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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
Commission file number: 000-25219
LINCOLN BANCORP
(Exact name of registrant specified in its charter)
Indiana 35-2055553
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1121 East Main Street
Plainfield, Indiana 46168-0510
(Address of principal executive offices, including Zip Code)
(317) 839-6539
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of the Registrant's common stock, without par value,
outstanding as of June 30, 2004 was 4,430,391.
LINCOLN BANCORP AND SUBSIDIARY
FORM 10-Q
INDEX
Page No.
FORWARD LOOKING STATEMENT 3
PART I. FINANCIAL INFORMATION 4
Item 1. Financial Statements 4
Consolidated Condensed Balance Sheets 4
Consolidated Condensed Statements of Income 5
Consolidated Condensed Statements of Comprehensive Income 6
Consolidated Condensed Statement of Shareholders' Equity 7
Consolidated Condensed Statements of Cash Flows 8
Notes to Unaudited Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
Item 4. Controls and Procedures 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
CERTIFICATIONS 19
2
FORWARD LOOKING STATEMENT
This Quarterly Report on Form 10-Q ("Form 10-Q") contains statements which
constitute forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements appear in a number of
places in this Form 10-Q and include statements regarding the intent, belief,
outlook, estimate or expectations of the Company (as defined in the notes to the
consolidated condensed financial statements), its directors or its officers
primarily with respect to future events and the future financial performance of
the Company. Readers of this Form 10-Q are cautioned that any such forward
looking statements are not guarantees of future events or performance and
involve risks and uncertainties, and that actual results may differ materially
from those in the forward looking statements as a result of various factors. The
accompanying information contained in this Form 10-Q identifies important
factors that could cause such differences. These factors include changes in
interest rates; loss of deposits and loan demand to other financial
institutions; substantial changes in financial markets; changes in real estate
values and the real estate market; or regulatory changes.
3
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
LINCOLN BANCORP AND SUBSIDIARY
Consolidated Condensed Balance Sheets
June 30, December 31,
2004 2003
--------------------- --------------------
(Unaudited)
Assets
Cash and due from banks $ 2,473,782 $ 1,946,033
Short-term interest-bearing demand deposits in other banks 3,649,430 14,829,890
--------------------- --------------------
Cash and cash equivalents 6,123,212 16,793,923
Investment securities
Available for sale 103,407,030 94,136,926
Held to maturity (market value $1,720,000 and $1,745,000) 1,720,000 1,745,000
--------------------- --------------------
Total investment securities 105,127,030 95,881,926
Loans held for sale 2,186,730 354,900
Loans, net of allowance for loan losses of $3,834,405 and $3,532,475 425,477,401 437,671,971
Premises and equipment 8,256,571 7,647,150
Investments in limited partnerships 1,183,777 1,249,777
Federal Home Loan Bank stock 9,491,000 9,270,200
Interest receivable 2,402,132 2,441,270
Goodwill 1,563,594 1,563,594
Cash surrender value life insurance 12,759,614 12,506,227
Other assets 6,598,578 6,304,312
--------------------- --------------------
Total assets $ 581,169,639 $ 591,685,250
===================== ====================
Liabilities
Deposits
Noninterest-bearing $ 18,439,891 $ 17,175,958
Interest-bearing 299,185,441 304,663,176
--------------------- --------------------
Total deposits 317,625,332 321,839,134
Borrowings 176,009,712 184,692,618
Interest payable 842,754 913,705
Other liabilities 6,138,256 5,013,042
--------------------- --------------------
Total liabilities 500,616,054 512,458,499
--------------------- --------------------
Commitments and Contingencies
Shareholders' Equity
Common stock, without par value
Authorized - 20,000,000 shares
Issued and outstanding - 4,430,391 and 4,411,891 shares 43,621,386 43,383,386
Retained earnings 41,366,394 40,526,766
Accumulated other comprehensive loss (200,683) (8,118)
Unearned recognition and retention plan (RRP) shares (644,352) (918,983)
Unearned employee stock ownership plan (ESOP) shares (3,589,160) (3,756,300)
--------------------- --------------------
Total shareholders' equity 80,553,585 79,226,751
--------------------- --------------------
Total liabilities and shareholders' equity $ 581,169,639 $ 591,685,250
===================== ====================
See notes to consolidated condensed financial statements.
