UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 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 as specified in its charter)
INDIANA 35-2055553
(State or other Jurisdiction (I.R.S. Employer Identification
of Incorporation or Organization) Number)
1121 E. Main Street, Plainfield, Indiana 46168
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number including area code:
(317) 839-6539
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, without par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405,
Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES ___ NO _X_
The aggregate market value of the Registrant's voting stock held by
non-affiliates, as of June 30, 2004, was $58,958,000.
The number of shares of the Registrant's Common Stock, without par value,
outstanding as of March 1, 2005, was 5,396,403 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the year ended December 31,
2004, are incorporated into Part II. Portions of the Proxy Statement for the
2005 Annual Meeting of Shareholders are incorporated in Part I and Part III.
Exhibit Index on Page E-1
Page 1 of 41 pages
LINCOLN BANCORP
Form 10-K
INDEX
Page
----
FORWARD LOOKING STATEMENT 3
PART I
Item 1. Business 3
Item 2. Properties 33
Item 3. Legal Proceedings 35
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 4.5. Executive Officers of the Registrant 35
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 36
Item 6. Selected Financial Data 36
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation 36
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 36
Item 8. Financial Statements and Supplementary Data 36
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 36
Item 9A. Controls and Procedures 36
Item 9B. Other Information. 37
PART III
Item 10. Directors and Executive Officers of the Registrant 37
Item 11. Executive Compensation 37
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 38
Item 13. Certain Relationships and Related Transactions 38
Item 14. Principal Accountant Fees and Services 38
PART IV
Item 15. Exhibits and Financial Statement Schedules 39
SIGNATURES 40
EXHIBITS E-1
2
FORWARD LOOKING STATEMENT
This Annual Report on Form 10-K ("Form 10-K") 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-K and include statements regarding the intent, belief,
outlook, estimate or expectations of the Holding Company (as defined below), or
its directors or officers primarily with respect to future events and the future
financial performance of the Holding Company. Readers of this Form 10-K 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-K identifies important factors that could cause such differences. These
factors include changes in interest rates; loss of deposits and loan demand to
other savings and financial institutions; substantial changes in financial
markets; changes in real estate values and the real estate market; regulatory
changes; or unanticipated results in pending legal proceedings.
Item 1. Business
General
Lincoln Bancorp (the "Holding Company") is an Indiana corporation organized
in September 1998 to become a savings and loan holding company upon its
acquisition of all the issued and outstanding capital stock of Lincoln Federal
Savings Bank, which was renamed Lincoln Bank on September 1, 2003 ("Lincoln
Bank" or the "Bank" and together with the Holding Company, the "Company"), in
connection with the Bank's conversion from mutual to stock form. The Holding
Company became the Bank's holding company on December 30, 1998. The principal
asset of the Holding Company currently consists of 100% of the issued and
outstanding shares of capital stock, $.01 par value per share, of the Bank.
Lincoln Bank was originally organized in 1884 as Ladoga Federal Savings and Loan
Association ("Ladoga Federal"), 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, changed its name to
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"), an Indiana corporation and wholly-owned
subsidiary of Citizens Savings, continues as a subsidiary of the Bank. On August
2, 2004, the Holding Company completed the acquisition of First Shares Bancorp,
Inc. ("First Shares") and its wholly-owned subsidiary First Bank, an Indiana
commercial bank ("First Bank"). First Shares was merged into the Holding Company
and First Bank was merged into Lincoln Bank. At December 31, 2004, Lincoln Bank
conducted its business from 16 full service offices located in Hendricks,
Montgomery, Clinton, Johnson, Brown and Morgan Counties, Indiana, with its main
office located in Plainfield. 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 and commercial property. Lincoln Bank's
deposit accounts are insured up to applicable limits required by the SAIF of the
FDIC.
Lincoln Bank offers a number of financial services, including: (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,
recreational vehicles and automobile loans; (vii) commercial loans; (viii) money
market demand accounts ("MMDAs"); (ix) savings accounts; (x) checking accounts;
(xi) NOW accounts; (xii) certificates of deposit; and (xiii) financial planning.
3
Lending Activities
The Bank has historically concentrated its lending activities on the
origination of loans secured by first mortgage liens for the purchase,
construction or refinancing of one- to four-family residential real property and
commercial real estate. One- to four-family residential mortgage loans continue
to be a major focus of Lincoln Bank's loan origination activities, representing
32.0% of its total loan portfolio at December 31, 2004. Commercial real estate
loans totaled approximately 24.7% of the Bank's total loan portfolio, and real
estate construction loans totaled approximately 9.0% of Lincoln Bank's total
loans as of December 31, 2004. Commercial loans were 12.1% of the loan portfolio
while consumer loans were 18.5% of the loan portfolio at December 31, 2004.
Lincoln Bank also offers commercial real estate loans, real estate construction
loans, commercial and consumer loans. To a lesser extent, Lincoln Bank also
offers multi-family loans and land loans.
Loan Portfolio Data. The following table sets forth the composition of
Lincoln Bank's loan portfolio (including loans held for sale) by loan type and
security type as of the dates indicated, including a reconciliation of gross
loans receivable after consideration of the allowance for loan losses, deferred
loan fees and loans in process.
At December 31,
-----------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------- ----------------- ----------------- ----------------- ----------------
Percent Percent Percent Percent Percent
of of of of of
Amount Total Amount Total Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
TYPE OF LOAN
Real estate mortgage loans:
One-to-four-family residential $187,040 32.04% $215,754 47.27% $168,054 44.59% $214,902 59.12% $231,157 68.44%
Multi-family 5,797 0.99 5,301 1.16 5,553 1.47 5,795 1.59 2,606 .77
Commercial real estate 144,288 24.72 96,079 21.05 80,753 21.43 52,176 14.35 31,784 9.41
Construction 52,630 9.02 50,580 11.08 50,147 13.30 26,681 7.34 24,843 7.36
Land 15,016 2.57 6,518 1.43 6,103 1.62 5,367 1.48 4,692 1.39
Commercial 70,810 12.13 37,081 8.12 22,382 5.94 9,614 2.65 2,796 .83
Consumer loans:
Home equity and second mortgages 59,835 10.25 38,747 8.49 35,234 9.35 37,724 10.38 32,572 9.64
Other 48,367 8.28 6,374 1.40 8,655 2.30 11,227 3.09 7,287 2.16
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Gross loans receivable $583,783 100.00% $456,434 100.00% $376,881 100.00% $363,486 100.00% $337,737 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
TYPE OF SECURITY
One-to-four-family
residential real estate $274,647 47.05% $284,194 62.26% $228,429 60.61% $266,682 73.37% $278,379 82.43%
Multi-family real estate 5,797 0.99 5,301 1.16 5,553 1.47 5,795 1.59 2,606 .77
Commercial real estate 169,145 28.98 116,967 25.63 105,758 28.06 64,801 17.83 41,977 12.43
Land 15,016 2.57 6,518 1.43 6,103 1.62 5,367 1.48 4,692 1.39
Deposits 1,044 0.18 499 0.11 415 0.11 427 .12 856 .25
Auto 15,313 2.62 4,666 1.02 6,997 1.86 9,614 2.64 5,303 1.57
Other security 101,647 17.41 37,987 8.32 23,247 6.17 10,317 2.84 3,349 .99
Unsecured 1,174 0.20 302 0.07 379 0.10 483 .13 575 .17
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Gross loans receivable 583,783 100.00 456,434 100.00 376,881 100.00 363,486 100.00 337,737 100.00
Deduct:
Allowance for loan losses 5,701 0.98 3,532 0.77 2,932 0.78 2,648 .73 2,367 .70
Deferred loan fees (1,543) (0.26) (213) (0.05) (63) (0.02) 515 .14 936 .28
Loans in process 12,442 2.13 15,088 3.31 17,744 4.71 5,307 1.46 8,243 2.44
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Net loans receivable $567,183 97.15% $438,027 95.97% $356,268 94.53% $355,016 97.67% $326,191 96.58%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
Mortgage Loans:
Adjustable-rate $263,891 56.80% $281,111 68.07% $120,205 34.76% $103,234 30.13% $119,445 36.45%
Fixed-rate 200,714 43.20 131,869 31.93 225,638 65.24 239,411 69.87 208,209 63.55
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total $464,605 100.00% $412,980 100.00% $345,843 100.00% $342,645 100.00% $327,654 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
The following table sets forth certain information at December 31, 2004,
regarding the dollar amount of loans maturing in Lincoln Bank's loan portfolio
based on the contractual terms to maturity. Demand loans having no stated
schedule of repayments and no stated maturity and overdrafts are reported as due
in one year or less. This schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses. Management expects
prepayments will cause actual maturities to be shorter.
