##### 



EXHIBIT 13 FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Financial Statements December 31, 2004 and 2003 (With Independent Auditors Reports Thereon)




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Table of Contents PageIndependent Auditors Report  BDO Seidman, LLP
    
    
    2Independent Auditors Report  KPMG LLP
    
    
    3Consolidated Balance Sheets
    
    
    4Consolidated Statements of Income
    
    
    5Consolidated Statements of Stockholders Equity and Comprehensive Income
    
    
    6Consolidated Statements of Cash Flows
    
    
    7Notes to Consolidated Financial Statements
    
    
    8Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    29
 1




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##### 



(BDO LOGO)
    
    BDO Seidman, LLP
Accountants and Consultants
    
    99 Monroe Avenue N.W., Suite 800
Grand Rapids, Michigan 49503-2654 
Telephone: (616) 774-7000
Fax: (616) 776-3680
 Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders
FNBH Bancorp, Inc.
Howell, MI We have audited the accompanying consolidated balance sheet of FNBH Bancorp, Inc. and subsidiaries
as of December 31, 2004 and the related consolidated statements of income, stockholders equity and
comprehensive income, and cash flows for the year ended December 31, 2004. 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 audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of FNBH Bancorp, Inc. and subsidiaries at December 31,
2004, and the results of their operations and their cash flows for the year ended December 31,
2004, in conformity with accounting principles generally accepted in the United States of America. (BDO saidman, LLP) Grand Rapids, Michigan
February 28, 2005 2




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##### 



(KPMG LOGO) KPMG LLP
Suite 1200
150 West Jefferson
Detroit, MI 48226-4429 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders
FNBH Bancorp, Inc.: We have audited the consolidated balance sheet of FNBH Bancorp, Inc. and subsidiaries
(Corporation) as of December 31, 2003 and the related consolidated statements of income,
stockholders equity and comprehensive income, and cash flows for each of the years in the two-year
period ended December 31, 2003. These consolidated financial statements are the responsibility of
the Corporations management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). 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 FNBH Bancorp, Inc. and subsidiaries as of December 31,
2003 and the results of their operations and their cash flows for each of the years in the two-year
period ended December 31, 2003, in conformity with U.S.
generally accepted accounting principles. (KPMG LLP) January 16, 2004 3




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2004 and 2003 2004
    
    
    2003AssetsCash and due from banks
    
    $
    12,157,948
    
    
    $
    16,035,121Short term investments
    
    
    5,680,395
    
    
    
    16,848,371Total cash and cash equivalents
    
    
    17,838,343
    
    
    
    32,883,492Certificates of deposit
    
    
    6,091,000
    
    
    
    1,553,000Investment securities held to maturity, net (fair value of $16,705,640
at December 31, 2004 and $16,006,625 at December 31, 2003)
    
    
    16,009,337
    
    
    
    15,051,293Investment securities available for sale, at fair value
    
    
    30,775,695
    
    
    
    26,787,863Mortgage-backed securities available for sale, at fair value
    
    
    16,432,188
    
    
    
    12,513,486FHLBI and FRB stock, at cost
    
    
    1,130,650
    
    
    
    1,082,750Total investment securities
    
    
    64,347,870
    
    
    
    55,435,392Loans:Commercial
    
    
    286,940,773
    
    
    
    278,002,975Consumer
    
    
    36,077,528
    
    
    
    34,995,478Real estate mortgage
    
    
    34,358,613
    
    
    
    34,087,202Total loans
    
    
    357,376,914
    
    
    
    347,085,655Less allowance for loan losses
    
    
    (6,399,949
    )
    
    
    (5,958,375
    )Net loans
    
    
    350,976,965
    
    
    
    341,127,280Premises and equipment, net
    
    
    11,086,901
    
    
    
    11,910,399Land and facilities held for sale, net
    
    
    95,680
    
    
    
    1,400,290Other real estate owned, held for sale
    
    
    735,000
    
    
    
    65,000Accrued interest and other assets
    
    
    5,431,302
    
    
    
    5,443,555Total assets
    
    $
    456,603,061
    
    
    $
    449,818,408Liabilities and Stockholders EquityLiabilitiesDeposits:Demand (non-interest bearing)
    
    $
    71,785,184
    
    
    $
    69,233,515NOW
    
    
    49,206,656
    
    
    
    46,056,749Savings and money market
    
    
    147,298,849
    
    
    
    140,639,653Time deposits
    
    
    128,593,689
    
    
    
    137,174,926Brokered certificates of deposit
    
    
    2,378,532
    
    
    
    5,968,458Total deposits
    
    
    399,262,910
    
    
    
    399,073,301Other borrowings
    
    
    8,066,836
    
    
    
    5,327,708Accrued interest, taxes, and other liabilities
    
    
    3,557,267
    
    
    
    4,181,918Total liabilities
    
    
    410,887,013
    
    
    
    408,582,927Stockholders EquityCommon stock, no par value. Authorized 4,200,000 shares; 3,179,654
shares issued and outstanding at December 31, 2004 and 3,168,931 shares
issued and outstanding at December 31, 2003
    
    
    6,009,181
    
    
    
    5,725,898Retained earnings
    
    
    39,430,621
    
    
    
    35,425,699Deferred directors compensation
    
    
    455,481
    
    
    
    Unearned long term incentive plan
    
    
    (151,048
    )
    
    
    (222,652
    )Accumulated other comprehensive income, net
    
    
    (28,187
    )
    
    
    306,536Total stockholders equity
    
    
    45,716,048
    
    
    
    41,235,481Total liabilities and stockholders equity
    
    $
    456,603,061
    
    
    $
    449,818,408
 See accompanying notes to consolidated financial statements. 4




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income December 31, 2004, 2003, and 2002 2004
    
    
    2003
    
    
    2002Interest and dividend income:Interest and fees on loans
    
    $
    22,137,252
    
    
    $
    22,666,583
    
    
    $
    23,040,432Interest and dividends on investment securities:U.S. Treasury and agency securities
    
    
    1,667,506
    
    
    
    975,069
    
    
    
    1,188,802Obligations of states and political subdivisions
    
    
    747,483
    
    
    
    770,269
    
    
    
    836,703Corporate bonds
    
    
    125,381
    
    
    
    188,463
    
    
    
    365,785Other securities
    
    
    51,278
    
    
    
    41,759
    
    
    
    61,650Interest on short term investments
    
    
    166,978
    
    
    
    104,818
    
    
    
    58,618Interest on certificates of deposit
    
    
    95,832
    
    
    
    109,201
    
    
    
    177,677Total interest and dividend income
    
    
    24,991,710
    
    
    
    24,856,162
    
    
    
    25,729,667Interest expense:Interest on deposits
    
    
    5,217,598
    
    
    
    5,757,465
    
    
    
    7,440,794Interest on other borrowings
    
    
    388,268
    
    
    
    409,389
    
    
    
    576,449Total interest expense
    
    
    5,605,866
    
    
    
    6,166,854
    
    
    
    8,017,243Net interest income
    
    
    19,385,844
    
    
    
    18,689,308
    
    
    
    17,712,424Provision for loan losses
    
    
    1,190,000
    
    
    
    1,270,000
    
    
    
    625,000Net interest income after provision for loan losses
    
    
    18,195,844
    
    
    
    17,419,308
    
    
    
    17,087,424Noninterest income:Service charges and other fee income
    
    
    3,318,666
    
    
    
    3,136,077
    
    
    
    2,973,691Trust income
    
    
    246,950
    
    
    
    287,344
    
    
    
    202,595Gain on sale of loans
    
    
    68,881
    
    
    
    373,516
    
    
    
    415,454Gain on sale/call of investments
    
    
    
    
    
    
    3,823
    
    
    
    36,570Other
    
    
    475,560
    
    
    
    73,376
    
    
    
    (7,710
    )Total noninterest income
    
    
    4,110,057
    
    
    
    3,874,136
    
    
    
    3,620,600Noninterest expense:Salaries and employee benefits
    
    
    7,236,801
    
    
    
    7,048,376
    
    
    
    6,445,184Net occupancy expense
    
    
    1,115,030
    
    
    
    957,710
    
    
    
    890,605Equipment expense
    
    
    864,604
    
    
    
    1,008,275
    
    
    
    866,409Professional and service fees
    
    
    1,622,399
    
    
    
    1,223,346
    
    
    
    1,276,489Printing and supplies
    
    
    302,032
    
    
    
    291,103
    
    
    
    327,284Advertising
    
    
    221,618
    
    
    
    304,589
    
    
    
    348,572Other
    
    
    1,924,166
    
    
    
    2,014,711
    
    
    
    1,621,000Total noninterest expense
    
    
    13,286,650
    
    
    
    12,848,110
    
    
    
    11,775,543Income before federal income taxes
    
    
    9,019,251
    
    
    
    8,445,334
    
    
    
    8,932,481Federal income taxes
    
    
    2,728,156
    
    
    
    2,554,437
    
    
    
    2,628,650Net income
    
    $
    6,291,095
    
    
    $
    5,890,897
    
    
    $
    6,303,831Per share statistics:Basic EPS
    
    $
    1.98
    
    
    $
    1.86
    
    
    $
    2.00Diluted EPS
    
    $
    1.97
    
    
    $
    1.86
    
    
    $
    2.00Dividends
    
    $
    0.720
    
    
    $
    0.680
    
    
    $
    0.628Basic average shares outstanding
    
    
    3,185,025
    
    
    
    3,162,836
    
    
    
    3,152,739Diluted average shares outstanding
    
    
    3,186,142
    
    
    
    3,162,836
    
    
    
    3,152,739
 See accompanying notes to consolidated financial statements. 5




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders Equity and Comprehensive Income December 31, 2004, 2003, and 2002 AccumulatedDeferred
    
    
    Unearned
    
    
    OtherCommon
    
    
    Retained
    
    
    Directors
    
    
    Long Term
    
    
    ComprehensiveStock
    
    
    Earnings
    
    
    Compensation
    
    
    Incentive Plan
    
    
    Income (Loss)
    
    
    TotalBalances at December 31, 2001
    
    $
    5,246,770
    
    
    $
    27,361,215
    
    
    $
    
    
    
    $
    (231,143
    )
    
    $
    26,961
    
    
    $
    32,403,803Issued 5,246 shares for long term incentive plan
    
    
    109,799
    
    
    
    
    
    
    
    
    
    
    
    (109,799
    )
    
    
    
    
    
    
    Amortization of long term incentive plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93,660
    
    
    
    
    
    
    
    93,660Issued 3,988 shares for employee stock purchase plan
    
    
    70,428
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70,428Issued 686 shares for current directors fees
    
    
    14,483
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,483Issued 1,128 shares for directors variable fee plan
    
    
    23,609
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,609Comprehensive income:Net income
    
    
    
    
    
    
    6,303,831
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,303,831Change in unrealized gain on investment securities
available for sale, net of tax effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    648,997
    
    
    
    648,997Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,952,828Cash dividends ($0.628 per share)
    
    
    
    
    
    
    (1,979,197
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,979,197
    )Balances at December 31,2002
    
    
    5,465,089
    
    
    
    31,685,849
    
    
    
    
    
    
    
    (247,282
    )
    
    
    675,958
    
    
    
    37,579,614Issued 4,482 shares for long term incentive plan
    
    
    110,137
    
    
    
    
    
    
    
    
    
    
    
    (110,137
    )
    
    
    
    
    
    
    Amortization of long term incentive plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    134,767
    
    
    
    
    
    
    
    134,767Issued 4,055 shares for employee stock purchase plan
    
    
    88,722
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88,722Issued 907 shares for current directors fees
    
    
    21,954
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,954Issued 1,689 shares for directors variable fee plan
    
    
    39,996
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,996Comprehensive income:Net income
    
    
    
    
    
    
    5,890,897
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,890,897Change in unrealized loss on investment securities
available for sale, net of tax effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (369,422
    )
    
    
    (369,422
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,521,475Cash dividends ($0.68 per share)
    
    
    
    
    
    
    (2,151,047
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,151,047
    )Balances at December 31, 2003
    
    
    5,725,898
    
    
    
    35,425,699
    
    
    
    
    
    
    
    (222,652
    )
    
    
    306,536
    
    
    
    41,235,481Issued 4,261 shares for long term incentive plan
    
    
    115,985
    
    
    
    
    
    
    
    
    
    
    
    (115,985
    )
    
    
    
    
    
    
    Amortization of long term incentive plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    184,530
    
    
    
    
    
    
    
    184,530146 shares from long term incentive plan forfeited
    
    
    (3,059
    )
    
    
    
    
    
    
    
    
    
    
    3,059
    
    
    
    
    
    
    
    Issued 4,352 shares for employee stock purchase plan
    
    
    109,521
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    109,521Issued 794 shares for current directors fees
    
    
    22,791
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,791Issued 1,179 shares for directors variable fee plan
    
    
    32,092
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,092Issued 283 shares for deferred directors fees
    
    
    5,953
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,953Directors deferred compensation (590 stock units)
    
    
    
    
    
    
    
    
    
    
    18,270
    
    
    
    
    
    
    
    
    
    
    
    18,270Reclassification of directors deferred
compensation (19,321 stock units)
    
    
    
    
    
    
    
    
    
    
    437,211
    
    
    
    
    
    
    
    
    
    
    
    437,211Comprehensive income:Net income
    
    
    
    
    
    
    6,291,095
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,291,095Change in unrealized loss on investment securities
available for sale, net of tax effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (334,723
    )
    
    
    (334,723
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,956,372Cash dividends ($0.72 per share)
    
    
    
    
    
    
    (2,286,173
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,286,173
    )Balances at December 31, 2004
    
    $
    6,009,181
    
    
    $
    39,430,621
    
    
    $
    455,481
    
    
    $
    (151,048
    )
    
    $
    (28,187
    )
    
    $
    45,716,048
 See accompanying notes to consolidated financial statements. 6




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows December 31, 2004, 2003, and 2002 2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    6,291,095
    
    
    $
    5,890,897
    
    
    $
    6,303,831Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses
    
    
    1,190,000
    
    
    
    1,270,000
    
    
    
    625,000Depreciation and amortization
    
    
    1,014,720
    
    
    
    992,986
    
    
    
    897,800Deferred income tax expense (benefit)
    
    
    159,167
    
    
    
    (118,597
    )
    
    
    (1,300
    )Net amortization (accretion) on investment securities
    
    
    (16,031
    )
    
    
    126,508
    
    
    
    239,341Earned portion of long term incentive plan
    
    
    184,530
    
    
    
    134,767
    
    
    
    93,660Shares issued for current directors compensation
    
    
    54,883
    
    
    
    61,950
    
    
    
    38,092Shares earned for deferred directors compensation
    
    
    24,223
    
    
    
    
    
    
    
    Gain on sale/call of investments
    
    
    
    
    
    
    (3,823
    )
    
    
    (36,570
    )Gain on sale of loans
    
    
    (68,881
    )
    
    
    (373,516
    )
    
    
    (415,454
    )Proceeds from sale of loans
    
    
    11,285,139
    
    
    
    23,486,120
    
    
    
