Item 1 - Business.
Empire Banc Corporation (the "Registrant") was incorporated under the laws of the state of Delaware on February 6, 1987, for the purpose of becoming a bank holding company. The Empire National Bank of Traverse City (the "Bank"), is a wholly-owned subsidiary of the Registrant. On June 1, 1994 the Registrant changed its state of incorporation from Delaware to Michigan.
The Bank was established under the banking laws of the State of Michigan in 1912 in Empire, Michigan. In 1961 the Bank converted its charter from a state bank to a national banking association. The Bank's deposits are insured by the Bank Insurance Fund, administered by the Federal Deposit Insurance Corporation, and the Bank is regulated by the U.S. Comptroller of the Currency.
In December 1991, the Traverse City and Grayling, Michigan branches of Great Lakes Bancorp were purchased by the Bank. In exchange for assuming deposit liabilities, the Bank received loans, property, equipment and cash. The acquisition provided entry into the Grayling-Crawford County market, opportunity to consolidate branches and improve customer service in the Traverse City market and a source of core deposits for increased funding of loans and investments.
The Bank is engaged in the general commercial banking business, providing a full range of loan and deposit products. These Bank services include customary retail and commercial banking services, including checking and savings accounts, time deposits, interest-bearing transaction accounts, safe deposit facilities, trust services, real estate mortgage lending and direct and indirect consumer financing. It makes secured and unsecured commercial loans and also operates a trust department providing fiduciary, investment and other related trust services. The Bank has contracted with a full-service securities brokerage firm to make available a variety of investment products to the Bank's customers. This program operates from two of the Bank's principal branch offices.
The principal source of revenue for the Registrant is dividends upstreamed from the Bank. The Bank's principal source of revenue is interest and fees on loans. The sources of income for the three most recent years are as follows.
The Bank's primary market area is the northwestern portion of the lower peninsula of Michigan. The Bank is headquartered in Traverse City, Michigan, County of Grand Traverse. The Bank maintains offices in Grand Traverse, Leelanau, Kalkaska, and Crawford counties. The population of these counties combined is approximately 100,000. The Bank operates ten full service offices, provides drive-in convenience at seven locations and has automatic teller machines operating at ten locations. The Bank has no foreign operations.
As of December 31, 1995, the Bank employed approximately 177 full-time and 34 part-time employees.
Banking is a highly competitive business. The Bank competes primarily with other financial institutions in its market areas for loans, deposits, and trust accounts. In its primary market, which includes the Grand Traverse, Kalkaska and Leelanau counties, the Bank maintains the second largest deposit base, or approximately 25 percent of the deposit market share. There are principally six banking institutions with offices is this area. Three of the competing banks with offices in this market are members of holding companies with substantially more assets than the Registrant.
The Bank is the only independent community bank in the Crawford County market. The Bank is the third largest in terms of deposits in the Crawford County market and competes with three financial institutions that are members of holding companies with substantially more assets than the Registrant.
In addition to these other banks, the Bank also competes for loans with savings and loan associations, credit unions, and certain large national retailers, and competes for deposits with investment firms and money market funds. In order to successfully compete, management has developed a sales and service culture, stresses and rewards excellent customer service and designs products to meet the needs of the customer. The Bank also utilizes its ability to sell loans in the secondary market.
The Bank makes mortgage, commercial and installment loans to customers primarily in northwestern lower Michigan. Fees may be charged for these services. Commitments to make loans and unused lines of credit outstanding are detailed in Note 16 of the Notes to Consolidated Financial Statements.
Historically, the Bank has predominantly sold its secondary market conforming residential mortgage loans. The mortgage loan portfolio serviced by the Bank for others, primarily the Federal Home Loan Mortgage Corporation, at December 31, 1995 totaled over $190 million. Mortgage banking activity is detailed in Note 6 of the Notes to Consolidated Financial Statements.
The Bank supports the growth of the service industry, with its year round resort and related businesses, manufacturing, the medical community, and many other activities important to growth in the greater Grand Traverse area. Designated as a Preferred Lender by the Small Business Administration (SBA), the Bank underwrites government guaranteed business loans, contributing to the economic growth in northern Michigan.
The Bank also arranges loan relationships with national and regional participating banks, increasing the amount of funds available for local businesses to grow. There are no material concentrations of credit to, nor have material portions of the Bank's deposits been received from, a single person, persons, industry or group.
In 1993, the Bank joined the Federal Home Loan Bank of Indianapolis, which generates an additional source of liquidity and long-term funds. Membership in the Federal Home Loan Bank also provides access to additional advantageous lending programs. The Community Investment Program makes advances to be used for funding community-oriented mortgage lending, and the Affordable Housing Program grants advances to fund lending for long- term low- and moderate-income owner occupied and affordable rental housing at subsidized interest rates.
The economy of the market areas of the Bank is affected by summer and winter tourism activities and, accordingly, the Bank experiences seasonal consumer and commercial deposit growth, with substantial growth increases from May to September. The Bank regularly assesses its ability to raise funds through the issuance of certificates of deposit in denominations of $100,000 or more in the local and regional market area and has established conservative guidelines for the total funding to be provided by these deposits. These deposits were less than three percent and four percent of total deposits at December 31, 1995 and 1994, respectively. The Bank also uses federal funds purchased from correspondent banks and the Federal Reserve Bank to respond to deposit fluctuations and temporary loan demands.
As of December 31, 1995, the Bank had no risks attendant to foreign sources. Compliance with federal, state and local statutes and/or ordinances relating to the protection of the environment is not expected to have material effect upon the Bank's capital expenditures, earnings or competitive position.
SUPERVISION AND REGULATION Banking is a highly regulated industry, with numerous federal and state laws and regulations governing the organization and operation of banks, bank holding companies, and their affiliates. As a bank holding company under the Bank Holding Company Act of 1956, the Registrant is regulated and examined by the Federal Reserve Board. This Act requires that the Registrant obtain prior Federal Reserve Board approval for bank and nonbank acquisitions and restricts the permissible activities of the Registrant. In addition, the Act formerly restricted the acquisition of shares of out-of-state banks unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located. Under the Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994, this restriction was repealed effective September 29, 1995, and the Federal Reserve Board generally is authorized to approve bank acquisitions by out-of-state bank holding companies whether or not such acquisition is prohibited by state law.
Federal law also regulates transactions between the Registrant and the Bank, including the amount and nature of loans or other extensions of credit. The Bank is also subject to regulation and examination by the Comptroller of the Currency.
The Comptroller of the Currency has established guidelines with respect to the maintenance of appropriate levels of capital for the Bank. The Federal Reserve Board has also established similar guidelines for the Registrant. Compliance with such standards can also limit the amount of dividends which the Bank can pay to the Registrant and the amount of dividends the Registrant can pay to its shareholders.
The banking industry is also affected by the monetary and fiscal policies of the federal government, including the Federal Reserve Board, which exerts considerable influence over the cost and availability of funds obtained for lending and investing.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") significantly affects the operation of banks and their relationship with federal regulatory agencies.
Under FDICIA, the FDIC has implemented a system of risk based premiums for deposit insurance pursuant to which the premiums paid by a depository institution are based on the probability that the applicable insurance fund will incur a loss in respect of such institution. Also under FDICIA federal regulatory agencies are developing comprehensive safety and soundness standards. FDICIA also prescribes various supervisory actions by federal regulatory agencies based on an insured institution's level of capital. These prescribed actions increase restrictions on and heighten regulatory scrutiny of the institution as its capital declines.
