOW accounts 101,511 104,251 Certificates of deposit and other savings 332,738 328,780 Certificates of deposit over $100,000 124,872 85,608 -------- -------- TOTAL DEPOSITS 633,152 592,478 Other borrowed funds 58,515 52,165 Escrow funds payable 5,692 9,823 Accrued interest and other liabilities 5,330 6,286 -------- -------- TOTAL LIABILITIES 702,689 660,752 Shareholders' Equity Common stock -- no par value 10,000,000 shares authorized; outstanding -- 5,510,418 in 2006 (4,974,715 in 2005) 83,070 72,296 Retained earnings 4,446 10,112 Accumulated other comprehensive loss (1,033) (1,506) -------- -------- TOTAL SHAREHOLDERS' EQUITY 86,483 80,902 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $789,172 $741,654 ======== ======== </TABLE> See notes to condensed consolidated financial statements. 3
IBT BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended September 30 ----------------------- (dollars in thousands) 2006 2005 ---------- ---------- <S> <C> <C> NUMBER OF SHARES OF COMMON STOCK OUTSTANDING Balance at beginning of period 4,974,715 4,896,412 10% common stock dividend 497,299 -- Issuance of common stock 38,404 32,820 ---------- ---------- BALANCE END OF PERIOD 5,510,418 4,929,232 ========== ========== COMMON STOCK Balance at beginning of period $ 72,296 $ 66,908 10% common stock dividend 8,887 -- Issuance of common stock 1,537 1,172 Share-based payment awards under equity compensation plan 350 -- ---------- ---------- BALANCE END OF PERIOD 83,070 68,080 RETAINED EARNINGS Balance at beginning of period 10,112 6,590 Net income 5,039 4,852 10% common stock dividend (8,887) -- Cash dividends ($0.33 per share in 2006 and $0.30 in 2005) (1,818) (1,622) ---------- ---------- BALANCE END OF PERIOD 4,446 9,820 ACCUMULATED OTHER COMPREHENSIVE LOSS Balance at beginning of period (1,506) (904) Other comprehensive income (loss) 473 (989) ---------- ---------- BALANCE END OF PERIOD (1,033) (1,893) ---------- ---------- TOTAL SHAREHOLDERS' EQUITY END OF PERIOD $ 86,483 $ 76,007 ========== ========== </TABLE> See notes to condensed consolidated financial statements. 4
IBT BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- (dollars in thousands) 2006 2005 2006 2005 ------- ------ ------- ------- <S> <C> <C> <C> <C> INTEREST INCOME Loans, including fees $ 9,269 $7,872 $26,129 $22,495 Investment securities Taxable 1,252 864 3,572 2,547 Nontaxable 693 599 2,018 1,774 Federal funds sold and other 98 104 236 234 ------- ------ ------- ------- TOTAL INTEREST INCOME 11,312 9,439 31,955 27,050 INTEREST EXPENSE Deposits 4,425 3,001 11,874 8,172 Borrowings 739 424 1,878 1,082 ------- ------ ------- ------- TOTAL INTEREST EXPENSE 5,164 3,425 13,752 9,254 ------- ------ ------- ------- NET INTEREST INCOME 6,148 6,014 18,203 17,796 Provision for loan losses 245 196 628 515 ------- ------ ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,903 5,818 17,575 17,281 NONINTEREST INCOME Trust fees 217 231 648 613 Service charges on deposit accounts 76 67 228 184 Other service charges and fees 1,138 1,041 3,175 2,803 Gain on sale of mortgage loans 53 60 164 196 Title insurance revenue 679 698 1,826 1,793 Other 243 231 702 695 ------- ------ ------- ------- TOTAL NONINTEREST INCOME 2,406 2,328 6,743 6,284 NONINTEREST EXPENSES Compensation 3,148 3,451 10,161 10,202 Occupancy 457 415 1,325 1,210 Furniture and equipment 677 666 2,113 1,977 Other 1,377 1,359 4,337 3,981 ------- ------ ------- ------- TOTAL NONINTEREST EXPENSES 5,659 5,891 17,936 17,370 INCOME BEFORE FEDERAL INCOME TAXES 2,650 2,255 6,382 6,195 Federal income taxes 619 511 1,343 1,343 ------- ------ ------- ------- NET INCOME $ 2,031 $1,744 $ 5,039 $ 4,852 ======= ====== ======= ======= EARNINGS PER SHARE Basic $ 0.37 $ 0.32 $ 0.92 $ 0.90 ======= ====== ======= ======= Diluted $ 0.36 $ 0.32 $ 0.89 $ 0.90 ======= ====== ======= ======= Cash dividends per share $ 0.11 $ 0.10 $ 0.33 $ 0.30 ======= ====== ======= ======= </TABLE> See notes to condensed consolidated financial statements. 5
IBT BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- (dollars in thousands) 2006 2005 2006 2005 ------ ------ ------ ------- <S> <C> <C> <C> <C> NET INCOME $2,031 $1,744 $5,039 $ 4,852 Other comprehensive income (loss) before income taxes: Unrealized holding gains (losses) on available-for-sale investment securities arising during the period 2,067 (857) 608 (1,498) Reclassification adjustment for net realized losses (gains) included in net income 6 -- 109 (2) ------ ------ ------ ------- Other comprehensive (loss) income before income taxes 2,073 (857) 717 (1,500) Income tax (expense) benefit related to other comprehensive income (loss) (705) 293 (244) 511 ------ ------ ------ ------- OTHER COMPREHENSIVE INCOME (LOSS) 1,368 (564) 473 (989) ------ ------ ------ ------- COMPREHENSIVE INCOME $3,399 $1,180 $5,512 $ 3,863 ====== ====== ====== ======= </TABLE> See notes to condensed consolidated financial statements. 6
IBT BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended September 30 ----------------------- (dollars in thousands) 2006 2005 ------------ -------- <S> <C> <C> OPERATING ACTIVITIES Net income $ 5,039 4,852 Reconciliation of net income to net cash provided by operations: Provision for loan losses 628 515 Depreciation 1,375 1,298 Net amortization of investment securities 572 739 Realized loss (gain) on sale of investment securities 109 (2) Amortization and impairment of mortgage servicing rights 141 110 Increase in cash value of life insurance (305) (271) Amortization of acquisition intangibles 70 70 Equity shares granted 350 -- Changes in operating assets and liabilities which provided (used)cash Mortgage loans available for sale 88 502 Interest receivable (682) (332) Other assets (737) (710) Escrow funds payable (4,131) 3,619 Accrued interest and other liabilities (956) 1,322 -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,561 11,712 INVESTING ACTIVITIES Activity in available-for-sale securities Maturities, calls, and sales 36,182 28,947 Purchases (46,008) (41,951) Net increase in loans (40,303) (26,079) Purchases of premises and equipment (2,183) (1,519) Purchases of corporate owned life insurance policies (499) -- Acquisition of title office (400) -- -------- -------- NET CASH USED IN INVESTING ACTIVITIES (53,211) (40,602) FINANCING ACTIVITIES Net increase in noninterest bearing deposits 192 4,805 Net increase in interest bearing deposits 40,482 12,087 Net increase in other borrowed funds 6,350 16,800 Cash dividends paid on common stock (1,818) (1,622) Proceeds from issuance of common stock 1,312 1,172 -------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES 46,518 33,242 -------- -------- (DECREASE) INCREASE IN CASH AND CASH EQUIVELANTS (5,132) 4,352 Cash and cash equivelants at beginning of period 30,825 20,760 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 25,693 $ 25,112 ======== ======== </TABLE> See notes to condensed consolidated financial statements. 7
