SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: O-18847
HOME FEDERAL BANCORP
(Exact name of registrant as specified in its charter)
Indiana 35-1807839
(State or other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
501 Washington Street, Columbus, Indiana 47201
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number including area code: (812) 522-1592
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
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 X NO_____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of October 25, 2004.
Common Stock, no par value - 4,027,991 shares outstanding
HOME FEDERAL BANCORP
FORM 10-Q
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Forward looking statements 8
Critical accounting policies 8
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 14
Item 4. Controls and Procedures 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 14
Item 3. Defaults Upon Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 5. Other Information 14
Item 6. Exhibits 15
Signatures 16
2
HOME FEDERAL BANCORP
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited) September 30, December 31,
2004 2003
------------ ----------------
ASSETS:
Cash $ 25,777 $ 22,734
Interest-bearing deposits 17,389 11,444
------------ ----------------
Total cash and cash equivalents 43,166 34,178
------------ ----------------
Securities available for sale at fair value (amortized cost $125,024
and $123,243) 125,290 123,638
Securities held to maturity (fair value $1,810 and $1,883) 1,781 1,828
Loans held for sale (fair value $7,454 and $6,357) 7,349 6,272
Loans receivable, net of allowance for loan losses of $8,626 and $7,506 641,165 630,672
Investments in joint ventures 4,328 5,501
Federal Home Loan Bank stock 9,965 9,965
Accrued interest receivable, net 3,716 3,733
Premises and equipment, net 15,193 14,168
Real estate owned 717 1,739
Prepaid expenses and other assets 9,133 8,880
Cash surrender value of life insurance 11,707 11,359
Goodwill 1,395 1,395
------------ ----------------
TOTAL ASSETS $ 874,905 $ 853,328
============ ================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits $ 638,705 $ 588,915
Advances from Federal Home Loan Bank 132,146 154,296
Senior debt 14,242 14,242
Other borrowings 1,459 624
Advance payments by borrowers for taxes and insurance 234 76
Accrued expenses and other liabilities 11,243 11,153
------------ ----------------
Total liabilities 798,029 769,306
------------ ----------------
Shareholders' equity:
No par preferred stock; Authorized: 2,000,000 shares
Issued and outstanding: None
No par common stock; Authorized: 15,000,000 shares
Issued and outstanding: 13,469 12,616
4,026,560 shares at September 30, 2004
4,312,805 shares at December 31, 2003
Retained earnings, restricted 63,367 71,436
Accumulated other comprehensive income, net of taxes 40 (30)
------------ ----------------
Total shareholders' equity 76,876 84,022
------------ ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 874,905 $ 853,328
============ ================
See notes to consolidated financial statements (unaudited)
3
HOME FEDERAL BANCORP
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
(unaudited) Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ----------------------------------
Interest income: 2004 2003 2004 2003
--------------- --------------- -------------- ---------------
Loans receivable $ 9,459 $ 10,175 $ 28,682 $ 31,498
Securities available for sale and held to maturity 1,034 916 3,056 2,958
Other interest income 41 69 152 304
--------------- --------------- -------------- ---------------
Total interest income 10,534 11,160 31,890 34,760
--------------- --------------- -------------- ---------------
Interest expense:
Deposits 2,701 2,910 7,993 9,411
Advances from Federal Home Loan Bank 1,880 2,316 5,944 7,073
Other borrowings 160 203 528 635
--------------- --------------- -------------- ---------------
Total interest expense 4,741 5,429 14,465 17,119
--------------- --------------- -------------- ---------------
Net interest income 5,793 5,731 17,425 17,641
Provision for loan losses 1,887 286 2,168 946
--------------- --------------- -------------- ---------------
Net interest income after provision for loan losses 3,906 5,445 15,257 16,695
--------------- --------------- -------------- ---------------
Other income:
Gain on sale of loans 435 2,538 2,057 6,889
Gain on sale of securities - - - 4
Income (loss) from joint ventures 13 (54) 128 520
Insurance, annuity income, other fees 403 447 1,395 1,280
Service fees on deposit accounts 773 691 2,160 1,996
Net gain on real estate owned and repossessed assets 88 91 223 179
Loan servicing income, net of impairments 95 437 491 304
Miscellaneous 309 304 911 989
--------------- --------------- -------------- ---------------
Total other income 2,116 4,454 7,365 12,161
--------------- --------------- -------------- ---------------
Other expenses:
Compensation and employee benefits 3,308 3,243 9,787 9,140
Occupancy and equipment 770 749 2,355 2,274
Service bureau expense 235 237 750 712
Federal insurance premium 21 24 67 73
Marketing 132 146 501 485
Miscellaneous 1,249 1,410 3,835 3,803