Proposals to change the laws and regulations governing the operations and taxation of banks, and companies which control banks and other financial institutions, are frequently raised in Congress. The likelihood of any major changes and the impact such changes might have on the Registrant are, however, impossible to predict.
Item 2

Item 2 - Properties. The executive offices of the Registrant and the Bank are maintained at the main office of the Bank, 1227 East Front St., Traverse City, Michigan. The Bank leases its main office and the following branch offices and automated teller machine facilities: Grand Traverse Mall Office, 3160 South Airport Rd, Traverse City, Michigan 49684; Kalkaska Office, 302 West Mile Road, Kalkaska, Michigan 49646; Acme Office, 3880 M-72 East, Acme, Michigan 49610; Woodmere Office, 859 Woodmere Avenue, Traverse City, Michigan 49686; Meijer Handy Teller ATM, 3955 South Memorial Highway, Traverse City, Michigan 49684. The leases expire at various times through the years 2011 and all include renewal periods. Net aggregate annual rentals for banking facilities in 1995 were $415,000.
In addition, the Bank owns and operates the following facilities none of which are encumbered: Northport Office, 122 Nagonaba, Northport, Michigan 49670; Leland Office, 111 North Main Street, Leland, Michigan 49654; Empire Office, 10210 Front Street, Empire, Michigan 49630; Cherryland Office, 1114 South Airport Road, Traverse City, Michigan 49686; Downtown Traverse City Office, 427 West Front St. Traverse City, Michigan 49684; Grayling Office, 2195 S. James St. Grayling, Michigan 49738.
The Bank operates drive-thru facilities at most of its office locations and has ten automatic teller machines for customer use in its market area.
Information about the executive officers of the Registrant is set forth below.
Item 3

Item 3 - Legal Proceedings. The Bank is routinely engaged in litigation, both as plaintiff and defendant, which is incident to its business. In certain proceedings, claims or counter-claims have been asserted against it. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of such litigation and threats of litigation will have a material effect on the financial statements of the Registrant.
Item 4

Item 4 - Submission of Matters to a Vote of Security Holders. No matters were submitted during the fourth quarter of fiscal 1995 to a vote of the Registrant's security holders.
PART II Item 5

Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters. The common stock of Empire Banc Corporation is traded on the electronic bulletin board system of the National Association of Securities Dealers, symbol EMBM. The primary market is the State of Michigan. Principal market makers of common stock transactions are F.J. Morrisey & Co., First of Michigan Corp, Howe, Barnes & Co., McDonald & Co., Robert W. Baird & Co., Roney & Co. and Stifel Nicolaus & Co.
Quarterly cash dividends were declared during 1995 and 1994 totaling $1.02 and $0.92 per common share per year, respectively. The following table sets forth, for the periods indicated, the high and low sale prices per share of the Corporation's common stock. All of the prices are adjusted for the five-for-four stock split, effected in the form of a 25% stock dividend, paid in November, 1995.
Item 6

Item 6 - Selected Financial Data - Empire Banc Corporation
Item 7

Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. Management's Discussion and Analysis is designed to provide shareholders of Empire Banc Corporation (the Corporation) with a more comprehensive review of the results of operations and financial position of the Corporation and its wholly-owned subsidiary, Empire National Bank (the Bank), than could be obtained from an examination of the consolidated financial statements alone. This discussion should be read in conjunction with the consolidated financial statements beginning on page 28 and the related footnotes.
Summary of Earnings In 1995, the Corporation achieved record earnings of $4,146,000, an increase of $392,000, or 10.4 percent, over the $3,754,000 earned in 1994. In 1994, net income increased $347,000, or 10.2 percent, over the $3,407,000 earned in 1993.
Earnings Per Share Earnings per share, computed on the average number of common shares and common equivalents outstanding during the year, increased 9.8 percent to $2.36, compared to the $2.15 earned in 1994 and $1.98 earned in 1993.
Return on Average Shareholders' Equity Return on average shareholders' equity measures how profitably the shareholders' invested capital is employed. Return on average equity was 14.8 percent for 1995 compared to 14.7 percent and 14.6 percent in 1994 and 1993, respectively.
Return on Average Assets Return on average assets, a key measure of bank profitability, was 1.18 percent in 1995 compared to 1.17 percent and 1.15 percent in 1994 and 1993, respectively.
Book Value Per Share Book value per share of common stock increased 12.7 percent to $18.20 at December 31, 1995, compared to $16.15 and $15.09 at December 31, 1994 and 1993, respectively.
Summary of Operating Results The following is a summary of the major components of the Corporation's consolidated operating results for the three years ended December 31:
Net Interest Income
Net interest income is the difference between interest and fees earned on earning assets (loans and investments) and the interest paid on deposits and other interest-bearing funds. It is the major component of earnings for a financial institution. For analytical purposes, the interest earned on investments and loans is measured and expressed on a fully taxable equivalent (FTE) basis. Tax-exempt interest income is increased to an amount comparable to interest subject to federal income taxes in order to properly evaluate the effective yields earned on earning assets. The tax equivalent adjustment is based on a federal income tax rate of 34 percent.
Net interest income is influenced primarily by changes in the balance and mix of earning assets and interest-bearing liabilities, the proportion of earning assets that are funded by demand deposits and equity capital, and market interest rates. Some of these factors may be controlled to a certain extent by management.
Conditions beyond management's control may have a significant impact on changes in net interest income from one period to another. Examples of such external factors are Federal Reserve Board monetary policy, introduction of new deposit products by bank and non-bank financial competitors and the fiscal and debt management policies of the federal government.
The table on the following page details the key determinants of net interest income: the average daily balance sheet for each year - including the components of earning assets and supporting liabilities - the related interest income on an FTE basis and interest expense, as well as the average rates earned and paid on these assets and liabilities.
Net Interest Income Average Balances, Interest Income/Expense, Average Rates
An analysis of the changes in net interest income from period to period is presented in the following table. This analysis highlights the relative effect of the changes in interest income or expense due to changes in the average balances of earning assets and interest-bearing liabilities and changes in interest rates.
Analysis of Changes in Net Interest Income
The following table allocates net interest income on earning assets by the interest spread earned on assets funded by interest-bearing liabilities and the amount funded by non-interest-bearing liabilities and equity capital. The interest spread on earning assets funded by interest-bearing liabilities is the difference between the average rate earned on total earning assets and the average cost of interest-bearing liabilities. The interest spread on earning assets funded by non-interest-bearing liabilities and equity capital is the rate earned on earning assets.
Net interest income (FTE) increased $1,576,000 or 11.3 percent, in 1995 as average earning assets increased $30.3 million, or 10.1 percent, and the net interest margin (net interest income as a percentage of average earning assets) increased 5 basis points. Earning assets funded with interest-bearing liabilities increased $24.1 million, or 9.6 percent, as the interest spread decreased 11 basis points, adding $670,000 in net interest income. Earning assets funded with non-interest-bearing liabilities and equity capital increased $6.2 million, or 12.9 percent, with an improved interest spread of 77 basis points, contributing $906,000 to the increase in net interest income.