4
Due During Years Ended December 31,
Balance -------------------------------------------------------------------------------------
Outstanding at 2008 2010 2015 2020
December 31, to to to and
2004 2005 2006 2007 2009 2014 2019 following
-------------- -------- ------- ------ ------ ------ ------ ---------
(In thousands)
Real estate mortgage loans:
One- to four-family
residential loans. $187,040 $ 359 $ 364 $ 597 $ 2,057 $ 22,923 $ 55,040 $105,700
Multi-family loans 5,797 -- -- 571 1,616 2,694 781 135
Commercial real estate loans 144,288 15,548 10,579 8,638 25,459 32,804 23,273 27,987
Construction loans 52,630 43,469 6,205 2,812 144 -- -- --
Land loans 15,016 6,593 1,774 4,334 419 408 1,488 --
Commercial loans 70,810 40,235 3,803 5,077 8,817 8,414 2,443 2,021
Consumer loans:
Installment loans 47,323 2,650 1,443 4,017 9,617 11,409 16,915 1,272
Loans secured by deposits 1,044 453 321 115 155 -- -- --
Home equity loans and
second mortgages 59,835 2,711 753 770 2,768 48,038 3,526 1,269
-------- -------- ------- ------- ------- -------- -------- --------
Total consumer loans 108,202 5,814 2,517 4,902 12,540 59,447 20,441 2,541
-------- -------- ------- ------- ------- -------- -------- --------
Total $583,783 $112,018 $25,242 $26,931 $51,052 $126,690 $103,466 $138,384
======== ======== ======= ======= ======= ======== ======== ========
The following table sets forth, as of December 31, 2004, the dollar amount
of all loans due after one year that have fixed interest rates and floating or
adjustable interest rates.
Due After December 31, 2005
-------------------------------------
Fixed Rates Variable Rates Total
----------- -------------- -------
(In thousands)
Real estate mortgage loans:
One- to four-family residential loans $136,749 $ 49,932 $186,681
Multi-family loans 2,958 2,839 5,797
Commercial real estate loans 61,810 66,930 128,740
Construction loans 9,161 -- 9,161
Land loans 8,423 -- 8,423
Commercial loans -- 30,575 30,575
Consumer loans:
Installment loans 44,673 -- 44,673
Loans secured by deposits 591 -- 591
Home equity loans and second mortgages 13,194 43,930 57,124
-------- -------- --------
Total Consumer Loans 58,458 43,930 102,388
-------- -------- --------
Total Loans $277,559 $194,206 $471,765
======== ======== ========
One- to Four-Family Residential Loans. Lincoln Bank's primary lending
activity consists of the origination of one- to four-family residential mortgage
loans secured by property located in its primary market area. Lincoln Bank
generally does not originate one- to four-family residential mortgage loans if
the ratio of the loan amount to the lesser of the current cost or appraised
value of the property (the "Loan-to-Value Ratio") exceeds 90%. Lincoln Bank
requires private mortgage insurance on loans with a Loan-to-Value Ratio in
excess of 80%. The cost of such insurance is factored into the annual percentage
rate on such loans.
Lincoln Bank's underwriting criteria for one- to four-family residential
loans include the value of the underlying collateral, such as the income,
debt-to-income ratio, stability of earnings and past credit history of a
potential borrower, in making credit decisions. These underwriting criteria are
based upon FHLMC lending guidelines. The Bank originates fixed-rate loans which
provide for the payment of principal and interest over a period of up to 30
years.
5
Lincoln Bank also offers adjustable-rate mortgage ("ARM") loans pegged to
the one-, three- and five-year U.S. Treasury securities yield adjusted to a
constant maturity. Lincoln Bank may offer discounted initial interest rates on
ARM loans, but requires that the borrower qualify for the loan at the
fully-indexed rate (the index rate plus the margin). A substantial portion of
the ARM loans in the Bank's portfolio at December 31, 2004 provide for maximum
rate adjustments per year and over the life of the loan of 2% and 6%,
respectively. Lincoln Bank's residential ARM loans are amortized over terms up
to 30 years.
Lincoln Bank occasionally makes certain fixed-rate one- to four-family
residential loans with the intent of pooling these loans into FHLMC
mortgage-backed securities. During 2004 Lincoln Bank securitized $25.8 million
of residential loans. No loans were securitized during 2003. During 2002 Lincoln
Bank securitized $18.2 million of residential loans. At December 31, 2004,
Lincoln Bank continued to hold in its investment portfolio approximately $30.9
million (amortized cost) of these securities that are backed by higher-yielding,
fixed-rate mortgage loans that it originated.
Lincoln Bank determines when it originates a one- to four-family
residential loan whether it intends to hold the loan until maturity or sell it
in the secondary market. Lincoln Bank generally sells on the secondary market
all of the fixed-rate loans that it originates with terms more than 15 years
that are written to FHLMC standards, and retains in its loan portfolio any loans
that it originates that are not written to FHLMC standards. During the fourth
quarter of 2002, the Bank amended its policy and stopped selling fixed-rate
loans with maturity of 15 years or less. During the first and second quarter of
2003, the Bank retained some of the residential real estate loan volume with
maturities greater than 15 years. This was in response to the severe decline in
residential loans in the Bank's loan portfolio due to customer refinancing.
During the third and fourth quarters of 2004, the Bank sold the majority of all
fixed and variable rate real estate loans. Lincoln Bank retained the servicing
rights on nearly all the loans that it sold prior to the acquisition of First
Bank in August 2004. Currently, the majority of loan production is sold with
servicing released. Customers are given an option to have local servicing, but
at a slightly higher note rate.
ARM loans decrease the risk associated with changes in interest rates by
periodically repricing, but involve other risks because, as interest rates
increase, the underlying payments by the borrower also increase, thus increasing
the potential for default by the borrower. At the same time, the marketability
of the underlying collateral may be adversely affected by higher interest rates.