--------------- --------------- -------------- ---------------
Total other expenses 5,715 5,809 17,295 16,487
--------------- --------------- -------------- ---------------
Income before income taxes 307 4,090 5,327 12,369
Income tax provision (benefit) (29) 1,462 1,690 4,513
--------------- --------------- -------------- ---------------
Net Income $ 336 $ 2,628 $ 3,637 $ 7,856
=============== =============== ============== ===============
Basic earnings per common share $ 0.08 $ 0.62 $ 0.88 $ 1.85
Diluted earnings per common share $ 0.08 $ 0.59 $ 0.84 $ 1.76
Basic weighted average number of shares 4,011,229 4,242,653 4,147,099 4,254,417
Dilutive weighted average number of shares 4,138,442 4,441,024 4,305,589 4,470,121
Dividends per share $ 0.188 $ 0.188 $ 0.563 $ 0.513
See notes to consolidated financial statements (unaudited)
4
HOME FEDERAL BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Nine Months Ended
(unaudited) September 30,
----------------------------------
2004 2003
----------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,637 $ 7,856
Adjustments to reconcile net income to net cash
from operating activities:
Accretion of discounts, amortization and depreciation 1,652 1,643
Provision for loan losses 2,168 946
Net gain from sale of loans (2,057) (6,778)
Net gain from sale of investment securities - (4)
Income from joint ventures and net gain from real estate owned (351) (699)
Loan fees recognized, net (57) (4)
Proceeds from sale of loans held for sale 105,064 346,787
Origination of loans held for sale (104,084) (320,990)
Decrease in accrued interest and other assets (206) (3,222)
Increase in other liabilities 165 1,303
------------ ------------
Net cash from operating activities 5,931 26,838
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net principal received (disbursed) on loans (5,660) 6,887
Proceeds from:
Maturities/Repayments of:
Securities held to maturity 421 1,204
Securities available for sale 21,194 124,194
Sales of:
Securities available for sale 17,089 27,312
Real estate owned and other asset sales 1,332 1,676
Purchases of:
Loans (6,944) (5,951)
Securities available for sale (40,553) (163,590)
Securities held to maturity (371) -
Repayment of joint ventures 1,301 1,090
Acquisition of property and equipment (2,374) (917)
------------ ------------
Net cash from investing activities (14,565) (8,095)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits 49,790 (15,630)
Proceeds from advances from FHLB 16,500 7,000
Repayment of advances from FHLB (38,650) (20,039)
Net proceeds from overnight borrowings 835 1,434
Common stock options exercised 1,402 2,853
Repurchase of common stock (9,953) (3,574)
Payment of dividends on common stock (2,302) (2,189)
------------ ------------
Net cash from financing activities 17,622 (30,145)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 8,988 (11,402)
Cash and cash equivalents, beginning of period 34,178 53,692
------------ ------------
Cash and cash equivalents, end of period $ 43,166 $ 42,290
============ ============
Supplemental information:
Cash paid for interest $ 14,440 $ 17,132
Cash paid for income taxes $ 1,714 $ 4,430
Assets acquired through foreclosure $ 503 $ 3,166
See notes to consolidated financial statements (unaudited)
5
Notes to Consolidated Financial Statements (unaudited)
1. Basis of Presentation
The consolidated financial statements include the accounts of Home Federal
Bancorp (the "Company") and its wholly-owned subsidiaries, HomeFed Financial,
Inc. and HomeFederal Bank (the "Bank") and the Bank's wholly owned subsidiaries.
These consolidated interim financial statements at September 30, 2004, and for
the three and nine month periods ended September 30, 2004, have not been audited
by independent registered public accountants, but reflect, in the opinion of the
Company's management, all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods, including elimination of all significant
intercompany balances and transactions.
These statements should be read in conjunction with the consolidated financial
statements and related notes, which are included in the Company's Annual Report
on Form 10-K for the twelve month period ended December 31, 2003.
2. Earnings Per Share
The following is a reconciliation of the weighted average common shares for the
basic and diluted earnings per share, ("EPS") computations:
Three months ended Nine months ended
September 30, September 30,
------------------------------ ------------------------------
2004 2003 2004 2003
Basic EPS:
Weighted average common shares 4,011,229 4,242,653 4,147,099 4,254,417
============== ============= ============= =============
Diluted EPS:
Weighted average common shares 4,011,229 4,242,653 4,147,099 4,254,417
Dilutive effect of stock options 127,213 198,371 158,490 215,704
-------------- ------------- ------------- -------------
Weighted average common and
incremental shares 4,138,442 4,441,024 4,305,589 4,470,121
============== ============= ============= =============
3. Reclassifications
Some items in the financial statements of previous periods have been
reclassified to conform to the current period presentation.