IBT BANCORP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation's annual report for the year ended December 31, 2005. All amounts other than share and per share amounts have been rounded to the nearest thousand ($000) in this report. NOTE 2 - IMPLEMENTATION OF NEW ACCOUNTING STANDARD On January 1, 2006, the Corporation adopted Statement of Financial Accounting Standards No. 123R (revised 2004), "Share-Based Payment" (SFAS No. 123R) issued by the Financial Accounting Standards Board (FASB). This statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity instruments issued. The adoption of this standard decreased dilutive earnings per share by $.01 and $.03 for the three month and nine month periods ended September 30, 2006, respectively. NOTE 3 - COMPUTATION OF EARNINGS PER SHARE Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding shares in the Corporation's Deferred Director fee plan. Earnings per common share have been computed based on the following: <TABLE> <CAPTION> Three months ended Nine months ended September 30 September 30 --------------------- --------------------- 2006 2005 2006 2005 --------- --------- --------- --------- <S> <C> <C> <C> <C> Average number of common shares outstanding* 5,503,044 5,414,567 5,491,180 5,405,979 Effect of shares in the Deferred Director fee plan* 166,278 -- 163,179 -- --------- --------- --------- --------- Average number of common shares outstanding used to calculate diluted earnings per common share 5,669,322 5,414,567 5,654,359 5,405,979 ========= ========= ========= ========= </TABLE> * As adjusted for the 10% stock dividend paid February 15, 2006 8
NOTE 4 - OPERATING SEGMENTS The Corporation's reportable segments are based on legal entities that account for at least 10% of operating results. The accounting policies are the same as those discussed in Note 1 to the Consolidated Financial Statements in the Corporation's annual report for the year ended December 31, 2005. The Corporation evaluates performance based principally on net income and asset quality of the respective segments. Summaries of selected financial information for the Corporation's reportable segments as of and for the three and nine month periods ended September 30 follow: (dollars in thousands) <TABLE> <CAPTION> All Others Isabella Bank Farmers (Including Three Months Ended and Trust State Bank Parent) Total ------------- ---------- ---------- -------- <S> <C> <C> <C> <C> SEPTEMBER 30, 2006 Total assets $631,429 $140,405 $ 17,338 $789,172 Interest income 9,055 2,251 6 11,312 Net interest income 4,789 1,297 62 6,148 Provision for loan losses 196 49 -- 245 Net income (loss) 1,714 420 (103) 2,031 SEPTEMBER 30, 2005 Total assets 574,047 132,396 13,637 720,080 Interest income 7,367 2,052 20 9,439 Net interest income 4,623 1,351 40 6,014 Provision for loan losses 146 50 -- 196 Net income (loss) 1,479 340 (75) 1,744 </TABLE> <TABLE> <CAPTION> All Others Isabella Bank Farmers (Including Nine Months Ended and Trust State Bank Parent) Total ------------- ---------- ---------- -------- <S> <C> <C> <C> <C> SEPTEMBER 30, 2006 Total assets $631,429 $140,405 $ 17,338 $789,172 Interest income 25,363 6,526 66 31,955 Net interest income 14,065 3,953 185 18,203 Provision for loan losses 483 145 -- 628 Net income (loss) 4,624 1,141 (726) 5,039 SEPTEMBER 30, 2005 Total assets 574,047 132,396 13,637 720,080 Interest income 21,138 5,842 70 27,050 Net interest income 13,726 3,949 121 17,796 Provision for loan losses 375 140 -- 515 Net income (loss) 4,206 1,043 (397) 4,852 </TABLE> 9
NOTE 5 - DEFINED BENEFIT PENSION PLAN The Corporation has a defined benefit pension plan covering substantially all of its employees. Benefits are based on years of service and the employees' five highest consecutive years of compensation out of the last ten years of service. The funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to services to date but also for those expected to be earned in the future. The Corporation used a January 1, 2006 measurement date for this pension plan. The components of net periodic benefit cost related to the Corporation's administered plan for the three and nine-month period ended September 30 were as follows: <TABLE> <CAPTION> Pension Benefits -------------------------------------- Three months ended Nine months ended September 30 September 30 ------------------ ----------------- 2006 2005 2006 2005 ----- ----- ----- ----- (thousands) <S> <C> <C> <C> <C> Components of net periodic benefit cost Service cost $ 159 $ 137 $ 478 $ 410 Interest cost 152 135 455 405 Expected return on plan assets (139) (116) (416) (348) Amortization of prior service cost 5 5 14 14 Amortization of net actuarial loss 58 50 174 151 ----- ----- ----- ----- Net periodic benefit cost $ 235 $ 211 $ 705 $ 632 ===== ===== ===== ===== </TABLE> The Corporation contributed $1,128 and $545 to the pension plan during the nine month periods ended September 30, 2006 and 2005, respectively. The Corporation does not expect to make additional contributions to the plan during the remainder of 2006. NOTE 6 - SUBSEQUENT EVENT On October 3, 2006, The Farwell State Savings Bank (FSSB) was acquired and merged with and into Farmers State Bank, a wholly-owned subsidiary of the Corporation. Under the terms of the Merger Agreement, for each share of FSSB common stock, the shareholder of FSSB received 3.0382 shares of IBT Bancorp common stock and $29.00 in cash. The Corporation issued an aggregate of 797,475 shares of IBT common stock valued at $30,448 and paid a total of $7,612 in cash to FSSB shareholders, resulting in total consideration of $38,060. NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Corporation is currently assessing the impact of SFAS No. 157 on its consolidated financial position and results of operations. In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158). SFAS No. 158 requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. SFAS No. 158 also requires additional disclosures in the notes to financial statements. SFAS No. 158 is effective for years ending after December 15, 2006. While the Corporation is currently assessing the impact of SFAS No. 158 on its consolidated financial statements for 2006, it is expected that adoption will not impact results of operations or cash flows, but will likely result in a decrease to net financial position by an amount that will likely not be material to other comprehensive loss. 10
In September 2006, the SEC staff issued Staff Accounting Bulletin ("SAB") 108 "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 requires that public companies utilize a "dual-approach" in assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Corporation is currently assessing the impact of adopting SAB 108 but does not expect that it will have a material effect on its consolidated financial position or results of operations. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of the major factors that influenced IBT Bancorp's financial performance. This analysis should be read in conjunction with the Corporation's 2005 annual report and with the unaudited condensed consolidated financial statements and notes, as set forth on pages 3 through 10 of this report. CRITICAL ACCOUNTING POLICIES: A summary of the Corporation's significant accounting policies is set forth in Note 1 of the Consolidated Financial Statements included in the Corporation's Annual Report for the year ended December 31, 2005. Of these significant accounting policies, the Corporation considers its policies regarding the allowance for loan losses to be its most critical accounting policies. The allowance for loan losses requires management's most subjective and complex judgment. Changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Corporation has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Corporation's assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers which is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Corporation's allowance for loan losses and related matters, see Provision for Loan Losses and Allowance for Loan Losses in the Corporation's 2005 Annual Report and herein. 11