    30,465,662Origination of loans held for sale
    
    
    (10,541,000
    )
    
    
    (22,524,120
    )
    
    
    (30,948,790
    )Gain on the sale of other real estate owned, held for sale
    
    
    (98,850
    )
    
    
    (22,710
    )
    
    
    Proceeds from sale of other real estate owned, held for sale
    
    
    990,652
    
    
    
    760,916
    
    
    
    546,812Proceeds from sale of land and facilities held for sale
    
    
    1,503,016
    
    
    
    
    
    
    
    Gain on sale of land and facilities held for sale
    
    
    (42,716
    )
    
    
    
    
    
    
    Loss on disposal of equipment
    
    
    
    
    
    
    8,958
    
    
    
    4,518(Increase) decrease in accrued interest income and other assets
    
    
    (135,314
    )
    
    
    48,167
    
    
    
    (672,538
    )Increase (decrease) in accrued interest, taxes, and other liabilities
    
    
    (29,240
    )
    
    
    906,988
    
    
    
    17,599Net cash provided by operating activities
    
    
    11,765,393
    
    
    
    10,645,491
    
    
    
    7,157,663Cash flows from investing activities:Purchases of available for sale securities
    
    
    (36,556,566
    )
    
    
    (22,783,210
    )
    
    
    (6,035,081
    )Purchases of held to maturity securities
    
    
    (4,776,698
    )
    
    
    (234,270
    )
    
    
    (203,250
    )Purchases/stock dividend FHLBI stock
    
    
    (47,900
    )
    
    
    (38,500
    )
    
    
    (211,500
    )Proceeds from maturities and calls of available for sale securities
    
    
    24,500,000
    
    
    
    3,500,000
    
    
    
    4,390,000Proceeds from sales of available for sale securities
    
    
    
    
    
    
    
    
    
    
    7,788,508Proceeds from mortgage-backed securities paydowns-available for sale
    
    
    3,660,069
    
    
    
    5,977,649
    
    
    
    5,061,306Proceeds from maturities and calls of held to maturity securities
    
    
    3,820,125
    
    
    
    2,046,100
    
    
    
    1,316,175Proceeds from mortgage-backed securities paydowns-held to maturity
    
    
    
    
    
    
    26,028
    
    
    
    51,835Purchases of certificates of deposit
    
    
    (5,993,000
    )
    
    
    (1,187,000
    )
    
    
    Maturity of certificates of deposit
    
    
    1,455,000
    
    
    
    3,514,000
    
    
    
    2,037,000Purchase of loans
    
    
    (6,279,807
    )
    
    
    (3,000,000
    )
    
    
    (3,116,728
    )Net increase in loans
    
    
    (6,996,938
    )
    
    
    (18,662,903
    )
    
    
    (38,059,057
    )Capital expenditures
    
    
    (346,912
    )
    
    
    (2,655,515
    )
    
    
    (2,052,498
    )Net cash used in investing activities
    
    
    (27,562,627
    )
    
    
    (33,497,621
    )
    
    
    (29,033,290
    )Cash flows from financing activities:Net increase in deposits
    
    
    3,779,535
    
    
    
    19,032,632
    
    
    
    22,403,461Increase (decrease) in brokered certificates of deposit
    
    
    (3,589,926
    )
    
    
    5,968,458
    
    
    
    Payments on FHLBI note
    
    
    (260,872
    )
    
    
    (241,547
    )
    
    
    (223,656
    )Proceeds from issuance of short term debt
    
    
    3,000,000
    
    
    
    
    
    
    
    Dividends paid
    
    
    (2,286,173
    )
    
    
    (2,151,047
    )
    
    
    (1,979,197
    )Shares issued for employee stock purchase plan
    
    
    109,521
    
    
    
    88,722
    
    
    
    70,428Net cash provided by financing activities
    
    
    752,085
    
    
    
    22,697,218
    
    
    
    20,271,036Net decrease in cash and cash equivalents
    
    
    (15,0415,149
    )
    
    
    (154,912
    )
    
    
    (1,604,591
    )Cash and cash equivalents at beginning of year
    
    
    32,883,492
    
    
    
    33,038,404
    
    
    
    34,642,995Cash and cash equivalents at end of year
    
    $
    17,838,343
    
    
    $
    32,883,492
    
    
    $
    33,038,404Supplemental disclosures:Interest paid
    
    $
    5,642,097
    
    
    $
    6,168,253
    
    
    $
    8,239,097Federal income taxes paid
    
    
    2,609,881
    
    
    
    2,460,000
    
    
    
    2,628,000Loans transferred to other real estate
    
    
    1,561,802
    
    
    
    95,000
    
    
    
    1,285,018Properties transferred to land and facilities, held for sale
    
    
    155,690
    
    
    
    
    
    
    
    Loans charged off
    
    
    922,078
    
    
    
    1,282,563
    
    
    
    767,302
 See accompanying notes to consolidated financial statements. 7




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  (1)
    Summary of Significant Accounting PoliciesPrinciples of ConsolidationThe consolidated financial statements include the accounts of FNBH Bancorp, Inc. and its
wholly owned subsidiaries, First National Bank in Howell (including its wholly owned
subsidiary FNBH Mortgage Company, LLC) and H.B. Realty Co. All significant intercompany
balances and transactions have been eliminated.First National Bank in Howell (Bank) is a full-service bank offering a wide range of
commercial and personal banking services. These services include checking accounts, savings
accounts, certificates of deposit, commercial loans, real estate loans, installment loans,
collections, travelers checks, night depository, safe deposit box, U.S. Savings Bonds, and
trust services. The Bank serves primarily five communities  Howell, Brighton, Green Oak
Township, Hartland, and Fowlerville  all of which are located in Livingston County, Michigan.
The Bank is not dependent upon any single industry or business for its banking opportunities.H.B. Realty Co. was established on November 26, 1997 to purchase land for a future branch site
of the Bank and to hold title to other Bank real estate when it is considered prudent to do
so.The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America 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. Actual results could differ from those estimates.The accounting and reporting policies of FNBH Bancorp, Inc. and subsidiaries (Corporation)
conform to accounting principles generally accepted in the United States of America and to
general practice within the banking industry. The following is a description of the more
significant of these policies.  (a)
    Brokered Certificates of DepositBrokered certificates of deposit are purchased periodically from other financial
institutions in denominations of less than $100,000. These investments are fully insured
by the FDIC. Brokered CDs are not marketable, and there is a penalty for early
withdrawal.(b)
    Investment and Mortgage-Backed SecuritiesInvestment securities held to maturity are those securities which management has the
ability and positive intent to hold to maturity. Investment securities held to maturity
are stated at cost, adjusted for amortization of premium and accretion of discount.Investment securities that we may not hold until maturity are accounted for as securities
available for sale and are stated at fair value, with unrealized gains and losses, net of
income taxes, reported as a separate component of other comprehensive income until
realized.Trading account securities are carried at fair value. Realized and unrealized gains or
losses on trading securities are included in noninterest income. The Bank holds no
securities under the trading classification.Gains or losses on the sale of securities are computed based on the adjusted cost of the
specific security.Management reviews impairments and records other-than-temporary impairments, if any, as a
component of noninterest income.(c)
    LoansLoans are stated at their principal amount outstanding, net of an allowance for loan
losses and unearned discount. Interest on loans is accrued daily based on the outstanding
principal balance. Loan origination fees 8




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  and certain direct loan origination costs are
deferred and recognized over the lives of the related loans as an adjustment of the
yield. Net unamortized deferred loan fees amounted to $1,006,000 and $931,000 at December
31, 2004 and 2003, respectively.The Bank originates real estate mortgage loans for sale to the secondary market and sells
the loans with servicing retained. Mortgage loans held for sale are carried at the lower
of cost or market, determined on a net aggregate basis. Market is determined on the basis
of delivery prices in the secondary mortgage market. When loans are sold, gains and
losses are recognized based on the specific identification method.The total cost of mortgage loans originated and sold is allocated between the loan
servicing right and the mortgage loan, 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 future servicing revenue. The Corporation enters
into interest rate lock commitments to originate loans at a rate determined prior to
funding. Interest rate lock commitments on residential mortgage loans that are intended
to be sold are considered to be derivatives. Fair value is based on fees currently
charged to enter into similar agreements. At December 31, 2004 and 2003, the fair value
of interest rate lock commitments was insignificant.Mortgage servicing rights which are included in other assets are periodically evaluated
for impairment. For purposes of measuring impairment, mortgage servicing rights are
stratified based on predominant risk characteristics of the underlying serviced loans.
These risk characteristics include loan type, term, year originated, and note rate.
Impairment represents the excess of cost of an individual mortgage servicing rights
stratum over its fair value and is recognized through a valuation allowance.
Fair values for individual strata are based on quoted market prices for comparable
transactions, if available, or estimated fair value. 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.(d)
    Allowance for Loan LossesThe allowance for loan losses is based on managements periodic evaluation of the loan
portfolio and reflects an amount that, in managements opinion, is adequate to absorb
probable losses in the existing portfolio. In evaluating the portfolio, management takes
into consideration numerous factors, including current economic conditions, prior loan
loss experience, nonperforming loan levels, the composition of the loan portfolio, and
managements evaluation of the collectability of specific loans, which includes analysis
of the value of the underlying collateral. Although the Bank evaluates the adequacy of
the allowance for loan losses based on information known to management at a given time,
various regulatory agencies, as part of their normal examination process, may require
future additions to the allowance for loan losses.(e)
    Nonperforming AssetsThe Bank charges off all or part of loans when amounts are deemed to be uncollectible,
although collection efforts may continue and future recoveries may occur.Nonperforming assets are comprised of loans for which the accrual of interest has been
discontinued, loans for which the terms have been renegotiated to less than market rates
due to a serious weakening of the borrowers financial condition, loans 90 days past due
and still accruing, and other real estate, which has been acquired primarily through
foreclosure and is awaiting disposition.Loans are generally placed on a nonaccrual status when principal or interest is past due
90 days or more and when, in the opinion of management, full collection of principal and
interest is unlikely. At the time a loan is 9




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  placed on nonaccrual status, interest
previously accrued but not yet collected is charged against current income. Income on
such loans is then recognized only to the extent that cash is received and where future
collection of principal is probable.The Bank considers a loan to be impaired when it is probable that it will be unable to
collect all or part of amounts due according to the contractual terms of the loan
agreement. Impaired loans are measured based on the present value of expected cash flows
discounted at the loans effective interest rate or, as a practical expedient, at a
loans observable market price, or the fair value of the collateral if the loan is
collateral dependent. Interest income on impaired loans is accrued based on the principal
amounts outstanding. The accrual of interest is discontinued when an impaired loan
becomes 90 days past due.(f)
    Real EstateOther real estate owned at the time of foreclosure is recorded at the lower of the Banks
cost of acquisition or the assets fair market value, net of disposal cost. Any
write-downs at date of acquisition are charged to the allowance for loan losses. Expenses
incurred in maintaining assets and subsequent write-downs to reflect declines in value
are charged to other expense.Real estate held for sale is recorded at the lower of carrying amount or estimated fair
value less estimated disposal costs. Subsequent declines in estimated fair value and/or
disposal costs are recorded as a component of noninterest expense.(g)
    Bank Premises and EquipmentBank premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization, computed on the straight-line method, are
charged to operations over the estimated useful lives of the assets. Estimated useful
lives range up to 40 years for buildings, up to 7 years for furniture and equipment and
up to 15 years for land improvements.(h)
    Federal Income TaxesDeferred tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.(i)
    Stock-Based CompensationAt December 31, 2004 and 2003, the Bank has two stock-based compensation plans, which are
described more fully in notes 16 and 17.(j)
    Statements of Cash FlowsFor purposes of reporting cash flows, cash equivalents include amounts due from banks,
federal funds sold and other short term investments.(k)
    Comprehensive IncomeSFAS No. 130, Reporting Comprehensive Income,established standards for the reporting and
display of comprehensive income and its components (such as changes in unrealized gains
and losses on securities available for sale) in a financial statement that is displayed
with the same prominence as other financial statements. The Bank reports comprehensive
income within the statement of stockholders equity and 10




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  comprehensive income.
Comprehensive income includes net income and any changes in equity from nonowner sources
that are not recorded in the income statement.(l)
    Earnings Per ShareBasic earnings per common share is calculated by dividing net income by the average
number of common shares and deferred director fee stock units outstanding during the
year. Diluted earnings per common share is calculated by dividing net income by the
average number of common shares and deferred director fee stock units outstanding during
the year, plus the effect of common stock equivalents (for example, restricted share
rights) that are dilutive.(m)
    Stock SplitThe Corporation issued a 2-for-1 stock split, payable July 10, 2002 as a dividend of one
share for each share of its stock held of record on July 1, 2002.(o)
    ReclassificationCertain reclassifications of 2003 and 2002 information have been made to conform to the
current year presentation.  (2)
    Certificates of DepositAt December 31, 2004, the scheduled maturities of brokered certificates were: Maturing in 2005
    
    $
    5,993,000Maturing in 2008
    
    
    98,000$
    6,091,000
 11




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  (3)
    Investment and Mortgage-Backed SecuritiesA summary of the amortized cost and approximate fair value of investment and mortgage-backed
securities at December 31, 2004 and 2003 follows: December 31, 2004
    
    
    December 31, 2003Unrealized
    
    
    Unrealized
    
    
    
    
    
    
    
    
    
    
    Unrealized
    
    
    UnrealizedAmortized
    
    
    gross
    
    
    gross
    
    
    Fair
    
    
    Amortized
    
    
    gross
    
    
    gross
    
    
    Faircost
    
    
    gains
    
    
    losses
    
    
    value
    
    
    cost
    
    
    gains
    
    
    losses
    
    
    valueHeld to maturity:Obligations of state and
political
subdivisions
    
    $
    16,009,337
    
    
    $
    696,303
    
    
    $
    
    
    
    $
    16,705,640
    
    
    $
    15,051,293
    
    
    $
    957,246
    
    
    $
    (1,914
    )
    
    $
    16,006,625Total held to maturity
    
    
    16,009,337
    
    
    
    696,303
    
    
    
    
    
    
    
    16,705,640
    
    
    
    15,051,293
    
    
    
    957,246
    
    
    
    (1,914
    )
    
    
    16,006,625Available for sale:U.S Treasury and agency
securities
    
    
    29,975,734
    
    
    
    61,903
    
    
    
    (299,522
    )
    
    
    29,738,115
    
    
    
    21,985,556
    
    
    
    325,413
    
    
    
    (159,966
    )
    
    
    22,151,003Corporate bonds
    
    
    1,001,104
    
    
    
    36,476
    
    
    
    
    
    
    
    1,037,580
    
    
    
    4,514,599
    
    
    
    122,261
    
    
    
    
    
    
    
    4,636,860Mortgage-backed securities
    
    
    16,270,832
    
    
    
    194,770
    
    
    
    (33,414
    )
    
    
    16,432,188
    
    
    
    12,336,459
    
    
    
    183,728
    
    
    
    (6,701
    )
    
    
    12,513,486Total available for sale
    
    
    47,247,670
    
    
    
    293,149
    
    
    