4. Comprehensive Income
The following is a summary of the Company's total comprehensive income for the
interim three and nine month periods ended September 30, 2004 and 2003. (In
thousands)
Three months Nine months
ended ended
September 30, September 30,
----------------------------------------------------
2004 2003 2004 2003
------- ------- ------- -------
Net Income $ 336 $ 2,628 $ 3,637 $ 7,856
Other comprehensive income:
Unrealized holding gains (losses) from securities available for sale 1,959 (1,046) (131) (1,262)
Reclassification adjustment for (gains) losses realized in income - - - (4)
Unrealized gains (losses) from cash flow hedge 24 115 254 213
----------------------------------------------------
Net unrealized gains (losses) 1,983 (931) 123 (1,053)
Tax effect (686) 317 (53) 361
----------------------------------------------------
Other comprehensive income (loss), net of tax 1,297 (614) 70 (692)
----------------------------------------------------
Comprehensive Income $ 1,633 $ 2,014 $ 3,707 $ 7,164
====================================================
6
5. Stock Based Compensation
The Company has stock-based employee compensation plans, which are accounted for
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 those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the company had
applied the fair value recognition provisions of SFAS Statement No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation.
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
----------------------------------- ------------------------------------
(dollars in thousands, except share data) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 336 $ 2,628 $ 3,637 $ 7,856
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects (12) (148) (43) (185)
-------- -------- -------- --------
Pro forma net income $ 324 $ 2,480 $ 3,594 $ 7,671
======== ======== ========= ========
Earnings per share:
Basic---as reported $ .08 $ .62 $ .88 $ 1.85
Basic---pro forma $ .08 $ .58 $ .87 $ 1.80
Diluted---as reported $ .08 $ .59 $ .84 $ 1.76
Diluted---pro forma $ .08 $ .56 $ .83 $ 1.72
6. Segment Reporting
Management has concluded that the Company is comprised of a single operating
segment, community banking activities, and has disclosed all required
information relating to its one reportable segment. Management considers parent
company activity to represent an overhead function rather than an operating
segment. The Company operates in one geographical area and does not have a
single customer from which it derives 10 percent or more of its revenue.
7. New Accounting Pronouncements
EITF Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" provides guidance for determining when an
investment is considered impaired (when fair value is less than cost), for
evaluating whether impairment is other-than-temporary, and, if
other-than-temporary, requiring recognition of an impairment loss equal to the
difference between the investment's cost and its fair value. Generally, an
impairment is considered other-than-temporary unless: (a) the investor has the
ability and intent to hold an investment for a reasonable period of time
sufficient for a forecasted recovery of fair value up to (or beyond) the cost of
the investment; and (b) evidence indicating that the cost of the investment is
recoverable within a reasonable period of time outweighs evidence to the
contrary. The Financial Accounting Standards Board, ("FASB"), delayed the
effective date for the measurement and recognition guidance contained in
paragraphs 10 - 20 of EITF Issue 03-1 by FSP EITF Issue 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," posted September 30,
2004. The delay of the effective date for paragraphs 10-20 will be superseded
concurrent with the final issuance of proposed FSP EITF Issue 03-1-a,
"Implication Guidance for the Application of Paragraph 16 of EITF Issue No.
03-1, 'The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments." Gross unrealized losses on available for sale securities
and held to maturity securities were $436,000 and $0, respectively, at September
30, 2004. The Company is currently evaluating the impact of EITF 03-1 and FSP
EITF Issue 03-1-1 and is unable to estimate what the impact of adoption, if any,
will be.
8. Senior Debt
On September 20, 2004, with the payment of its third quarter dividend, the
Company violated a covenant in its revolving note agreement with LaSalle Bank
that restricts the declaration and payment of dividends during any year in
excess of 50% of the Company's net annual income. LaSalle Bank has waived this
covenant breach and the applicability of the covenant for the quarter ended
December 31, 2004. Management anticipates full compliance with this covenant
during 2005.
7
Part I, Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q ("Form 10-Q") contains statements that
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 below), 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, regulatory changes, changes in
the financial condition of issuers of the Company's investments and borrowers,
changes in economic condition of the Company's market area, increases in
compensation and employee expenses, or unanticipated results in pending legal
proceedings.
Home Federal Bancorp (the "Company") is organized as a financial holding company
and owns all the outstanding capital stock of HomeFederal Bank (the "Bank"). The
business of the Bank and therefore, the Company, is to provide consumer and
business banking services to certain markets in the south-central portions of
the State of Indiana. The Bank does business through 18 full service banking
branches.
CRITICAL ACCOUNTING POLICIES
The notes to the consolidated financial statements contain a summary of the
Company's significant accounting policies presented on pages 24 through 28 of
the annual report for the twelve month period ended December 31, 2003. 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, and the valuation of mortgage
servicing rights, ("MSR's").