4
LINCOLN BANCORP AND SUBSIDIARY
Consolidated Condensed Statements of Income
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------ ----------------- ---------------
2004 2003 2004 2003
------------------ ------------------ ----------------- ---------------
Interest Income
Loans, including fees $ 6,622,058 $ 6,422,227 $13,291,230 $12,576,952
Investment securities 602,618 981,075 1,295,325 2,095,718
Deposits with financial institutions 9,030 56,361 26,076 107,501
Dividend income 94,256 118,045 211,216 222,280
------------------ ------------------ ----------------- ---------------
Total interest and dividend income 7,327,962 7,577,708 14,823,847 15,002,451
------------------ ------------------ ----------------- ---------------
Interest Expense
Deposits 1,393,652 1,674,231 2,826,837 3,288,239
Federal Home Loan Bank advances 2,029,895 2,007,812 4,064,089 3,978,956
------------------ ------------------ ----------------- ---------------
Total interest expense 3,423,547 3,682,043 6,890,926 7,267,195
------------------ ------------------ ----------------- ---------------
Net Interest Income 3,904,415 3,895,665 7,932,921 7,735,256
Provision for loan losses 223,281 269,632 423,453 434,163
------------------ ------------------ ----------------- ---------------
Net Interest Income After Provision for Loan Losses 3,681,134 3,626,033 7,509,468 7,301,093
------------------ ------------------ ----------------- ---------------
Other Income
Service charges on deposit accounts 305,034 208,122 518,990 407,681
Net realized and unrealized gains on loans 68,041 411,953 138,407 663,089
Net realized losses on sales of available-for-sale
securities -- (9,106) -- (34,824)
Point of sale income 102,575 81,159 189,264 153,516
Loan servicing fees 81,805 98,576 164,706 205,081
Increase in cash value of life insurance 116,051 160,164 253,387 329,463
Equity in losses of limited partnerships (33,000) (36,000) (66,000) (72,000)
Other income 159,918 210,571 273,156 335,618
------------------ ------------------ ----------------- ---------------
Total other income 800,424 1,125,439 1,471,910 1,987,624
------------------ ------------------ ----------------- ---------------
Other Expenses
Salaries and employee benefits 1,641,923 1,674,548 3,495,524 3,444,230
Net occupancy expenses 230,435 196,802 467,538 413,260
Equipment expenses 222,263 240,740 408,051 480,117
Advertising and business development 132,225 99,699 235,222 209,457
Data processing fees 375,737 324,837 736,455 650,551
Professional fees 119,634 87,565 234,587 201,117
Director and committee fees 10,712 66,172 90,390 136,374
Other expenses 487,775 663,248 994,009 1,178,674
------------------ ------------------ ----------------- ---------------
Total other expenses 3,220,704 3,353,611 6,661,776 6,713,780
------------------ ------------------ ----------------- ---------------
Income Before Income Tax 1,260,855 1,397,861 2,319,602 2,574,937
Income tax expense 324,656 360,757 571,655 634,867
------------------ ------------------ ----------------- ---------------
Net Income $ 936,199 $ 1,037,104 $ 1,747,947 $ 1,940,070
================== ================== ================= ===============
Basic earnings per share $ .24 $ .27 $ .44 $ .49
Diluted earnings per share .23 .26 .43 .47
Dividends per share .13 .12 .26 .24
5
LINCOLN BANCORP AND SUBSIDIARY
Consolidated Condensed Statements of Comprehensive Income
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2004 2003 2004 2003
------------ ----------- ----------- -----------
Net Income $ 936,199 $ 1,037,104 $ 1,747,947 $ 1,940,070
Other comprehensive income, net of tax
Unrealized losses on securities available for sale
Unrealized holding losses arising during the
period, net of tax benefit of $325,263, $163,726,
$99,135, and $266,585 (631,380) (308,577) (192,565) (503,746)
Less: Reclassification adjustment for losses
included in net income, net of tax benefit of $0,
$3,096, $0 and $11,840 -- (6,010) -- (22,984)
----------- ----------- ----------- -----------
(631,380) (302,567) (192,565) (480,762)
----------- ----------- ----------- -----------
Comprehensive income $ 304,819 $ 734,537 $ 1,555,382 $ 1,459,308
=========== =========== =========== ===========
See notes to consolidated condensed financial statements.
6
LINCOLN BANCORP AND SUBSIDIARY
Consolidated Condensed Statement of Shareholders' Equity
For the Six Months Ended June 30, 2004
(Unaudited)
Common Stock Accumulated
-------------------------- Other Unearned
Shares Retained Comprehensive Unearned ESOP
Outstanding Amount Earnings Loss Compensation Shares Total
-------------- ----------- ----------- ------------- ------------ --------- -----------
Balances, January 1, 2004 4,411,891 $43,383,386 $40,526,766 $ (8,118) $(918,983) $(3,756,300) $79,226,751
Net income for the period 1,747,947 1,747,947
Unrealized losses on
securities, net of
reclassification
adjustment (192,565) (192,565)
Stock options exercised 18,500 238,000 238,000
ESOP shares earned 155,105 167,140 322,245
Amortization of unearned
compensation expense (10,746) 274,631 263,885
Cash dividends ($.26
per share) (1,052,678) (1,052,678)
----------- ----------- ----------- --------- ---------- ----------- -----------
Balances, June 30, 2004 4,430,391 $43,621,386 $41,366,394 $(200,683) $ (644,352) $(3,589,160) $80,553,585
=========== =========== =========== ========= ========== =========== ===========
See notes to consolidated condensed financial statements.