RESULTS OF OPERATIONS The following table outlines the results of operations for the periods ended September 30, 2006 and 2005. Return on average assets measures the ability of the Corporation to profitably and efficiently employ its resources. Return on average equity indicates how effectively the Corporation is able to generate earnings on shareholder invested capital. SUMMARY OF SELECTED FINANCIAL DATA (Dollars in thousands except per share data) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- 2006 2005 2006 2005 ------ ------ ------- ------- <S> <C> <C> <C> <C> INCOME STATEMENT DATA Net interest income $6,148 $6,014 $18,203 $17,796 Provision for loan losses 245 196 628 515 Net income 2,031 1,744 5,039 4,852 PER SHARE DATA Earnings per share Basic $ 0.37 $ 0.32 $ 0.92 $ 0.90 Diluted 0.36 0.32 0.89 0.90 Cash dividends per common share 0.11 0.10 0.33 0.30 RATIOS Average primary capital to average assets 11.67% 11.18% 11.69% 11.46% Net income to average assets 1.03 0.99 0.88 0.93 Net income to average equity 9.51 9.61 8.06 8.80 </TABLE> NET INTEREST INCOME Net interest income equals interest income less interest expense and is the primary source of income for IBT Bancorp. Interest income includes loan fees of $325 and $881 in the three and nine month periods ended September 30, 2006, respectively, as compared to $305 and $849 during the same periods in 2005. 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. (Continued on page 15) 12
TABLE 1 - AVERAGE BALANCES; INTEREST RATE AND NET INTEREST INCOME Results for the three months ended September 30, 2006 and September 30, 2005. (Dollars in Thousands) The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. This schedule also presents an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a fully taxable equivalent (FTE) basis using a 34% tax rate. Nonaccruing loans, for the purpose of the following computations, are included in the average loan amounts outstanding. Federal Reserve and Federal Home Loan Bank restricted equity holdings are included in Other. <TABLE> <CAPTION> Three Months Ended ----------------------------------------------------------------- September 30, 2006 September 30, 2005 ------------------------------- ------------------------------- Tax Average Tax Average Average Equivalent Yield\ Average Equivalent Yield\ Balance Interest Rate Balance Interest Rate -------- ---------- ------- -------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS: Loans $520,348 $ 9,269 7.13% $470,955 $7,872 6.69% Taxable investment securities 119,936 1,252 4.18% 101,950 864 3.39% Non-taxable investment securities 75,885 1,095 5.77% 65,772 953 5.80% Federal funds sold 2,367 31 5.24% 5,353 46 3.44% Other 5,299 67 5.06% 5,792 58 4.01% -------- ------- ---- -------- ------ ---- Total earning assets 723,835 11,714 6.47% 649,822 9,793 6.03% NON EARNING ASSETS: Allowance for loan losses (7,081) (6,753) Cash and due from banks 21,281 18,016 Premises and equipment 17,612 15,620 Accrued income and other assets 29,710 26,095 -------- -------- Total assets $785,357 $702,800 ======== ======== INTEREST BEARING LIABILITIES: Interest-bearing demand deposits $104,870 449 1.71% $109,307 289 1.06% Savings deposits 148,988 669 1.80% 152,465 436 1.14% Time deposits 302,956 3,307 4.37% 248,108 2,276 3.67% Other borrowed funds 58,756 739 5.03% 39,335 424 4.31% -------- ------- ---- -------- ------ ---- Total interest bearing liabilities 615,570 5,164 3.36% 549,215 3,425 2.49% NONINTEREST BEARING LIABILITIES: Demand deposits 69,349 68,932 Other 15,033 12,066 Shareholders' equity 85,405 72,587 -------- -------- Total liabilities and equity $785,357 $702,800 ======== ======== Net interest income (FTE) $ 6,550 $6,368 ======= ====== ---- ---- Net yield on interest earning assets (FTE) 3.62% 3.92% ==== ==== </TABLE> 13
TABLE 2 - AVERAGE BALANCES; INTEREST RATE AND NET INTEREST INCOME Results for the nine months ended September 30, 2006 and September 30, 2005. (Dollars in Thousands) The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. This schedule also presents an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a fully taxable equivalent (FTE) basis using a 34% tax rate. Nonaccruing loans, for the purpose of the following computations, are included in the average loan amounts outstanding. Federal Reserve and Federal Home Loan Bank restricted equity holdings are included in Other. <TABLE> <CAPTION> Nine Months Ended ----------------------------------------------------------------- September 30, 2006 September 30, 2005 ------------------------------- ------------------------------- Tax Average Tax Average Average Equivalent Yield\ Average Equivalent Yield\ Balance Interest Rate Balance Interest Rate -------- ---------- ------- -------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS: Loans $500,168 $26,129 6.97% $460,064 $22,495 6.52% Taxable investment securities 120,433 3,572 3.95% 102,312 2,547 3.32% Non-taxable investment securities 74,053 3,195 5.75% 64,867 2,826 5.81% Federal funds sold 1,417 52 4.89% 4,620 99 2.86% Other 5,135 184 4.78% 4,254 135 4.23% -------- ------- ---- -------- ------- ---- Total earning assets 701,206 33,132 6.30% 636,117 28,102 5.89% NON EARNING ASSETS: Allowance for loan losses (6,983) (6,635) Cash and due from banks 25,361 20,458 Premises and equipment 17,405 17,773 Accrued income and other assets 29,002 25,244 -------- -------- Total assets $765,991 $692,957 ======== ======== INTEREST BEARING LIABILITIES: Interest-bearing demand deposits $104,259 1,191 1.52% $106,165 708 0.89% Savings deposits 153,734 1,892 1.64% 158,131 1,087 0.92% Time deposits 285,361 8,791 4.11% 241,499 6,377 3.52% Other borrowed funds 52,398 1,878 4.78% 34,187 1,082 4.22% -------- ------- ---- -------- ------- ---- Total interest bearing liabilities 595,752 13,752 3.08% 539,982 9,254 2.29% NONINTEREST BEARING LIABILITIES: Demand deposits 69,559 64,927 Other 17,329 11,520 Shareholders' equity 83,351 73,528 -------- -------- Total liabilities and equity $765,991 $689,957 ======== ======== Net interest income (FTE) $19,380 $18,848 ======= ======= ---- ---- Net yield on interest earning assets (FTE) 3.69% 3.95% ==== ==== </TABLE> 14
TABLE 3 - VOLUME AND RATE VARIANCE ANALYSIS (Dollars in Thousands) The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows: Volume Variance - change in volume multiplied by the previous year's rate. Rate Variance - change in the fully taxable equivalent (FTE) rate multiplied by the prior year's volume. 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> Three Months Ended Nine Months Ended September 30, 2006 September 30, 2006 compared to compared to September 30, 2005 September 30, 2005 Increase (Decrease) Increase (Decrease) Due to Due to ----------------------- ------------------------ Volume Rate Net Volume Rate Net ------ ----- ------ ------ ------ ------ <S> <C> <C> <C> <C> <C> <C> CHANGES IN INTEREST INCOME: Loans $ 859 $ 538 $1,397 $2,036 $1,598 $3,634 Taxable investment securities 168 220 388 493 532 1,025 Nontaxable investment securities 146 (4) 142 397 (28) 369 Federal funds sold (33) 18 (15) (93) 46 (47) Other (5) 14 9 30 19 49 ------ ----- ------ ------ ------ ------ Total changes in interest income 1,135 786 1,921 2,863 2,167 5,030 Interest bearing demand deposits (12) 172 160 (13) 496 483 Savings deposits (10) 243 233 (31) 836 805 Time deposits 555 476 1,031 1,259 1,155 2,414 Other borrowings 235 80 315 638 158 796 ------ ----- ------ ------ ------ ------ Total changes in interest expense 768 971 1,739 1,853 2,645 4,498 ------ ----- ------ ------ ------ ------ Net change in interest margin (FTE) $ 367 $(185) $ 182 $1,010 $ (478) $ 