Allowance for Loan Losses
A loan is considered impaired when it is probable the Company will be unable to
collect all contractual principal and interest payments due in accordance with
the terms of the loan agreement. Impaired loans are measured based on the loan's
observable market price or the estimated fair value of the collateral if the
loan is collateral dependent. The amount of impairment, if any, and any
subsequent changes are included in the allowance for loan losses.
The allowance for loan losses is established through a provision for loan losses
charged to operating expense. Loan losses are charged against the allowance when
management believes the loans are uncollectible. Subsequent recoveries, if any,
are credited to the allowance.
The Company maintains an allowance for loan losses to absorb probable loan
losses inherent in the portfolio. The allowance for loan losses is maintained at
a level management considers to be adequate to absorb probable loan losses
inherent in the portfolio, based on evaluations of the collectibility and
historical loss experience of loans. The allowance is based on ongoing
assessments of the probable estimated losses inherent in the loan portfolio. The
Company's methodology for assessing the appropriate allowance level consists of
several key elements, as described below.
All delinquent loans that meet regulatory requirements are included on the Asset
Watch List. The Asset Watch List is reviewed quarterly by the Asset Watch
Committee for any classification beyond the regulatory rating based on the
loans' delinquency.
Commercial and commercial real estate loans are individually risk rated per the
loan policy. Homogeneous loans such as consumer and residential mortgage loans
are not individually risk rated by management. They are risk rated based on
computer file data that management believes will provide a good basis for the
loans' quality. For all loans not listed individually on the Asset Watch List,
historical loss rates based on the last four years are the basis for developing
expected charge-offs for each pool of loans.
Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgment, reflect the impact of any
current conditions on loss recognition. Factors which management considers in
the analysis include the effects of the local economy, trends in the nature and
volume of loans (delinquencies,
8
charge-offs, nonaccrual and problem loans), changes in the internal lending
policies and credit standards, collection practices, and examination results
from bank regulatory agencies and the Company's internal credit review function.
A portion of the allowance is not allocated to any particular loan type and is
maintained in recognition of the inherent inability to precisely determine the
loss potential in any particular loan or pool of loans. Among the factors used
by management in determining the unallocated portion of the allowance are
current economic conditions; trends in the Company's loan portfolio delinquency,
losses and recoveries; level of under performing and nonperforming loans; and
concentrations of loans in any one industry.
Valuation of Mortgage Servicing Rights
The Company recognizes the rights to service mortgage loans as separate assets,
which are included in other assets in the consolidated balance sheet. The total
cost of loans when sold is allocated between loans and mortgage servicing
rights, ("MSR's"), based on the relative fair values of each. MSR's are
subsequently carried at the lower of the initial carrying value, adjusted for
amortization, or fair value. MSR's are evaluated for impairment based on the
fair value of those rights. The Company uses a present value cash flow valuation
model to establish the fair value of the MSR's. Factors included in the
calculation of fair value of the MSR's 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 MSR's, resulting in
different valuations of the MSR's. The differing valuations will affect the
carrying value of the MSR's on the balance sheet as well as the income recorded
from loan servicing in the income statement. As of September 30, 2004, MSR's had
a carrying value of $3.1 million.
RESULTS OF OPERATIONS:
Quarter Ended September 30, 2004 Compared to Quarter Ended September 30, 2003
General
The Company reported net income of $336,000 for the quarter ended September 30,
2004, compared to $2,628,000 for the quarter ended September 30, 2003, a
decrease of $2,292,000 or 87.2%. Basic earnings per common share for the current
quarter were $0.08 compared to $0.62 for the quarter ended September 30, 2003.
Diluted earnings per common share were $0.08 for the quarter ended September 30,
2004, compared to $0.59 for the quarter ended September 30, 2003.
Net Interest Income
Net interest income before provision for loan losses increased slightly by
$62,000 or 1.1% for the quarter ended September 30, 2004, compared to the
quarter ended September 30, 2003. This slight increase was due to the net effect
of an 11 basis point, (a basis point is defined as 1/100th of a percent),
increase in the net interest margin to average interest earning assets, as the
cost of funds declined more rapidly than the decline in the yields on interest
earning assets, being offset by a decrease of $21,344,000 in average interest
earning assets versus a decrease of $6,188,000 in average interest bearing
liabilities for the three month period ended September 30, 2004, compared to the
same quarter last year.
The provision for loan losses was $1,887,000 for the quarter ended September 30,
2004, an increase of $1,601,000, compared to the quarter ended September 30,
2003. At September 30, 2004, the loan loss allowance covered 57.6% of
non-performing loans. The increase in the loan loss provision is primarily
attributable to two large commercial loans that are discussed in the asset
quality section. See the Critical Accounting Policies, Allowance for Loan Losses
section for a description of the systematic analysis the Bank uses to determine
its allowance for loan losses.