    (332,936
    )
    
    
    47,207,883
    
    
    
    38,836,614
    
    
    
    631,402
    
    
    
    (166,667
    )
    
    
    39,301,349Total securities
    
    $
    63,257,007
    
    
    $
    989,452
    
    
    $
    (332,936
    )
    
    $
    63,913,523
    
    
    $
    53,887,907
    
    
    $
    1,588,648
    
    
    $
    (168,581
    )
    
    $
    55,307,974
  There were three securities in a continuous loss position for 12 months or more at December
31, 2004, which consisted of an asset-backed security and two agency securities. Because the
declines in fair value were due to changes in market interest rates, not in estimated cash
flows, no other-than-temporary impairment was recorded at December 31, 2004. The Corporation has
both the intent and ability to hold these securities for the time necessary to recover the
amortized cost.The following is a summary of the unrealized losses and fair value of securities available for
sale portfolio at December 31, 2004, by length of time that individual securities in each
category have been in a continuous loss position: December 31, 2004Less than 12 months
    
    
    12 months or more
    
    
    TotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    Unrealizedgross
    
    
    Fair
    
    
    gross
    
    
    Fair
    
    
    gross
    
    
    Fairlosses
    
    
    value
    
    
    losses
    
    
    value
    
    
    losses
    
    
    valueAvailable for sale:U.S. Treasury and agency securities
    
    $
    (212,126
    )
    
    $
    21,264,600
    
    
    $
    (87,396
    )
    
    $
    2,912,605
    
    
    $
    (299,522
    )
    
    $
    24,177,205Mortgage-backed securities
    
    
    (24,430
    )
    
    
    4,771,822
    
    
    
    (8,984
    )
    
    
    1,064,810
    
    
    
    (33,414
    )
    
    
    5,836,632Total available for sale
    
    $
    (236,556
    )
    
    $
    26,036,422
    
    
    $
    (96,380
    )
    
    $
    3,977,415
    
    
    $
    (332,936
    )
    
    $
    30,013,837
  As of December 31, 2003, there were no investments that had been in a continuous loss
position for 12 months or more. 12




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  The amortized cost and approximate fair value of investment and mortgage-backed securities at
December 31, 2004 and 2003, by contractual maturity, are shown below. Expected maturities may
differ from contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. December 31, 2004
    
    
    December 31, 2003Amortized
    
    
    Approximate
    
    
    Amortized
    
    
    Approximatecost
    
    
    fair value
    
    
    cost
    
    
    fair valueHeld to maturity:Due in one year or less
    
    $
    1,279,805
    
    
    $
    1,308,479
    
    
    $
    3,115,340
    
    
    $
    3,174,341Due after one year through
five years
    
    
    8,926,155
    
    
    
    9,398,970
    
    
    
    9,147,796
    
    
    
    9,798,561Due after five years through
ten years
    
    
    1,953,582
    
    
    
    2,029,413
    
    
    
    2,788,157
    
    
    
    3,033,723Due after ten years
    
    
    3,849,795
    
    
    
    3,968,777
    
    
    
    
    
    
    
    $
    16,009,337
    
    
    $
    16,705,640
    
    
    $
    15,051,293
    
    
    $
    16,006,625Available for sale:Due in one year or less
    
    $
    3,005,150
    
    
    $
    2,986,680
    
    
    $
    11,505,883
    
    
    $
    11,660,092Due after one year through
five years
    
    
    26,992,032
    
    
    
    26,810,797
    
    
    
    14,017,622
    
    
    
    14,170,240Due after five years through
ten years
    
    
    979,656
    
    
    
    978,218
    
    
    
    976,650
    
    
    
    957,53130,976,838
    
    
    
    30,775,695
    
    
    
    26,500,155
    
    
    
    26,787,863Mortgage-backed securities
    
    
    16,270,832
    
    
    
    16,432,188
    
    
    
    12,336,459
    
    
    
    12,513,486$
    47,247,670
    
    
    $
    47,207,883
    
    
    $
    38,836,614
    
    
    $
    39,301,349
  Proceeds from sales/calls of available for sale securities totaled approximately
$8,000,000, $3,500,000 and $7,789,000 during 2004, 2003, and 2002, respectively; gross
realized gains of $0, $4,587 and $43,000 and gross realized losses of $0, $764 and $6,000 were
recorded as a result of sales of available-for-sale securities during 2004, 2003, and 2002.The amortized cost and approximate fair value of investment securities of states (including
all their political subdivisions) that individually exceeded 10% of stockholders equity at
December 31, 2004 and 2003 are as follows: 2004
    
    
    2003Amortized
    
    
    Approximate
    
    
    Amortized
    
    
    Approximatecost
    
    
    fair value
    
    
    cost
    
    
    fair valueState of Michigan
    
    $
    10,545,620
    
    
    $
    10,971,396
    
    
    $
    9,183,802
    
    
    $
    9,738,000
  Investment securities, with an amortized cost of approximately $1,865,000 at December 31,
2004 and $1,848,000 at December 31, 2003, were pledged to secure public deposits and for other
purposes as required or permitted by law.The Bank owns stock in both the Federal Home Loan Bank of Indianapolis (FHLBI) and the Federal
Reserve Bank (FRB). The Bank is required to hold stock in the FHLBI equal to 5% of the
institutions borrowing capacity with the FHLBI. The Banks investment in FHLBI stock amounted to $1,086,400 and $1,038,500 as of
December 31, 13




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  2004 and 2003, respectively. The Banks investment in FRB stock, which totaled
$44,250 at December 31, 2004 and 2003, respectively, is a requirement for the Banks
membership in the Federal Reserve System.  (4)
    LoansLoans on nonaccrual status amounted to $1,146,000, $4,292,889 and $3,288,000, at December 31,
2004, 2003, and 2002, respectively. If these loans had continued to accrue interest in
accordance with their original terms, approximately $98,000, $320,000, and $181,000 of
interest income would have been recognized in 2004, 2003, and 2002, respectively. The Bank had
no troubled-debt restructured loans at December 31, 2004 and 2003.Details of past-due and nonperforming loans follow: 90 days past dueand still accruing interest
    
    
    Nonaccrual2004
    
    
    2003
    
    
    2004
    
    
    2003Commercial and mortgage
loans secured by real estate
    
    $
    285,771
    
    
    $
    
    
    
    $
    243,374
    
    
    $
    4,253,075Consumer loans
    
    
    2,541
    
    
    
    
    
    
    
    92,285
    
    
    
    24,882Commercial and other loans
    
    
    
    
    
    
    
    
    
    
    810,175
    
    
    
    14,932$
    288,312
    
    
    $
    
    
    
    $
    1,145,834
    
    
    $
    4,292,889
  Impaired loans totaled $5.9 million, $9.6 million, and $9.3 million at December 31, 2004,
2003, and 2002, respectively. Specific reserves relating to these loans were $1.7 million,
$1.6 million, and $2.0 million at December 31, 2004, 2003, and 2002, respectively.Cash receipts received and recognized as income on impaired loans approximated $428,000,
$308,000, and $409,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
Average impaired loans for the years ended December 31, 2004, 2003, and 2002 were
approximately $7.4 million, $9.6 million, and $8.8 million, respectively.Loans serviced for others including commercial participations sold, were approximately $52.6
million, $59.4 million, and $64.5 million at December 31, 2004, 2003, and 2002, respectively.The Bank capitalized $21,000, $140,000, and $171,000 in mortgage servicing rights and incurred
approximately $94,000, $94,000, and $70,000 in related amortization expense during 2004, 2003,
and 2002, respectively. At December 31, 2004 and 2003, these mortgage servicing rights had a
gross book value of $308,000 and $380,000, respectively and fair value of approximately
$355,000 and $375,000, respectively. The weighted average amortization period for mortgage
servicing rights capitalized in 2004 is approximately 5 years. Mortgage loans with mortgage
servicing rights capitalized totaled approximately $38.9 million at December 31, 2004 and
$43.2 million at December 31, 2003. The valuation allowance for capitalized mortgage servicing
rights was $103,000 at December 31, 2004, and $137,000 at December 31, 2003. 14




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  Estimated aggregate amortization expense relating to the Banks mortgage servicing rights
as of December 31, 2004 is as follows: Year:2005
    
    $
    78,0002006
    
    
    61,0002007
    
    
    48,0002008
    
    
    40,0002009
    
    
    29,0002010 and thereafter
    
    
    52,000$
    308,000
  Included in real estate loans at December 31, 2004 and 2003 were approximately $274,000 and
$0, respectively, of fixed-rate mortgage loans held for sale. The Bank enters into forward
commitments to sell these loans into the secondary market prior to origination. Additionally,
the Bank had 45-day forward commitments to sell mortgages as of December 31, 2004, which had
not yet been funded. These commitments approximated $445,000.(5)
    Allowance for Loan LossesThe following represents a summary of the activity in the allowance for loan losses for the
years ended December 31, 2004, 2003, and 2002: 2004
    
    
    2003
    
    
    2002Balance at beginning of year
    
    $
    5,958,375
    
    
    $
    5,794,399
    
    
    $
    5,667,906Provision charged to operations
    

    
    1,190,000
    
    
    
    1,270,000
    
    
    
    625,000Loans charged off
    
    
    (922,078
    )
    
    
    (1,282,563
    )
    
    
    (767,302
    )Recoveries of loans charged off
    
    
    173,652
    
    
    
    176,539
    
    
    
    268,795Balance at end of year
    
    $
    6,399,949
    
    
    $
    5,958,375
    
    
    $
    5,794,399
  (6)
    Bank Premises and EquipmentA summary of bank premises and equipment, and related accumulated depreciation and
amortization, at December 31, 2004 and 2003 follows: 2004
    
    
    2003Land and land improvements
    
    $
    2,897,502
    
    
    $
    3,041,082Bank premises
    
    
    10,055,978
    
    
    
    10,008,044Furniture and equipment
    
    
    6,550,056
    
    
    
    6,263,18819,503,536
    
    
    
    19,312,314Less accumulated depreciation and amortization
    
    
    (8,416,635
    )
    
    
    (7,401,915
    )$
    11,086,901
    
    
    $
    11,910,399
  (7)
    Land and Facilities Held for SaleIn 1998, the Corporation exercised an option to purchase an 18 acre tract of land in northwest
Brighton, primarily to acquire a prime site for a new branch. The cost of the property was approximately $4,000,000. In 1999, a new 15




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  branch of the Bank was built on a portion of the
land valued at approximately $800,000. During 2000, one parcel of the property was sold and
the remaining property was sold in the first quarter of 2004, at book value. The Bank had
reduced the carrying cost of this land in 2003 by approximately $130,000 to provide for
estimated disposal costs and a decline in estimated market value.During the first quarter of 2004, the Bank also transferred two pieces of property originally
acquired for future expansion, and previously recorded as premises and equipment, to land and
facilities held for sale. One of the properties was sold in the fourth quarter of 2004 and a
gain of approximately $43,000 was recognized as a component of non-interest income. The
remaining property amount is included in Land and facilities held for sale, net at December
31, 2004.(8)
    Other Real Estate OwnedAt December 31, 2004, the Bank owned four foreclosed properties with a lower of cost or market
value of $735,000. As of December 31, 2003, the Bank owned two foreclosed properties with a
lower of cost or market value of $65,000. Costs to maintain the properties are included as a
component of noninterest expense. A gain or loss will be recognized upon the sale of the
properties, which will be included as a component of noninterest income or expense.(9)
    Time Certificates of DepositAt December 31, 2004, the scheduled maturities of time deposits with a remaining term of more
than one year were: Year of maturity:2006
    
    $
    32,308,0322007
    
    
    14,292,6932008
    
    
    3,479,5912009
    
    
    8,101,0892010 and thereafter
    
    
    843,841$
    59,025,246
  Included in time deposits are certificates of deposit in amounts of $100,000 or more.
These certificates and their remaining maturities at December 31, 2004 and 2003 are as
follows: 2004
    
    
    2003Three months or less
    
    $
    18,229,224
    
    
    $
    16,246,970Three through six months
    
    
    6,204,213
    
    
    
    9,652,578Six through twelve months
    
    
    4,769,590
    
    
    
    16,862,463Over twelve months
    
    
    25,146,559
    
    
    
    11,349,341$
    54,349,586
    
    
    $
    54,111,352
  Interest expense attributable to the above deposits amounted to approximately $1,472,000,
$1,472,000, and $1,436,000 in 2004, 2003, and 2002, respectively.(10)
    Other BorrowingsThe Bank has a borrowing capacity of approximately $35,600,000 with the FHLBI and had advances
outstanding of approximately $8,067,000 and $5,328,000 at December 31, 2004 and 2003,
respectively. Variable- or fixed-rate advances are available with terms ranging from one day
to 10 years. An outstanding advance requires 125% 16




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  collateral coverage by one-to-four family whole-mortgage loans. A summary of outstanding advances at December 31, 2004, follows: WeightedaverageMaturity
    
    interestrate
    
    
    AmountShort term advances:Fixed rate:Within 30 days
    
    
    2.48
    %
    
    $
    3,000,000Long term advances:Fixed rate:Within one year
    
    
    7.18
    %
    
    
    3,281,742Two years
    
    
    7.29
    %
    
    
    304,281Three years
    
    
    7.29
    %
    
    
    328,623Four years
    
    
    7.29
    %
    
    
    354,913Five years
    
    
    7.29
    %
    
    
    383,307Thereafter
    
    
    7.29
    %
    
    
    413,9705,066,836$
    8,066,836
  (11)
    Deferred Gain on the Sale of Real EstateIn December 2003, the Bank sold a piece of real estate previously classified as
facilities held for sale on the balance sheet and provided financing to the buyer. In
accordance with SFAS No. 66, Accounting for Sales of Real Estate,the Bank deferred the gain
of $299,000 on the sale under the installment method. This deferral is included in other
liabilities as of December 31, 2003. In the first quarter of 2004, theBank sold the loan associated with this transaction with no recourse and accordingly
recognized the deferred gain as a component of noninterest income.(12)
    Federal Income TaxesFederal income tax expense (benefit) consists of: 2004
    
    
    2003
    
    
    2002Current
    
    $
    2,568,989
    
    
    $
    2,673,034
    
    
    $
    2,629,950Deferred
    
    
    159,167
    
    
    
    (118,597
    )
    
    
    (1,300
    )$
    2,728,156
    
    
    $
    2,554,437
    
    
    $
    2,628,650
 17




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  Federal income tax expense differed from the amounts computed by applying the U.S.
Federal income tax rate of 34% to pretax income as a result of the following: 2004
    
    
    2003
    
    
    2002Computed expected tax expense
    
    $
    3,066,545
    
    
    $
    2,871,414
    
    
    $
    3,037,043Increase (reduction) in tax resulting from:Tax-exempt interest and dividends, net
    
    
    (331,745
    )
    
    
    (336,850
    )
    
    
    (367,786
    )Other, net
    
    
    (6,644
    )
    
    
    19,873
    
    
    
    (40,607
    )$
    2,728,156
    
    
    $
    2,554,437
    
    
    $
    2,628,650
  The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at December 31, 2004 and 2003 are presented
below: 2004
    