7
LINCOLN BANCORP AND SUBSIDIARY
Consolidated Condensed Statements of Cash Flows
(Unaudited)
Six Months Ended
June 30,
-------------------- -------------------
2004 2003
-------------------- -------------------
Operating Activities
Net income $ 1,747,947 $ 1,940,070
Adjustments to reconcile net income to net cash provided
by (used in) operatingactivities
Provision for loan losses 423,453 434,163
Investment securities accretion, net 145,594 107,075
Investment securities losses -- 34,824
Loans originated for sale in the secondary market (10,494,480) (25,168,691)
Proceeds from sale of loans in the secondary market 8,759,295 21,853,037
Gain on sale of loans (138,407) (663,089)
Amortization of net loan origination fees (130,138) (352,469)
Depreciation and amortization 369,267 373,091
Amortization of unearned compensation expense 263,885 311,076
ESOP shares earned 322,245 304,709
Net change in:
Interest receivable 39,138 (202,887)
Interest payable (70,951) (71,008)
Other adjustments 45,483 (168,556)
-------------------- -------------------
Net cash provided by (used in) operating activities 1,282,331 (1,268,655)
-------------------- -------------------
Investing Activities
Purchases of securities available for sale (34,776,645) (28,976,092)
Proceeds from sales of securities available for sale -- 1,952,511
Proceeds from maturities of securities available for sale 52,042,457 32,156,276
Proceeds from maturities of securities held to maturity 25,000 10,000
Net change in loans (15,643,150) (46,799,928)
Purchases of property and equipment (980,206) (407,670)
Purchases of Federal Home Loan Bank stock -- (865,600)
Proceeds from sale of foreclosed real estate 493,218 25,659
Other investing activities 1,365 --
-------------------- -------------------
Net cash provided by (used in) investing activities 1,162,039 (42,904,844)
-------------------- -------------------
Financing Activities
Net change in
Noninterest-bearing, interest-bearing demand, money market and savings
deposits (2,366,972) 31,623,955
Certificates of deposit (1,846,830) (6,575,637)
Proceeds from FHLB advances 51,800,000 20,000,000
Repayment of FHLB advances (60,500,000) (10,000,000)
Payment on note payable to limited partnership -- (248,501)
Dividends paid (1,050,273) (996,925)
Exercise of stock options 238,000 268,152
Purchase of common stock -- (4,920,913)
Net change in advances by borrowers for taxes and insurance 610,994 1,028,690
-------------------- -------------------
Net cash provided by (used in) financing activities (13,115,081) 30,178,821
-------------------- -------------------
Net Change in Cash and Cash Equivalents (10,670,711) (13,994,678)
Cash and Cash Equivalents, Beginning of Period 16,793,923 27,298,093
-------------------- -------------------
Cash and Cash Equivalents, End of Period $ 6,123,212 $ 13,303,415
==================== ===================
Additional Cash Flows and Supplementary Information
Interest paid $ 6,961,877 $ 7,338,203
Income tax paid 472,000 820,000
Loan balances transferred to foreclosed real estate 499,100 275,536
Securitization of loans 27,068,072 --
See notes to consolidated condensed financial statements.
8
LINCOLN BANCORP AND SUBSIDIARY
Notes to Unaudited Consolidated Condensed Financial Statements
Note 1: Basis of Presentation
The consolidated financial statements include the accounts of Lincoln Bancorp
(the "Company"), its wholly owned subsidiary, Lincoln Bank, a federally
chartered savings bank ("Lincoln" or the "Bank"), and Lincoln's wholly owned
subsidiaries, LF Service Corporation ("LF Service") and Citizens Loan and
Service Corporation ("CLSC"), both Indiana corporations, and LF Portfolio
Services, Inc. ("LF Portfolio"), a Delaware corporation. A summary of
significant accounting policies is set forth in Note 1 of Notes to Financial
Statements included in the December 31, 2003 Annual Report to Shareholders. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
The interim consolidated financial statements have been prepared in accordance
with instructions to Form 10-Q, and therefore do not include all information and
footnotes necessary for a fair presentation of financial position, results of
operations and cash flows in conformity with generally accepted accounting
principles.
The interim consolidated financial statements at June 30, 2004, and for the
three and six months ended June 30, 2004 and 2003, have not been audited by
independent accountants, but reflect, in the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position, results of operations and cash flows for
such periods. The results of operations for the three-month and six-month
periods ended June 30, 2004, are not necessarily indicative of the results which
may be expected for the entire year. The consolidated condensed balance sheet of
the Company as of December 31, 2003 has been derived from the audited
consolidated balance sheet of the Company as of that date.
Note 2: Earnings Per Share
Earnings per share have been computed based upon the weighted-average common
shares outstanding. Unearned Employee Stock Ownership Plan shares have been
excluded from the computation of average common shares outstanding.