532 ====== ===== ====== ====== ====== ====== </TABLE> NET INTEREST INCOME, CONTINUED As shown in Table 1, net interest income, on a fully taxable equivalent (FTE) basis, was $6,550 for the three months ended September 30, 2006 compared to $6,368 for the same period in 2005, an increase of $182 or 2.86%. This increase was primarily the result of a $74,013 or 11.39% increase in earning assets, which was funded by a $66,355 or 12.08% increase in interest bearing liabilities. As shown in Table 3, these changes in volume provided the Corporation with an additional $367 of FTE net interest income. The $367 increase was offset by a decrease of 0.30% in the FTE net yield on interest earning assets, which resulted in a $185 decrease in FTE net interest income. This 0.30% decrease in FTE rate was a result of the average rate earned on interest earning assets rising slower than those paid on interest bearing liabilities. As shown in Table 2, net interest income, on a fully taxable equivalent (FTE) basis, was $19,380 for the nine months ended September 30, 2006 compared to $18,848 for the same period in 2005, an increase of $532 or 2.82%. This increase was primarily the result of a $65,089 or 10.23% increase in earning assets, which was funded by a $55,770 or 10.33% increase in interest bearing liabilities. As shown in Table 3, these changes in volume provided the Corporation with an additional $1,010 of FTE net interest income. The $1,010 increase was offset by a 0.26% decrease in the FTE net yield on interest earning assets, which resulted in a $478 decrease in FTE net interest income. This 0.26% decrease in FTE rate was a result of the average rate earned on interest earning assets rising slower than those paid on interest bearing liabilities. Management expects the high level of competition for funding to continue for the remainder of the year, which will result in further tightening of the Corporation's interest rate margins. However, the Corporation does anticipate that projected increases in interest earning assets will continue to be strong enough to overshadow the tightening interest rate margins and result in continued increases in net interest margin. 15
ALLOWANCE FOR LOAN LOSSES The viability of any financial institution is ultimately determined by its management of credit risk. Net loans outstanding represent 66.3% of the Corporation's total assets and is the Corporation's single largest concentration of risk. The allowance for loan losses is management's estimation of potential future losses inherent in the existing loan portfolio. Factors used to evaluate the loan portfolio, and thus to determine the current charge to expense, include recent loan loss history, financial condition of borrowers, amount of nonperforming and impaired loans, overall economic conditions, and other factors. The following table summarizes the Corporation's charge off and recovery activity for the nine month periods ended September 30, 2006 and 2005. The table also compares the Corporation's allowance for loan loss as a percent of loans and loans classified as nonperforming as a percent of outstanding loans to its peer group. The Corporation's peer group includes 416 holding companies with assets between $500 million and $1.0 billion. Since September 2005, the Corporation has experienced an increase in the percent of loans classified as nonperforming. This is mainly being caused by the increase in nonaccrual loans. However, based on management's analysis of the allowance for loan losses, the current allowance stills falls within the acceptable range and therefore the allowance for loan losses is adequate as of September 30, 2006. <TABLE> <CAPTION> Nine Months Ended September 30 ----------------- 2006 2005 ------ ------ <S> <C> <C> Allowance for loan losses - January 1 $6,899 $6,444 Loans charged off Commercial and agricultural 181 15 Real estate mortgage 166 135 Personal 362 256 ------ ------ TOTAL LOANS CHARGED OFF 709 406 Recoveries Commercial and agricultural 98 100 Real estate mortgage 15 -- Personal 198 148 ------ ------ TOTAL RECOVERIES 311 248 ------ ------ Net loans charged off 398 158 Provision charged to income 628 515 ------ ------ ALLOWANCE FOR LOAN LOSSES - SEPTEMBER 30 $7,129 $6,801 ====== ====== ALLOWANCE FOR LOAN LOSSES AS A % OF LOANS 1.36% 1.42% ====== ====== PEER GROUP (AS OF JUNE 30, 2006 AND 2005) 1.19% 1.22% ====== ====== </TABLE> NONPERFORMING LOANS <TABLE> <CAPTION> September 30 ------------------- 2006 2005 -------- -------- <S> <C> <C> Total amount of loans outstanding at September 30 $523,147 $478,816 Nonaccrual loans 2,272 1,208 Accruing loans past due 90 days or more 1,308 1,771 Restructured loans 705 542 -------- -------- TOTAL $ 4,285 $ 3,521 ======== ======== LOANS CLASSIFIED AS NONPERFORMING AS A % OF OUTSTANDING LOANS 0.82% 0.74% ======== ======== PEER GROUP (AS OF JUNE 30, 2006 AND 2005) 0.49% 0.51% ======== ======== </TABLE> To management's knowledge, there are no other loans which cause management to have serious doubts as to the ability of a borrower to comply with their loan repayment terms. 16
NONINTEREST INCOME Noninterest income consists of trust fees, deposit service charges, fees for other financial services, gains on the sale of mortgage loans, title insurance revenue, and other. Significant account balances are highlighted in the following table: <TABLE> <CAPTION> Three Months Ended Nine Months Ended ------------------------------- ------------------------------- September 30 Change September 30 Change --------------- ------------- --------------- ------------- 2006 2005 $ % 2006 2005 $ % ------ ------ ---- ------ ------ ------ ---- ------ <S> <C> <C> <C> <C> <C> <C> <C> <C> Trust fees $ 217 $ 231 $(14) -6.1% $ 648 $ 613 $ 35 5.7% Service charges on deposit accounts 76 67 9 13.4% 228 184 44 23.9% Other service charges and fees NSF and overdraft fees 798 711 87 12.2% 2,175 1,874 301 16.1% ATM and debit card fees 144 124 20 16.1% 400 332 68 20.5% Freddie Mac servicing fee 158 157 1 0.6% 475 464 11 2.4% All other 38 49 (11) -22.4% 125 133 (8) -6.0% ------ ------ ---- ----- ------ ------ ---- ----- Total other service charges and fees 1,138 1,041 97 9.3% 3,175 2,803 372 13.3% ------ ------ ---- ----- ------ ------ ---- ----- Gain on sale of mortgage loans 53 60 (7) -11.7% 164 196 (32) -16.3% Title insurance revenue 679 698 (19) -2.7% 1,826 1,793 33 1.8% Other Increase in cash value of corporate owned life insurance policies 102 92 10 10.9% 305 273 32 11.7% Brokerage and advisory fees 51 47 4 8.5% 156 142 14 9.9% All other 90 92 (2) -2.2% 241 280 (39) -13.9% ------ ------ ---- ----- ------ ------ ---- ----- Total other 243 231 12 5.2% 702 695 7 1.0% ------ ------ ---- ----- ------ ------ ---- ----- TOTAL NONINTEREST INCOME $2,406 $2,328 $ 78 3.4% $6,743 $6,284 $459 7.3% ====== ====== ==== ===== ====== ====== ==== ===== </TABLE> Since the first quarter of 2005, the Corporation has made substantial efforts to increase noninterest income. To help achieve this goal, management analyzed various fees related to deposit accounts, including service charges, NSF and overdraft fees, and ATM and debit card fees. Based on this analysis, the Corporation made any necessary adjustments to ensure that its fee structure fell within a range of its competitors, while at the same time making sure that the fees remained fair to deposit customers. Management does not expect significant changes to its deposit fee structure for the remainder of 2006. The competitive landscape in the Michigan title insurance industry has had both positive and negative