The change to the loan loss allowance for the three month period ended September
30, 2004 and 2003 is as follows:
Quarter ended September 30: (in thousands) 2004 2003
------------------------------------------ ---- ----
Allowance beginning balance $ 7,583 $ 7,284
Provision for loan losses 1,887 286
Charge-offs (900) (229)
Recoveries 56 20
-------- --------
Loan Loss Allowance ending balance $ 8,626 $ 7,361
======== =========
Allowance to Total Loans 1.31% 1.14%
Allowance to Nonperforming Assets 55% 116%
9
Net interest income after provision for loan loss decreased $1,539,000 or 28.3%
for the three month period ended September 30, 2004, compared to the three
months ended September 30, 2003.
Interest Income
Total interest income for the three month period ended September 30, 2004,
decreased $626,000, or 5.6%, over the same period of the prior year. This
decrease is primarily the result of a $21,344,000 decrease in average interest
earning assets as well as a 17 basis point decrease in the weighted average
interest rate earned on average interest earning assets for the quarter ended
September 30, 2004, as compared to the quarter ended September 30, 2003.
Interest Expense
Total interest expense for the three month period ended September 30, 2004,
decreased $688,000, or 12.7%, as compared to the same period a year ago. The
factors that caused the decrease in interest expense mirrors the same two
factors for the decrease in interest income. The interest rate paid on average
interest bearing liabilities declined 32 basis points in the quarter ended
September 30, 2004, as compared to the quarter ended September 30, 2003, and the
balance of average interest bearing liabilities declined $6,188,000 over the
same two periods.
Other Income
Total other income for the three-month period ended September 30, 2004,
decreased $2,338,000 or 52.5% over the same period a year ago. This decrease was
primarily the result of a decrease of $2,103,000 from the gain on sale of loans.
For the three-month period ended September 30, 2003, the Bank originated
approximately $392,034,000 in residential loans, compared to $166,719,000 for
the three-month period ended September 30, 2004. In the third quarter of 2003
the Bank sold approximately $119,163,000 of the loans originated versus
$21,580,000 in the third quarter of 2004. The difference in loan activity for
these two periods was the result of the low interest rate environment in 2003
and the high volumes of mortgage loan refinance activity.
Another factor that decreased other income is the $342,000 decrease in loan
servicing income, net of impairments for the three months ended September 30,
2004, compared to September 30, 2003. The originated mortgage servicing rights
asset is reviewed for impairment each quarter. This asset is created when
mortgage loans are sold and the Bank retains the servicing rights. The servicing
rights are recognized as income at the time the loan is sold and the servicing
asset is also recorded. The asset is then amortized as an expense to mortgage
servicing income over the life of the loan. The impairment charge is the
recognition of the change in value of mortgage servicing rights that result with
changes in interest rates and loan prepayment speeds. Mortgage servicing
portfolios typically decline in value as interest rates drop and increase in
value as rates rise. The reason for this decline in value is as rates drop,
prepayment speeds increase causing the average life of the servicing portfolio
to shorten. This reduces the amount of servicing income the Bank receives over
time and thus reduces the value of the servicing portfolio. If rates rise the
opposite occurs, prepayments slow, the average life of the mortgage servicing
portfolio lengthens, increasing the amount of servicing income the Bank receives
over time thus increasing the value of the servicing portfolio. In the
three-month period ended September 30, 2004, the impairment charge was $38,000
compared to the same period ending September 30, 2003 where the impairment
recovery was $260,000 for a decrease in pre-tax income of $298,000. The
amortization charge in the current three-month period was $389,000 compared to
$364,000 for the same period a year ago.
Other Expenses
Other expenses for the three month period ended September 30, 2004, decreased
$94,000, or 1.6% over the three month period ended September 30, 2003. This
decrease was the net result of two primary factors including a $65,000 increase
in compensation expenses. The increase was primarily the result of increases
totaling $315,000 from personnel increases, including the staffing of the
Greenwood branch, which opened in December of 2003, salary increases, retirement
costs, and a reduction in deferred salary costs in accordance with Financial
Accounting Standard, ("FAS"), 91, offset by a $250,000 decrease in the bonus
expense. The current period does not have any bonus expense compared to the
three month period ended September 30, 2003, which had a $250,000 accrual for
bonus expense. Offsetting this net increase in compensation and employee
benefits was a decrease of $161,000 in miscellaneous expenses. Decreases of
$84,000 in real estate owned expenses and $121,000 in loan related expenses were
offset by increases of $78,000 in consulting expenses related primarily to
compliance with the Sarbanes-Oxley Act of 2002. Other small changes in various
categories resulted in the remaining difference in miscellaneous expenses.