    
    2003Deferred tax assets:Allowance for loan losses
    
    $
    2,022,336
    
    
    $
    1,872,201Unrealized loss on securities available for sale
    
    
    11,600
    
    
    
    Deferred directors fees
    
    
    154,864
    
    
    
    121,986Other
    
    
    235,914
    
    
    
    595,832Total gross deferred tax assets
    
    
    2,424,714
    
    
    
    2,590,019Deferred tax liabilities:Deferred loan fees
    
    
    158,016
    
    
    
    121,608Unrealized gain on securities available for sale
    
    
    
    
    
    
    158,200Other
    
    
    251,968
    
    
    
    306,114Total gross deferred tax liabilities
    
    
    409,984
    
    
    
    585,922Net deferred tax asset
    
    $
    2,014,730
    
    
    $
    2,004,097
  The deferred tax assets are subject to certain asset realization tests. Management
believes no valuation allowance is required at December 31, 2004, due to the combination of
potential recovery of tax previously paid and the reversal of certain deductible temporary
differences.(13)
    Related Party TransactionsCertain directors and executive officers, including their immediate families and companies in
which they are principal owners, were loan customers of the Bank during 2004 and 2003. Such
loans were made in the ordinary course of business, in accordance with the Banks normal
lending policies, including the interest rate charged and collateralization, and do not
represent more than a normal credit risk.Loans to related parties are summarized below for the periods indicated: 2004
    
    
    2003Balance at beginning of year
    
    $
    4,226,100
    
    
    $
    4,410,000New loans and related parties
    
    
    1,500,000
    
    
    
    166,000Loan repayments
    
    
    (546,800
    )
    
    
    (349,900
    )Balance at end of year
    
    $
    5,179,300
    
    
    $
    4,226,100
 18




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  (14)
    LeasesThe Bank has a noncancelable operating lease that provides for renewal options.Future minimum lease payments under the noncancelable lease as of December 31, 2004 are as
follows: Year ending December 31:2005
    
    $
    46,6602006
    
    
    46,6602007
    
    
    34,995$
    128,315
  Rental expense charged to operations in 2004, 2003, and 2002 amounted to approximately
$60,000, $60,000, and $47,000 respectively, including amounts paid under short term,
cancelable leases.(15)
    Retirement PlanThe Bank sponsors a defined contribution money purchase thrift plan covering all employees 21
years of age or older who have completed one year of service as defined in the plan agreement.
Contributions are equal to 5% of total employee earnings plus 50% of employee contributions
(limited to 10% of their earnings) or the maximum amount permitted by the Internal Revenue
Code. The plan expense of the Bank for 2004, 2003, and 2002 was approximately $376,000,
$344,000, and $247,000, respectively.(16)
    Long Term Incentive PlanThe Corporation maintains a Long Term Incentive Plan under which stock options and restricted
stock may be granted to employees. To date, no stock options have been granted under the plan.
Restricted stock is awarded to key employees, providing for the immediate award of the
Corporations stock, subject to a five-year vesting period. The awards are recorded at fair
market value and are amortized into salary expense over the vesting period. Compensation costs
related to restricted stock awards included in salary expense in 2004, 2003, and 2002 amounted
to $185,000, $135,000, and $94,000, respectively. 19




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  (17)
    Directors Stock Fee PlanEach director of the Corporation who is not an officer or employee of any subsidiary of the
Corporation is eligible to participate in the Compensation Plan for Nonemployee Directors. The
plan fees consist of both a fixed and variable component. The fixed component equals the
per-meeting fee paid for attendance at board meetings of both the Bank and the Corporation and
any committees of their respective boards. The variable component of the plan, which was added
in 2002, is equal to the total fixed fees paid to a specific director for services performed
during the preceding calendar year, multiplied by bonus amounts, (expressed as the percentage
of base compensation payable to officers of the Bank for the preceding calendar year under the
Banks Incentive Bonus Plan). Expenses related to both fixed and variable fees are recorded as
noninterest expense in the year incurred regardless of payment method. Compensation costs
related to both fixed and variable stock directors fees included in noninterest expense in
2004, 2003, and 2002 amounted to $103,000, $84,000, and $102,000, respectively.Fixed directors fees may be paid in cash, to a current stock purchase account, to a deferred
cash investment account, or to a deferred stock account according to each eligible directors
payment election. Current stock is issued quarterly based on the fair market value of the
stock for the preceding quarter. When deferred stock is elected, payments are credited to a
deferred stock account for each participating director, and stock units are computed quarterly
based on the fair market value of the stock for the preceding quarter. When dividends are
declared, they are computed based on the stock units available in each directors deferred
account, are reinvested in stock units and charged to expense. The units are converted to
            shares and issued to participating directors upon retirement. As of December 31,
2004, there were approximately 16,800 shares earned and available for distribution in the
fixed-fee deferred stock accounts.Variable directors fees may be paid to a current stock purchase account or to a deferred
stock account. Current stock is issued based on the average fair market value of the stock for
the preceding quarter. Deferred stock units are computed for directors electing to use a
deferred stock account, and dividends are reinvested throughout the year as declared. As of
December 31, 2004, there were approximately 3,200 shares earned and available for distribution
in the variable-fee deferred stock accounts. In September 2004, the Corporation reclassified
Deferred Directors Compensation related to fixed and variable fees from a liability to a
component of equity. Prior periods were not reclassified as the impact of this change was
determined not to be significant.(18)
    Employees Stock Purchase PlanThe Employees Stock Purchase Plan allows eligible employees to purchase shares of common
stock, no par value, of FNBH Bancorp, Inc. at a price less than market price under Section 423
of the Internal Revenue Code of 1986 as amended. Eligible employees must have been
continuously employed for one year, must work at least 20 hours per week, and must work at
least five months in a calendar year. The purchase price for each share of stock was 85% of
fair market value of a share of stock on the purchase date. Since the adoption of the plan,
effective April 1, 2005, the purchase price for each share of stock will be 95% of fair market
value of a share of stock on the purchase date.(19)
    Financial Instruments with Off-Balance-Sheet RiskThe 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 are loan
commitments to extend credit and letters of credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amounts recognized in the consolidated
balance sheets.The Banks exposure to credit loss in the event of the nonperformance by the other party to
the financial instruments for loan commitments to extend credit and letters of credit is
represented by the contractual amounts of these instruments. The Bank uses the same credit policies in making credit commitments as it
does for on-balance-sheet loans. 20




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  Financial instruments whose contract amounts represent credit risk at December 31, 2004 and
2003 are as follows: 2004
    
    
    2003Consumer
    
    $
    12,625,000
    
    
    $
    13,743,000Commercial construction
    
    
    14,200,000
    
    
    
    11,055,000Commercial
    
    
    51,027,000
    
    
    
    34,617,000Total credit commitments
    
    $
    77,852,000
    
    
    $
    59,415,000
  Loan commitments to extend credit are agreements to lend to a customer as long as there
is no violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require 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. The Bank evaluates each customers
creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on managements credit evaluation of
the counterparty. Collateral held varies but may include accounts receivable; inventory;
property, plant, and equipment; residential real estate; and income-producing commercial
properties. Market risk may arise if interest rates move adversely subsequent to the extension
of commitments.As of December 31, 2004 and 2003, the Bank had outstanding irrevocable standby letters of
credit, which carry a maximum potential commitment of approximately $3,236,000 and $2,551,000,
respectively. These letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The majority of these letters of
credit are short term guarantees of one year or less, although some have maturities which
extend as long as two years. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loans to customers. The Bank primarily
holds real estate as collateral supporting those commitments for which collateral is deemed
necessary. The extent of collateral held on those commitments at December 31, 2004 and 2003,
where there is collateral, is in excess of the committed amount. A letter of credit is not
recorded on the balance sheet until a customer fails to perform.(20)
    CapitalThe Corporation and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by regulators that,
if undertaken, could have a direct, material effect on the Corporations financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action,
the Corporation and the Bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Corporations and the Banks capital classification are
also subject to qualitative judgments by regulators with regard to components, risk
weightings, and other factors.Quantitative measures established by regulation to ensure capital adequacy require the
Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital
(as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as
defined) to average assets (as defined).The most recent notification from the Office of the Comptroller of the Currency categorized
the Bank as well capitalized under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the institutions
category. 21




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The Corporations and the Banks actual capital amounts and ratios are also presented in
the following table as of December 31, 2004 and 2003: Minimum for
    
    
    To be well capitalizedCapital Adequacy
    
    
    under prompt correctiveActual
    
    
    Purposes
    
    
    action provisionAs of December 31, 2004
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioTotal Capital (to risk weighted assets)Bank
    
    $
    47,813,000
    
    
    
    12.80
    %
    
    $
    29,893,000
    
    
    
    38
    %
    
    $
    37,367,000
    
    
    
    310
    %FNBH Bancorp
    
    
    48,423,000
    
    
    
    12.96
    %
    
    
    29,902,000
    
    
    
    38
    %
    
    
    N/A
    
    
    
    N/ATier 1 Capital (to risk weighted assets)Bank
    
    
    43,121,000
    
    
    
    11.54
    %
    
    
    14,947,000
    
    
    
    34
    %
    
    
    22,420,000
    
    
    
    36
    %FNBH Bancorp
    
    
    43,729,000
    
    
    
    11.70
    %
    
    
    14,951,000
    
    
    
    34
    %
    
    
    N/A
    
    
    
    N/ATier 1 Capital (to average assets)Bank
    
    
    43,121,000
    
    
    
    9.65
    %
    
    
    17,870,000
    
    
    
    34
    %
    
    
    22,338,000
    
    
    
    35
    %FNBH Bancorp
    
    
    43,729,000
    
    
    
    9.78
    %
    
    
    17,877,000
    
    
    
    34
    %
    
    
    N/A
    
    
    
    N/AAs of December 31, 2003Total Capital (to risk weighted assets)Bank
    
    $
    43,054,000
    
    
    
    11.73
    %
    
    $
    29,483,000
    
    
    
    38
    %
    
    $
    36,854,000
    
    
    
    310
    %FNBH Bancorp
    
    
    45,563,000
    
    
    
    12.33
    %
    
    
    29,551,000
    
    
    
    38
    %
    
    
    N/A
    
    
    
    N/ATier 1 Capital (to risk weighted assets)Bank
    
    
    38,447,000
    
    
    
    10.47
    %
    
    
    14,742,000
    
    
    
    34
    %
    
    
    22,113,000
    
    
    
    36
    %FNBH Bancorp
    
    
    40,929,000
    
    
    
    11.08
    %
    
    
    14,775,000
    
    
    
    34
    %
    
    
    N/A
    
    
    
    N/ATier 1 Capital (to average assets)Bank
    
    
    38,447,000
    
    
    
    8.95
    %
    
    
    17,187,000
    
    
    
    34
    %
    
    
    21,483,000
    
    
    
    35
    %FNBH Bancorp
    
    
    40,929,000
    
    
    
    9.49
    %
    
    
    17,243,000
    
    
    
    34
    %
    
    
    N/A
    
    
    
    N/A
 22




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  (21)
    Net Income Per Common ShareBasic net income per common share is computed by dividing net income applicable to common
stock by the weighted average number of shares of common stock and deferred director fee stock
units outstanding during the period. Diluted net income per common share is computed by
dividing net income applicable to common stock by the weighted average number of shares and
deferred director fee stock units outstanding and potential common
stock outstanding, such as shares of unvested restricted stock outstanding during the period, of which there were 1,117
shares as of December 31, 2004, calculated under the treasury stock method.The following table presents basic and diluted net income per share: 2004
    
    
    2003
    
    
    2002Weighted average basic shares outstanding
    
    
    3,185,025
    
    
    
    3,162,836
    
    
    
    3,152,739Effect of dilutive restricted stock
    
    
    1,117
    
    
    
    
    
    
    
    Weighted average diluted shares outstanding
    
    
    3,186,142
    
    
    
    3,162,836
    
    
    
    3,152,739Net income
    
    $
    6,291,095
    
    
    $
    5,890,897
    
    
    $
    6,303,831Basic net income per share
    
    $
    1.98
    
    
    $
    1.86
    
    
    $
    2.00Diluted net income per share
    
    $
    1.97
    
    
    $
    1.86
    
    
    $
    2.00
  (22)
    Contingent LiabilitiesThe Corporation is subject to various claims and legal proceedings arising out of the normal
course of business, none of which, in the opinion of management, based on the advice of legal
counsel, is expected to have a material effect on the Corporations financial position or
results of operations.(23)
    Fair Value of Financial InstrumentsSFAS No. 107, Disclosures About Fair Value of Financial Instruments,requires disclosure of
fair-value information about financial instruments for which it is practicable to estimate
that value. In cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair-value estimates cannot be substantiated by
comparison to independent markets and, in many cases, cannot be realized in immediate
settlement of the instrument.Fair-value methods and assumptions for the Corporations financial instruments are as follows:Cash and cash equivalents The carrying amounts reported in the consolidated balance sheet
for cash and short term investments reasonably approximate those assets fair values.Certificates of deposit The carrying amounts reported in the consolidated balance sheet for
certificates of deposit reasonably approximate those assets fair values.Investment and mortgage-backed securities Fair values for investment and mortgage-backed
securities are based on quoted market prices.FHLBI and FRB stock The carrying amounts reported in the consolidated balance sheet for
FHLBI and FRB stock reasonably approximate those assets fair values.Loans For variable-rate loans that reprice frequently and with no significant change in
credit risk, fair values are generally based on carrying values. The fair value of fixed-rate
loans is estimated by discounting future cash flows using the current rates at which similar
loans would be made to borrowers with similar credit ratings and for the same remaining
maturities. 23




---



##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  Accrued interest income The carrying amount of accrued interest income is a reasonable
estimate of fair value.Deposit liabilities The fair value of deposits with no stated maturity, such as demand
deposit, NOW, savings, and money market accounts, is equal to the amount payable on demand.
The fair value of certificates of deposit is estimated using rates currently offered for
deposits with similar remaining maturities.Other borrowings The fair value of other borrowings is estimated based on quoted market
prices.Accrued interest payable The carrying amount of accrued interest payable is a reasonable
estimate of fair value.Off-balance-sheet instruments The fair value of commitments to extend credit is estimated
using the fees currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between current levels
of interest rates and the committed rates. The fair value of commitments to extend credit,
including letters of credit, is estimated to approximate their aggregate book balance and is
not considered material and therefore not included in the following table.The estimated fair values of the Corporations financial instruments are as follows: 2004
    
    
    2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fairvalue
    
    
    value
    
    
    value
    
    
    valueFinancial assets:Cash and cash equivalent
    
    $
    17,838,000
    
    
    $
    17,838,000
    
    
    $
    32,883,000
    
    
    $
    32,883,000Certificates of deposit
    
    
    6,091,000
    
    
    
    6,081,000
    
    
    
    1,553,000
    
    
    
    1,581,000Investment and
mortgage-backed
securities
    
    
    63,217,000
    
    
    
    63,914,000
    
    
    
    54,353,000
    
    
    