impacts on title insurance revenues. The Corporation has seen increased title insurance activity resulting from other title insurance companies closing offices around the state as a result of the struggling Michigan economy and the decrease in volume of mortgage activity. These closures have provided the Corporation with an opportunity to take advantage of the decreased level of competition for business. However, these same factors make continued increases in revenues challenging. Management does anticipate that title insurance revenues will approximate current levels for the rest of the year. The increase in the cash value from corporate owned life insurance policies relates to policies that had a carrying value of $11,337 as of September 30, 2006, and were included in other assets. These policies earned an average rate of 3.59% and 3.49% during the nine month periods ended September 30, 2006 and 2005, respectively. Due to their preferential tax treatment, these policies have a taxable equivalent rate of 5.43% and 5.28% as of September 30, 2006 and 2005, respectively. These policies are placed with five different insurance companies with an S & P rating of A- or better. The increase in income related to the change of the cash surrender value of the policies can be attributed to both the increases in rates and the purchase of additional policies in January 2006. All other noninterest income includes losses on the sale of securities of $6 and $109 which occurred in the three and nine month periods ended September 30, 2006, respectively, as compared to $2 and $0 in the same periods in 2005. Management has determined that the additional interest income which will be earned from the reinvestment of the proceeds of these sales will exceed the losses recognized by approximately $25 by year end 2006. 17
NONINTEREST EXPENSES Noninterest expenses include compensation, occupancy, furniture and equipment, and other expenses. Significant account balances are outlined in the following table: <TABLE> <CAPTION> Three Months Ended Nine Months Ended -------------------------------- ----------------------------------- September 30 Change September 30 Change --------------- -------------- ----------------- --------------- 2006 2005 $ % 2006 2005 $ % ------ ------ ----- ------ ------- ------- ----- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Compensation Leased employee salaries $2,501 $2,427 $ 74 3.0% $ 7,426 $ 7,162 $ 264 3.7% Leased employee benefits 612 1,002 (390) -38.9% 2,621 2,992 (371) -12.4% All other 35 22 13 59.1% 114 48 66 137.5% ------ ------ ----- ------ ------- ------- ----- ------- Total compensation 3,148 3,451 (303) -8.8% 10,161 10,202 (41) -0.4% ------ ------ ----- ------ ------- ------- ----- ------- Occupancy Depreciation 103 92 11 12.0% 302 272 30 11.0% Property taxes 87 87 -- 0.0% 254 261 (7) -2.7% Outside services 77 82 (5) -6.1% 242 236 6 2.5% Utilities 78 70 8 11.4% 242 213 29 13.6% Building rent 64 35 29 82.9% 142 91 51 56.0% All other 48 49 (1) -2.0% 143 137 6 4.4% ------ ------ ----- ------ ------- ------- ----- ------- Total occupancy 457 415 42 10.1% 1,325 1,210 115 9.5% ------ ------ ----- ------ ------- ------- ----- ------- Furniture and equipment Depreciation 351 346 5 1.4% 1,072 1,026 46 4.5% Service contracts 178 155 23 14.8% 541 455 86 18.9% Computer costs 73 89 (16) -18.0% 269 270 (1) -0.4% ATM and debit card fees 60 61 (1) -1.6% 188 185 3 1.6% All other 15 15 -- 0.0% 43 41 2 4.9% ------ ------ ----- ------ ------- ------- ----- ------- Total furniture and equipment 677 666 11 1.7% 2,113 1,977 136 6.9% ------ ------ ----- ------ ------- ------- ----- ------- Other SOX compliance fees 47 42 5 11.9% 499 336 163 48.5% Marketing 174 158 16 10.1% 479 450 29 6.4% Audit fees 50 66 (16) -24.2% 173 191 (18) -9.4% All other 1,106 1,093 13 1.2% 3,186 3,004 182 6.1% ------ ------ ----- ------ ------- ------- ----- ------- Other 1,377 1,359 18 1.3% 4,337 3,981 356 8.9% ------ ------ ----- ------ ------- ------- ----- ------- TOTAL NONINTEREST EXPENSES $5,659 $5,891 $(232) -3.9% $17,936 $17,370 $ 566 3.3% ====== ====== ===== ====== ======= ======= ===== ======= </TABLE> Management is continuously analyzing noninterest expenses to determine where expenditures can be decreased or held to modest increases. Management has been fairly successful in stabilizing noninterest expenses as compared to the percentage increase in total assets. Leased employee salaries expense has increased due to normal merit increases, and also due to the Corporation's growth in both size as well as complexity. Management does not anticipate any significant changes in leased employee salaries for the remainder of 2006. Leased employee benefits have decreased substantially during the three and nine month periods ended September 30, 2006, when compared to the same periods in 2005. This decrease is primarily attributed to the Corporation changing medical insurance administrators. One of the benefits of the change was that the Corporation's premium payments would be capped based on the current year's projected claims. This cap allowed the Corporation to reduce its medical reserve liability by $304 in the three month period ended September 30, 2006. Leased employee benefit expenses are expected to approximate $313 a month for the rest of 2006. Upon completion of a new branch location for the Canadian Lakes branch of Isabella Bank & Trust (IB&T), IB&T terminated a building lease for space that had previously housed the Canadian Lakes employees. Pursuant to the terms of the lease, IB&T paid $37 in one time penalties, which was included in building rent. The Corporation anticipates that the building rent for the remainder of 2006 to approximate the amounts paid in the first six months of the year. Service contracts continue to increase significantly from year to year. These increases are a result of the Corporation reinvesting in its technological infrastructure as well as increases in fees charged by vendors. This constant reinvestment helps the Corporation maintain a competitive edge in an ever changing marketplace. Management does expect service contracts to remain at current levels for the remainder of 2006 as a significant amount of annual service contracts were renewed in June and July. 18
The Corporation continues to experience elevated costs associated with complying with the Sarbanes-Oxley Act of 2002 (SOX). The costs associated with compliance extend beyond the continued increases in SOX compliance fees and into other areas including compensation expense. Management is continually analyzing ways to minimize the adverse financial statement impact of SOX compliance through the streamlining of the Corporation's loan and deposit operations. The Corporation has also made staff changes in the internal audit department which are expected to decrease auditing and SOX compliance fees. All other expenses includes consulting fees, director's fees, legal fees, postage fees, printing and supplies, title insurance expenses, as well as other miscellaneous expenses that are not individually significant. These increases are a result of overall increases in the cost of doing business. ANALYSIS OF CHANGES IN FINANCIAL CONDITION <TABLE> <CAPTION> September 30 December 31 % Change 2006 2005 $ Change (unannualized) ------------ ----------- -------- -------------- <S> <C> <C> <C> <C> ASSETS Cash and demand deposits due from banks $ 25,693 $ 30,825 $(5,132) -16.65% Securities available for sale 193,268 183,406 9,862 5.38% Mortgage loans available for sale 656 744 (88) -11.83% Loans 523,147 