Taxes
The Company recorded a $29,000 income tax benefit during the quarter ended
September 30, 2004, which reflects the Company's revised estimate of its
anticipated federal and state effective tax rate of 31% for 2004.
10
Nine months Ended September 30, 2004 Compared to Nine months Ended September 30,
2003:
General
The Company reported net income of $3,637,000, or $.84 diluted earnings per
share, for the nine months ended September 30, 2004, compared to $7,856,000, or
$1.76 diluted earnings per share, for the same period a year ago, a decrease of
$4,219,000 or a 52.3% decrease in earnings per dilutive common share.
Net Interest Income
Net interest income before provision for loan losses decreased $216,000 or 1.2%
for the nine month period ended September 30, 2004, compared to the same period
ended September 30, 2003. This decrease was due to the net effect of an 4 basis
point increase in the net interest margin to average interest earning assets, as
the cost of funds declined more rapidly than the decline in the yields on
interest earning assets, being offset by a decrease of $20,572,000 in average
interest earning assets versus a decrease of $15,192,000 in average interest
bearing liabilities for the nine month period ended September 30, 2004, compared
to the same period last year.
The provision for loan losses was $2,168,000 for the nine months ended September
30, 2004, an increase of $1,222,000, compared to the nine months ended September
30, 2003. As mentioned in the quarterly comparison the increase in the loan loss
provision is primarily attributable to two large commercial loans that are
discussed in the asset quality section.
The change to the loan loss allowance for the nine month period ended September
30, 2004 is as follows:
Nine months ended September 30: (in thousands) 2004 2003
- ---------------------------------------------- ---- ----
Allowance beginning balance $ 7,506 $ 7,172
Provision for loan losses 2,168 946
Charge-offs (1,145) (882)
Recoveries 97 125
-------- --------
Loan Loss Allowance $ 8,626 $ 7,361
======== =========
Allowance to Total Loans 1.31% 1.14%
Allowance to Nonperforming Assets 55% 116%
Interest Income
Total interest income for the nine month period ended September 30, 2004,
decreased $2,870,000, compared to the nine month period ended September 30,
2003. The nine month period decrease was due to a decrease of $20,572,000 in
average interest earning assets and a 34 basis point decrease in the weighted
average yield earned on those assets.
Interest Expense
Total interest expense for the nine month period ended September 30, 2004,
decreased $2,654,000, compared to the nine month period ended September 30,
2003. Similar to the decrease in interest income, the decrease in interest
expense was due to a 41 basis point decrease in the weighted average cost of
funds for the nine month period ended September 30, 2004, as compared to the
same period ended September 30, 2003, as well as a $15,192,000 decrease in
average interest bearing liabilities.
Other Income
Total other income for the nine month period ended September 30, 2004, decreased
$4,796,000 or 39.4% as compared to the same period one year ago. This decrease
was primarily the result of a decrease in gain on sale of loans of $4,832,000 as
discussed in the third quarter results above. Another factor decreasing other
income for the nine months ended September 30, 2004, was a $392,000 decrease in
the income from joint ventures. The primary reason for the decrease was the
result of a large real estate sale by a joint venture in the nine months ended
September 30, 2003, which produced $480,000 of income in the prior year. In the
current nine month period ended September 30, 2004, the same joint venture
produced $37,000 of income.
A factor that increased other income was a $187,000 increase in loan servicing
income. For the nine month period ended September 30, 2004, the amortization
charge on originated mortgage servicing rights increased $174,000 due to the
increased size of the mortgage servicing rights asset. Offsetting this expense
was a $80,000 recovery of impairment charges in the nine month period ended
September 30, 2004, compared to a $240,000 impairment
11
charge for the period ended September 30, 2003, for an increase in pre-tax
income of $320,000. Two other factors which increased other income include a
$164,000 increase in service fees on deposit accounts due to increased deposits
and a $115,000 increase in insurance, annuity income and other fees that is
primarily the result of increased brokerage fees of $132,000 in the nine months
ended September 30, 2004, compared to the nine months ended September 30, 2003.
Other Expenses
Total other expenses for the nine month period ended September 30, 2004,
increased $808,000 or 4.9%. This increase is primarily the result of a $647,000
increase in compensation and employee benefits and as well as a $81,000 increase
in occupancy and equipment expenses. The increase in compensation and employee
benefits for the nine month period ended September 30, 2004, was primarily the
result of increases totaling $1,101,000 from personnel increases, including the
staffing of the Greenwood branch, which opened in December of 2003, salary
increases, retirement costs and a reduction in deferred salary costs in
accordance with FAS 91, offset by a $455,000 decrease in the bonus expense. The
current period does not have any bonus expense compared to the nine month period
ended September 30, 2003, which had a $455,000 accrual for bonus expense. The
increase in occupancy expense is the result of expenses associated with the new
Greenwood branch, which opened in December of 2003, and additional software
expenses related to compliance and security projects.