Three Months Ended Three Months Ended
June 30, 2004 June 30, 2003
------------- -------------
Weighted Per Weighted Per
Average Share Average Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings per share
Income available to
common shareholders $936,199 3,970,084 $.24 $ 1,037,104 3,910,399 $ .27
========= =========
Effect of dilutive RRP
awards and stock options 122,720 148,136
-------------------------- --------------------------
Diluted earnings per share
Income available to
common shareholders and
assumed conversions
$936,199 4,092,804 $.23 $ 1,037,104 4,058,535 $ .26
========================================= ========================================
9
Six Months Ended Six Months Ended
June 30, 2004 June 30, 2003
------------- -------------
Weighted Per Weighted Per
Average Share Average Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings per share
Income available to
common shareholders $1,747,947 3,960,111 $ .44 $ 1,940,070 3,948,503 $ .49
========= =========
Effect of dilutive RRP
awards and stock options 141,337 145,050
--------------------------- --------------------------
Diluted earnings per share
Income available to
common shareholders and
assumed conversions
$1,747,947 4,101,448 $ .43 $1,940,070 4,093,553 $ .47
========================================= ========================================
Note 3: Stock Options
The Company has a stock-based employee compensation plan, which is described
more fully in Notes to Financial Statements included in the December 31, 2003
Annual Report to Shareholders. The Company accounts for this plan under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under the
plan had an exercise price equal to the market value of the underlying common
stock on the grant date. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------------------------------------------------------
Net income, as reported $ 936,199 $ 1,037,104 $ 1,747,947 $ 1,940,070
Less: Total stock-based employee compensation
cost determined under the fair value based
method, net of income taxes 7,224 36,257 16,328 72,515
------------------------------------------------------------
Pro forma net income $ 928,975 $ 1,000,847 $ 1,731,619 $ 1,867,555
============================================================
Earnings per share:
Basic - as reported $ .24 $ .27 $ .44 $ .49
Basic - pro forma .23 .26 .44 .47
Diluted - as reported .23 .26 .43 .47
Diluted - pro forma .23 .25 .42 .46
10
Note 4: Business Combination
On August 2, 2004, the Company announced the completion of the acquisition of
First Shares Bancorp, Inc., Greenwood, Indiana (First Shares), the holding
company of First Bank, an Indiana commercial bank. Under the terms of the
agreement, shareholders of First Shares could elect to receive in exchange for a
share of First Shares common stock either .75 shares of the Company's common
stock or $14.80 in cash; provided that an aggregate of 878,685 shares of Company
stock were to be issued in the acquisition. As a result of the various
shareholder elections made, all shareholders who elected only cash and all
shareholders who failed to make a proper election by the July 14, 2004 deadline
will receive $14.80 for each share of First Shares they own. Because more
shareholders elected stock than were permitted in the transaction, shareholders
electing Company stock will receive for each share of First Shares common stock
approximately .55 shares of Company common stock and approximately $4.00 in
cash, based on a stock exchange pro ration factor of .7293141, an exchange ratio
of .75 and a cash payment of $14.80. Cash will be paid for fractional shares in
an amount determined by multiplying the fractional interest by $19.73.
In the aggregate, the Company issued 878,685 shares of common stock in the
transaction and paid cash in the aggregate of approximately $17.3 million. The
cash consideration was derived from borrowings by Lincoln Bank that were paid to
the Company in the form of dividend distributions and borrowings by the Company
under its line of credit.
In addition, options for 31,500 shares of First Shares common stock were
purchased at the closing of the transaction by the Company for an aggregate of
$329,490 in cash. Moreover, options for an aggregate of 93,186 Company shares
with an average option price per share of $7.42 were exchanged for options for
124,250 shares of First Shares common stock with an average option price of
$5.56 per share.
On August 2, 2004, First Bank merged into Lincoln Bank. The transaction was
approved by the shareholders of the Company and First Shares as well as
regulatory authorities. Total assets of Lincoln after the merger are
approximately $815 million.
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
The Company was organized in September 1998. On December 30, 1998, it acquired
the common stock of Lincoln upon the conversion of Lincoln from a federal mutual
savings bank to a federal stock savings bank.
Lincoln Bank was originally organized in 1884 as Ladoga Federal Savings and Loan
Association, located in Ladoga, Indiana. In 1979 Ladoga Federal merged with
Plainfield First Federal Savings and Loan Association, a federal savings and
loan association located in Plainfield, Indiana which was originally organized
in 1896. Following the merger, the Bank changed its name to Lincoln Federal
Savings and Loan Association and, in 1984, adopted the name, Lincoln Federal
Savings Bank. On September 26, 2000, the Company acquired Citizens Bancorp
("Citizens"), the holding company of Citizens Savings Bank of Frankfort
("Citizens Savings"), a federally chartered savings bank. Citizens was merged
into the Company and Citizens Savings was merged into the Bank. Citizens Loan
and Service Corporation ("CLSC"), a wholly-owned subsidiary of Citizens Savings,
continues as a subsidiary of Lincoln. Lincoln currently conducts its business
from nine full-service offices located in Hendricks, Montgomery, Clinton,
Johnson and Morgan Counties, Indiana, with its main office located in
Plainfield. On September 1, 2003, the Bank adopted the name Lincoln Bank.