Upward adjustments of the contractual interest rate are also limited by the
maximum periodic and lifetime interest rate adjustment permitted by the loan
documents, and, therefore, is potentially limited in effectiveness during
periods of rapidly rising interest rates. At December 31, 2004, approximately
26.8% of Lincoln Bank's one- to four-family residential loans had adjustable
rates of interest.
All of the one- to four-family residential mortgage loans that Lincoln Bank
originates include "due-on-sale" clauses, which give Lincoln Bank the right to
declare a loan immediately due and payable in the event that, among other
things, the borrower sells or otherwise disposes of the real property subject to
the mortgage and the loan is not repaid. However, Lincoln Bank occasionally
permits assumptions of existing residential mortgage loans on a case-by-case
basis.
At December 31, 2004, approximately $187.0 million, or 32.0% of Lincoln
Bank's portfolio of loans, consisted of one- to four-family residential loans.
Approximately $1.4 million, or 0.7% of total residential loans, were included in
non-performing assets as of that date.
Commercial Real Estate and Multi-Family Loans. Lincoln Bank's commercial
real estate loans are secured by churches, warehouses, office buildings, hotels
and other commercial properties. Lincoln Bank generally issues commercial real
estate loans as five-year balloon loans amortized over a 15- or 20-year period,
with a fixed interest rate indexed primarily to a spread utilizing the five-year
swap rate. At December 31, 2004 Lincoln Bank had $54.4 million in outstanding
balloon loans secured by commercial and multi-family real estate. Lincoln Bank
generally requires a Loan-to-Value Ratio of at least 80% on commercial real
estate
6
loans, although it may make loans with a higher Loan-to-Value Ratio on loans
secured by owner-occupied commercial real estate or by multi-family residential
properties.
Commercial real estate loans generally are larger than one- to four-family
residential loans and involve a greater degree of risk. Commercial real estate
loans often involve large loan balances to single borrowers or groups of related
borrowers. Payments on these loans depend to a large degree on results of
operations and management of the properties and may be affected to a greater
extent by adverse conditions in the real estate market or the economy in
general. Accordingly, the nature of the loans makes them more difficult for
management to monitor and evaluate. In addition, balloon loans may involve a
greater degree of risk to the extent the borrower is unable to obtain financing
or cannot repay the loan when the loan matures and the balloon payment is due.
At December 31, 2004, Lincoln Bank's largest commercial real estate
borrower had a single loan outstanding in the amount of $3.9 million which was
secured by a hotel located in West Lafayette, Indiana. At December 31, 2004,
approximately $144.3 million, or 24.7% of Lincoln Bank's total loan portfolio,
consisted of commercial real estate loans. On the same date, there were $2.9
million in commercial real estate loans included in non-performing assets.
At December 31, 2004, approximately $5.8 million, or 1.0% of Lincoln Bank's
total loan portfolio, consisted of mortgage loans secured by multi-family
dwellings (those consisting of more than four units). Lincoln Bank writes
multi-family loans on terms and conditions similar to its commercial real estate
loans. The largest multi-family loan as of December 31, 2004, was $1.7 million
and was secured by an apartment complex in Fortville, Indiana. On the same date,
there were no multi-family loans included in non-performing assets.
Multi-family loans, like commercial real estate loans, involve greater risk
than do residential loans. Also, the loan-to-one-borrower limitation restricts
Lincoln Bank's ability to make loans to certain developers of apartment
complexes and other multi-family units.
Construction Loans. Lincoln Bank offers construction loans to developers
for the acquisition and development of residential and nonresidential real
estate and to builders of one- to four-family residential properties. A
significant portion of these loans are made on a speculative basis (i.e., before
the builder/developer obtains a commitment from a buyer). At December 31, 2004,
approximately $52.6 million, or 9.0% of Lincoln Bank's total loan portfolio,
consisted of construction loans. Of these loans, approximately $17.2 million
were for the acquisition and development of residential housing developments,
$10.5 million financed the construction of one- to four-family residential
properties and $24.9 million financed the construction of commercial real
estate. As of December 31, 2004, Lincoln Bank's largest construction loan
relationship had a balance of $3.1 million and was secured by a hotel in
Lebanon, Indiana. Also on that date, no construction loans were included in
non-performing assets.
Construction loans on residential properties where the borrower has entered
into a verifiable sales contract to a non-related party to purchase the
completed home may be made with a maximum Loan-to-Value Ratio of the lesser of
90% of the price stipulated in the sales contract or 80% of the appraised value
of the property. With respect to residential properties constructed on a
speculative basis, Lincoln Bank generally requires a Loan-to-Value Ratio of 75%
of the "as completed" appraised value of the property. Although speculative
loans make up a significant percentage of Lincoln Bank's construction loan
portfolio, Lincoln Bank generally will finance only two speculative construction
projects per builder. Residential construction loans are generally written with
a fixed rate of interest and for an initial term of six months. Lincoln Bank
generally offers construction loans on commercial land development projects with
a maximum Loan-to-Value Ratio of 75% of the appraised value of the property or
80% of the property's cost plus 80% of the cost of verifiable improvements to
the property. The term of construction loans on commercial real estate
properties generally do not exceed 12 months.
7
Construction loans provide a comparable, and in some cases higher, yield
than a conventional mortgage loan, however, they also involve a higher degree of
risk. For example, if a project is not completed and the borrower defaults,
Lincoln Bank may have to hire another contractor to complete the project at a
higher cost. Also, a project may be completed, however, it may not be salable,
which might cause the borrower to default on the loan and require Lincoln Bank
take title to the project.
Land Loans. At December 31, 2004, approximately $15.0 million, or 2.6% of
Lincoln Bank's total loan portfolio, consisted of mortgage loans secured by
undeveloped real estate. Lincoln Bank requires a maximum Loan-to-Value Ratio of
65% of the appraised value of the land or 90% of the cost of the undeveloped
land for pre-development land acquisition loans. Lincoln Bank writes these loans
for a maximum term of 12 months. At December 31, 2004, the Bank's largest land
loan relationship totaled $0.5 million and was secured by a 3.8-acre commercial
tract in Carmel, Indiana. At December 31, 2004, no land loans were included in
non-performing assets.
Land loans present greater risk than conventional loans since land
development borrowers who are over budget may divert the loan funds to cover
cost-overruns rather than direct them toward the purpose for which such loans
were made. In addition, land loans are more difficult to monitor than
conventional mortgage loans. As such, a defaulting borrower could cause Lincoln
Bank to take title to partially improved land that is unmarketable without
further capital investment.
Consumer Loans. Lincoln Bank's consumer loans consist of variable- and
fixed-rate home equity loans; lines of credit; automobile, recreational vehicle,
boat and motorcycle loans; and loans secured by deposits. Lincoln Bank generally
does not make indirect consumer loans. Consumer loans generally have shorter
terms and higher yields than permanent residential mortgage loans. At December
31, 2004, Lincoln Bank's consumer loans aggregated approximately $108.2 million,
or 18.5% of Lincoln Bank's total loan portfolio. Included in consumer loans at
December 31, 2004 were $43.9 million of variable-rate home equity lines of
credit. These variable-rate loans improve Lincoln Bank's exposure to interest
rate risk.