    55,275,000FHLBI and FRB stock
    
    
    1,131,000
    
    
    
    1,131,000
    
    
    
    1,083,000
    
    
    
    1,083,000Loans, net
    
    
    350,977,000
    
    
    
    355,277,000
    
    
    
    341,127,000
    
    
    
    344,346,000Accrued interest income
    
    
    2,080,000
    
    
    
    2,080,000
    
    
    
    1,240,000
    
    
    
    1,240,000Financial liabilities:Deposits:Demand
    
    $
    71,785,000
    
    
    $
    71,785,000
    
    
    $
    69,234,000
    
    
    $
    69,234,000NOW
    
    
    49,207,000
    
    
    
    49,207,000
    
    
    
    46,057,000
    
    
    
    46,057,000Savings and money
market accounts
    
    
    147,299,000
    
    
    
    147,299,000
    
    
    
    140,640,000
    
    
    
    140,640,000Time deposits
    
    
    128,594,000
    
    
    
    128,584,000
    
    
    
    137,175,000
    
    
    
    139,029,000Brokered certificates



    
    
    2,379,000
    
    
    
    2,365,000
    
    
    
    5,968,000
    
    
    
    5,969,000Other borrowings
    
    
    8,067,000
    
    
    
    8,298,000
    
    
    
    5,328,000
    
    
    
    5,822,000Accrued interest expense
    
    
    573,000
    
    
    
    573,000
    
    
    
    609,000
    
    
    
    609,000
 LimitationsFair-value estimates are made at a specific point in time based on relevant market information
and information about the financial instrument. These estimates do not reflect any premium or
discounts that could result from offering for sale at one time the Corporations entire
holdings of a particular financial instrument. Because no market exists for a significant
portion of the Corporations financial instruments, fair-value estimates are based on
judgments regarding future loss experience, current economic conditions, risk characteristics
of various financial instruments, and other factors. These estimates are subjective in nature
and involve uncertainties and matters of 24




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  significant judgment, and, therefore, cannot be
determined with precision. Changes in assumptions could significantly affect the estimates.(24)
    Dividend RestrictionsOn a parent company-only basis, the Corporations only source of funds is dividends paid by
the Bank. The ability of the Bank to pay dividends is subject to limitations under various
laws and regulations and to prudent and sound banking principles. The Bank may declare a
dividend without the approval of the Office of Comptroller of the Currency (OCC) unless the
total dividend in a calendar year exceeds the total of its net profits for the year combined
with its retained profits of the two preceding years. Under these provisions, approximately
$13.2 million was available for dividends on December 31, 2004, without the approval of the
OCC.(25)
    Condensed Financial Information  Parent Company OnlyThe condensed balance sheets at December 31, 2004 and 2003, and the condensed statements of
income and cash flows for the years ended December 31, 2004, 2003, and 2002, of FNBH Bancorp,
Inc. follow: Condensed Balance Sheet 2004
    
    
    2003Assets:Cash
    
    $
    148,585
    
    
    $
    77,379Investment in subsidiaries:First National Bank in Howell
    
    
    44,302,826
    
    
    
    37,948,788H.B. Realty Co.
    
    
    200,530
    
    
    
    2,171,163FNBH Mortgage Company, LLC
    
    
    805,000
    
    
    
    805,000Other assets
    
    
    259,107
    
    
    
    257,851Total assets
    
    $
    45,716,048
    
    
    $
    41,260,181Liabilities and Stockholders Equity:Other liabilities
    
    $
    
    
    
    $
    24,700Stockholders equity
    
    
    45,716,048
    
    
    
    41,235,481Total liabilities and stockholders equity
    
    $
    45,716,048
    
    
    $
    41,260,181
 Condensed Statements of Income Year ended December 312004
    
    
    2003
    
    
    2002Operating income:Dividends from subsidiaries
    
    $
    1,680,000
    
    
    $
    2,014,688
    
    
    $
    1,813,875Total operating income
    
    
    1,680,000
    
    
    
    2,014,688
    
    
    
    1,813,875Operating expenses:Administrative and other expenses
    
    
    97,032
    
    
    
    46,602
    
    
    
    46,944Total operating expenses
    
    
    97,032
    
    
    
    46,602
    
    
    
    46,944Income before equity in
undistributed net income
of subsidiaries
    
    
    1,582,968
    
    
    
    1,968,086
    
    
    
    1,766,931Equity in undistributed net income of
subsidiaries
    
    
    4,708,127
    
    
    
    3,922,811
    
    
    
    4,536,900Net income
    
    $
    6,291,095
    
    
    $
    5,890,897
    
    
    $
    6,303,831
 25




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Condensed Statements of Cash Flows Year ended December 312004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    6,291,095
    
    
    $
    5,890,897
    
    
    $
    6,303,831Adjustments to reconcile net income to
net cash from operating activities:Decrease (increase) in other assets
    
    
    (1,256
    )
    
    
    8,305
    
    
    
    16,361Increase (decrease) in other liabilities
    
    
    (24,700
    )
    
    
    3,500
    
    
    
    4,700Change in long term incentive plan and
    
    
    
    
    
    
    24,630
    
    
    
    (16,139
    )deferred compensation
    
    
    263,635
    
    
    
    
    
    
    
    Equity in undistributed net income of
subsidiaries
    
    
    (4,708,127
    )
    
    
    (3,922,811
    )
    
    
    (4,536,900
    )(4,470,448
    )
    
    
    (3,886,376
    )
    
    
    (4,531,978
    )Net cash provided by
operating activities
    
    
    1,820,647
    
    
    
    2,004,521
    
    
    
    1,771,853Cash flows from investing activities:Investments in and advancements to
subsidiary, net
    
    
    (10,000
    )
    
    
    (70,000
    )
    
    
    (3,500
    )Net cash used in investing
activities
    
    
    (10,000
    )
    
    
    (70,000
    )
    
    
    (3,500
    )Cash flows from financing activities:Dividends paid
    
    
    (2,286,173
    )
    
    
    (2,151,047
    )
    
    
    (1,979,197
    )Common stock issued
    
    
    109,521
    
    
    
    260,809
    
    
    
    218,319Transfer from subsidiary for directors
deferred compensation
    
    
    437,211
    
    
    
    
    
    
    
    Net cash used in financing
activities
    
    
    (1,739,441
    )
    
    
    (1,890,238
    )
    
    
    (1,760,878
    )Net increase in cash
    
    
    71,206
    
    
    
    44,283
    
    
    
    7,475Cash at beginning of year
    
    
    77,379
    
    
    
    33,096
    
    
    
    25,621Cash at end of year
    
    $
    148,585
    
    
    $
    77,379
    
    
    $
    33,096
 26




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  (26)
    Quarterly Financial Data  UnauditedThe following table presents summarized quarterly data for each of the two years ended
December 31: Quarters ended in 2004March 31
    
    
    June 30
    
    
    September 30
    
    
    December 31Selected operations data:Interest and dividend income
    
    $
    6,109,186
    
    
    $
    5,984,536
    
    
    $
    6,256,913
    
    
    $
    6,641,075Net interest income
    
    
    4,677,850
    
    
    
    4,625,586
    
    
    
    4,902,904
    
    
    
    5,179,504Provision for loan losses
    
    
    495,000
    
    
    
    200,000
    
    
    
    300,000
    
    
    
    195,000Income before income taxes
    
    
    2,081,310
    
    
    
    1,863,320
    
    
    
    2,370,692
    
    
    
    2,703,929Net income
    
    
    1,455,804
    
    
    
    1,315,270
    
    
    
    1,647,092
    
    
    
    1,872,929Basic net income per share
    
    
    0.46
    
    
    
    0.41
    
    
    
    0.52
    
    
    
    0.59Diluted net income per share
    
    
    0.46
    
    
    
    0.41
    
    
    
    0.52
    
    
    
    0.58Cash dividends per share
    
    
    0.17
    
    
    
    0.17
    
    
    
    0.19
    
    
    
    0.19
 Quarters ended in 2003March 31
    
    
    June 30
    
    
    September 30
    
    
    December 31Selected operations data:Interest and dividend income
    
    $
    6,218,947
    
    
    $
    6,181,657
    
    
    $
    6,255,806
    
    
    $
    6,199,752Net interest income
    
    
    4,497,121
    
    
    
    4,630,089
    
    
    
    4,786,999
    
    
    
    4,775,099Provision for loan losses
    
    
    325,000
    
    
    
    275,000
    
    
    
    200,000
    
    
    
    470,000Income before income taxes
    
    
    1,891,174
    
    
    
    1,908,863
    
    
    
    2,713,429
    
    
    
    1,931,868Net income
    
    
    1,317,649
    
    
    
    1,327,413
    
    
    
    1,871,729
    
    
    
    1,374,106Basic net income per share
    
    
    0.42
    
    
    
    0.42
    
    
    
    0.59
    
    
    
    0.43Diluted net income per share
    
    
    0.42
    
    
    
    0.42
    
    
    
    0.59
    
    
    
    0.43Cash dividends per share
    
    
    0.17
    
    
    
    0.17
    
    
    
    0.17
    
    
    
    0.17
  (27)
    Impact of New Accounting StandardsIn December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123®,
Share-Based Payment. This Statement is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation,and supersedes APB opinion No. 25, Accounting for Stock Issued to Employees,and
its related implementation guidance. The Statement is effective July 1, 2005 and is required
to be adopted using a modified prospective method. Under the modified prospective method,
the Statement applies to new awards and to awards modified, repurchased or cancelled after the
effective date. Additionally, compensation cost for the unvested portion of awards as of the
effective date is required to be recognized as the awards vest after the effective date. This
Statement focuses on the accounting for transactions that involve employee services
compensated for in share-based payments and requires that the cost resulting from all
share-based payment transactions be recognized in the financial statements. The Statement also
establishes fair value as the measurement objective in accounting for share-based payment
arrangements and requires all entities to apply a fair-value-based measurement method in
accounting for share-based payment transactions with employees.The Corporation currently has two plans affected by the issuance of this Statement. The Long
Term Incentive Plan allows for the granting of stock options to certain employees; however,
the Corporation has not, to date, issued any
options under this plan consequently, the Statement will have no impact on the Corporations
results of operations or financial condition until such time as options are granted. The
second plan affected is the Employee Stock Purchase Plan (ESPP). The Statement allows for
ESPP shares to be issued at ninety-five percent of fair market value as of the grant date with
no compensation expense recognized. Effective April 1, 2005, the Corporations 27




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements  plan allows for
the purchase of shares at ninety-five percent of fair market value as of the grant date, thus
no compensation expense will be recognized upon the effectiveness of SFAS 123®. The
Corporation does not expect the implementation of this Statement to have an impact on its
results of operations or financial position.In March 2004, the Emerging Issues Task Force (EITF) reached consensus on Issue No. 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,(EITF
03-1). EITF 03-1 provides guidance for assessing impairment losses on investments and
includes new disclosure requirements for investments that are deemed to be temporarily
impaired. In September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1, Effective
Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than Temporary
Impairment and Its Application to Certain Investments, which delays the effective date for the
measurement and recognition guidance contained in selected paragraphs of EITF 03-1 until final
application guidance is issued. The delay does not suspend the requirement to recognize
other-than-temporary impairments as required by existing authoritative literature. The
adoption of EITF-03-1 is not expected to have a significant impact on the Corporations
results of operations or financial position.FASB Interpretation No. 46, Consolidation of Variable Interest Entities,(revised December
2003) (FIN46®), clarifies when some entities previously not consolidated under prior
accounting guidance, should be. In some instances, it also requires certain previously
consolidated entities to be de-consolidated. FIN 46® is effective for periods ended after
December 15, 2003 for special purpose entities and for periods ended after March 15, 2004 for
other types of variable interest entities (VIEs) that are not defined as special purpose
entities. This Interpretation did not have an impact on the Corporations consolidated
financial statements as the Corporation does not currently have an interest in any VIEs.AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in
a Transfer(SOP 03-3), addresses the accounting for differences between contractual cash flows
and cash flows expected to be collected from the initial investment in loans acquired in a
transfer if those differences are attributable, at least in part, to credit quality. It
includes such loans acquired in purchase business combinations and does not apply to loans
originated by the entity. The SOP prohibits carrying over or creation of valuation allowances
in the initial accounting for loans acquired in a transfer. It is effective for loans acquired
in fiscal years beginning after December 15, 2004. The effects of this new guidance on the
Corporations financial statements will depend on future loan acquisition activity, thus is
not determinable at this time. 28




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##### 



FNBH BANCORP, INC. AND
SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 Managements Discussion and Analysis of Financial Condition
and Results of Operations This discussion provides information about the consolidated financial condition and results of
operations of FNBH Bancorp, Inc. (Corporation) and its subsidiaries, First National Bank in
Howell (Bank) and HB Realty Co., and should be read in conjunction with the Consolidated
Financial Statements. Included or incorporated by reference in this document are 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. Such forward-looking statements are based on the
beliefs of the Corporations management as well as on assumptions made by, and information
currently available to, the Corporation at the times such statements were made. Actual results
could differ materially from those included in such forward-looking statements as a result of,
among other things, factors set forth below in this Report generally, and certain economic and
business factors, some of which may be beyond the control of the Corporation. Investors are
cautioned that all forward-looking statements involve risks and uncertainty. FINANCIAL CONDITION At year end 2004, total assets were $456,603,000 representing a 1.5% increase from the prior
year when assets were $449,818,000. Investment securities increased $8.9 million (16.1%) to
$64,348,000 while gross loans increased $10.3 million (3.0%) to $357,377,000. Deposits remained
stable at $399,263,000. Stockholders equity increased $4.5 million (10.9%) to $45,716,000. Securities During 2004, securities increased due to the relatively low loan demand in the first three
quarters of 2004. Certificates of deposit also increased $4.5 million in 2004 compared to 2003. At
year end the Corporation had $5.7 million in short term investments, an $11.2 million decrease from
the $16,848,000 reported the previous year as excess funds were used to fund loan growth in the
fourth quarter. The following table shows the percentage composition of the securities portfolio as of December 31: 2004
    
    
    2003U.S. Tresury & agency securities
    
    
    46.2
    %
    
    
    39.9
    %Agency mortgage backed securities
    
    
    25.5
    %
    
    
    22.6
    %Tax exempt obligations of states and political subdivisions
    
    
    24.9
    %
    
    
    27.1
    %Corporate bonds
    
    
    1.6
    %
    
    
    8.4
    %Other
    
    
    1.8
    %
    
    
    2.0
    %Total securities
    
    
    100.0
    %
    
    
    100.0
    %
 Loans The loan personnel of the Bank are committed to making quality loans that produce acceptable
rates of return for the Bank and also serve the community by providing funds for home purchases,
business purposes, and consumer needs. The overall loan portfolio grew $10,291,000 (3.0%) in 2004. As a full service lender, the Bank offers a variety of home mortgage loan products. The Bank
makes and subsequently sells fixed rate long-term mortgages, which conform to secondary market
standards. This practice allows the Bank to meet the housing credit needs of its service area,
while at the same time maintaining loan to deposit ratios and interest sensitivity and liquidity
positions within Bank policy. The Bank retains servicing on sold mortgages, thereby furthering the
customer relationship and adding to servicing income. During 2004, the Bank sold $3,799,000 in residential mortgages as
compared to $23,200,000 in 2003. This was partially the result of a slow down in the refinancing
market in 2004. 29