Lincoln offers a variety of lending, deposit and other financial services to its
retail and commercial customers. The Bank's principal business consists of
attracting deposits from the general public and originating fixed-rate and
adjustable-rate loans secured primarily by first mortgage liens on one- to
four-family residential real estate. Lincoln's deposit accounts are insured up
to applicable limits by the Savings Association Insurance Fund of the Federal
Deposit Insurance Corporation. Lincoln offers a number of financial services,
which includes: (i) one-to four-family residential real estate loans; (ii)
commercial real estate loans; (iii) real estate construction loans; (iv) land
loans; (v) multi-family residential loans; (vi) consumer loans, including home
equity loans and automobile loans; (vii) commercial loans; (viii) money market
demand accounts; (ix) savings accounts; (x) checking accounts; (xi) NOW
accounts; (xii) certificates of deposit; and (xiii) financial planning.
11
Lincoln currently owns three subsidiaries. First, LF Service, whose assets
consist of an investment in Family Financial Holdings, Inc. ("Family Financial")
and in Bloomington Housing Associates, L.P. ("BHA"). Family Financial primarily
engages in retail sales of insurance products in connection with loans
originated by its shareholder financial institutions. BHA is an Indiana limited
partnership that was organized to construct, own and operate a 130-unit
apartment complex in Bloomington, Indiana (the "BHA Project"). Development of
the BHA Project was completed in 1993 and the project is performing as planned.
Second, CLSC, which primarily engages in the purchase and development of tracts
of undeveloped land. Because CLSC engages in activities that are not permissible
for a national bank, OTS regulations prohibit Lincoln from including its
investment in CLSC in its calculation of regulatory capital. CLSC purchases
undeveloped land, constructs improvements and infrastructure on the land, and
then sells lots for residential home construction. Third, LF Portfolio, which is
located in Nevada, holds and manages a significant portion of Lincoln's
investment portfolio.
Lincoln's results of operations depend primarily upon the level of net interest
income, which is the difference between the interest income earned on
interest-earning assets, such as loans and investments, and costs incurred with
respect to interest-bearing liabilities, primarily deposits and borrowings.
Results of operations also depend upon the level of Lincoln's non-interest
income, including fee income and service charges and the level of its
non-interest expenses, including general and administrative expenses.
Critical Accounting Policies
Note 1 to the consolidated financial statements contains a summary of the
Company's significant accounting policies presented on pages 28 through 31 of
the Annual Report to Shareholders for the year ended December 31, 2003, which
was filed on Form 10-K with the Securities and Exchange Commission on March 30,
2004. Certain of these policies are important to the portrayal of the Company's
financial condition, since they require management to make difficult, complex or
subjective judgments, some of which may relate to matters that are inherently
uncertain. Management believes that its critical accounting policies include
determining the allowance for loan losses, the valuation of mortgage servicing
rights, and the valuation of intangible assets.
Allowance for loan losses
The allowance for loan losses represents management's estimate of probable
losses inherent in the Company's loan portfolios. In determining the appropriate
amount of the allowance for loan losses, management makes numerous assumptions,
estimates and assessments.
The Company's strategy for credit risk management includes conservative,
centralized credit policies, and uniform underwriting criteria for all loans as
well as an overall credit limit for each customer significantly below legal
lending limits. The strategy also emphasizes diversification on a geographic,
industry and customer level, regular credit quality reviews and quarterly
management reviews of large credit exposures and loans experiencing
deterioration of credit quality. A standard credit scoring system is used to
assess credit risks during the loan approval process of all consumer loans while
commercial loans are individually reviewed by a credit analyst with formal
presentations to the Bank's Loan Committee.
The Company's allowance consists of two components: probable losses estimated
from individual reviews of specific loans and probable losses estimated from
historical loss rates. Also, probable losses resulting from economic or other
deterioration above and beyond what is reflected in the first two components of
the allowance are considered.
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to the Company. Included in the review of individual
loans are those that are impaired as provided in SFAS No. 114, Accounting by
Creditors for Impairment of a Loan. Any allowances for impaired loans are
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or fair value of the underlying collateral.
The Company evaluates the collectibility of both principal and interest when
assessing the need for a loss accrual. Estimated loss rates are applied to other
commercial loans not subject to specific reserve allocations Homogenous loans,
such as consumer installment and residential mortgage loans are not individually
risk graded. Rather, standard credit scoring systems are used to assess credit
risks. Reserves are established for each category of loans based on the expected
net charge-offs for one year. Loss rates are based on the average net charge-off
estimated by loan category.