The increase in average earning assets of $30.3 million was principally in loans, which increased $19.5 million or 8.5 percent, and the average rate on loans increased 75 basis points. Investment securities increased $7.0 million, or 10.7 percent, and the average rate increased 96 basis points. The primary funding for earning assets is interest-bearing deposits which increased $20.4 million, or 8.4 percent, and the average rate increased 81 basis points over 1994.
In 1994, net interest income increased $819,000, or 6.3 percent, due to increases in average earning assets of $24.9 million, or 9.1 percent, and the net interest margin decreased 12 basis points. The increase in earning assets funded with interest-bearing liabilities, at a decreased interest spread, accounted for $361,000 of the increase in net interest income. The increase in earning assets funded with non-interest-bearing liabilities, at a reduced interest spread, added $458,000 in net interest income.
Loan Portfolio Management and Non-Performing Assets
Portfolio Quality
Loan portfolio quality, diversification of the portfolio and the monitoring of potential problem loans are the primary functions of loan portfolio management. The Bank adheres to internally established written loan policies and procedures. Management has established a loan review process which provides for frequent review of the loan portfolio in order to monitor loan portfolio quality and performance. In addition, management conducts a review of loan concentrations which could have an impact on the financial condition of the Bank. As of December 31, 1995, there were no industry concentrations in which the total loans to borrowers in one industry comprised 10 percent or more of total loans.
Loans outstanding at year-end for the five years ended December 31, are shown in the following table according to the type of loan:
Maturity and Rate Sensitivity of Selected Loans
The following table presents the remaining maturity of total loans outstanding (excluding residential real estate mortgage and consumer loans) at December 31, 1995, according to scheduled repayments of principal. The amounts due after one year are classified according to the sensitivity to changes in interest rates.
Non-Performing Assets and Problem Loans
The following table is a summary of non-performing assets as of December 31:
In 1995, total non-performing assets decreased $172,000, or 8.9 percent, as other real estate owned increased $227,000 and non-performing loans decreased $399,000. In addition to loans classified as non-performing or 90 days past due, there were other loans totaling $3,213,000 at December 31, 1995, on which payments were current and management closely monitors the borrowers' ability to comply with payment terms. Effective January 1, 1995, the Corporation adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (SFAS 114), as amended by Statement No. 118 (SFAS 118). Implementation of SFAS 114 and SFAS 118 did not have a material impact on the consolidated financial position and results of operations in 1995 as disclosed in Note 5, Loans, to the Consolidated Financial Statements. See Note 2, Significant Accounting Policies, to the Consolidated Financial Statements, for a description of SFAS 114 and SFAS 118.
Management regularly reviews the loan portfolio to identify loans for which there are concerns that the borrower will be unable to satisfy existing payment terms. Management reports monthly, to the Board of Directors, information regarding significant past-due and problem loans, non-accrual loans and other real estate owned. Non-performing assets are carried at estimated realizable values and the known losses of principal have been recognized. Management cannot predict which, if any, loans will eventually result in losses.
Included in other assets is $1,041,000 of cash value of life insurance which has been classified non-accrual. The Trustee for the insurer/debtor has signed an agreement in principle with a new insurer to assume these policies at full value. The definitive agreement is being drafted and the transfer to the new insurer is expected in 1996.
The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that collection of interest is doubtful. The gross interest income that would have been recorded in 1995 on the $867,000 of non-accrual loans amounted to $128,000 if the loans would have been current in accordance with their original terms and outstanding throughout the period. The amount of interest income included in net income on these loans amounted to $6,000.
All loans classified for regulatory purposes as loss, doubtful, substandard or special mention have been included in the above disclosures. There were no other interest bearing assets at December 31, 1995 that would be required to be disclosed as non-performing or potential problem loans.
There were no foreign loans outstanding at December 31, 1995.
Provision for Loan Losses
The following table summarizes the provision for loan losses, net loan losses and the allowance for loan losses over the last three years:
In 1995, the decrease in the provision for loan losses of $51,000 was primarily due to a decrease in net loan charge-offs of $81,000. The ratio of net loan losses to average loans of 0.18 percent for 1995 and 0.23 percent for 1994 are substantially below historical industry norms. A sustained period of national and local economic growth has resulted in substantial growth in the loan portfolio. In 1995, the allowance for loan losses increased $300,000 and was 1.24 percent of loans at December 31, 1995. The allowance for loan losses was considered adequate by management and was 183 percent of non-performing assets at year-end compared to 151 percent at December 31, 1994.
In 1994, the $349,000 increase in the provision for loan losses was due to an increase in net loan charge-offs of $259,000, primarily indirect consumer loans, and growth in the loan portfolio of over 11 percent.
Summary of Loan Loss Experience
Additional information relative to the allowance for possible loan losses is presented in the following table. This table summarizes loan balances at the end of each period and daily average balances, changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off by loan category, and additions to the allowance for possible loan losses through provisions charged to expense. Factors which influence management's judgement in determining the provision for loan losses each period include establishing specific loss allowances for selected loans (including large loans, non-accrual loans, and problem and delinquent loans) and consideration of historical loss information and local economic conditions.
Allocation of the Allowance for Loan Losses
The allocation of the allowance for possible loan losses for the years ended December 31 is:
Non-Interest Income Total non-interest income increased $174,000, or 3.6 percent, from 1994. Income from the origination, sales and servicing of mortgage loans decreased $71,000, or 6.2 percent. The higher level of interest rates in 1995 compared to 1994 substantially reduced mortgage activity in the industry and created a tightening of fees earned on new loans. Fees and gains on loans sold in 1995 were $589,000, a decrease of $123,000, or 17.3 percent, from 1994. Effective July 1, 1995 the Bank adopted Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" (SFAS 122). This standard requires capitalizing the cost of mortgage servicing rights on loans sold. The capitalized cost of the mortgage servicing rights is amortized over the estimated period of servicing income. This standard also requires periodic evaluation of the capitalized servicing rights for impairment. The adoption of SFAS 122 increased gains on loans sold $154,000 in 1995. Servicing income on loans sold increased $52,000, or 12.1 percent, over 1994.
Trust income increased $254,000, or 16.3 percent, in 1995, as funds under management increased $43 million, or 16.7 percent. Other service charges and fees increased 7.1 percent due to income earned from credit card fees and ATM fees.
In 1994, total non-interest income decreased $220,000, or 4.3 percent, due primarily to decreases in income from the origination, sales and servicing of mortgage loans of $637,000, or 35.8 percent, as fees and gains on loans sold decreased 50 percent, or $708,000, due to the substantially reduced new loan volume from the record levels of 1992 and 1993. Loan servicing
income increased $71,000, or 19.8 percent over 1993. Trust fees increased $181,000, or 13.1 percent, due to a 17.2 percent increase in assets under management. Other significant increases were in service charges and fees on deposit accounts of 5.2 percent; other service charges and fees of 6.9 percent; and other income of 58.7 percent due to increased fees earned through investment product sales by a third party vendor in the Bank's branches and gains on sales of other real estate owned.
Non-Interest Expense In 1995, total non-interest expense increased $1,253,000, or 10.2 percent. Total personnel expense increased $1,079,000, or 15.9 percent, as benefit costs related to the 38 percent increase in the Corporation's stock price during the year increased $698,000 and the profit sharing incentive award paid to all employee partners increased $110,000, or 24.6 percent.