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##### 



FNBH BANCORP, INC. AND
SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The Bank has also been able to service customers with loan needs which do not conform to
secondary market requirements by offering variable rate products which are retained in the mortgage
portfolio. While not meeting secondary market requirements, these nonconforming mortgages do meet
Bank loan guidelines. During 2004, the Bank made approximately $7,908,000 in variable rate mortgage
loans which are retained in the mortgage portfolio. The Bank experienced much slower loan demand in the first three quarters of 2004 due to
increased competition and a slow economy. During the fourth quarter of 2004, demand recovered and
commercial loans increased $19.7 million from September 30, 2004 to December 31, 2004. Included in
this increase are loans purchased by the Bank during the fourth quarter totaling $5.5 million.
Commercial loans ended the year at $286,941,000, a 3.2% annual increase. Consumer loans increased
$1,082,000, or 3.1%, from the preceding year. The following table reflects the composition of the commercial and consumer loans in the
Consolidated Financial Statements. Included in the residential first mortgage totals below are the
real estate mortgage loans listed in the Consolidated Financial Statements and other loans to
customers who pledge their homes as collateral for their borrowings. A portion of the loans listed
in residential first mortgages represent commercial loans where the borrower has pledged his/her
residence as collateral. In the majority of the loans to commercial customers, the Bank is relying
on the borrowers cash flow to service the loans. Commercial real estate loans at December 31,
2004 include $159,839,000 in loans secured by commercial and retail property, with the remaining
$3,867,000 secured by multi-family units. The most significant loan growth was in commercial and
retail loans secured by first or second liens on residential properties which increased $8,232,000
(13.5%) compared to the prior year. Commercial loans not secured by real estate decreased
$2,175,000 (6.4%) compared to the prior year. The shift from commercial loans not secured by real
estate to commercial loans secured by real estate results from the continued growth of real estate
development in Livingston County. The following table shows the balance and percentage composition of loans as of December 31: (dollars in thousands)2004
    
    
    2003Balances
    
    
    Percentage
    
    
    Balances
    
    
    PercentageSecured by real estate:Residential first mortgage
    
    $
    53,059
    
    
    
    14.8
    %
    
    $
    46,845
    
    
    
    13.5
    %Residential home equity/other junior liens
    
    
    16,017
    
    
    
    4.5
    %
    
    
    13,999
    
    
    
    4.0
    %Construction, land development and farmland
    
    
    59,873
    
    
    
    16.7
    %
    
    
    54,554
    
    
    
    15.7
    %Commercial
    
    
    163,706
    
    
    
    45.7
    %
    
    
    165,464
    
    
    
    47.5
    %Consumer
    
    
    26,965
    
    
    
    7.5
    %
    
    
    25,842
    
    
    
    7.4
    %Commerical
    
    
    31,772
    
    
    
    8.9
    %
    
    
    33,947
    
    
    
    9.8
    %Other, primarily to political subdivisions
    
    
    6,991
    
    
    
    1.9
    %
    
    
    7,366
    
    
    
    2.1
    %Total gross loans
    
    
    358,383
    
    
    
    100.0
    %
    
    
    348,017
    
    
    
    100.0
    %Net unearned fees
    
    
    (1,006
    )
    
    
    
    
    
    
    (931
    )Total Loans
    
    $
    357,377
    
    
    
    
    
    
    $
    347,086
 The Banks loan personnel have endeavored to make high quality loans using well established
policies and procedures and a thorough loan review process. Loans to a borrower with aggregate
indebtedness in excess of $1,500,000 are approved by a committee of the Board or the entire Board.
The Bank has hired an independent contractor to review the quality of the loan portfolio on a
regular basis. 30




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##### 



BFNBH BANCORP, INC. AND
SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The quality of the loan portfolio is illustrated in the table below for December 31: (dollars in thousands)2004
    
    
    2003
    
    
    2002Nonperforming Loans:Nonaccrual loans
    
    $
    1,146
    
    
    $
    4,293
    
    
    $
    3,288Loans past due 90 days and still accruing
    
    
    288
    
    
    
    
    
    
    
    809Total nonperforming loans
    
    
    1,434
    
    
    
    4,293
    
    
    
    4,097Other real estate
    
    
    735
    
    
    
    65
    
    
    
    738Total nonperforming assets
    
    $
    2,169
    
    
    $
    4,358
    
    
    $
    4,835Nonperforming loans as a percent of total loans
    
    
    0.40
    %
    
    
    1.24
    %
    
    
    1.25
    %Allowance for loan losses as a percent of nonperforming loans
    
    
    446
    %
    
    
    139
    %
    
    
    141
    %
 Nonperforming assets are comprised of loans for which the accrual of interest has been
discontinued, accruing loans 90 days or more past due in payments, loans which have been
renegotiated to less than market rates, and other real estate which has been acquired primarily
through foreclosure and is awaiting disposition. Loans are generally placed on a nonaccrual basis
when principal or interest is past due 90 days or more and when, in the opinion of management, full
collection of principal and interest is unlikely. Nonperforming assets decreased in 2004 due to the
sale of the underlying collateral of a $2.2 million loan and the transfer of $1.4 million of loans
to other real estate owned held for sale that were classified as nonperforming loans as of December
31, 2003. Impaired loans totaled $5,900,000 at December 31, 2004, compared to $9,600,000 at the prior
year end, and $9,300,000 at December 31, 2002. Included in impaired loans at December 31, 2004 are
nonperforming loans from the above table, and an additional $4,500,000 of commercial loans
separately identified as impaired. Homogenous residential mortgage and consumer loans are not
separately identified for impairment. Nonperforming loans are reviewed regularly for
collectability. Any uncollectable balances are promptly charged off. During 2004, the Bank charged off loans totaling $922,000 and recovered $174,000 for a net
charge off amount of $748,000. The Bank had net charge offs totaling $1,106,000 in 2003 and
$499,000 in 2002. The allowance for loan losses totaled $6,400,000 at year end which was 1.79% of total loans,
compared to $5,958,000 (1.72%) in 2003, and $5,794,000 (1.77%) in 2002. The adequacy of the
allowance for loan losses is determined by managements assessment of the composition of the loan
portfolio, an evaluation of specific credits, and an analysis of the following environmental
factors: delinquency trends, delinquency levels, loss trends, concentrations of credit, economic
trends, loan growth, and management changes. Management continues to refine its techniques in this
analysis. Economic factors considered in arriving at the loan loss reserve adequacy as of December
31, 2004 included low levels of consumer confidence, rising rate environment, increased
bankruptcies and the unemployment rate. When all environmental factors were considered, management
determined that the $1,190,000 provision and resulting $6,400,000 allowance were appropriate.
Although management evaluates the adequacy of the allowance for loan losses based on information
known at a given time, as facts and circumstances change, the provision and resulting allowance may
also change. 31




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##### 



FNBH BANCORP, INC. AND
SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The following table shows changes in the allowance for loan losses for the years ended December 31: (dollars in thousands)2004
    
    
    2003
    
    
    2002Balance at beginning of the year
    
    $
    5,958
    
    
    $
    5,794
    
    
    $
    5,668Additions (deduction):Loans charged off
    
    
    (922
    )
    
    
    (1,283
    )
    
    
    (767
    )Recoveries of loans previously charged off
    
    
    174
    
    
    
    177
    
    
    
    268Provision charged to operations
    
    
    1,190
    
    
    
    1,270
    
    
    
    625Balance at end of year
    
    $
    6,400
    
    
    $
    5,958
    
    
    $
    5,794Allowance for loan losses to loans outstanding
    
    
    1.79
    %
    
    
    1.72
    %
    
    
    1.77
    %
 Deposits Deposit balances of $399,263,000 at December 31, 2004 were approximately $190,000 higher than
the previous year end. Because year end deposit balances can fluctuate it is more meaningful to
analyze changes in average balances. Average deposits increased 5.2% in 2004 compared to 2003.
Average demand deposits increased $4.8 million (7.2%) while average NOW, savings and money market
deposit account (MMDA) balances increased $12.2 million (7.1%). Average certificates of deposit
increased $2.6 million (1.9%). Management has generated deposits in 2004 with various rate specials
on selected certificates, and the effects of opening a new branch in December 2003. Noninterest
bearing deposits grew by 7.3% from 2002 to 2003, NOW, savings, and MMDA balances grew 12.3% from
2002 to 2003, and certificates of deposit grew 3.7% from 2002 to 2003. The following table sets forth average deposit balances for the years ended December 31: (in thousands)
    
    2004
    
    
    2003
    
    
    2002Noninterest bearing demand
    
    $
    70,477
    
    
    $
    65,719
    
    
    $
    61,223NOW, savings, & MMDA
    
    
    184,791
    
    
    
    172,611
    
    
    
    153,651Time deposits
    
    
    138,463
    
    
    
    135,842
    
    
    
    131,019Total average deposits
    
    $
    393,731
    
    
    $
    374,172
    
    
    $
    345,893
 The growth in NOW, savings, and MMDA was primarily in the MMDA which increased 5.6% on
average. This growth is attributable to consumers and public funds preference for more liquidity
in this low rate environment. Average personal MMDAs increased 7.0% while business accounts
decreased 7.8% on average, and public MMDAs increased 18.9% on average. Average personal MMDA
accounts increased 6.9%, business accounts decreased 5.3% and public accounts increased 62.5% from
2002 to 2003. This growth in MMDA has slowed due to changes in the collection and disbursement of
taxes by the public fund entities. The majority of the Banks deposits are from core customer sources, long term relationships
with local personal, business, and public customers. In some financial institutions, the presence
of interest bearing certificates greater than $100,000 indicates a reliance upon purchased funds.
However, large certificates in the Banks portfolio consist primarily of core deposits of local
customers. See Note 9 of the Consolidated Financial Statements for a maturity schedule of
certificates over $100,000. The Bank does issue brokered certificates of deposit in the market to
meet liquidity needs with alternative funding sources and had an average balance of brokered
certificates in 2004 of $3.7 million compared to $1.8 million in 2003. 32




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 Capital The Corporations capital at year end totaled $45,716,000, a $4,481,000 (10.9%) increase
compared to capital of $41,235,000 at December 31, 2003 and $37,580,000 at December 31, 2002, an
increase of 9.7%. Included in year end capital is a $28,000 net of tax unrealized loss on
investment securities available for sale. Banking regulators have established various ratios of capital to assets to assess a financial
institutions soundness. Tier 1 capital is equal to shareholders equity adjusted for the
allowance for loan losses while Tier 2 capital includes a portion of the allowance for loan losses.
The regulatory agencies have set capital standards for well capitalized institutions. The
leverage ratio, which divides Tier 1 capital by three months average assets, must be 5% for a well
capitalized institution. The Banks leverage ratio was 9.65% at year end 2004. Tier 1 risk-based
capital, which includes some off balance sheet items in assets and weights assets by risk, must be
6% for a well capitalized institution. The Banks was 11.54% at year end 2004. Total risk-based
capital, which includes Tier 1 and Tier 2 capital, must be 10% for a well capitalized institution.
The Banks total risk based capital ratio was 12.80% at year end 2004. The Banks strong capital
ratios put it in the best classification on which the FDIC bases its assessment charge. The following table lists various Bank capital ratios at December 31: 2004
    
    
    2003
    
    
    2002Average equity to average asset ratio
    
    
    9.71
    %
    
    
    9.32
    %
    
    
    8.80
    %Tier 1 leverage ratio
    
    
    9.65
    %
    
    
    8.95
    %
    
    
    8.47
    %Tier 1 risk-based capital
    
    
    11.54
    %
    
    
    10.47
    %
    
    
    9.89
    %Total risk-based capital
    
    
    12.80
    %
    
    
    11.73
    %
    
    
    11.15
    %
 The Corporations ability to pay dividends is subject to various regulatory and state law
requirements. Management believes, however, that earnings will continue to generate adequate
capital to continue the payment of dividends. In 2004, the Corporation paid dividends totaling
$2,286,000, or 36.3% of earnings. Book value of the stock was $14.38 at year end. Liquidity and Funds Management Liquidity is monitored by the Banks Asset/Liability Management Committee (ALCO) which meets
at least monthly. The Board of Directors has approved a liquidity policy which requires the Bank,
while it is well capitalized as defined by the Federal Financial Institutions Examination Council
(FFIEC), to maintain a current ratio of no less than 1:1 (core basic surplus liquidity equal to 0).
Additional requirements of the policy are that when credit available from the Federal Home Loan
Bank of Indianapolis (FHLBI) is added to core basic surplus liquidity, the Bank must have liquidity
totaling 5% of assets; and when brokered CDs and Federal Funds (Fed Funds) lines are added, the
Bank must have liquidity totaling 8% of assets. Should the Banks capital ratios fall below the
well capitalized level, additional liquidity totaling 5% of assets will be required. As of
December 31, 2004, the Bank had excess liquidity of at least 5.3% of assets under any of the above
standards. Deposits are the principal source of funds for the Bank. Management monitors rates at other
financial institutions in the area to ascertain that its rates are competitive in the market.
Management also attempts to offer a wide variety of products to meet the needs of its customers. It is the intention of the Banks management to handle unexpected liquidity needs through its
Fed Funds position with a correspondent bank and by FHLBI borrowings. The Bank has a $43,714,000
line of credit available at the FHLBI and the Bank has pledged certain mortgage loans as collateral
for this borrowing. At December 31, 2004, the Corporation had $8,067,000 in borrowings against the
line. The Bank also has a blanket repurchase agreement in place where it can borrow from a broker,
pledging Treasury and Agency securities as collateral. In the event the Bank must borrow for an
extended period, management may look to available for sale securities in the investment portfolio
for liquidity. Throughout the past year, Fed Funds Sold balances averaged approximately $14,539,000.
Periodically, the Bank borrowed money through the Fed Funds market and through short term advances
from the FHLBI. Fed Funds Purchased balances averaged $200,000 and short term FHLBI advances
averaged $426,000 for 2004. 33




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 Contractual Obligations and Commitments The following table lists significant fixed and determinable contractual obligations to third
parties as of December 31, 2004: Within
    
    
    One to
    
    
    Three to
    
    
    Over(in thousands)
    
    One Year
    
    
    Three Years
    
    
    Five Years
    
    
    Five Years
    
    
    TotalDeposits without a stated maturity(1)
    
    $
    268,291
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    268,291Consumer and brokered certificates of deposits(1)
    
    
    71,947
    
    
    
    46,601
    
    
    
    11,580
    
    
    
    844
    
    
    
    130,972Short term advances(1) (2)
    
    
    3,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,000Long term advances(1) (2)
    
    
    3,282
    
    
    
    633
    
    
    
    738
    
    
    
    414
    
    
    
    5,067Operating leases(3)
    
    
    47
    
    
    
    81
    
    
    
    
    
    
    
    
    
    
    
    128Purchase obligations(4)
    
    
    204
    
    
    
    83
    
    
    