Lincoln Bank's home equity lines of credit and fixed-term loans are
generally written for up to 90% of the available equity (the appraised value of
the property less any first mortgage amount). Lincoln Bank's home equity and
second mortgage loans were $59.8 million, or 10.3% of total loans at December
31, 2004. Lincoln Bank generally will write automobile loans for up to 100% of
the acquisition price for a new automobile and up to the NADA retail value for a
used automobile. New car loans are written for terms of up to 60 months and used
car loans are written for terms up to 48 months, depending on the age of the
car. Loans for recreational vehicles and boats are written for no more than 80%
of the purchase price or "verified value," whichever is less, for a maximum term
of 120 months and 84 months, respectively. Motorcycle loans are written for no
more than 75% of the purchase price or "verified value" with a term not to
exceed 48 months. All of Lincoln Bank's consumer loans have a fixed rate of
interest except for home equity lines of credit, which are offered at a variable
rate. At December 31, 2004, consumer loans in the amount of $0.3 million, or
0.2% of total consumer loans, were included in non-performing assets.
Consumer loans may entail greater risk than residential mortgage loans,
particularly in the case of consumer loans that are unsecured or are secured by
rapidly depreciable assets, such as automobiles. Further, any repossessed
collateral under a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance. In addition, consumer loan
collections depend on the borrower's continuing financial stability, and thus
are more likely to be affected by adverse personal circumstances. Furthermore,
the application of various federal and state laws, including bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Commercial Loans. Lincoln Bank offers commercial loans, which consist
primarily of loans to businesses that are secured by assets other than real
estate. As of December 31, 2004, commercial loans amounted to $70.8 million.
Commercial loans generally bear greater risk than residential mortgage loans,
8
depending on the ability of the underlying enterprise to repay the loan.
Although commercial loans have not historically comprised a large portion of
Lincoln Bank's loan portfolio, Lincoln Bank has increased the amount of loans it
has made to small businesses in order to increase its rate of return and
diversify its portfolio. As of December 31, 2004, $0.5 million, or 0.7%, of
Lincoln Bank's commercial loans were included in nonperforming assets.
Origination, Purchase and Sale of Loans. Historically, Lincoln Bank has
confined its loan origination activities primarily to Hendricks, Montgomery,
Clinton, Johnson and Morgan Counties. Lincoln Bank may from time to time make
mortgage loans secured by property located outside of Indiana. Lincoln Bank's
loan originations are generated from referrals from existing customers, real
estate brokers, newspaper and periodical advertising.
Lincoln Bank's loan approval process is intended to assess the borrower's
ability to repay the loan, the viability of the loan and the adequacy of the
value of the property that will secure the loan. To assess the borrower's
ability to repay, the Bank evaluates the employment and credit history and
information on the historical and projected income and expenses of its
borrowers.
Lincoln Bank generally requires appraisals on all real property securing
its first-mortgage loans and requires title insurance and a valid lien on the
mortgaged real estate. Appraisals for all real property securing first-mortgage
loans are performed by independent appraisers who are state-licensed. Lincoln
Bank requires fire and extended coverage insurance in amounts at least equal to
the principal amount of the loan and also requires flood insurance to protect
the property, which secures its interest, if the property is in a flood plain.
Lincoln Bank also generally requires private mortgage insurance for all
residential mortgage loans with Loan-to-Value Ratios of greater than 80%.
Lincoln Bank generally requires escrow accounts for insurance premiums and taxes
for residential mortgage loans that it originates.
Lincoln Bank's underwriting standards for consumer loans are intended to
protect against some of the risks inherent in making consumer loans. Borrower
character, paying habits, length of employment and financial strengths are
important considerations.
Lincoln Bank occasionally purchases participation interests in loans
originated by other financial institutions in order to diversify its portfolio,
supplement local loan demand and to obtain more favorable yields. The
participations that Lincoln Bank purchases normally represent a portion of
residential or commercial real estate loans originated by other Indiana
financial institutions, most of which are secured by property located in
Indiana. As of December 31, 2004, Lincoln Bank had $21.3 million of loan
participations in its asset portfolio.
The Bank occasionally sells participation interests in loans it originates
in order to limit the risk on a specific credit or industry type or to remain
within its self-imposed lending limit to a single borrower. The self-imposed
lending limit for Lincoln Bank is currently $3 million. Loans above this limit
require special Board of Director approval as an exception. Regulatory
guidelines allow significantly higher lending limits. As of December 31, 2004,
Lincoln Bank had $11.6 million of loan participations sold.
9
The following table shows loan origination and repayment activity for
Lincoln Bank during the periods indicated:
Year Ended December 31,
----------------------------------
2004 2003 2002
------- ------ ------
(In thousands)
Gross loans receivable at beginning of period $456,434 $376,881 $363,486
Loans Originated:
Real estate mortgage loans:
One-to-four family loans (1) 83,305 141,409 130,367
Multi-family loans 120 -- 296
Commercial real estate loans 48,174 42,290 35,034
Construction loans 32,984 56,696 34,990
Land loans 9,986 13,947 10,987
Commercial loans 17,383 17,401 14,546
Consumer loans 27,581 31,849 30,569
-------- -------- --------
Total originations 219,533 303,592 256,789
-------- -------- --------
Purchases (sales) of participation loans, net (68,264) (19,771) (93,530)
Loans from First Bank merger 154,927 -- --
Reductions:
Repayments and other deductions 177,096 203,302 149,511
Transfers from loans to real estate owned 1,751 966 353
-------- -------- --------
Total reductions 178,847 204,268 149,864
-------- -------- --------
Total gross loans receivable at end of period $583,783 $456,434 $376,881
======== ======== ========
- ----------------
(1) Includes certain home equity loans.
Lincoln Bank's total loan originations during the year ended December 31,
2004 totaled $219.5 million, compared to $303.6 million during the year ended
December 31, 2003, and $256.8 million during the year ended December 31, 2002.
Origination and Other Fees. Lincoln Bank realizes income from late charges,
checking account service charges, loan servicing fees and fees for other
miscellaneous services. Late charges are generally assessed if a loan payment is
not received within a specified number of days after it is due. The grace period
depends on the individual loan documents. The Bank also receives a loan
servicing fee of 1/4% on fixed-rate loans and 3/8% on ARM loans that it services
for others.
Non-Performing and Problem Assets
After a mortgage loan becomes 17 days past due, Lincoln Bank delivers a
delinquency notice to the borrower. When loans are 30 to 60 days in default,
Lincoln Bank sends additional delinquency notices and telephone calls are placed
with the borrower to establish an acceptable repayment schedule. When loans
become 60 days in default, Lincoln Bank again contacts the borrower to establish
an acceptable repayment schedule. When a mortgage loan is 90 days delinquent,
Lincoln Bank will have either entered into a workout plan with the borrower or
referred the matter to its attorney for collection. Management is authorized to
commence foreclosure proceedings for any loan upon making a determination that
it is prudent to do so.
Lincoln Bank reviews mortgage loans on a regular basis and places one- to
four-family residential loans on a non-accrual status when they become 120 days
delinquent. Other loans are placed on a non-accrual status when they become 90
days delinquent. Generally, when loans are placed on a non-accrual status,
unpaid accrued interest is written off.
Non-performing Assets. At December 31, 2004, $6.9 million, or .85%, of
Lincoln Bank's total assets, were non-performing (including loans past due 90
days or more and non-accruing loans) compared to $2.7
10
million, or .46%, of its total assets at December 31, 2003. At December 31,
2004, residential loans accounted for $1.4 million of Lincoln Bank's
non-performing assets, commercial real estate accounted for $2.9 million of its
non-performing assets, commercial loans accounted for $0.5 million of its
non-performing assets, and consumer loans accounted for $0.3 million of
non-performing assets. Lincoln Bank had real estate owned ("REO") properties in
the amount of $1.8 million as of December 31, 2004.