Occupancy expense for 1995 increased $68,000, or 7.2 percent, due to increased lease and branch remodeling costs.
Other operating expenses increased $59,000, or 1.6 percent, in 1995. FDIC insurance expense decreased $254,000, or 41.1 percent, due to the reduction in FDIC rates from $.23 per $100 of deposits to $.04, effective June 1, 1995. For 1996, the rate has been reduced to the statutory minimum of $2,000 per year for well-capitalized banks. The rate continues at $.23 for deposits purchased from savings associations.
The FDIC is proposing a one-time charge on all deposits purchased from savings associations and savings association deposits to bring the Savings Association Insurance Fund to the required level and reduce the premium rate to the level equivalent to the commercial banks' rate. Although legislation to implement the proposed one-time charge has not been enacted, management currently anticipates that any such charge would not have a significant impact on the Corporation's financial position or results of operations.
Legal and professional fees increased $69,000, or 25.4 percent, and business taxes increased $54,000, or 17 percent. Other areas of expense increased due to increased activity levels in the overall growth of the Bank.
In 1994, total non-interest expense decreased $301,000, or 2.4 percent. Personnel expense decreased $121,000, or 1.8 percent, due to the $420,000, or 80.7 percent, decrease in benefit costs related to the change in the Corporation's stock price from year to year and the decrease in the profit sharing incentive award of $56,000, or 11.1 percent. Equipment expense increased 6.4 percent for investment in technology.
Other operating expense declined $233,000, or 5.9 percent, in 1994. Legal and professional fees decreased $73,000, or 21.2 percent, and expenses associated with the sale of other real estate owned decreased $201,000, or 93 percent. Other areas of expense increased due to increased activity levels and overall growth of the Company.
Federal Income Taxes Federal income tax expense for 1995 was $2,007,000 compared to $1,841,000 in 1994 and $1,600,000 in 1993 due to the increased profitability of the Corporation. The Corporation's effective tax rate has been substantially unchanged from 1993 through 1995 due to the consistency of statutory tax rates and the relative percentage of tax-exempt income.
Capital Resources and Cash Dividends The foundation of a strong financial institution is a strong capital base. Shareholders' equity in 1995 increased $3.7 million, or 13.9 percent, to $30 million at year-end 1995. During 1994, total shareholders' equity increased $1.8 million, or 7.5 percent, over 1993. Shareholders' equity was 8.1 percent and 7.8 percent of total assets at December 31, 1995 and 1994, respectively.
The Federal bank regulatory agencies have established capital standards for financial institutions. The Corporation's capital ratios are all significantly above the guidelines for well-capitalized institutions, the highest capital standard. Note 19 to the consolidated financial statements details the Corporation's regulatory capital and the capital standards.
Total dividends in 1995 were $1,671,000, or $1.02 per share, compared to the $1,499,000, or $.92 per share in 1994, a 10.9 percent increase. The dividend payout ratio was 40 percent in 1995 and 1994, and 34 percent in 1993. A 25 percent stock dividend was paid in November of 1995. Cash dividends per share have increased at an average annual rate of 17.3 percent since 1990. Future dividends are declared at the discretion of the Board of Directors and may be determined by the financial performance, future prospects and capital requirements of the Corporation.
The Corporation's principal source of funds to pay cash dividends is the earnings of its subsidiary, the Bank. Consequently, cash dividends depend upon the earnings, capital needs, regulatory restraints and other factors affecting the Bank. Under current banking laws and regulations, during 1996 the Bank can distribute to the Corporation cash dividends in the amount of $4,831,000 plus 1996 net profits.
The Company maintains a five-year capital plan and utilizes a formal strategic planning process. Management and the Board continue to monitor long-term goals which include maintaining capital growth in relation to asset growth and the retention of earnings to fund growth while providing above-average returns to shareholders.
Interest Rate Sensitivity and Liquidity Asset and liability management involves the development and implementation of strategies to maximize net interest income, minimize the vulnerability of earnings to major changes in interest rates and allow the Bank to profitably compete in all phases of the business cycle. This process is carried out through monthly meetings of senior officers representing lending, deposit-gathering, funds management and marketing functions.
Interest rate risk arises when the maturity or repricing characteristics of assets differ significantly from the maturity or the repricing characteristics of liabilities. One of the goals of asset and liability management is to balance the various factors that create interest rate risk, thereby maintaining the interest rate risk of the Bank within acceptable levels.
While controlling interest rate risk is an important objective, accommodating customer maturity and repricing preferences is an equally important objective. It is the function of asset and liability management to develop strategies to reconcile these objectives. Management has developed definitive policies and procedures to sell the current production of long-term residential mortgages in the secondary market to mitigate
interest rate risk. Long-term commercial loans are generally written with three- and five-year balloons and long-term fixed rate SBA guaranteed loans are sold in the secondary market.
One measure of interest rate risk is "gap," which represents the cumulative difference between the amount of assets and liabilities maturing or repricing at various time intervals. In measuring the interest rate risk gap, management estimates loan repayments and early withdrawals of deposits and the interest sensitivity of assets and liabilities which do not mature or reprice. Because assets and liabilities do not reprice in the same manner as interest levels change, the gap should not be viewed as a sole indicator of how the net interest income of the Bank will be affected by changes in interest rates. The Bank continually monitors and has maintained within its policy a one-year rate sensitive asset-to- liability ratio (RSA-RSL) of between 0.8 and 1.2. The one year RSA-RSL ratio was 0.93 and 0.88 at December 31, 1995 and 1994, respectively.
The Bank measures the impact of changes in interest rates on net interest income through a comprehensive analysis of the Bank's interest rate sensitive assets and liabilities. This analysis takes into consideration the projected changes in market interest rates and alternative rate scenarios, the amount of change in the rate of individual interest rate sensitive assets and liabilities, changes in rate of growth and rate of prepayment of assets and liabilities and the effect of competition. Through this analysis, management is able to more realistically measure the projected effect on net interest income than by traditional gap analysis.
The period of 1993 through 1995 included periods of sustained significant interest rate decreases and increases as well as changes in the shape of the yield curve. The steady increase in net interest income demonstrates the effectiveness of these risk management techniques.
Liquidity management for a commercial bank is closely related to asset and liability management. The goal of liquidity management is to maintain the availability of resources to fund withdrawals and other operating requirements. Monitoring maturities and future commitments and the use of short-term investments are integral parts of liquidity management.
The primary objective of the Bank's investment securities portfolio is to invest in securities of high quality that will provide a fair and reasonable return and will allow the Bank to maintain a sound liquidity position. Management of the portfolio is an integral part of liquidity and interest rate risk management. The Bank does not have complex or leveraged derivatives or structured notes in its portfolio.
The Corporation adopted on January 1, 1994, Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). The adoption of SFAS 115 requires management to designate as available for sale those securities which are intended to be used for interest rate risk management, liquidity needs and portfolio management.
The Board of Directors has established policies regarding the potential price fluctuation of the available for sale portfolio. At December 31, 1995, the available for sale portfolio had a net unrealized gain of $506,000 compared to a net unrealized loss of $774,000 at December 31, 1994. The price fluctuations experienced during 1994 and 1995 were primarily due to changes in market interest rates and were well within the policies established by the Board of Directors. Realization of any unrealized gain or loss will depend upon the future portfolio management, interest rate risk management and liquidity needs of the Bank. The regulatory agencies do not include the SFAS 115 adjustment in the calculation of regulatory capital. Please see Note 2, Significant Accounting Policies, for a description of SFAS 115.