483,242 39,905 8.26% Allowance for loan losses (7,129) (6,899) (230) 3.33% Other assets 53,537 50,336 3,201 6.36% -------- -------- ------- ------ TOTAL ASSETS $789,172 $741,654 $47,518 6.41% ======== ======== ======= ====== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Deposits $633,152 $592,478 $40,674 6.87% Other borrowed funds 58,515 52,165 6,350 12.17% Escrow funds payable 5,692 9,823 (4,131) -42.05% Accrued interest and other liabilities 5,330 6,286 (956) -15.21% -------- -------- ------- ------ TOTAL LIABILITIES 702,689 660,752 41,937 6.35% SHAREHOLDERS' EQUITY 86,483 80,902 5,581 6.90% -------- -------- ------- ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $789,172 $741,654 $47,518 6.41% ======== ======== ======= ====== </TABLE> Since December 2005, the Corporation has experienced strong loan growth. In the first nine months of 2006, commercial loans have increased $26,608 and residential real estate mortgages have increased $14,160. The increase in commercial loans was driven by the establishment of a new business development team at Isabella Bank and Trust. The increase in residential mortgage loans can be attributed to various loan specials that were offered during 2006. Management does anticipate that loan demand, particularly commercial loan demand, will remain strong for the remainder of 2006. The Corporation, as part of its goal to increase 2006 average assets by 8.0% over 2005, also increased securities during the nine month period ended September 30, 2006. To achieve this growth, however, the Corporation experienced smaller interest margins than in the past. Management anticipates that the security portfolio will approximate current levels for the remainder of 2006. The Corporation, through its Banks, has established a policy that all amortized fixed rate mortgage loans with maturities greater than 15 years will be sold. During the nine month period ended September 30, 2006, the Corporation sold $22,247 of mortgages as compared to $26,973 in mortgages for the same period in 2005. Management does not expect the sale of mortgages to fluctuate significantly from current levels based on current market trends and the current and projected interest rate environment. The Corporation enjoyed a solid increase in deposits during the first nine months of 2006. A significant portion of the deposit growth came in the form of brokered and internet certificate of deposits. However, the increases in deposits were not enough to fund the increases in loans and securities. To help overcome this funding shortfall, the Corporation utilized wholesale borrowing sources such as the Federal Home Loan Bank. Management is constantly monitoring deposit account balances in an effort to maintain and increase the current customer base, as deposit account rates are typically lower than those demanded from internet and brokered deposits and wholesale borrowing sources. Management is also performing market analyses to help ensure that the Corporation's products remain attractive to consumers. 19
The Corporation observed a substantial decrease in escrow funds payable during the first nine months of 2006. This decrease can be attributed to Internal Revenue Code Section ( "IRC") 1031 exchange account balances being reinvested by customers of IBT Title and Insurance Agency, Inc. ("IBT Title"). These IRC 1031 accounts allow owners of business or investment property to defer realized gains from the sale of business or investment property if the funds are reinvested in another property. As such, these balances can fluctuate significantly between periods as the funds are reinvested. The Corporation does anticipate that these 1031 exchange accounts will continue to decrease through 2006 as the funds are reinvested by IBT Title's customers. 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, cash equivalents, and available-for-sale investment securities. As of September 30, 2006, cash and cash equivalents as a percentage of total assets equaled 3.26%, versus 4.16% as of December 31, 2005. During the first nine months of 2006, operating activities provided $1,561 of cash and financing activities provided $46,518, while investing activities used $53,211. The accumulated effect of the Corporation's operating, investing and financing activities was a $5,132 decrease in cash and cash equivalents during the first nine months of 2006. In addition to cash and cash equivalents, investment securities available for sale are another source of liquidity. Securities available for sale were $193,268 as of September 30, 2006 and $183,406 as of December 31, 2005. In addition to these primary sources of liquidity, the Corporation has the ability to borrow in the federal funds market and at both the Federal Reserve Bank and the Federal Home Loan Bank. The Corporation's liquidity is considered adequate by management. CAPITAL The capital of the Corporation consists solely of common stock, surplus, retained earnings, and accumulated other comprehensive loss. The overall capital has increased $5,581 since December 31, 2005 primarily due to corporate earnings. Accumulated other comprehensive loss decreased $473 due to unrealized gains in available-for-sale securities during 2006. There are no significant regulatory constraints placed on the Corporation's capital. The Federal Reserve Board's current recommended minimum tier 1 and tier 2 capital to average assets requirement is 6.0%. The Corporation's tier 1 and tier 2 capital to adjusted average assets, which consists of shareholders' equity plus the allowance for loan losses less unamortized acquisition intangibles, was 11.85% as of September 30, 2006. 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 ratios as of September 30, 2006: PERCENTAGE OF CAPITAL TO RISK ADJUSTED ASSETS <TABLE> <CAPTION> IBT Bancorp September 30, 2006 ------------------ Required Actual -------- ------ <S> <C> <C> Equity Capital 4.00% 15.90% Secondary Capital* 4.00% 1.25% ---- ----- Total Capital 8.00% 17.15% ==== ===== </TABLE> * IBT Bancorp's secondary capital consists solely of the allowance for loan losses. The percentage for the secondary capital under the required column is the maximum allowed from all sources. 20
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET ARRANGEMENTS The Corporation is party to financial instruments with off-balance-sheet risk. These instruments are entered into in the normal course of business to meet the financing needs of its customers. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in a particular class of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Corporation uses the same credit policies in deciding to make these commitments as it does for extending loans to customers. Commitments to extend credit, which totaled $86,660 at September 30, 2006, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have variable interest rates, fixed expiration dates, or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. At September 30, 2006, the Corporation had a total of $1,733 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. Isabella Bank and Trust (IB&T), a subsidiary of the Corporation, sponsors the IBT Foundation (the "Foundation"), which is a nonprofit entity formed for the purpose of distributing charitable donations to recipient organizations generally located in the communities serviced by Isabella Bank and Trust. IB&T periodically makes charitable contributions in the form of cash transfers to the Foundation. The Foundation is administered by members of the Corporation's Board of Directors. The assets and transactions of the Foundation are not included in the consolidated financial statements of IBT Bancorp, Inc. The assets of the Foundation as of September 30, 2006 were $1,358. FORWARD LOOKING STATEMENTS This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Corporation intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Corporation, are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Corporation's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Corporation and the subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Corporation's market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Corporation and its business, including additional factors that could materially affect the Corporation's financial results, is included in the Corporation's filings with the Securities and Exchange Commission. 21