The table below sets forth the amounts and categories of Lincoln Bank's
non-performing assets (non-performing loans, foreclosed real estate and troubled
debt restructurings) for the last five years. It is Lincoln Bank's policy that
earned but uncollected interest on all loans be reviewed monthly to determine if
any portion thereof should be classified as uncollectible for any loan past due
in excess of 90 days. Lincoln Bank deems any delinquent loan that is 90 days or
more past due to be a non-performing asset. Additionally, loans less than 90
days past due may be nonperforming if they are not accruing interest.
At December 31,
------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Non-performing assets:
Non-performing loans $5,084 $1,903 $2,043 $1,297 $2,263
Troubled debt restructurings -- -- -- -- --
------ ------ ------ ------ ------
Total non-performing loans 5,084 1,903 2,043 1,297 2,263
Foreclosed real estate 1,804 825 213 356 103
------ ------ ------ ------ ------
Total non-performing assets $6,888 $2,728 $2,256 $1,653 $2,366
====== ====== ====== ====== ======
Non-performing loans to total loans .87% .43% .57% .36% .69%
Non-performing assets to total assets .85% .46% .43% .34% .47%
Interest income of $156,000 for the year ended December 31, 2004, was
recognized on the non-performing loans summarized above. Interest income of
$326,000 for the year ended December 31, 2004, would have been recognized under
the original loan terms of these loans.
At December 31, 2004, Lincoln Bank held loans delinquent from 30 to 89 days
totaling $5.9 million. As of that date, Lincoln Bank was not aware of any other
loans in which borrowers were experiencing financial difficulties and was not
aware of any assets that would need to be disclosed as non-performing assets.
Delinquent Loans. The following table sets forth certain information at
December 31, 2004, 2003 and 2002, relating to delinquencies in Lincoln Bank's
portfolio. Delinquent loans that are 90 days or more past due are considered
non-performing assets.
At December 31, 2004 At December 31, 2003 At December 31, 2002
------------------------------------ ------------------------------------- --------------------------------------
30-89 Days 90 Days or More 30-89 Days 90 Days or More 30-89 Days 90 Days or More
------------------ ----------------- ------------------ ------------------ ------------------- -----------------
Principal Principal Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Residential
mortgage loans 76 $3,422 19 $1,282 46 $1,727 27 $1,416 94 $4,474 27 $1,394
Commercial
real estate loans 3 1,064 1 2,295 5 866 -- -- 6 608 -- --
Multi-family
mortgage loans -- -- -- -- -- -- -- -- -- -- -- --
Construction loans 1 249 -- -- -- -- -- -- 4 3,651 1 54
Land loans 5 419 -- -- -- -- 1 11 -- -- 2 206
Commercial loan 11 835 7 516 5 116 1 238 7 455 1 59
Consumer loans 58 625 20 238 25 385 8 181 49 499 18 330
--- ------ -- ------ -- ------ -- ------ --- ------ -- ------
Total 154 $6,614 47 $4,331 81 $3,094 37 $1,846 160 $9,687 49 $2,043
=== ====== == ====== == ====== == ====== === ====== == ======
Delinquent loans to
total loans 1.93% 1.12% 3.29%
==== ==== ====
11
Classified Assets. Federal regulations and Lincoln Bank's Asset
Classification Policy provide for the classification of loans and other assets
such as debt and equity securities considered by the OTS to be of lesser quality
as "substandard," "doubtful" or "loss" assets. An asset is considered
"substandard" if it is inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the institution will sustain "some loss" if the deficiencies are not
corrected. Assets classified as "doubtful" have all of the weaknesses inherent
in those classified "substandard," with the added characteristic that the
weaknesses present make "collection or liquidation in full," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." Assets classified as "loss" are those considered "uncollectible"
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted.
An insured institution is required to establish general allowances for loan
losses in an amount deemed prudent by management for loans classified
substandard or doubtful, as well as for other problem loans. General allowances
represent loss allowances which have been established to recognize the inherent
risk associated with lending activities, but which, unlike specific allowances,
have not been allocated to particular problem assets. When an insured
institution classifies problem assets as "loss," it is required either to
establish a specific allowance for losses equal to 100% of the amount of the
asset so classified or to charge off such amount. An institution's determination
as to the classification of its assets and the amount of its valuation
allowances is subject to review by the OTS which can order the establishment of
additional general or specific loss allowances.
Lincoln Bank regularly reviews its loan portfolio to determine whether any
loans require classification in accordance with applicable regulations. Lincoln
Bank's classified assets are made up entirely of non-performing assets.
Allowance for Loan Losses
The allowance for loan losses is maintained through the provision for loan
losses, which is charged to earnings. The allowance for loan losses is
determined in conjunction with Lincoln Bank's review and evaluation of current
economic conditions (including those of its lending area), changes in the
character and size of its loan portfolio, loan delinquencies (current status as
well as past and anticipated trends) and adequacy of collateral securing loan
delinquencies, historical and estimated net charge-offs, and other pertinent
information derived from a review of the loan portfolio. In management's
opinion, Lincoln Bank's allowance for loan losses is adequate to absorb probable
losses inherent in the loan portfolio at December 31, 2004. However, there can
be no assurance that regulators, when reviewing the Bank's loan portfolio in the
future, will not require increases in its allowances for loan losses or that
changes in economic conditions will not adversely affect its loan portfolio. For
more discussion on the allowance for loan losses, see "Management's Discussion
and Analysis of Financial Condition and Results of Operation" in the Annual
Report.
12
Summary of Loan Loss Experience. The following table analyzes changes in
the allowance during the past five fiscal years ended December 31, 2004.
Year Ended December 31,
----------------------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of period .......... $3,532 $2,932 $2,648 $2,367 $1,761
Transfer from First Bank (2004) and
Citizens (2000) mergers .............. 1,757 -- -- -- 343
Charge-offs:
One- to four-family residential
mortgage loans ..................... (5) (22) -- (60) (5)
Commercial real estate mortgage loans -- -- -- -- --
Construction loans ................... -- -- -- -- --
Commercial loans ..................... (25) (20) -- -- --
Consumer loans ....................... (251) (202) (77) (266) (139)
------ ------ ------ ------ ------
Total charge-offs .................. (281) (244) (77) (326) (144)
------ ------ ------ ------ ------
Recoveries:
One- to four-family residential
mortgage loans ..................... 1 22 22 18 79
Commercial real estate mortgage loans 3 3 3 4 4
Construction loans ................... -- -- -- -- --
Commercial loans ..................... -- -- -- -- --
Consumer loans ....................... 34 66 34 97 41
------ ------ ------ ------ ------
Total recoveries ................... 38 91 59 119 124
------ ------ ------ ------ ------
Net charge-offs ...................... (243) (153) (18) (207) (20)
------ ------ ------ ------ ------
Provision for losses on loans ........... 655 753 302 488 283
------ ------ ------ ------ ------
Balance end of period ................ $5,701 $3,532 $2,932 $2,648 $2,367
====== ====== ====== ====== ======
Allowance for loan losses as a percent of
total loans outstanding .............. .98% .80% .82% .74% .72%
Ratio of net charge-offs to average
loans outstanding .................... .05% .04% --% .06% --%
Allocation of Allowance for Loan Losses. The following table presents an
analysis of the allocation of Lincoln Bank's allowance for loan losses at the
dates indicated.