Other than securities guaranteed by the US Government or its agencies, the Bank held no investment securities from any one issuer that exceed ten percent of stockholders' equity at December 31, 1995.
Management believes that deposit growth through core deposits provides the primary funding for increases in loans and investment securities. Core deposits include demand deposits, savings and money market accounts and certificates of deposit of consumer and corporate customers. Core deposits represented 97 percent and 96 percent of total deposits at December 31, 1995 and 1994, respectively.
Management also regularly assesses the ability of the Bank to raise funds through the issuance of certificates of deposit in denominations of $100,000 or more in the local and regional market area and has established conservative guidelines for the total funding to be provided by these deposits. These deposits were less than 4 percent of total deposits at December 31, 1995 and 1994.
Management also believes that an integral part of liquidity management is the development of other sources of funding. It is management's policy to actively cultivate and maintain relationships with correspondent and other banks for sales of loans for liquidity, credit and interest rate risk management. Additionally, the Bank has established substantial federal funds lines with correspondent banks and may borrow from the Federal Reserve Bank.
The Bank is a member of the Federal Home Loan Bank of Indianapolis, which provides an additional source of liquidity and long-term funds to meet the borrowing needs of customers. Advances from the Federal Home Loan Bank of Indianapolis are secured through the pledge of investment securities or mortgage loans. Federal Home Loan Bank advances were $17 million and $8 million at December 31, 1995 and 1994, respectively. Management believes that with the combination of federal funds lines and borrowings from the Federal Reserve Bank and the Federal Home Loan Bank, the Bank has more than adequate resources available to meet liquidity needs and to provide for growth.
Sources and Uses of Funds Trends This table is an analysis of the changes in the average balances for the last two years:
Analysis of Changes in Average Balances
Total average earning assets increased $30.3 million, or 10.1 percent, in 1995. Total average loans increased $19.5 million, or 8.5 percent. The increase in average loans was primarily in mortgage loans, which increased $12.4 million, or 26.1 percent. Commercial loans increased $10.5 million, or 10.4 percent. Average consumer loans decreased $3.5 million, or 4.3 percent, as management reduced the emphasis on indirect lending and continues to concentrate on direct consumer lending. Average investment securities increased $7.0 million, or 10.7 percent.
The increase in average earning assets was funded by a $24.1 million, or 9.6 percent, increase in total average interest-bearing funds. Total average interest-bearing core deposits increased $21.5 million, or 9.2 percent. With increases in interest rates, consumers increased their investments in certificates of deposit, which grew $15.2 million, or 14.4 percent, in 1995 and money market accounts, which increased $10.2 million, or 16.1 percent. Total non-interest bearing funds invested in earning assets increased $6.2 million, or 12.9 percent. Average time certificates in denominations of $100,000 or more decreased $1.1 million and represented 3 percent of average total deposits in 1995, compared to 4 percent in 1994 and 2 percent in 1993, significantly below the levels of banks of comparable size. With the growth in average earning assets, deposit funding was augmented with Federal Home Loan Bank advances which increased $4.1 million, or 54.6 percent, in 1995.
In 1994, total average earning assets increased $24.9 million, or 9.1 percent. Total average loans increased $25.4 million, or 12.5 percent, due to increases in consumer loans of $11.6 million, or 16.9 percent, and commercial loans of $12.4 million, or 13.9 percent. Mortgage loans increased $2.4 million, or 5.4 percent. Average investment securities increased $1.3 million.
The increase in average earning assets in 1994 was funded by an $18.9 million, or 8.1 percent, increase in total average interest-bearing funds. Average interest-bearing core deposits increased $6.6 million, or 2.9 percent. Average time deposits in denominations of $100,000 or more increased $4.3 million in 1994. Total non-interest bearing funds invested in earning assets increased $6.0 million, or 14.4 percent. Federal Home Loan Bank advances averaged $7.5 million in 1994.
Item 8

Item 8 - Financial Statements and Supplementary Data Consolidated Balance Sheet-Empire Banc Corporation
Consolidated Statement of Income-Empire Banc Corporation
Consolidated Statement of Cash Flows-Empire Banc Corporation
Consolidated Statement of Cash Flows-Empire Banc Corporation (continued)
Consolidated Statement of Changes in Shareholders' Equity- Empire Banc Corporation
Notes to Consolidated Financial Statements
Note 1 - Nature of Operations
Empire Banc Corporation, a one-bank holding company for Empire National Bank, is the largest independent bank holding company in northern Michigan. The Bank is engaged in the general commercial, retail and mortgage banking business, providing a full range of loan and deposit products. It also operates a trust department providing fiduciary, investment and other related services, and has contracted with a full-service brokerage firm to make available a variety of investment products to the Bank's customers.
The Bank is headquartered in Traverse City, Michigan, which is the retail, medical and financial hub for northern Michigan. The Bank's primary market area is the northwestern portion of northern Michigan.
Note 2 - Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include the accounts of Empire Banc Corporation (the Corporation) and its wholly- owned subsidiary, Empire National Bank (the Bank), after elimination of significant intercompany transactions and accounts.
Statement of Cash Flows - Cash and cash equivalents includes cash on hand, demand deposits in other institutions, and federal funds sold. The Corporation reports net cash flows for customer loan transactions and deposit transactions and for deposits made with other financial institutions.
Securities - Effective January 1, 1994 the Corporation adopted Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). In adopting SFAS 115, certain securities have been identified as available for sale. Securities available for sale may be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs, or other factors. Securities identified as available for sale are reported at their fair value and the net unrealized gain or loss is reported, net of related tax effect, as a separate component of shareholders' equity, until realized. In the event that a security available for sale is sold or called, the adjusted cost of the specific security is used to compute the applicable gain or loss. Securities held to maturity are those securities which management has the ability and positive intent to hold to maturity. Securities held to maturity are stated at amortized cost. Premiums and discounts are recognized in interest income using the interest method.
Allowance for Loan Losses - The allowance for loan losses represents that amount which management estimates is adequate to provide for losses inherent in the loan portfolio. Management determines the adequacy of the allowance for loan losses by reviewing selected loans (including large loans, non-accrual loans and problem and delinquent loans) and establishes specific loss allowances on these loans. Historical loss information and local economic conditions are considered in establishing allowances on the remaining loan portfolio. The allowance is increased by provisions charged to expense and reduced by loan losses, net of recoveries.
Effective January 1, 1995 the Corporation adopted Statement of Financial Accounting Standards No. 114 (SFAS 114), later amended by Statement No. 118 (SFAS 118), on accounting and disclosure by creditors for impairment of a loan. These standards require that impaired loans be measured based on the present value of expected cash flows discounted at each loans' effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Under this standard, loans considered to be impaired are reduced to the present value of expected future cash flows or to the fair value of collateral, by allocating a portion of the allowance for loan losses to such loans. If these allocations cause the allowance for loan losses to require increase, such increase is reported as an additional provision for loan losses. The impact of adopting these standards on the Corporation's financial condition and results of operations in 1995 is not material.