12
An unallocated reserve is maintained to recognize the imprecision in estimating
and measuring loss when evaluating reserves for individual loans or categories
of loans. Allowances on individual loans and historical loss rates are reviewed
quarterly and adjusted as necessary based on changing borrower and/or collateral
conditions.
The Company's primary market area for lending is central Indiana. When
evaluating the adequacy of allowance, consideration is given to this regional
geographic concentration and the closely associated effect changing economic
conditions have on the Company's customers.
The Company has not substantively changed any aspect to its overall approach in
the determination of the allowance for loan losses. There have been no material
changes in assumptions or estimation techniques as compared to prior periods
that impacted the determination of the current period allowance.
Mortgage servicing rights
The Company recognizes the rights to service sold mortgage loans as separate
assets in the consolidated balance sheet. The total cost of loans when sold is
allocated between loans and mortgage servicing rights based on the relative fair
values of each. Mortgage servicing rights are subsequently carried at the lower
of the initial carrying value, adjusted for amortization, or fair value.
Mortgage servicing rights are evaluated for impairment based on the fair value
of those rights. Factors included in the calculation of fair value of the
mortgage servicing rights include, estimating the present value of future net
cash flows, market loan prepayment speeds for similar loans, discount rates,
servicing costs, and other economic factors. Servicing rights are amortized over
the estimated period of net servicing revenue. It is likely that these economic
factors will change over the life of the mortgage servicing rights, resulting in
different valuations of the mortgage servicing rights. The differing valuations
will affect the carrying value of the mortgage servicing rights on the
consolidated balance sheet as well as the amounts recorded in the consolidated
income statement.
Intangible assets
Management periodically assesses the impairment of its goodwill and the
recoverability of its core deposit intangible. Impairment is the condition that
exists when the carrying amount of goodwill exceeds its implied fair value. If
actual external conditions and future operating results differ from management's
judgments, impairment and/or increased amortization charges may be necessary to
reduce the carrying value of these assets to the appropriate value.
Financial Condition
Assets totaled $581.2 million at June 30, 2004, a decrease from December 31,
2003 of $10.5 million. This decline occurred in cash and interest-bearing
deposits at other banks, down $10.7 million from yearend 2003. Additionally net
loans declined by $10.4 million and investment securities available for sale
increased $9.3 million. This was the result of the securitization of $27.0
million of mortgage loans into investment securities and their transfer to the
Bank's investment portfolio offset by growth in other loan categories and
maturity of other investment securities. Excess cash was used to pay Federal
Home Loan Bank advances down $8.7 million.
Deposits totaled $317.6 million at June 30, 2004, a decrease of $4.2 million
from December 31, 2003. No major changes occurred in any deposit category from
December 31, 2003 to June 30, 2004. Federal Home Loan Bank advances decreased
$8.7 million to $176.0 million as a result of the payoff of advances utilizing
excess cash.
Shareholders' equity increased $1.3 million from December 31, 2003 to June 30,
2004. The increase was a result of net income of $1.7 million, stock options
exercised of $238,000, Employee Stock Ownership Plan shares earned of $322,000
and unearned compensation amortization of $264,000. These increases were
partially offset by cash dividends of $1.1 million and an increase in unrealized
losses on investment securities available for sale of $193,000.
13
Comparison of Operating Results for the Three Months Ended June 30, 2004 and
2003
Net income for the second quarter ended June 30, 2004 was $936,000, or $.24 for
basic and $.23 for diluted earnings per share. This compared to net income for
the comparable period in 2003 of $1,037,000, or $.27 for basic and $.26 for
diluted earnings per share. Return on assets was .64% and return on equity was
4.62% for the second quarter of 2004 compared to .75% and 5.25%, respectively,
for the same period last year.
Net interest income for the second quarter of 2004 was $3,904,000 compared to
$3,895,000 for the same period in 2003. Net interest margin was 2.79% for the
three-month period ended June 30, 2004 compared to 2.96% for the same period in
2003. The average yield on earning assets decreased .52% for the second quarter
of 2004 compared to the same period in 2003. The average cost of
interest-bearing liabilities decreased .42% from the second quarter of 2003 to
the second quarter of 2004. This decreased spread from 2.50% for the 2003 period
to 2.40% for the 2004 period, or .10%.