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Corporation's primary market risks are interest rate risk and, to a lesser extent, liquidity risk. The Corporation has very limited foreign exchange risk and holds no trading account assets, nor does it utilize interest rate swaps or derivatives in the management of its interest rate risk. The Corporation does have a significant amount of loans extended to borrowers involved in agricultural production. Cash flow and ability to service debt of such customers is largely dependent on growing conditions and the commodity prices for corn, soybeans, sugar beets, milk, beef and a variety of dry beans. The Corporation mitigates these risks by using conservative price and production yields when calculating a borrower's available cash flow to service their debt. Interest rate risk ("IRR") is the exposure to the Corporation's net interest income, its primary source of income, to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. Interest rate risk is the fundamental method in which financial institutions earn income and create shareholder value. Excessive exposure to interest rate risk could pose a significant risk to the Corporation's earnings and capital. The Federal Reserve, the Corporation's primary Federal regulator, has adopted a policy requiring the Board of Directors and senior management to effectively manage the various risks that can have a material impact on the safety and soundness of the Corporation. The risks include credit, interest rate, liquidity, operational, and reputational. The Corporation has policies, procedures and internal controls for measuring and managing these risks. Specifically, the IRR policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to the Board of Directors. The Corporation uses several techniques to manage interest rate risk. The first method is gap analysis. Gap analysis measures the cash flows and/or the earliest repricing of the Corporation's interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the imbedded repricing options contained in assets and liabilities. A substantial portion of the Corporation's assets are invested in loans and investment securities. These assets have imbedded options that allow the borrower to repay the balance prior to maturity without penalty. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current interest rates, for residential mortgages the level of sales of used homes, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in the Corporation's cash flows from these assets. Investment securities, other than those that are callable, do not have any significant imbedded options. Saving and checking deposits may generally be withdrawn on request without prior notice. The timing of cash flow from these deposits is estimated based on historical experience. Time deposits have penalties which discourage early withdrawals. Cash flows may vary based on current offering rates, competition, customer need for deposits, and overall economic activity. The second technique used in the management of interest rate risk is to combine the projected cash flows and repricing characteristics generated by the gap analysis and the interest rates associated with those cash flows and projected future interest income. By changing the amount and timing of the cash flows and the repricing interest rates of those cash flows, the Corporation can project the effect of changing interest rates on its interest income. The following table provides information about the Corporation's assets and liabilities that are sensitive to changes in interest rates as of September 30, 2006. The Corporation has no interest rate swaps, futures contracts, or other derivative financial options, except for derivative loan commitments, which are not significant. The principal amounts of assets and time deposits maturing were calculated based on the contractual maturity dates. Savings and NOW accounts are based on management's estimate of their future cash flows. 22
Quantitative Disclosures of Market Risk <TABLE> <CAPTION> September 30, 2006 Fair ------------------------------------------------------------------ Value (dollars in thousands) 2007 2008 2009 2010 2011 Thereafter Total 09/30/06 -------- ------- ------- ------- ------- ---------- -------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Rate sensitive assets Other interest bearing assets $ 3,409 $ -- $ -- $ -- $ -- $ -- $ 3,409 $ 3,409 Average interest rates 1.31% -- -- -- -- -- 1.31% Fixed interest rate securities $ 55,374 $44,316 $22,064 $14,303 $22,271 $34,940 $193,268 $193,268 Average interest rates 3.92% 3.71% 3.84% 4.33% 4.52% 4.58% 4.08% Fixed interest rate loans $127,399 $80,772 $78,644 $58,334 $63,692 $32,735 $441,576 $436,267 Average interest rates 6.39% 6.38% 6.39% 6.47% 7.70% 5.94% 6.55% Variable interest rate loans $ 46,872 $14,398 $13,355 $ 4,438 $ 1,603 $ 905 $ 81,571 $ 81,571 Average interest rates 9.51% 8.85% 8.91% 9.54% 8.86% 7.63% 9.26% Rate sensitive liabilities Borrowed funds $ 20,671 $ 3,000 $12,558 $ 4,000 $ 5,286 $13,000 $ 58,515 $ 58,547 Average interest rates 5.73% 3.70% 4.89% 4.11% 5.69% 4.84% 5.13% Savings and NOW accounts $ 98,954 $65,802 $60,842 $19,491 $ 5,310 $ -- $250,399 $250,399 Average interest rates 3.37% 1.19% 0.69% 0.65% 0.78% -- 1.88% Fixed interest rate time deposits $199,830 $45,448 $20,224 $28,767 $11,548 $ 1,492 $307,309 $307,036 Average interest rates 4.53% 4.27% 4.04% 4.49% 4.57% 5.18% 4.46% Variable interest rate time deposits $ 761 $ 652 $ -- $ -- $ -- $ -- $ 1,413 $ 1,413 Average interest rates 4.23% 4.28% -- -- -- -- 4.25% </TABLE> Quantitative Disclosures of Market Risk <TABLE> <CAPTION> September 30, 2005 Fair ------------------------------------------------------------------ Value (dollars in thousands) 2006 2007 2008 2009 2010 Thereafter Total 09/30/05 -------- ------- ------- ------- ------- ---------- -------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Rate sensitive assets Other interest bearing assets $ 4,606 $ -- $ -- $ -- $ -- $ -- $ 4,606 $ 4,606 Average interest rates 1.88% -- -- -- -- -- 1.88% Fixed interest rate securities $ 38,344 $45,593 $32,571 $15,619 $ 9,057 $33,167 $174,351 $173,322 Average interest rates 3.81% 3.28% 3.34% 3.55% 3.82% 3.42% 3.49% Fixed interest rate loans $ 97,038 $74,027 $81,593 $50,603 $55,355 $29,472 $388,088 $408,347 Average interest rates 6.23% 6.02% 6.19% 5.87% 6.31% 5.97% 6.13% Variable interest rate loans $ 47,607 $15,323 $18,991 $ 5,794 $ 4,069 $ 781 $ 92,565 $ 92,565 Average interest rates 8.08% 7.71% 7.24% 7.43% 8.55% 8.46% 7.83% Rate sensitive liabilities Borrowed funds $ 16,857 $ 4,000 $ 3,113 $ 2,500 $ 4,000 $17,312 $ 47,782 $ 47,645 Average interest rates 3.94% 3.59% 3.71% 3.46% 4.11% 5.11% 4.31% Savings and NOW accounts $ 77,049 $77,400 $76,571 $20,810 $ 5,439 $ -- $257,269 $257,269 Average interest rates 2.16% 0.95% 0.80% 0.51% 0.59% 0.00% 1.22% Fixed interest rate time deposits $127,447 $56,069 $29,413 $15,262 $22,589 $ 818 $251,598 $252,487 Average interest rates 3.47% 4.13% 3.79% 3.49% 4.23% 4.67% 3.73% Variable interest rate time deposits $ 975 $ 377 $ 8 $ -- $ -- $ -- $ 1,360 $ 1,360 Average interest rates 3.05% 3.05% 3.05% -- -- -- 3.05% </TABLE> 23