Smaller-balance homogeneous loans include residential first mortgage loans secured by one-to-four family residences, residential construction loans, automobile, home equity and second mortgage loans and are collectively evaluated for impairment. Commercial loans and first mortgage loans secured by other properties are evaluated individually for impairment. Under the Corporation's loan evaluation system, loans rated substandard, doubtful and loss are considered impaired, since it is probable that such loans will be not be collected under their contractual terms. Loans, or portions thereof, are charged-off when deemed uncollectible. SFAS No. 114 and No. 118 disclosures for impaired loans are not expected to be materially different from non-accrual and renegotiated loan disclosures or non-performing asset and past-due disclosures.
Premises and Equipment - Premises and equipment are depreciated over their estimated useful lives and are stated at cost less accumulated depreciation. The provision for depreciation is computed principally using the straight-line method. Leasehold improvements are amortized over the shorter of the respective lease term or the asset's useful life. Expenditures for normal repairs and maintenance are charged to operations as incurred.
Other Real Estate - Other real estate is carried at the lower of cost or fair value less estimated costs to sell. Any reduction to fair value at the time of acquisition from a related loan is accounted for as a loan loss. Any subsequent reduction in fair value is charged to other non- interest expense. The costs incurred to carry other real estate are expensed as incurred.
Interest and Fees on Loans - Interest on loans is accrued over the term of the loans based upon the principal outstanding. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the collection of interest is doubtful. Loans are generally moved to non- accrual status at 90 days or more past due. Under SFAS No. 114, as amended by SFAS No. 118, the carrying value of impaired loans is periodically adjusted to reflect cash payments, revised estimates of future cash flows, and increases in the present value of expected cash flows due to the passage of time. Cash payments representing interest income are reported as such. Other cash payments are reported as reductions in carrying value, while increases or decreases due to changes in estimates of future payments and due to the passage of time are reported as reductions or increases to bad debt expense.
Loan origination and commitment fees and related costs are recognized over the life of the loan as an adjustment of yield. Fees on loans sold are recognized at the time of sale.
Loan Servicing Rights - The Bank originates and purchases mortgage loans for sale to the secondary market, and sells the loans with servicing retained. Effective July 1, 1995 the Corporation adopted Statement of Financial Accounting Standards No. 122 (SFAS 122), "Accounting for Mortgage Servicing Rights." For servicing retained, this Statement requires capitalizing the cost of mortgage servicing rights, regardless of whether those rights were acquired through purchase or origination activities. Prior to adoption of SFAS 122, only purchased loan servicing rights were capitalized.
Beginning July 1, 1995, the total cost of mortgage loans originated with the intent to sell is allocated between the loan servicing right and the mortgage loan without servicing based on their relative fair values at the date of origination. The capitalized cost of loan servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenue.
Mortgage servicing rights are periodically evaluated for impairment by stratifying them based on predominant risk characteristics of the underlying serviced loans. These risk characteristics include loan type (i.e., conventional or government insured, fixed or adjustable rate), term (i.e., 15 year or 30 year), and note rate. Impairment represents the excess of cost of an individual mortgage rights stratum over its fair value, and is recognized through a valuation allowance. Estimates of fair value include assumptions about prepayment, default and interest rates and other factors which are subject to change over time. Changes in these underlying assumptions could cause the fair value of mortgage servicing rights, and the related valuation allowance, to change significantly in the future.
Income Taxes - In 1993, the Corporation adopted Statement of Financial Accounting Standards 109, "Accounting for Income Taxes," (SFAS 109). The Corporation records income tax expense based on the amount of taxes due on its return plus deferred taxes computed based on the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, using current tax rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
The Corporation and the Bank file a consolidated federal income tax return. Intercompany tax liabilities are settled as if each entity filed a separate return.
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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Areas were estimates are used in the accompanying financial statements include the allowance for loan losses, carrying value of mortgage servicing rights, fair values of financial instruments, the accrued liability associated with the defined benefit pension plan and supplemental retirement plan, the carrying value of impaired loans, deferred tax assets, the estimated life of loans and securities and the carrying value of other real estate. Estimates incorporated into the Corporation's financial statements which are more susceptible to change in the near term include the allowance for loan losses, carrying value of mortgage servicing rights, fair value of financial instruments, and the defined benefit pension plan and supplemental retirement plan liabilities. Actual results could differ from those estimates.
Earnings Per Share - Earnings per share of common stock are computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding during the period. Common stock equivalents consist of common stock issuable under the assumed exercise of stock options granted under the Corporation's stock option plan, using the treasury stock method. All per share data presented in the consolidated financial statements is retroactively adjusted for all stock dividends and splits. The Corporation declared and issued a stock split effected in the form of a 25% stock dividend in November, 1995.
Issued But Not Yet Adopted Accounting Standards - The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, "Accounting for Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of" (SFAS 121). The Statement requires that long- lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and establishes criteria for evaluating recoverability. The Statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell, with certain exceptions. The Corporation will adopt SFAS No. 121 effective January 1, 1996. Management does not expect the Statement to have a material impact on the consolidated financial condition and results of operations of the Corporation.
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123). This Statement establishes a fair value based method of accounting for employee stock options and similar equity instruments, such as warrants, and encourages all companies to adopt this method of accounting for all of their employee stock compensation plans. However, the Statement allows companies to continue measuring compensation cost for such plans using accounting guidelines in place prior to SFAS 123. Companies that elect to remain with the former method of accounting must make pro forma disclosures of net income and earnings per share as if the fair value method provided for in SFAS 123 had been adopted. The accounting and disclosure requirements of the Statement are required for the Corporation for transactions entered into in fiscal years that begin after December 15, 1995.
The Corporation entered into no transactions in 1995 or 1994 for which the accounting treatment would differ between SFAS No. 123 and current accounting guidance or for which SFAS No. 123 would require pro forma disclosures. Further, the Corporation currently has no plans for transactions for which the fair value based method of accounting or disclosure, defined by SFAS No. 123, would apply. Accordingly, management does not expect the Statement to have material impact on the financial condition or results of the operations of the Corporation.
Reclassifications - Certain 1994 and 1993 amounts have been reclassified to conform with the 1995 presentation.
Note 3 - Cash and Cash Equivalents
The Bank is required to maintain non-interest-bearing deposits (required reserve balances) with the Federal Reserve, based on a percentage of deposits. The required reserve balances at December 31, 1995 and 1994 were $3,976,000 and $3,691,000, respectively.
Note 4 - Securities
The carrying amount of securities and their approximate fair values at December 31 were as follows:
Note 4 - Securities (continued)
The carrying amount of securities and their approximate fair values at December 31 were as follows:
Sales of securities available for sale during 1995 resulted in gross realized losses of $5,000 and no realized gains. Sales of securities available for sale during 1994 resulted in gross realized gains of $11,000 and no realized losses. There were no sales of securities held to maturity during 1995 or 1994. During 1993 there were no sales of securities; realized gains and losses during this period resulted from called securities.
Pursuant to the FASB Special Report, "A Guide to Implementation of Statement No. 115 on Accounting for Certain Investments in Debt and Equity Securities," securities with a carrying value of $2,853,000, fair value of $2,883,000 and unrealized gain of $30,000, were transferred at fair value to the available for sale classification on December 31, 1995, classifying all mortgage-backed securities as available for sale.