The Bank's provision for loan losses for the second quarter 2004 was $223,000
compared to $269,000 for the same period in 2003. Non-performing loans to total
loans at June 30, 2004 were .95% compared to .43% at December 31, 2003, while
non-performing assets to total assets were .85% at June 30, 2004 compared to
..46% at December 31, 2003. The increase in non-performing loans at June 30,
2004, was the result of loans to two large commercial real estate borrowers
being placed in nonaccrual status. In addition, the securitization of mortgage
loans discussed above removed $27.0 million of performing loans from the loan
portfolio resulting in a higher concentration of non-performing loans. The loans
to the two commercial real estate borrowers total $3.5 million and are well
secured. Only one loan in the amount of $149,000 was past due more than ninety
days. We do not anticipate a loss in principal on the loans. Additional reserves
were provided in the allowance for loan losses for the increase in
non-performing loans, however, this was partially offset by a reduction in
reserves for residential mortgages due to the securitization of mortgages
discussed above. The allowance for loan losses as a percentage of loans at June
30, 2004 was .89% compared to .80% at December 31, 2003.
Other income for the three months ended June 30, 2004 was $801,000 compared to
$1,126,000 for the same quarter of 2003. The decrease in other income was
primarily related to the decrease in net realized and unrealized gains on sale
of loans. Net realized and unrealized gains on sale of loans were $68,000, down
from $412,000 during the same period in 2003. The decrease in gain on sale of
loans was the result of selling fewer loans and at a lower price than during the
second quarter of 2004 compared to the same quarter in 2003. Proceeds from loan
sales were $4,147,000 for the second quarter of 2004 compared to $12,994,000 for
the second quarter of 2003. The decline in loan sales was a product of a decline
in refinancing activity and a policy change made in 2003 to retain certain types
of residential loan production that had previously been sold in the secondary
market. The decision to sell or retain loans is evaluated regularly depending on
the Bank's interest rate sensitivity and excess investable funds.
Other expenses were $3,221,000 for the three months ended June 30, 2004 compared
to $3,354,000 for the same three month period of 2003, a decrease of $133,000.
Income tax expense was approximately 26% of pretax income for the second quarter
of 2004 and 2003.
Comparison of Operating Results for the Six Months Ended June 30, 2004 and 2003
Net income for the six-month period ended June 30, 2004 was $1,748,000, or $.44
for basic and $.43 for diluted earnings per share. This compared to $1,940,000
or $.49 for basic and $.47 for diluted earnings per share for the same period of
2003. Return on average assets was .59% and return on average equity was 4.33%
compared to .72% and 4.87%, respectively, for same period ended June 30, 2003.
Net interest income year-to-date through June 30, 2004 was $7,933,000 compared
to $7,735,000 for the same period in 2003. Net interest margin was 2.83% through
June 30, 2004 down from 3.01% for the same six-month period one year ago. Net
interest income was down from one year age as a result of declining margins and
reduced spreads.
The provision for the first six months of 2004 was $423,000 compared to $434,000
last year for the same six-month period.
14
Other income for the six months ended June 30, 2004 was $1,472,000 compared to
$1,988,000 during the same period in 2003. The decline in other income was
primarily the result of $525,000 less net realized and unrealized gains on sale
of loans down from $663,000 during the six-month period ended June 30, 2003 to
$138,000 for the same period in 2004. As stated previously, the decrease in gain
on sale of loans was the result of selling fewer loans and at a lower price than
during 2004 compared to same period in 2003. Proceeds from loan sales were
$8,759,000 during the first six months of 2004 as compared to $21,853,000 during
the comparable 2003 period.
Other expenses for the six months ended June 30, 2004 were $6,662,000 compared
to $6,714,000 for the same period last year.
Income tax expense was approximately 25% of pretax income for the six months
ended June 30, 2004 and 2003.
Asset Quality
The Company currently classifies loans as special mention, substandard, doubtful
and loss to assist management in addressing collection risks and pursuant to
regulatory requirements. Special mention loans represent credits that have
potential weaknesses that deserve management's close attention. If left
uncorrected, these potential weaknesses may result in deterioration of the
repayment prospects or Lincoln's credit position at some future date.
Substandard loans represent credits characterized by the distinct possibility
that some loss will be sustained if deficiencies on the loans are not corrected.
Doubtful loans possess the characteristics of substandard loans, but collection
or liquidation in full is doubtful based upon existing facts, conditions and
values. A loan classified as a loss is considered uncollectible. Lincoln had
$9.7 million and $5.2 million of loans classified as special mention as of June
30, 2004 and December 31, 2003, respectively. In addition, Lincoln had $4.1
million and $2.5 million of loans classified as substandard at June 30, 2004 and
December 31, 2003, respectively. At June 30, 2004 and December 31, 2003, no
loans were classified as doubtful or loss. At June 30, 2004, and December 31,
2003, respectively, non-accrual loans were $4.0 million and $1.6 million. At
June 30, 2004 and December 31, 2003, respectively, accruing loans delinquent 90
days or more totaled $57,000 and $272,000. At June 30, 2004 and December 31,
2003, the allowance for loan losses was $3.8 million and $3.5 million,
respectively or approximately .89% and .80% of loans, including loans held for
sale, respectively.