At December 31,
-------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------- ---------------- --------------- ---------------- ---------------
Percent Percent Percent Percent Percent
of loans of loans of loans of loans of loans
in each in each in each in each in each
category category category category category
to total to total to total to total to total
Amount loans Amount loans Amount loans Amount loans Amount loans
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(Dollars in thousands)
Balance at end of period applicable to:
Real estate mortgage loans:
One- to four-family residential $ 568 32.04% $ 717 47.27% $ 624 44.59% $ 674 59.12% $ 856 68.44%
Multi-family 58 0.99 53 1.16 58 1.47 58 1.59 26 .77
Commercial 2,024 24.72 999 21.05 838 21.43 707 14.35 420 9.41
Construction loans 484 9.02 526 11.08 338 13.30 261 7.34 201 7.36
Land loans 210 2.57 89 1.43 63 1.62 68 1.48 73 1.39
Commercial loans 991 12.13 385 8.12 235 5.94 122 2.65 29 .83
Consumer loans 1,365 18.53 619 9.89 771 11.65 758 13.47 642 11.80
Unallocated 1 -- 144 -- 5 -- -- -- 120 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total $5,701 100.00% $3,532 100.00% $2,932 100.00% $2,648 100.00% $2,367 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
13
Investments
Investments. The Company has adopted an investment policy that authorizes
investments in U.S. Treasury securities, securities guaranteed by the Government
National Mortgage Association ("GNMA"), securities issued by agencies of the
U.S. Government, mortgage-backed securities issued by the FHLMC or the Federal
National Mortgage Association ("FNMA") and in highly-rated mortgage-backed
securities, collateralized mortgage obligations and investment-grade corporate
debt securities. This policy permits the Company's management to react quickly
to market conditions. Most of the securities in its portfolio are considered
available-for-sale. At December 31, 2004, the Company's investment portfolio
consisted of investments in mortgage-backed securities, corporate securities,
federal agency securities, municipal securities, FHLB stock, an investment in
Bloomington Housing Associates, L.P., and an investment in an insurance company.
See "-Investments in Multi-Family, Low- and Moderate-Income Housing Projects"
and "Service Corporation Subsidiary." At December 31, 2004, approximately $132.4
million, or 16.4%, of the Company's total assets consisted of such investments.
The Company also had $20.8 million in interest-earning deposits with and federal
funds sold to the FHLB-Indianapolis and other financial institutions as of that
date. As of that date, the Company also had pledged as collateral investment
securities with a carrying value of $59.9 million.
Investment Securities. The following table sets forth the amortized cost
and the market value of the Company's investment portfolio at the dates
indicated.
At December 31,
---------------------------------------------------------------
2004 2003 2002
------------------- ------------------- -------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- ------- --------- ------ --------- ------
(In thousands)
Investment securities available for sale:
Federal agencies $ 43,102 $42,821 $ 45,403 $45,450 $ 24,053 $ 24,505
Mortgage-backed securities 45,092 45,894 21,761 22,339 44,971 46,705
Corporate debt obligations 19,099 18,704 20,595 19,786 23,906 22,444
Marketable equity securities 357 481 252 354 252 318
Municipal securities 10,963 11,017 6,138 6,208 5,574 5,628
-------- ------- -------- ------- -------- --------
Total investment securities
available for sale 118,613 118,917 94,149 94,137 98,756 99,600
Investment securities held to maturity:
Municipals 1,695 1,695 1,745 1,745 1,780 1,780
-------- ------- -------- ------- -------- --------
Total investment securities 120,308 120,612 95,894 95,882 100,536 101,380
Investment in limited partnerships 1,025 (1) 1,250 (1) 1,388 (1)
Investment in insurance company 650 (1) 650 (1) 650 (1)
FHLB stock (2) 10,427 10,427 9,270 9,270 8,160 8,160
-------- -------- --------
Total investments $132,410 $107,064 $110,734
======== ======== ========
- ------------------
(1) Market values are not available
(2) Market value is based on the price at which the stock may be resold to the
FHLB of Indianapolis.
The following table sets forth the amount of investment securities
(excluding mortgage-backed securities and marketable equity securities) which
mature during each of the periods indicated and the weighted average yields for
each range of maturities at December 31, 2004.
14
Amount at December 31, 2004 which matures in
Less Than One Year Five to After
One Year to Five Years Ten Years Ten Years
------------------- -------------------- -------------------- --------------------
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- ------- --------- -------- --------- ------- ---------- -------
(Dollars in thousands)
Federal agency securities --
available for sale $23,839 1.33% $19,263 2.63% $ -- --% $ -- --%
Corporate securities --
available for sale 4,020 3.09 1,680 -- -- -- 13,399 2.94
Municipals -- held to maturity 60 4.61 370 5.00 755 5.56 510 5.96
Municipals -- available for sale 3,949 2.17 1,290 2.35 1,294 3.77 4,430 3.79
------- ------- ------ -------
$31,868 $22,603 $2,049 $18,339
======= ======= ====== =======
At December 31, 2004, the Company had no corporate investments which
exceeded 10% of its equity capital.
Mortgage-backed Securities. The following table sets forth the composition
of the Company's mortgage-backed securities portfolio at December 31, 2004 and
2003.
December 31, 2004 December 31, 2003
---------------------------- ----------------------------
Amortized Percent Market Amortized Percent Market
Cost of Total Value Cost of Total Value
--------- -------- ------- --------- -------- -------
(Dollars in thousands)
Federal Home Loan
Mortgage Corporation $41,658 92.4% $42,423 $14,808 68.0% $15,272
Government National
Mortgage Association 1,013 2.2 1,068 1,822 8.4 1,925
Collateralized mortgage
obligations 2,421 5.4 2,403 5,131 23.6 5,142
------- ----- ------- ------- ----- -------
Total mortgage-backed securities $45,092 100.0% $45,894 $21,761 100.0% $22,339
======= ===== ======= ======= ===== =======
At December 31, 2004, mortgage-backed securities having an amortized cost
of $5,485,000 mature in five to ten years and have a weighted average yield of
4.73% and mortgage-backed securities having an amortized cost of $36,152,000
mature after ten years and have a weighted average yield of 5.06%.
The following table sets forth the changes in the Company's mortgage-backed
securities portfolio for the years ended December 31, 2004, 2003 and 2002.
For the Year Ended December 31,
------------------------------------
2004 2003 2002
-------- -------- --------
(Dollars in thousands)
Beginning balance $ 22,339 $ 46,705 $ 59,017
Securitization of loans 25,663 -- 18,222
Purchases 9,137 7,963 5,047
Monthly repayments (11,378) (31,158) (36,417)
Proceeds from sales -- -- --
Net accretion (amortization) (91) (15) (140)
Gains on sales -- -- --
Change in unrealized gain on
securities available for sale 224 (1,156) 976
-------- -------- --------
Ending balance $ 45,894 $ 22,339 $ 46,705
======== ======== ========
15
Investments in Multi-Family, Low- and Moderate-Income Housing Projects.
Lincoln Bank had an investment in Pedcor Investments - 1987 - I, L.P.