The scheduled maturities of securities available for sale and held to maturity at December 31, 1995 were as follows:
Note 5 - Loans
Accounting and disclosure regarding impaired loans, as required by Statement of Financial Accounting Standards No. 114 and amended by No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures," became effective for the Corporation in 1995.
The average investment in impaired loans for the year ended December 31, 1995 is $1,919,000, with $98,000 interest income recognized, including $96,000 interest income recognized on a cash basis. At December 31, 1995 there is $1,429,000 outstanding in impaired loans, with $1,173,000 for which an allowance for credit losses is allocated, and $256,000 for which no allowance for loan losses is allocated. The portion of the allowance loan losses allocated to the impaired loan balance is $355,000 at December 31, 1995, although the entire allowance is available for charge-offs of any loans.
Loans on which the accrual of interest was discontinued at December 31, 1995 amounted to $867,000 (including $777,000 that would be considered impaired under Statement No. 114). Non-accrual loans at December 31, 1994 amounted to $1,228,000. If the non-accrual loans had performed in accordance with their original terms, additional interest income would have been recorded in 1995, 1994 and 1993 of $122,000, $146,000 and $98,000, respectively.
Marketable mortgage loans held for sale at December 31, 1995 and 1994, which are accounted for at the lower of aggregate cost or market, were $2,054,000 and $1,360,000, respectively.
Loans with a book value of $12,762,000 at December 31, 1995 were pledged to secure Federal Home Loan Bank advances.
Note 6 - Mortgage Banking
Note 6 - Mortgage Banking (continued)
Note 7 - Premises and Equipment
Note 8 - Time Deposits
Included within total time deposits are time deposit liabilities issued in denominations of $100,000 or more. At December 31, 1995 and 1994, these deposits amounted to $8,899,000 and $11,114,000, respectively. Interest expense on time deposits issued in denominations of $100,000 or more for 1995, 1994 and 1993 amounted to $589,000, $449,000 and $227,000, respectively. Maturities of time deposits of $100,000 or more outstanding at December 31, 1995 are summarized below:
Note 9 - Federal Home Loan Bank Advances
The $5,000,000 floating rate advance due January 1999 carries a current interest rate of 7.65 percent, which is adjusted annually based on the one- year constant maturity treasury rate. This advance was prepaid on January 16, 1996. The fixed rate advances have no prepayment provisions. Prepayment of these notes would be subject to the credit policy of the Federal Home Loan Bank. Securities and mortgage loans have been pledged to fully collateralize these advances.
Note 10 - Other Non-Interest Expense
Note 11 - Federal Income Taxes
Note 12 - Employee Benefit Plans
The Bank maintains an integrated employee benefit plan structure designed to provide basic retirement income for employees on a non-contributory basis, and to provide opportunities for employees to build additional retirement savings through tax-deferred voluntary contributions and participation in the Bank's success through stock ownership in the Corporation. A description of the individual plan components of this integrated structure follows.
A non-contributory, defined benefit pension plan which covers substantially all full-time employees was established in 1991. The Bank's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Prior service cost is amortized on a straight-line basis. The plan assets consist of equity and fixed income securities at December 31, 1995. The following sets forth the plan's funded status and amounts included in the consolidated balance sheet at December 31, 1995 and 1994.
Note 12 - Employee Benefit Plans (continued)
The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7 percent in 1995 and 8 percent and 7 percent in 1994 and 1993, respectively. The rate of increase in future compensation used was 4.5 percent in each period presented. As a result of the change in the discount rate for 1995, the accumulated benefit obligation and the projected benefit obligation have increased by $124,000 and $228,000, respectively. The expected long-term rate of return on assets was 9 percent for all periods presented. As a result of the change in the discount rate for 1994, the accumulated benefit obligation and the projected benefit obligation decreased by $111,000 and $204,000, respectively.
In 1991, the Bank established a supplemental retirement program for certain executive officers. This plan provides benefits which are integrated with certain of the Bank's other benefit plans.
Note 12 - Employee Benefit Plans (continued)
The weighted average discount rate and rate of increase in future compensation used for the supplemental executive retirement plan in determining the actuarial present value of the projected benefit obligation were 7 percent and 5 percent, respectively in 1995, 8 percent and 6 percent, respectively in 1994 and 7 percent and 5 percent, respectively, in 1993. As a result of the change in the rates for 1995, the accumulated benefit obligation has increased $22,000 and the projected benefit obligation has decreased $46,000. As a result of the change in the rates for 1994, the accumulated benefit obligation decreased $24,000 and the projected benefit obligation increased $31,000.
The Bank has a profit sharing 401(k) plan covering substantially all of its full-time employees. Under this plan, participants may elect to defer up to 10 percent of their salaries and the Bank may match 50 percent of the employees' deferrals to a maximum of three percent. The Bank contributions for 1995, 1994 and 1993 amounted to $107,000, $103,000 and $90,000, respectively.
The Bank has an Employee Stock Ownership Plan (ESOP) covering substantially all of its full-time employees. At December 31, 1995 the plan had no indebtedness and held 226,643 shares of stock allocated and voted on by employees. The amount of the annual contribution to the ESOP is determined by the Board of Directors. The contributions for 1995, 1994, and 1993 amounted to $129,000, $123,000 and $115,000, respectively.
The Bank has agreements with certain officers to provide benefits upon death prior to retirement which are funded with life insurance contracts. The financial statement impact from these arrangements is not material.
Note 13 - Long-Term Incentive Plan
The Corporation has a long-term incentive plan granting certain officers stock options and tandem stock appreciation rights. All options and rights under the plan have been granted. The right to exercise the stock options and related stock appreciation rights vest over a five year period and expire ten years and one day from the date of grant. As of December 31, 1995, 169,473 stock options and 81,299 stock appreciation rights were vested. The expense related to the tandem stock appreciation rights for 1995, 1994 and 1993 amounted to $798,000, $100,000 and $520,000, respectively. The following is a summary of stock options and rights, granted and exercised, for the years presented, restated for all stock dividends and splits.
Note 14 - Related Party Transactions
Certain directors and executive officers of the Corporation and the Bank (including family members, affiliates, and companies in which they are principal owners) had loans outstanding with the Bank in the ordinary course of business. A summary of the aggregate loans outstanding which exceeded $60,000 to these individuals follows:
Note 15 - Restrictions on Subsidiary Retained Earnings
Regulations issued by the Office of the Comptroller of the Currency limit the amount of dividends that the Bank may declare to the Corporation. The regulations specify the amount to be the sum of the current year's "net profit" and "retained net profits" for the previous two years, as defined in the regulations. The aggregate amount of cash dividends which may be paid to the Corporation by the Bank in 1996 approximates $4,831,000 plus current 1996 net profits.
Dividends paid to the Corporation by the Bank amounted to $1,700,000 in 1995, $1,564,000 in 1994 and $1,432,000 in 1993.
Note 16 - Off-Balance Sheet Financial Instruments
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to make loans and unused lines of credit. The Bank's exposure to credit loss is the contractual amount of these instruments, assuming the amounts are fully advanced and collateral or other security is of no value. Collateral for loans and letters of credit is usually in the form of cash, inventory, securities or other real and personal property. The Bank's policy is to require suitable collateral to be provided prior to the disbursement of funds. The following is a summary of commitments as of December 31:
At December 31, 1995 and 1994, commitments to make loans included $5.8 million and $4.8 million, respectively, of primarily variable rate commercial loans. These commitments generally have fixed termination dates of 90 days or less and may require payment of a fee. Commitments to make loans also include primarily fixed rate mortgage loans of $11.3 million and $6.0 million at December 31, 1995 and 1994, respectively, which are intended for sale in the secondary market upon closing. Other commitments include variable rate mortgage loans of $4.5 million and $2.0 million at December 31, 1995 and 1994, respectively.