Taxes
The Company's estimated effective federal and state income tax rate is 31% for
the nine months ended September 30, 2004, compared to 36% for the nine months
ended September 30, 2003. The decline in the Company's effective income tax rate
results from the reduction in net income for the comparable periods.
Asset Quality
Non-performing assets to total assets increased to 1.80% at September 30, 2004,
compared to 0.73% at September 30, 2003. Non-performing loans to total gross
loans increased to 2.28% from 0.63%, respectively, for the same periods. This
increase in non-performing assets is primarily attributable to the two large
commercial loans discussed below.
In February of 1999 the Bank, through a loan participation with another
commercial bank (the "Lead Bank"), agreed to purchase up to $2.5 million of a
$4.0 million line of credit to floor plan new cars for a car dealership. The
loan is secured by vehicles, a second mortgage on real estate, and two
individual guarantors for up to 15% each on the loan balance. In addition, other
items of collateral are cross-collateralized with other loans advanced by the
Lead Bank and might provide some recovery. At the end of the current quarter the
Lead Bank notified the Bank that the dealership was in material breach of the
loan covenants and that there was not sufficient vehicle collateral to cover the
outstanding balance of the loan. The Bank's share of the outstanding loan
balance at September 30, 2004, was $2.5 million.
After meeting with the Lead Bank and representatives of the dealership, and
review of the collateral including guarantees discussed above, it is estimated
by management that the loss could be approximately $1,225,000. Management
charged off $500,000 of that amount and has set aside specific reserves of
$725,000 for the remaining $2,000,000 balance outstanding at September 30, 2004.
The total charge to the provision for loan losses in the current quarter for
this loan is $1,225,000. The Bank intends to pursue several possible courses of
action to mitigate the ultimate losses on this loan. However, it is currently
too early to determine if any of these actions will be successful.
As was previously announced, one of the Bank's commercial borrowers ("the
Borrower") filed for Chapter 11 Bankruptcy protection on June 15, 2004. Total
loans outstanding with the Borrower at June 30, 2004 were $15,798,000, of which
$9,178,000 is sold to other loan participants leaving a net loan balance of
$6,620,000 outstanding. These loans are secured by first mortgages on multiple
properties located in Indiana, Illinois, Kentucky and Ohio. These loans have
been classified as substandard and approximately $1,194,000 has been set aside
as specific reserves for these loans. Of the $1,194,000 in specific reserves,
$200,000 has been charged to the provision for loan losses in the current
period. The Borrower is in the process of liquidating the business through an
auction process of the properties under the supervision of the bankruptcy court.
Preliminary bids indicate there will be a loss on this loan. However, management
currently believes the remaining $1,194,000 specific reserve is adequate to
cover potential losses.
The ultimate amount of the impairment, for both of these loans, and the actual
losses to the Bank, may be higher or lower depending on the value of the
collateral ultimately realized. The Bank may be required to make additional
provisions with respect to these loans if the actual value of the collateral is
less than presently estimated. The Bank may recognize a recovery of the
provision if the actual value is higher than anticipated.
12
FINANCIAL CONDITION:
Total assets as of September 30, 2004, were $874,905,000, which was an increase
of $21,577,000 from December 31, 2003, total assets of $853,328,000. Changes
within the various balance sheet categories included a $49,790,000 increase in
deposits and an $8,988,000 increase in cash and cash equivalents. The funds from
deposits were used to pay off $22,150,000 of FHLB advances, fund $10,493,000 of
loan growth and repurchase $9,953,000 of company stock.
Shareholders' equity decreased $7,146,000 during the same period. Retained
earnings increased $3,637,000 from net income and decreased $2,302,000 for
dividends paid and $9,404,000 from stock buy backs. Common stock increased
$1,277,000 from the exercise of common stock options and $125,000 from the
related tax benefit of disqualifying dispositions of such options. Common stock
decreased $549,000 from stock buy backs. The Company had a decrease from
$260,000 in unrealized gains in its securities available for sale portfolio, net
of tax, to $177,000 unrealized gains over the nine month period ended September
30, 2004. This decrease in unrealized gains resulted in $83,000 of other
comprehensive losses, net of tax, for the nine months ended September 30, 2004.
Additionally, the Company had other comprehensive gain, net of tax, from the
change in fair value of a cash flow hedge of $153,000 for the same nine month
period.