("Pedcor"), an Indiana limited partnership that was organized to construct, own
and operate a 208-unit apartment complex in Indianapolis, Indiana (the "Pedcor
Project"). The Pedcor Project, which was operated as a multi-family, low- and
moderate-income housing project, had been completed and performed as planned. At
the inception of the Pedcor Project in August 1988, Lincoln Bank committed to
invest $2.7 million in Pedcor. In January 1998, the final payment pursuant to
this commitment had been made and no additional funds were required for the
Pedcor Project. Per terms of the limited partnership, Pedcor liquidated on July
27, 2004, with no asset distribution to any of the limited partners.
Lincoln Bank holds a separate investment in a multi-family, low- and
moderate-income housing project through its wholly-owned subsidiary, LF Service
Corp. ("LF"). LF has invested in Bloomington Housing Associates, L.P. ("BHA"),
which 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 has been completed and the project is
performing as planned. LF has invested approximately $4.9 million in BHA since
the inception of the Bloomington Project in August 1992.
A low- and moderate-income housing project qualifies for certain federal
income tax credits if (i) it is a residential rental property, (ii) the units
are used on a nontransient basis, and (iii) 20% or more of the units in the
project are occupied by tenants whose incomes are 50% or less of the area median
gross income, adjusted for family size, or alternatively, at least 40% of the
units in the project are occupied by tenants whose incomes are 60% or less of
the area median gross income. Qualified low income housing projects generally
must comply with these and other rules for fifteen years, beginning with the
first year the project qualified for the tax credit, or some or all of the tax
credit together with interest may be recaptured. The tax credit is subject to
the limitations on the use of general business credit, but no basis reduction is
required for any portion of the tax credit claimed. As of December 31, 2004,
95.4% of the units in the Pedcor Project and the Bloomington Project were
occupied and each project complied with the low income occupancy requirements
described above.
Lincoln Bank has received tax credits of $355,000 from the operation of the
Bloomington Project for the year ended December 31, 2004. The tax credits from
the BHA project will be available through 2007. Additionally, Pedcor and BHA
have incurred operating losses in the early years of their operations primarily
due to accelerated depreciation of assets. Lincoln Bank has accounted for its
investment in Pedcor, and LF has accounted for Lincoln Bank's investment in BHA,
on the equity method. Accordingly, Lincoln Bank and LF have each recorded their
share of these losses as reductions to their investments in Pedcor and BHA,
respectively. At December 31, 2004, Lincoln Bank had no remaining investment on
the books for Pedcor, and LF's investment in BHA was $1,025,000.
Sources of Funds
General. Deposits have traditionally been the Company's primary source of
funds for use in lending and investment activities. In addition to deposits, the
Company derives funds from scheduled loan payments, investment maturities, loan
prepayments, retained earnings, income on earning assets and borrowings. While
scheduled loan payments and income on earning assets are relatively stable
sources of funds, deposit inflows and outflows can vary widely and are
influenced by prevailing interest rates, market conditions and levels of
competition. Borrowings from the FHLB of Indianapolis have been used to
compensate for reductions in deposits or deposit inflows at less than projected
levels.
16
Deposits. The Company attracts deposits principally from within Hendricks,
Montgomery, Clinton, Johnson, Brown and Morgan Counties through the offering of
a broad selection of deposit instruments, including passbook accounts, NOW
accounts, variable rate money market accounts, fixed-term certificates of
deposit, individual retirement accounts and savings accounts. The Company does
not actively solicit or advertise for deposits outside of Hendricks, Montgomery,
Clinton, Johnson, Brown and Morgan Counties, and substantially all of the
Company's depositors are residents of those counties. Deposit account terms
vary, with the principal differences being the minimum balance required, the
amount of time the funds remain on deposits and the interest rate. The Company
may sometimes accept brokered deposits and bids for public deposits and it held
$6.5 million and $40.5 million of such funds, or 1.3% and 7.8% of its total
deposits, at December 31, 2004. The Company periodically runs specials on
certificates of deposit with specific maturities.
The Company establishes the interest rates paid, maturity terms, service
fees and withdrawal penalties on a periodic basis. Determination of rates and
terms are predicated on funds acquisition and liquidity requirements, rates paid
by competitors, growth goals, and applicable regulations. The Company relies, in
part, on customer service and long-standing relationships with customers to
attract and retain its deposits. The Company also closely prices its deposits to
the rates offered by its competitors.
Approximately 50.2% of the Company's deposits consist of certificates of
deposit, which generally have higher interest rates than other deposit products
that it offers. Certificates of deposit have increased 64.3% during the year
ended December 31, 2004. Money market savings accounts represent 25.1% of the
Company's deposits and have grown 61.4% during the year ended December 31, 2004.
Non-interest bearing demand accounts have grown $19.8 million, or 115.2%, during
the year ended December 31, 2004. The Company offers special rates on
certificates of deposit with maturities that fit its asset and liability
strategies.
The flow of deposits is influenced significantly by general economic
conditions, changes in money market and other prevailing interest rates and
competition. The variety of deposit accounts that the Company offers has allowed
it to compete effectively in obtaining funds and to respond with flexibility to
changes in consumer demand. The Company has become more susceptible to
short-term fluctuations in deposit flows as customers have become more interest
rate conscious. The Company manages the pricing of its deposits in keeping with
its asset/liability management and profitability objectives. Based on its
experience, management believes that the Company's savings accounts, NOW and
MMDAs are relatively stable sources of deposits. However, the ability to attract
and maintain certificates of deposit, and the rates the Company pays on these
deposits, have been and will continue to be significantly affected by market
conditions.
17
An analysis of the Company's deposit accounts by type and maturity at
December 31, 2004, is as follows:
Minimum Balance at Weighted
Opening December 31, % of Average
Type of Account Balance 2004 Deposits Rate
------- ------------ -------- --------
(Dollars in thousands)
Withdrawable:
Savings accounts $ 25 $ 43,821 8.49% 0.64%
Money market 1,000 129,392 25.06 1.67
NOW accounts 200 46,982 9.10 0.66
Non-interest bearing demand accounts 50 36,956 7.15 --
-------- ------
Total withdrawable 257,151 49.80 1.06
-------- ------
Certificates (original terms):
3 months or less 1,000 8,318 1.61 2.36
6 months 1,000 7,457 1.44 1.78
12 months 1,000 26,359 5.11 1.80
18 months 1,000 25,973 5.03 2.39
24 months 1,000 61,863 11.98 2.68
30 months 1,000 18,294 3.54 2.87
36 months 1,000 27,204 5.27 3.21
48 months 1,000 8,605 1.67 4.28
60 months 1,000 28,138 5.45 4.66
Public fund and brokered certificates 46,967 9.10 2.48
-------- ------
Total certificates 259,178 50.20 2.83
-------- ------
Total deposits $516,329 100.00% 1.95%
======== ======
The following table sets forth by various interest rate categories the
composition of the Company's time deposits at the dates indicated:
At December 31,
----------------------------------------
2004 2003 2002
-------- -------- --------
(In Thousands)
Less than 2.00% $ 41,288 $ 59,371 $ 26,989
2.00 to 2.99% 140,006 35,409 34,303
3.00 to 3.99% 46,733 29,734 35,170
4.00 to 4.99% 18,269 12,992 25,908
5.00 to 5.99% 10,288 17,237 23,863
6.00 to 6.99% 2,249 2,988 5,886
7.00 to 7.99% 345 5 79
-------- -------- --------
Total $259,178 $157,736 $152,198
======== ======== ========
18
The following table represents, by various interest rate categories, the
amounts of time deposits maturing during each of the three years following
December 31, 2004. Matured certificates, which have not been renewed as of
December 31, 2004, have been allocated based upon certain rollover assumptions.