Note 17 - Shareholder Rights Plan
In December 1990, the Corporation's Board of Directors adopted a Shareholder Rights Plan which is designed to protect shareholders against unsolicited attempts to acquire control of the Corporation in a manner that does not offer a fair price to all shareholders. The Corporation has reserved 500,000 shares of preferred stock for issuance as Series A Junior Participating Preferred Stock upon the exercise of certain preferred stock purchase rights issued to holders of and in tandem with shares of the common stock. The description and terms of the rights are set forth in a Rights Agreement dated December 19, 1990 between the Corporation and the Bank as Rights Agent.
Generally, in the event a person or group acquires or announces a tender offer which could result in ownership of 20 percent or more of the Corporation's common stock, and the acquiror engages in certain business transactions involving the Corporation as specified in the Rights Agreement, each right, other than those held by the acquiror, shall entitle the holder thereof to acquire common stock or other securities having a market value of twice the $50 per right exercise price.
The Corporation may redeem the rights at a price of one cent per right at anytime until 20 days after a 20 percent position has been acquired.
Note 18 - Fair Value Disclosure
The following methods and assumptions were used by the Bank in estimating fair values of financial instruments as disclosed herein.
Short-term financial instruments: For these instruments, the carrying value is deemed a reasonable estimate of fair value due to the relatively short period to maturity of the instruments. This approach applies to cash and cash equivalents and accrued interest receivable and payable. Securities held to maturity and available for sale: Fair values for securities is based on quoted market prices. Loans: Fair value for certain homogeneous categories of loans, such as some residential mortgages, is estimated using quoted market prices for similar loans, adjusted for differences in loan characteristics. The fair values of other types of loans are estimated by discounting future cash flows, including estimates of prepayments, using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Deposits: The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The value of long-term relationships with depositors is not taken into account in estimating the fair value disclosures. Short-term borrowings: The carrying amounts of federal funds purchased, and other short-term borrowings maturing within 90 days approximate their fair value. Federal Home Loan Bank advances: The fair values of the Bank's long-term debt are estimated using discounted cash flow analyses based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements. 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 account the remaining terms of the agreements and the counterparties' credit standing.
Note 18 - Fair Value Disclosure (continued)
The estimated fair values of the Corporation's financial instruments were as follows at December 31:
Note 19 - Regulatory Capital
The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. The regulations require the Corporation to meet specific capital adequacy guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation's capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. To be considered adequately capitalized, as defined under the regulatory framework for prompt corrective action, the Corporation must maintain minimum tier 1 leverage, tier 1 risk-based and total risk-based ratios as set forth in the table below. As shown, the Corporation's capital ratios are significantly above the well-capitalized standards.
Note 20 - Empire Banc Corporation (Parent Company Only) Condensed Financial Statements
Note 20 - Empire Banc Corporation (Parent Company Only) Condensed Financial Statements (continued)
Independent Auditor's Report
CROWE CHIZEK
To the Shareholders and Board of Directors Empire Banc Corporation Traverse City, Michigan
We have audited the accompanying consolidated balance sheet of Empire Banc Corporation as of December 31, 1995 and 1994 and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Empire Banc Corporation as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Corporation changed its methods of accounting for mortgage servicing rights and impaired loans in 1995, securities in 1994, and income taxes in 1993, all to conform to new accounting standards.
/s/ Crowe, Chizek and Company LLP - --------------------------------- Crowe, Chizek and Company LLP
Grand Rapids, Michigan January 18, 1996
Quarterly Financial Data Empire Banc Corporation
The following is a summary of selected quarterly results of operations for the years ended December 31, 1995 and 1994.
Item 9

Item 9 - Changes in and disagreements with Accountants on Accounting and Financial Disclosure.
None
PART III
The information called for by the items within this part is included in the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 14, 1996, to be filed with the Commission, and is incorporated herein by reference, as follows:
PART IV ITEM 14

ITEM 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 20, 1996.
EXHIBIT INDEX


Item 1. Business
The Sears Credit Account Master Trust I (the "Trust") was formed pursuant to the Pooling and Servicing Agreement dated as of November 18, 1992 (the "Pooling and Servicing Agreement") among Sears, Roebuck and Co. ("Sears") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. ("SRFG") as Seller, and Bank of America Illinois as trustee (the "Trustee"). The Trust's only business is to act as a passive conduit to permit investment in a pool of retail consumer receivables.
Item 2.

Item 2. Properties
The property of the Trust includes a portfolio of receivables (the "Receivables") arising in selected accounts under open-end credit plans of Sears (the "Accounts") and all monies received in payment of the Receivables. At the time of the Trust's formation, Sears sold and contributed to SRFG, which in turn conveyed to the Trust, all Receivables existing under the Accounts as of the end of certain of Sears regular billing cycles ending in May and November, 1991 and all Receivables arising under the Accounts from time to time thereafter until the termination of the Trust. Information related to the performance of the Receivables during 1995 is set forth in the ANNUAL STATEMENT filed as Exhibit 21 to this Annual Report on Form 10-K.
Item 3.

Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Investor Certificates are held and delivered in book-entry form through the facilities of The Depository Trust Company ("DTC"), a "clearing agency" registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended. The sole definitive Investor Certificate is held by CEDE and Co., the nominee of DTC.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
PART III
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
As of March 15, 1996, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.
SRFG, as of March 15, 1996, owned 100% of the Seller Certificate, which represented beneficial ownership of a residual interest in the assets of the Trust as provided in the Pooling and Servicing Agreement.
Item 13.

Item 13. Certain Relationships and Related Transactions
None
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits:
21. 1995 ANNUAL STATEMENT prepared by the Servicer.
28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.
(a) Agreed Upon Pricedures Letter.
(b) Annual Servicing Letter.
(b) Reports on Form 8-K:
Current reports on Form 8-K are filed on or before the Distribution Date each month (on, or the first business day after, the 15th of the month). The reports include as an exhibit, the MONTHLY INVESTOR CERTIFICATEHOLDERS' STATEMENT. Current Reports on Form 8-K were filed on October 16, 1995, November 15, 1995, and December 15, 1995.
SIGNATURES
Pursuant to the requirements of Section 13 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.
Sears Credit Account Master Trust I (Registrant)
By: Sears Receivables Financing Group, Inc. (Originator of the Trust)
By: Larry R. Raymond Vice President, Finance
Dated: March 28, 1996
EXHIBIT INDEX
Exhibit No.
21. 1995 ANNUAL STATEMENT prepared by the Servicer.
28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.
(a) Agreed Upon Procedures Letter.
(b) Annual Servicing Letter.
SIGNATURES
Pursuant to the requirements of Section 13 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.
Sears Credit Account Master Trust I (Registrant)
By: Sears Receivables Financing Group, Inc. (Originator of the Trust)
By: /S/Larry R. Raymond Larry R. Raymond Vice President, Finance
Dated: March 28, 1996