ITEM 4 - CONTROLS AND PROCEDURES DISCLOSURE CONTROLS AND PROCEDURES The Corporation's management carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Corporation's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as of September 30, 2006, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that the Corporation's disclosure controls and procedures as of September 30, 2006, were effective to ensure that information required to be disclosed by the Corporation in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING During the most recent fiscal quarter, no change occurred in the Corporation's internal control over financial reporting that materially affected, or is likely to materially affect, the Corporation's internal control over financial reporting. The Corporation is currently evaluating what changes, if any, might be necessary in internal control arising as a result of the October 3, 2006 acquisition of the Farwell State Savings Bank. 24
PART II - OTHER INFORMATION ITEM 1A - RISK FACTORS There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2005. ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (A) NONE (B) NONE (C) REPURCHASES OF COMMON STOCK In October 2002, the Corporation's Board of Directors authorized the repurchase of up to $2 million of the Corporation's common stock. This authorization does not have an expiration date. Based on repurchases since October 2002, the Corporation is currently able to repurchase up to $1.7 million of its common stock or 38,636 shares under the repurchase authorization. The following table provides information as of September 30, 2006, with respect to this plan: <TABLE> <CAPTION> Total Number Shares Repurchased of Shares ------------------ Purchased as Average Part of Publicly Maximum Shares That Price Announced Plan May Be Purchased Under (Dollars in thousands) Number Per Share or Program the Plans or Programs ------ --------- ---------------- ---------------------- <S> <C> <C> <C> <C> Balance, June 30, 2006 38,636 July 1 - 31, 2006 -- $-- -- -- August 1 - 31, 2006 -- -- -- -- September 1 - 30, 2006 -- -- -- -- --- --- --- ------ Balance September 30, 2006 -- $-- -- 38,636 === === === ====== </TABLE> 25
ITEM 6 - EXHIBITS (a) Exhibits The following exhibits are filed as part of this report: 3(a) Amended Articles of Incorporation (1) 3(b) Amendment to the Articles of Incorporation (2) 3(c) Amendment to the Articles of Incorporation (4) 3(d) Amendment to the Articles of Incorporation (4) 3(e) Amended Bylaws (7) 10(a)* Isabella Bank & Trust Executive Supplemental Income Agreement (2) 10(b)* Isabella Bank & Trust Deferred Compensation Plan (3) 10(c)* IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Directors (5) 10(d)* Isabella Bank and Trust Death Benefit Only Agreement (6) 10(e)* Amendment to the IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Directors (8) 10(f)* The IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Non-Employee Directors (9) 10(g)* First amendment to the IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Non-Employee Directors (10) 31(a) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer 31(b) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer 32 Section 1350 Certification of Principal Executive Officer and Principal Financial Officer 1) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 12, 1991, and incorporated herein by reference. 2) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 26, 1994, and incorporated herein by reference. 3) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 26, 1996, and incorporated herein by reference. 4) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 22, 2000, and incorporated herein by reference. 5) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 27, 2001, and incorporated herein by reference. 6) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 25, 2002, and incorporated herein by reference. 7) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 16, 2005, and incorporated herein by reference. 8) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 8-K dated March 10, 2006, and incorporated herein by reference. 9) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 8-K dated December 19, 2005, and incorporated herein by reference. 10) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 8-K dated March 28, 2006, and incorporated herein by reference. * Management contract or compensatory plan or arrangement. 26
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. IBT Bancorp, Inc. Date: October 30, 2006 /s/ Dennis P. Angner ---------------------------------------- Dennis P. Angner Chief Executive Officer /s/ Peggy L. Wheeler ---------------------------------------- Peggy L. Wheeler Principal Financial Officer 27
Exhibit Index <TABLE> <CAPTION> Exhibit No. Description - ------- ---------------------------------------------------------------------- <S> <C> 3(a) Amended Articles of Incorporation (1) 3(b) Amendment to the Articles of Incorporation (2) 3(c) Amendment to the Articles of Incorporation (4) 3(d) Amendment to the Articles of Incorporation (4) 3(e) Amended Bylaws (7) 10(a)* Isabella Bank & Trust Executive Supplemental Income Agreement (2) 10(b)* Isabella Bank & Trust Deferred Compensation Plan (3) 10(c)* IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Directors (5) 10(d)* Isabella Bank and Trust Death Benefit Only Agreement (6) 10(e)* Amendment to the IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Directors (8) 10(f)* The IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Non-Employee Directors (9) 10(g)* First amendment to the IBT Bancorp, Inc. and Related Companies Deferred Compensation Plan for Non-Employee Directors (10) 31(a) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer 31(b) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer 32 Section 1350 Certification of Principal Executive Officer and Principal Financial Officer </TABLE> 1) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 12, 1991, and incorporated herein by reference. 2) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 26, 1994, and incorporated herein by reference. 3) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 26, 1996, and incorporated herein by reference. 4) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 22, 2000, and incorporated herein by reference. 5) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 27, 2001, and incorporated herein by reference. 6) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 25, 2002, and incorporated herein by reference. 7) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 10-K, dated March 16, 2005, and incorporated herein by reference. 8) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 8-K dated March 10, 2006, and incorporated herein by reference. 9) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 8-K dated December 19, 2005, and incorporated herein by reference. 10) Previously filed as an Exhibit to the IBT Bancorp, Inc. Form 8-K dated March 28, 2006, and incorporated herein by reference. * Management contract or compensatory plan or arrangement. 28