    
    
    
    
    
    
    
    
    287
   (1)
    
    Excludes interest.(2)
    
    See Note 10 in Notes to Consolidated Financial Statements.(3)
    
    See Note 14 in Notes to Consolidated Financial Statements.(4)
    
    Purchase obligations amounts relate to certain contractual payments for services provided
for information technology, data processing and training consultants. The following table lists significant commitments as of December 31, 2004 by maturity date: Within
    
    
    One to
    
    
    Three to
    
    
    Over(in thousands)
    
    One Year
    
    
    Three Years
    
    
    Five Years
    
    
    Five Years
    
    
    TotalCommericial loans
    
    $
    37,357
    
    
    $
    12,989
    
    
    $
    681
    
    
    $
    
    
    
    $
    51,027Commercial construction loans
    
    
    10,670
    
    
    
    2,986
    
    
    
    
    
    
    
    544
    
    
    
    14,200Consumer loans
    
    
    7,082
    
    
    
    2,706
    
    
    
    2,837
    
    
    
    
    
    
    
    12,625Standby letters of credit
    
    
    2,932
    
    
    
    304
    
    
    
    
    
    
    
    
    
    
    
    3,236
 Commitments to extend credit, including loan commitments, standby letters of credit, and commercial
letters of credit do not necessarily represent future cash requirements, in that these commitments
often expire without being drawn upon. Quantitative and Qualitative Disclosures about Market Risk ALCO reviews other areas of the Banks performance. This committee discusses the current
economic outlook and its impact on the Bank and current interest rate forecasts. Actual results are
compared to budget in terms of growth and income. A yield and cost analysis is done to monitor
interest margin. Various ratios are discussed including capital ratios and liquidity. Also, the
quality of the loan portfolio is reviewed in light of the current allowance, and the Banks
exposure to market risk is reviewed. Interest rate risk is the potential for economic losses due to future rate changes and can be
reflected as a loss of future net interest income and/or a loss of current market values. ALCOs
objective is to measure the effect on net interest income and to adjust the balance sheet to
minimize the inherent risk while at the same time maximizing income. Tools used by management
include the standard GAP report which reflects the repricing schedule for various asset and
liability categories and an interest rate shock simulation report. The Bank has no market risk
sensitive instruments held for trading purposes. However, the Bank is party to financial
instruments with off-balance sheet risk in the normal course of business to meet the financing
needs of its customers
including commitments to extend credit and letters of credit. A commitment or letter of
credit is not recorded as an asset until the instrument is exercised (see Note 19 in Notes to
Consolidated Financial Statements). 34




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The table below shows the scheduled maturity and repricing of the Banks interest sensitive assets
and liabilities as of December 31, 2004: (dollars in thousands)0-3
    
    
    4-12
    
    
    1-5
    
    
    5+Months
    
    
    Months
    
    
    Years
    
    
    Years
    
    
    TotalAssets:Loans
    
    $
    181,956
    
    
    $
    40,992
    
    
    $
    76,652
    
    
    $
    57,777
    
    
    $
    357,377Securities
    
    
    3,618
    
    
    
    8,376
    
    
    
    43,910
    
    
    
    8,444
    
    
    
    64,348Certificates of deposit
    
    
    2,358
    
    
    
    3,635
    
    
    
    98
    
    
    
    
    
    
    
    6,091Short term investments
    
    
    5,680
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,680Total assets
    
    $
    193,612
    
    
    $
    53,003
    
    
    $
    120,660
    
    
    $
    66,221
    
    
    $
    433,496Liabilities:NOW, savings, & MMDA
    
    $
    95,872
    
    
    $
    
    
    
    $
    
    
    
    $
    100,634
    
    
    $
    196,506Time deposits
    
    
    35,209
    
    
    
    36,807
    
    
    
    58,113
    
    
    
    843
    
    
    
    130,972FHLBI advances
    
    
    3,282
    
    
    
    3,000
    
    
    
    1,371
    
    
    
    414
    
    
    
    8,067Total liabilities
    
    $
    134,363
    
    
    $
    39,807
    
    
    $
    59,484
    
    
    $
    101,891
    
    
    $
    335,545Rate sensitivity GAP and ratios:GAP for period
    
    $
    59,249
    
    
    $
    13,196
    
    
    $
    61,176
    
    
    $
    (35,670
    )Cumulative GAP
    
    
    59,249
    
    
    
    72,445
    
    
    
    133,621
    
    
    
    97,951
 The preceding table sets forth the time periods in which earning assets and interest bearing
liabilities will mature or may re-price in accordance with their contractual terms. The entire
balance of NOW, savings, and MMDA are not categorized as 0-3 months, although they are variable
rate products. Some of these balances are core deposits and are not considered rate sensitive.
Allocations are made to time periods based on the Banks historical experience and managements
analysis of industry trends. In the GAP table above, the short term (one year and less) cumulative interest rate
sensitivity is 42% asset sensitive at year end, compared to 34% asset sensitive the previous year.
The rate sensitivity was impacted by higher short term liability balances only partially offset by
higher short term assets. Because of the Corporations asset sensitive position, if market interest rates decrease, this
positive GAP position indicates that the interest margin would be negatively affected. However,
GAP analysis is limited and may not provide an accurate indication of the impact of general
interest rate movements on the net interest margin since repricing of various categories of assets
and liabilities is subject to the Banks needs, competitive pressures, and the needs of the Banks
customers. In addition, various assets and liabilities indicated as repricing within the same
period may in fact reprice at different times within the period and at different rate indices.
Additionally, simulation modeling, which measures the impact of upward and downward movements of
interest rates on interest margin, indicates that a 100 basis point decrease in interest rates
would reduce net interest income by approximately 4% in the first year, while a 200 basis point
increase in interest rates would increase net interest income by approximately 2% in the first
year. 35




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The following table contains the fair market value for interest earning assets and interest bearing
liabilities as of December 31, 2004: (dollars in thousands)Total
    
    
    Average Interest Rate
    
    
    Estimated Fair ValueAssets:Loans, net
    
    $
    350,977
    
    
    
    6.54
    %
    
    $
    355,277Securities
    
    
    64,348
    
    
    
    4.68
    %
    
    
    65,045Certificates of deposit
    
    
    6,091
    
    
    
    2.51
    %
    
    
    6,081Short term investments
    
    
    5,680
    
    
    
    1.14
    %
    
    
    5,680Liabilities:NOW, savings, & MMDA
    
    $
    196,506
    
    
    
    0.64
    %
    
    $
    196,506Time deposits
    
    
    130,972
    
    
    
    2.92
    %
    
    
    130,949FHLBI advances
    
    
    8,067
    
    
    
    7.40
    %
    
    
    8,298
 Estimated fair value for securities are based on quoted market prices. For variable rate
loans that reprice frequently and with no significant change in credit risk, fair values are
generally based on carrying values. The fair value of other loans is estimated by discounting
future cash flows using the current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities. Because it has a one day maturity,
the carrying value is used as fair value for short term investments. The fair value of deposits
with no stated maturity, such as NOW, savings, and money market accounts is equal to the amount
payable on demand. The fair value of certificates of deposit and FHLBI borrowings are estimated
using rates currently offered for products with similar remaining maturities. RESULTS OF OPERATIONS Net income was $6,300,000 in 2004, a $400,000 (6.8%) increase compared to net income of
$5,900,000 in 2003, a decrease of 6.6% from 2002 net income of $6,304,000. The following table contains key performance ratios for years ended December 31: 2004
    
    
    2003
    
    
    2002Net income to:Average stockholders equity
    
    
    14.51
    %
    
    
    14.90
    %
    
    
    17.97
    %Average assets
    
    
    1.41
    %
    
    
    1.39
    %
    
    
    1.58
    %Basic earnings per common share:
    
    $
    1.98
    
    
    $
    1.86
    
    
    $
    2.00Diluted earnings per common share
    
    $
    1.97
    
    
    $
    1.86
    
    
    $
    2.00
 Net Interest Income Net interest income is the difference between interest earned on earning assets and interest
paid on deposits and other borrowings. It is the major component of the Corporations earnings.
For analytical purposes, the interest earned on investments and loans is expressed on a fully
taxable equivalent (FTE) basis. Tax-exempt interest 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%. 36




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The following table shows the average balance and percentage earned or paid on key components of
earning assets and interest bearing liabilities for the years ended December 31: (dollars in thousands)2004
    
    
    2003
    
    
    2002Average
    
    
    Yield/
    
    
    Average
    
    
    Yield/
    
    
    Average
    
    
    Yield/Balance
    
    
    Rate
    
    
    Balance
    
    
    Rate
    
    
    Balance
    
    
    RateInterest earning assets:Short term investments
    
    $
    14,587
    
    
    
    1.14
    %
    
    $
    9,625
    
    
    
    1.07
    %
    
    $
    3,522
    
    
    
    1.63
    %Certificates of deposit
    
    
    3,817
    
    
    
    2.51
    %
    
    
    3,135
    
    
    
    3.48
    %
    
    
    5,424
    
    
    
    3.28
    %Taxable securities
    
    
    46,914
    
    
    
    3.93
    %
    
    
    29,550
    
    
    
    4.08
    %
    
    
    34,869
    
    
    
    4.63
    %Tax-exempt securities
    
    
    15,612
    
    
    
    6.94
    %
    
    
    15,845
    
    
    
    7.00
    %
    
    
    17,109
    
    
    
    6.94
    %Loans
    
    
    340,859
    
    
    
    6.54
    %
    
    
    340,384
    
    
    
    6.70
    %
    
    
    311,060
    
    
    
    7.46
    %Total earning assets
    
    $
    421,789
    
    
    
    6.04
    %
    
    $
    398,539
    
    
    
    6.36
    %
    
    $
    371,984
    
    
    
    7.05
    %Interest bearing funds:NOW, savings & MMDA
    
    $
    184,791
    
    
    
    0.64
    %
    
    $
    172,611
    
    
    
    0.85
    %
    
    $
    153,651
    
    
    
    1.49
    %Time deposits
    
    
    138,463
    
    
    
    2.92
    %
    
    
    135,842
    
    
    
    3.16
    %
    
    
    131,019
    
    
    
    3.93
    %Short term borrowings
    
    
    626
    
    
    
    1.95
    %
    
    
    1,300
    
    
    
    1.37
    %
    
    
    8,430
    
    
    
    1.99
    %FHLBI advances
    
    
    5,080
    
    
    
    7.40
    %
    
    
    5,337
    
    
    
    7.34
    %
    
    
    5,578
    
    
    
    7.23
    %Total interest bearing funds:
    
    $
    328,960
    
    
    
    1.70
    %
    
    $
    315,090
    
    
    
    1.96
    %
    
    $
    298,678
    
    
    
    2.68
    %Interest spread
    
    
    
    
    
    
    4.34
    %
    
    
    
    
    
    
    4.40
    %
    
    
    
    
    
    
    4.37
    %Net interest margin
    
    
    
    
    
    
    4.71
    %
    
    
    
    
    
    
    4.81
    %
    
    
    
    
    
    
    4.90
    %
 Tax equivalent interest income in each of the three years includes loan origination fees. A
substantial portion of such fees is deferred for recognition in future periods or is considered in
determining the gain or loss on the sale of real estate mortgage loans. Tax equivalent interest
income includes net loan origination fees totaling $726,000 in 2004, $720,000 in 2003, and $750,000
in 2002. 37




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 The following table sets forth the effects of volume and rate changes on net interest income on a
taxable equivalent basis. The change in interest due to changes in both volume and rate has been
allocated to the change due to volume and the change due to rate in proportion to the relationship
of the absolute dollar amounts of the change in each. (dollars in thousands)Year ended December 31, 2004
    
    
    
    
    
    Year ended December 31, 2003compared to
    
    
    
    
    
    compared toYear ended December 31, 2003
    
    
    
    
    
    Year ended December 31, 2002Amount of Increase (Decrease) Due to Change inTotal
    
    
    
    
    
    
    
    
    
    
    TotalAmount
    
    
    
    
    
    
    
    
    
    
    AmountAverage
    
    
    of Increase/
    


    
    Average
    
    
    of IncreaseVolume
    
    
    Rate
    
    
    (Decrease)
    
    
    Volume
    
    
    Rate
    
    
    (Decrease)Interest Income:Short term investments
    
    $
    53
    
    
    $
    9
    
    
    $
    62
    
    
    $
    99
    
    
    $
    (53
    )
    
    $
    46Certificates of deposit
    
    
    24
    
    
    
    (37
    )
    
    
    (13
    )
    
    
    (75
    )
    
    
    6
    
    
    
    (69
    )Securities:Taxable
    
    
    708
    
    
    
    (70
    )
    
    
    638
    
    
    
    (246
    )
    
    
    (163
    )
    
    
    (409
    )Tax Exempt
    
    
    (16
    )
    
    
    (9
    )
    
    
    (25
    )
    
    
    (88
    )
    
    
    10
    
    
    
    (78
    )Loans
    
    
    32
    
    
    
    (557
    )
    
    
    (525
    )
    
    
    2,187
    
    
    
    (2,579
    )
    
    
    (392
    )Total interest income
    
    $
    801
    
    
    $
    (664
    )
    
    $
    137
    
    
    $
    1,877
    
    
    $
    (2,779
    )
    
    $
    (902
    )Interest Expense:Interest bearing deposits:NOW, savings & MMDA
    
    $
    104
    
    
    $
    (396
    )
    
    $
    (292
    )
    
    $
    282
    
    
    $
    (1,100
    )
    
    $
    (818
    )Time deposits
    
    
    83
    
    
    
    (330
    )
    
    
    (247
    )
    
    
    190
    
    
    
    (1,055
    )
    
    
    (865
    )Short term borrowings
    
    
    (9
    )
    
    
    4
    
    
    
    (5
    )
    
    
    (142
    )
    
    
    (8
    )
    
    
    (150
    )FHLBI advances
    
    
    (19
    )
    
    
    3
    
    
    
    (16
    )
    
    
    (18
    )
    
    
    1
    
    
    
    (17
    )Total interest expense
    
    $
    159
    
    
    $
    (719
    )
    
    $
    (560
    )
    
    $
    312
    
    
    $
    (2,162
    )
    
    $
    (1,850
    )Net interest income (FTE)
    
    $
    642
    
    
    $
    55
    
    
    $
    697
    
    
    $
    1,565
    
    
    $
    (617
    )
    
    $
    948
 Tax equivalent net interest income increased $697,000 in 2004. The increase was primarily the
result of a $560,000 decrease in interest expense and a $137,000 increase in interest income. The
modest increase in interest income is attributable to an increase in average earning assets of
$23,250,000 during the year partially offset by a decrease of 32 basis points in the interest rate
earned on assets. Tax equivalent loan interest income was $525,000 less in 2004 than the previous
year. The decrease was due to a decrease of 16 basis points in the rate of interest earned on
loans although average balances had a small increase of $475,000 in 2004. The decrease in rates on
loans is due to the low interest rate environment that existed throughout the first three quarters
of 2004 and low new loan demand which had a further impact of increasing competitive pressures on
loan pricing. Income on taxable securities increased $638,000 in 2004 due to a $17,364,000 increase in average
balances partially offset by a decline of 15 basis points in yield. With low loan growth and
deposit growth in 2004 and 2003, there were additional funds available for investment securities.
In 2003 the opposite situation occurred. Loan demand exceeded deposit growth which then led to
a decline in average taxable investment securities of $5,319,000 compared to 2002. Tax equivalent
income on tax-exempt bonds decreased $25,000 in 2004. The average balance of these securities
decreased $233,000 while the rate decreased 6 basis points. The decrease in balances with the
subsequent decrease in yields was the result of the maturity and/or calls of bonds that were
purchased at slightly 38