Liquidity and Capital Resources
The Financial Regulatory Relief and Economic Efficiency Act of 2000, which was
signed into law on December 27, 2000, repealed the former statutory requirement
that all savings associations maintain an average daily balance of liquid assets
in a minimum amount of not less than 4% or more than 10% of their withdrawable
accounts plus short-term borrowings. The OTS adopted an interim final rule in
March 2001 that implemented this revised statutory requirement, although savings
associations remain subject to the OTS regulation that requires them to maintain
sufficient liquidity to ensure their safe and sound operation.
Pursuant to OTS capital regulations in effect at June 30, 2004, savings
associations were required to maintain a 1.5% tangible capital requirement, a 4%
leverage ratio (or core capital) requirement, and a total risk-based capital to
risk-weighted assets ratio of 8%. At June 30, 2004, Lincoln's capital levels
exceeded all applicable regulatory capital requirements in effect as of that
date.
Recent Development
On August 2, 2004, the Company announced the completion of the acquisition of
First Shares Bancorp, Inc., and of First Bank, as discussed in Note 4 to the
Financial Statements.
Other
The Securities and Exchange Commission maintains a Web site that contains
reports, proxy information statements, and other information regarding
registrants that file electronically with the Commission, including the Company.
The address is http://www.sec.gov.
15
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Presented below, as of March 31, 2004 and 2003, is an analysis performed by the
OTS of Lincoln's interest rate risk as measured by changes in Lincoln's net
portfolio value ("NPV") for instantaneous and sustained parallel shifts in the
yield curve, in 100 basis point increments, up 300 basis points and down 100
basis points.
March 31, 2004
--------------
Net Portfolio Value NPV as % of PV of Assets
Changes
In Rates $ Amount $ Change %Change NPV Ratio Change
-------- -------- --------- ------- --------- ------
(Dollars in thousands)
+300 bp $57,463 $(15,678) (21)% 10.08% (204) bp
+200 bp 64,278 (8,863) (12) 11.04 (107) bp
+100 bp 70,145 (2,996) (4) 11.81 (30) bp
0 bp 73,141 12.12
-100 bp 70,819 (2,322) (3) 11.61 (50) bp
March 31, 2003
--------------
Net Portfolio Value NPV as % of PV of Assets
Changes
In Rates $ Amount $ Change %Change NPV Ratio Change
-------- -------- --------- ------- --------- ------
(Dollars in thousands)
+300 bp $64,069 $(13,093) (17)% 12.17% (162) bp
+200 bp 70,557 (6,605) (9) 13.10 (69) bp
+100 bp 75,789 (1,373) (2) 13.77 (2) bp
0 bp 77,162 13.78
-100 bp 75,933 (1,229) (2) 13.38 (40) bp
Management believes at March 31, 2004 and June 30, 2004 there have been no
material changes in Lincoln's interest rate sensitive instruments which would
cause a material change in the market risk exposures which affect the
quantitative and qualitative risk disclosures as presented in Item 7A of the
Company's Annual Report on Form 10-K for the period ended December 31, 2003.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. The Company's chief
executive officer and chief financial officer, after evaluating the
effectiveness of the Company's disclosure controls and procedures (as defined in
Sections 13a-15(e) and 15d-15(e) of the regulations promulgated under the
Securities Exchange Act of 1934, as amended), as of the end of the most recent
fiscal quarter covered by this quarterly report (the "Evaluation Date"), have
concluded that as of the Evaluation Date, the Company's disclosure controls and
procedures were adequate and are designed to ensure that material information
relating to the Company would be made known to such officers by others within
the Company on a timely basis.
(b) Changes in internal controls. There were no significant changes in the
Company's internal control over financial reporting identified in connection
with the Company's evaluation of controls that occurred during the Company's
last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Although the Company and its subsidiaries are involved, from time to
time, in various legal proceedings arising in the ordinary course of
business, there are no material legal proceedings to which they are a
party or to which their property is subject.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
The Company announced a stock repurchase program on April 23, 2003,
and up to 127,963 additional shares may still be repurchased under
that program. No shares were repurchased during the quarter ended June
30, 2004. The repurchase program does not have an expiration date.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to Vote of Security Holders.
No matter was submitted to a vote of the Company's shareholders during
the second quarter of 2003.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31(1) Certification required by 17 C.F.R. Section 240.13a-14(a)
31(2) Certification required by 17 C.F.R. Section 240.13a-14(a)
32 Certification pursuant to 18 U.S.C. Section 1350, as adopted to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Lincoln Bancorp filed one Current Report on Form 8-K during the
quarter ended June 30, 2004:
(1) Date of report: April 23, 2004
Items reported: News release dated April 21, 2004 regarding the
announcement of results of operations for the
quarter ended March 31, 2004.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LINCOLN BANCORP
Date: August 16, 2004 By: /s/ T. Tim Unger
----------------------------------------
T. Tim Unger
President and Chief Executive Officer
Date: August 16, 2004 By: /s/ John M. Baer
----------------------------------------
John M. Baer
Treasurer
18