At September 30, 2004, the Company and the Bank exceeded all current applicable
regulatory capital requirements as follows:
As of September 30, 2004
(Dollars in Thousands)
To be "Well-
Capitalized" under
Minimum Prompt Corrective
Actual Requirements Action Provisions
------ ------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Consolidated
Tier I Capital to Risk-
Weighted Assets $75,795 11.04% $27,473 4.00% $41,209 6.00%
Total Risk-Based Capital to
Risk-Weighted Assets $84,370 12.28% $54,945 8.00% $68,681 10.00%
Tier I Leverage Ratio $75,795 8.76% $34,594 4.00% $43,242 5.00%
HomeFederal Bank
Tier I Capital to Risk-
Weighted Assets $84,074 12.26% $27,438 4.00% $41,157 6.00%
Total Risk-Based capital to
Risk-Weighted Assets $92,649 13.51% $54,876 8.00% $68,596 10.00%
Tier I Leverage Ratio $84,074 9.76% $34,460 4.00% $43,074 5.00%
EITF Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" provides guidance for determining when an
investment is considered impaired (when fair value is less than cost), for
evaluating whether impairment is other-than-temporary, and, if
other-than-temporary, requiring recognition of an impairment loss equal to the
difference between the investment's cost and its fair value. Generally, an
impairment is considered other-than-temporary unless: (a) the investor has the
ability and intent to hold an investment for a reasonable period of time
sufficient for a forecasted recovery of fair value up to (or beyond) the cost of
the investment; and (b) evidence indicating that the cost of the investment is
recoverable within a reasonable period of time outweighs evidence to the
contrary. The Financial Accounting Standards Board, ("FASB"), delayed the
effective date for the measurement and recognition guidance contained in
paragraphs 10 - 20 of EITF Issue 03-1 by FSP EITF Issue 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," posted September 30,
2004. The delay of the effective date for paragraphs 10-20 will be superseded
concurrent with the final issuance of proposed FSP EITF Issue 03-1-a,
"Implication Guidance for the Application of Paragraph 16 of EITF Issue No.
03-1, 'The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments." Gross unrealized losses on available for sale securities
and held to maturity securities were $436,000 and $0, respectively, at September
30, 2004. The Company is currently evaluating the impact of EITF 03-1 and FSP
EITF Issue 03-1-1 and is unable to estimate what the impact of adoption, if any,
will be.
13
Liquidity and Capital Resources
Historically, the Bank has maintained its liquid assets at a level believed
adequate to meet requirements of normal daily activities, repayment of maturing
debt and potential deposit outflows. Cash flow projections are regularly
reviewed and updated to assure that adequate liquidity is maintained. Cash for
these purposes is generated through the sale or maturity of investment
securities and loan sales and repayments, and may be generated through increases
in deposits. Loan payments are a relatively stable source of funds, while
deposit flows are influenced significantly by the level of interest rates and
general money market conditions. Borrowings may be used to compensate for
reductions in other sources of funds such as deposits. As a member of the
Federal Home Loan Bank ("FHLB") system, the Bank may borrow from the FHLB of
Indianapolis. At September 30, 2004, the Bank had $132,146,000 in such
borrowings. In addition, at September 30, 2004, the Bank had commitments to
purchase loans of $4,537,000, fund loan originations of $24,800,000, unused home
equity lines of credit of $63,878,000 and unused commercial lines of credit of
$39,197,000, as well as commitments to sell loans of $11,250,000. Generally, a
significant portion of amounts available in lines of credit will not be drawn.
In the opinion of management, the Bank has sufficient cash flow and borrowing
capacity to meet current and anticipated funding commitments.
On September 20, 2004, with the payment of its third quarter dividend, the
Company violated a covenant in its revolving note agreement with LaSalle Bank
that restricts the declaration and payment of dividends during any year in
excess of 50% of the Company's net annual income. LaSalle Bank has waived this
covenant breach and the applicability of the covenant for the quarter ended
December 31, 2004. Management anticipates full compliance with this covenant
during 2005.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
In the opinion of management the interest rate sensitivity results for the
quarter ended September 30, 2004, is not materially different from the results
presented on page 14 of the annual report for the twelve month period ended
December 31, 2003, which is incorporated by reference herein.
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 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.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
N/A
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
N/A
Item 3. Defaults Upon Senior Securities
N/A
Item 4. Submission of Matters to a Vote of Security Holders
N/A
Item 5. Other information
N/A
14
Item 6. Exhibits
(a) Exhibits
31(1) Certification required by 12 C.F.R. 240.13a-14(a).
31(2) Certification required by 12 C.F.R. 240.13a-14(a).
32 Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbances-Oxley Act of 2002.
15
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 behalf of
the undersigned thereto duly authorized.
Home Federal Bancorp
DATE: November 3, 2004 /s/ Lawrence E. Welker
---------------------------------------------
Lawrence E. Welker, Executive Vice President,
Treasurer, and Chief Financial Officer
16