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 higher interest rates than that of the average portfolio. Interest income on short term
investments increased $62,000 due to an increase in average balances of $4,962,000 and an increase
in interest rates of 7 basis points. The average balance of purchased certificates increased
$682,000 while the interest yield decreased 97 basis points, primarily the result of the
certificates purchased in late 2003 and 2004 when rates were low. Interest income on purchased
certificates decreased $13,000. Interest expense decreased $560,000 in 2004 because interest rates decreased 26 basis points
although average balances increased approximately $13,870,000. The interest cost for NOW, savings
and MMDA accounts decreased $292,000 because the interest rate paid declined 21 basis points
although average balances increased $12,180,000. Interest on time deposits decreased $247,000
because interest rates decreased 24 basis points although average time deposits increased
$2,261,000. Growth in NOW, savings, and MMDA deposits appears to be a preference for liquidity on
the part of depositors as they avoided certificates of deposit. Fed Funds and short term advances
from the FHLBI were used infrequently in 2004; therefore, there was little effect from these items
on the change in interest expense. The Corporation entered into two long term borrowings with the
FHLBI in 2000. One of the loans amortizes and had a balance of $2,067,000 at year end while the
other loan, for $3,000,000, matures in its entirety in April 2005. In the previous year, net interest income had increased $948,000. The increase in net
interest income was the result of a $1,850,000 decrease in interest expense partially offset by a
decrease in interest income of $902,000. The decrease in interest income in 2003 was due to decline
in yield of 69 basis points partially offset by higher average earning assets of $26,555,000. The
decrease in interest expense was the result of a 72 basis drop in rates paid partially offset by an
increase of $16,412,000 in average interest bearing liabilities. The following table shows the composition of average earning assets and interest paying liabilities
for the years ended December 31: 2004
    
    
    2003
    
    
    2002As a percent of average earning assets:Loans
    
    
    80.82
    %
    
    
    85.41
    %
    
    
    83.62
    %Securities
    
    
    14.82
    %
    
    
    11.39
    %
    
    
    13.97
    %Certificates of deposit
    
    
    0.90
    %
    
    
    0.80
    %
    
    
    1.46
    %Short term investments
    
    
    3.46
    %
    
    
    2.40
    %
    
    
    0.95
    %Average earning assets
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %NOW, savings, & MMDA
    
    
    43.81
    %
    
    
    43.31
    %
    
    
    41.31
    %Time deposits
    
    
    32.83
    %
    
    
    34.08
    %
    
    
    35.22
    %Short term borrowing
    
    
    0.15
    %
    
    
    0.33
    %
    
    
    2.27
    %FHLBI advances
    
    
    1.20
    %
    
    
    1.34
    %
    
    
    1.50
    %Average interest bearing liabilities
    
    
    77.99
    %
    
    
    79.06
    %
    
    
    80.30
    %Earning asset ratio
    
    
    94.51
    %
    
    
    93.99
    %
    
    
    93.25
    %Free-funds ratio
    
    
    22.01
    %
    
    
    20.94
    %
    
    
    19.70
    %
 Provision for Loan Losses The provision for loan losses decreased to $1,190,000 in 2004 compared to $1,270,000 in 2003
and $625,000 in 2002. At year end, the ratio of allowance for loan loss to loans was 1.79%,
compared to 1.72% in 2003 and 1.77% in 2002. The slight dollar decrease in 2004 was deemed
appropriate considering the allowance adequacy analysis which showed that the balance in the
allowance was adequate to cover anticipated losses. While the level of nonperforming loans and
impaired loans decreased in 2004, management feels the allowance is appropriate due to higher
balances of watch commercial loan credits in 2004. 39




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FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 Noninterest Income Noninterest income, which includes service charges on deposit accounts, trust income, loan
fees, other operating income, and gain (loss) on sale of assets and securities transactions,
increased approximately $236,000 (6.1%) in 2004 compared to 2003 and increased $254,000 (7.0%) in
2003 compared to 2002. The primary reason for the increase in noninterest income was other income
which increased $402,000 in 2004 from 2003 due to the recognition in 2004 of a nonrecurring
$299,000 gain deferred in 2003 on the disposition of properly held for sale and higher than normal
gains on the sale of foreclosed real estate. Service charge and other fee income increased to
$3,319,000 (5.8%) in 2004 and to $3,136,000 (5.5%) in 2003. The 2004 increase was due primarily to
the recovery of a mortgage servicing right impairment recorded in 2003. The 2003 increase from 2002
was due to the increase in deposits and loans. Trust income decreased $40,000 in 2004 and increased
$85,000 in 2003. Trust income in 2003 included nonrecurring income of approximately $42,000. The
$69,000 gain realized on the sale of real estate mortgage loans was $305,000 lower than the gains
recognized in 2003, which were $42,000 lower than the gains recognized in 2002. Sales volume was
down approximately $19,400,000 as mortgage rates began to rise in the latter part of 2003 and
refinancing activity decreased. Sales volume in 2003 was approximately $900,000 lower than 2002.
Management expects the volume of loans sold and the corresponding gain on sold loans to remain
relatively constant in 2005. There were no security sales in 2004; there was a small gain of $4,000
in 2003 related to the call of a security. From time to time, securities were sold in 2002 to
improve the Corporations liquidity position. Included in noninterest income were gains totaling
$37,000 related to those sales. Noninterest Expense Non-interest expense totaled $13,300,000 in 2004, a 3.4% increase over expenses of $12,800,000
in 2003, and a 9.1% increase over expenses of $11,800,000 in 2002. The most significant component
of non-interest expense is salaries and benefits. In 2004, salaries and benefits expense increased
2.7% to $7,200,000, due to salary increases, new positions and increased health care costs.
Management expects costs to continue to increase in 2005 due to new positions, the filling of open
positions as of December 31, 2004 and increased benefit costs. In 2003, salaries and benefits
expense increased 9.4% to $7,000,000 due to the combined effects of salary increases, increased
cost of medical insurance, and an increase in the employee profit sharing expense. Occupancy
expense increased $157,000 (16.4%) in 2004 primarily due to the costs of new facilities and
increased maintenance and utility costs. In 2003, occupancy expense increased 7.5% to $958,000 the
result of costs associated with a new branch and operations center. Equipment expense decreased
$144,000 (14.2%) in 2004 over 2003. The decrease is attributable to lower software amortization
costs and lower equipment maintenance costs. In 2003, equipment expense increased 16.4% to
$1,008,000 due to the cost of equipping new facilities. In 2004, professional and service fees
increased $399,000 (32.6%) due to increased costs associated with increased accounting fees due to
the Sarbanes-Oxley Act, and increased personnel costs related to recruitment and staff development.
In 2003, these costs decreased by $53,000 (4.2%) from 2002. Advertising expense decreased $83,000
(27.2%) in 2004 due to fewer loan and deposit marketing campaigns. In 2003, advertising expense
also decreased 12.6% to $305,000 for the same reasons. Other expense decreased $91,000 (4.5%) due
to a $130,000 write down of the Challis road property held for sale in 2003, net of increased loan
and collection expenses in 2004. Federal Income Tax Expense Fluctuations in income taxes resulted primarily from changes in the level of profitability and
in variations in the amount of tax-exempt income. Income tax expense increased $174,000 to
$2,728,000 (6.8%) in 2004 and decreased $74,000 to $2,554,000 (2.8%) in 2003. Although income tax
expense increased, the effective rate remained at 30% in 2004 and 2003. For further information
see Note 12 Federal Income Taxes in Notes to Consolidated Financial Statements. Critical Accounting Policies Our accounting and reporting policies are in accordance with accounting principles generally
accepted within the United States of America and conform to general practices within the banking
industry. Accounting and reporting policies for the allowance for loan losses is deemed critical
since it involves the use of estimates and requires significant management judgments. Application
of assumptions different from those that we have used could result in material changes in our
financial position or results of operations. Our methodology for determining the allowance and related provision for loan losses is
described above in Financial Condition  Loans. In particular, this area of accounting requires
a significant amount of judgment because a multitude of factors can influence the ultimate
collection of a loan or other type of credit should the factors noted above and as described in
Note 1 in 40




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 Notes to Consolidated Financial Statements differ from out assumptions (for example, an increase in
past due loans, deterioration of the economy), our allowance for loan losses would likely be
adversely impacted. It is extremely difficult to precisely measure the
amount of losses that may be inherent in our loan portfolio. We attempt to accurately quantify the
necessary allowance and related provision for loan losses, but there can be no assurance that our
modeling process will successfully identify all of the losses inherent in our loan portfolio. As a
result, we could record future provisions for loan losses that may be significantly different from
the levels that we have recorded. Impact of New Accounting Standards See Note 27 Impact of New Accounting Standards in Notes to Consolidated Financial Statements for
discussion of new accounting standards and their impact. SUMMARY FINANCIAL DATA(in thousands, except per share data)2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Income Statement Data:Interest income
    
    $
    24,992
    
    
    $
    24,856
    
    
    $
    25,729
    
    
    $
    27,095
    
    
    $
    26,047Interest expense
    
    
    5,606
    
    
    
    6,167
    
    
    
    8,017
    
    
    
    10,861
    
    
    
    10,042Net interest income
    
    
    19,386
    
    
    
    18,689
    
    
    
    17,712
    
    
    
    16,234
    
    
    
    16,005Provision for loan losses
    
    
    1,190
    
    
    
    1,270
    
    
    
    625
    
    
    
    900
    
    
    
    1,200Noninterest income
    
    
    4,110
    
    
    
    3,874
    
    
    
    3,621
    
    
    
    3,120
    
    
    
    2,604Noninterest expense
    
    
    13,287
    
    
    
    12,848
    
    
    
    11,775
    
    
    
    11,061
    
    
    
    10,188Income before tax
    
    
    9,019
    
    
    
    8,445
    
    
    
    8,933
    
    
    
    7,393
    
    
    
    7,221Net income
    
    
    6,291
    
    
    
    5,891
    
    
    
    6,304
    
    
    
    5,220
    
    
    
    5,106Per Share Data(1):Basic net income per share
    
    $
    1.98
    
    
    $
    1.86
    
    
    $
    2.00
    
    
    $
    1.66
    
    
    $
    1.63Diluted net income per share
    
    
    1.97
    
    
    
    1.86
    
    
    
    2.00
    
    
    
    1.66
    
    
    
    1.63Dividends paid
    
    
    0.72
    
    
    
    0.68
    
    
    
    0.63
    
    
    
    0.60
    
    
    
    0.58Weighted average basic shares outstanding
    
    
    3,185,025
    
    
    
    3,162,836
    
    
    
    3,152,739
    
    
    
    3,141,118
    
    
    
    3,132,780Weighted average diluted shares outstanding
    
    
    3,186,142
    
    
    
    3,162,836
    
    
    
    3,152,739
    
    
    
    3,141,118
    
    
    
    3,132,780Balance Sheet Data:Total assets
    
    
    456,603
    
    
    
    449,818
    
    
    
    420,686
    
    
    
    392,978
    
    
    
    348,363Loans, net
    
    
    357,377
    
    
    
    347,086
    
    
    
    327,117
    
    
    
    286,280
    
    
    
    255,414Allowance for loan losses
    
    
    6,400
    
    
    
    5,958
    
    
    
    5,794
    
    
    
    5,668
    
    
    
    5,193Deposits
    
    
    399,263
    
    
    
    399,073
    
    
    
    374,072
    
    
    
    351,669
    
    
    
    310,214Shareholders equity
    
    
    45,716
    
    
    
    41,235
    
    
    
    37,580
    
    
    
    32,404
    
    
    
    28,887Ratios:Dividend payout ratio
    
    
    36.34
    %
    
    
    36.51
    %
    
    
    31.40
    %
    
    
    36.12
    %
    
    
    35.29
    %Equity to asset ratio
    
    
    9.71
    %
    
    
    9.32
    %
    
    
    8.80
    %
    
    
    8.69
    %
    
    
    8.68
    %
   (1)
    
    Per share data for 2000  2002 has been restated to give effect to the two-for-one stock split, payable as a dividend of one share for each share of the
Corporations stock held of record July 1, 2002, paid July 10, 2002. 41




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##### 



FNBH BANCORP, INC. AND SUBSIDIARIES Managements Discussion and Analysis December 31, 2004, 2003, and 2002 STOCK AND EARNINGS HIGHLIGHTS There is not an established trading market for the Corporations Common Stock. Information
regarding its market price can be obtained on the internet at nasdaq.com, symbol FNHM. There is
one market maker for the stock. There are occasional direct sales by shareholders of which the
Corporations management is generally aware. It is the understanding of the management of the
Corporation that over the last two years the Corporations Common Stock has sold at a premium to
book value. From January 1, 2003, through December 31, 2004, there were, so far as the
Corporations management knows, a total of 264,280 shares of the Corporations Common Stock sold.
The price was reported to management in some of these transactions; however there may have been
other transactions involving the Corporations stock at prices not reported to management. During
2004, the highest and lowest prices known to management, involving sales of more than 100 shares,
were $32.00 and $26.00 per share, respectively. As of March 1, 2005, there were approximately 940 holders of record of the Corporations
Stock. The following table sets forth the range of high and low sales prices of the Corporations
Common Stock during 2003 and 2004, based on information made available to the Corporation, as well
as per share cash dividends declared during those periods. Although management is not aware of any
transactions at higher or lower prices, there may have been transactions at prices outside the
ranges listed in the table. Sales prices, for sales involving more than 200 shares, and dividend information for the years 2003
and 2004 are as follows: Sale Prices2003
    
    High
    
    
    Low
    
    
    Cash Dividends DeclaredFirst Quarter
    
    $
    25.00
    
    
    $
    23.00
    
    
    $
    0.17Second Quarter
    
    $
    25.00
    
    
    $
    24.00
    
    
    $
    0.17Third Quarter
    
    $
    31.00
    
    
    $
    24.00
    
    
    $
    0.17Fourth Quarter
    
    $
    27.50
    
    
    $
    25.25
    
    
    $
    0.17
 Sale Prices2004
    
    High
    
    
    Low
    
    
    Cash Dividends DeclaredFirst Quarter
    
    $
    29.98
    
    
    $
    26.00
    
    
    $
    0.17Second Quarter
    
    $
    31.50
    
    
    $
    27.00
    
    
    $
    0.17Third Quarter
    
    $
    31.25

    
    
    $
    27.55
    
    
    $
    0.19Fourth Quarter
    
    $
    32.00
    
    
    $
    28.50
    
    
    $
    0.19
 42