Amounts at December 31, 2004 Maturing In
--------------------------------------------------
One Year Two Three Greater Than
or Less Years Years Three Years
-------- ------- ------- ------------
(In thousands)
Less than 2.00% $ 35,176 $ 3,333 $ 2,779 $ --
2.00 to 2.99% 91,620 44,754 3,147 485
3.00 to 3.99% 10,421 13,968 9,747 12,597
4.00 to 4.99% 8,244 3,205 4,984 1,836
5.00 to 5.99% 807 7,665 1,766 50
6.00 to 6.99% 1,288 846 -- 115
7.00 to 7.99% 340 5 -- --
-------- ------- ------- -------
Total $147,896 $73,776 $22,423 $15,083
======== ======= ======= =======
The following table indicates the amount of the Company's other
certificates of deposit of $100,000 or more by time remaining until maturity as
of December 31, 2004.
At December 31, 2004
--------------------
Maturity Period (In thousands)
Three months or less $ 45,273
Greater than three months through six months 17,874
Greater than six months through twelve months 9,516
Over twelve months 34,726
--------
Total $107,389
========
DEPOSIT ACTIVITY
Balance Increase Balance Increase Balance
at (Decrease) at (Decrease) at
December 31, % of from December 31, % of from December 31, % of
2004 Deposits 2003 2003 Deposits 2002 2002 Deposits
-------- -------- ---------- ------------ -------- ------ ------------ --------
(Dollars in thousands)
Withdrawable:
Savings accounts $ 43,821 8.49% $10,416 $ 33,405 10.38% $ 49 $ 33,356 12.34%
Money market accounts 129,392 25.06 49,213 80,179 24.91 26,404 53,775 19.89
NOW accounts 46,982 9.10 13,639 33,343 10.36 15,594 17,749 6.56
Noninterest-bearing
demand accounts 36,956 7.15 19,780 17,176 5.34 3,887 13,289 4.92
-------- ------ -------- -------- ------ ------- -------- ------
Total withdrawable 257,151 49.80 93,048 164,103 50.99 45,934 118,169 43.71
-------- ------ -------- -------- ------ ------- -------- ------
Certificates (original terms):
91 days 8,318 1.61 7,345 973 .30 170 803 .30
6 months 7,457 1.44 3,191 4,266 1.33 (1,793) 6,059 2.24
12 months 26,359 5.11 14,002 12,357 3.84 (4,249) 16,606 6.14
18 months 25,973 5.03 15,757 10,216 3.17 (1,709) 11,925 4.41
24 months 61,863 11.98 24,737 37,126 11.54 3,734 33,392 12.35
30 months 18,294 3.54 1,474 16,820 5.23 (3,691) 20,511 7.59
36 months 27,204 5.27 13,197 14,007 4.35 (866) 14,873 5.50
48 months 8,605 1.67 (2,489) 11,094 3.45 471 10,623 3.93
60 months 28,138 5.45 9,236 18,902 5.87 1,697 17,205 6.36
Public fund and brokered
certificates 46,967 9.10 14,992 31,975 9.93 11,774 20,201 7.47
-------- ------ -------- -------- ------ ------- -------- ------
Total certificates 259,178 50.20 101,442 157,736 49.01 5,538 152,198 56.29
-------- ------ -------- -------- ------ ------- -------- ------
Total deposits $516,329 100.00% $194,490 $321,839 100.00% $51,472 $270,367 100.00%
======== ====== ======== ======== ====== ======= ======== ======
19
Total deposits at December 31, 2004 were approximately $516.3 million,
compared to approximately $321.8 million at December 31, 2003. The Company's
deposit base depends somewhat upon the manufacturing sector of Hendricks,
Montgomery, Clinton, Johnson, Brown and Morgan Counties. Although the
manufacturing sector in these counties is relatively diversified and does not
significantly depend upon any industry, a loss of a material portion of the
manufacturing workforce could adversely affect the Company's ability to attract
deposits due to the loss of personal income attributable to the lost
manufacturing jobs and the attendant loss in service industry jobs.
In the unlikely event of the Bank's liquidation, all claims of creditors
(including those of deposit account holders, to the extent of their deposit
balances) would be paid first followed by distribution of the liquidation
account to certain deposit account holders, with any assets remaining thereafter
distributed to the Holding Company as the sole shareholder of Lincoln Bank.
Borrowings. Lincoln Bank focuses on generating high quality loans and then
seeking the best source of funding from deposits, investments or borrowings. At
December 31, 2004, Lincoln Bank had borrowings in the amount of $174.8 million
from the FHLB of Indianapolis which bear fixed and variable interest rates and
which are due at various dates through 2013. Lincoln Bank is required to
maintain eligible loans and investment securities in its portfolio of at least
145% and 115%, respectively, of outstanding advances as collateral for advances
from the FHLB of Indianapolis. As an additional funding source, Lincoln Bank has
also sold securities under repurchase agreements. Lincoln Bank had $6.5 million
of overnight securities sold under repurchase agreement at December 31, 2004.
The Company does not anticipate any difficulty in obtaining advances and other
borrowings appropriate to meet its requirements in the future.
20
The following table presents certain information relating to Lincoln Bank's
borrowings at or for the years ended December 31, 2004, 2003 and 2002.
At or for the Year
Ended December 31,
----------------------------------
2004 2003 2002
-------- -------- --------
(Dollars in thousands)
Outstanding at end of period
Securities sold under repurchase
agreements $ 6,500 $ -- $ --
FHLB advances 174,829 184,693 163,010
Notes payable 3,000 -- --
Average balance outstanding for period
Securities sold under repurchase
agreements 2,456 -- 11,425
FHLB advances 175,074 170,343 138,941
Notes payable 1,238 -- --
Maximum amount outstanding at any
month-end during the period
Securities sold under repurchase agreements 6,511 -- 15,000
FHLB advances 185,105 184,695 163,010
Notes payable 3,000 -- --
Weighted average interest rate during the period
Securities sold under repurchase agreements 1.05 -- 5.94
FHLB advances 4.68 4.74 5.09
Notes payable 3.64 -- --
Weighted average interest rate
at end of period
Securities sold under repurchase agreements 1.37 -- --
FHLB advances 4.67 4.38 4.69
Notes payable 3.87 -- --
Note payable to BHA $ -- $ -- $ 248
Service Corporation Subsidiaries
OTS regulations permit federal savings banks to invest in the capital
stock, obligations or other specified types of securities of subsidiaries
(referred to as "service corporations") and to make loans to such subsidiaries
and joint ventures in which such subsidiaries are participants in an aggregate
amount not exceeding 2% of the bank's assets, plus an additional 1% of assets if
the amount over 2% is used for specified community or inner-city development
purposes. In addition, federal regulations permit banks to make specified types
of loans to such subsidiaries (other than special purpose finance subsidiaries)
in which the bank owns more than 10% of the stock, in an aggregate amount not
exceeding 50% of the bank's regulatory capital if the bank's regulatory capital
is in compliance with applicable regulations. A savings bank that acquires a
non-savings bank or association subsidiary, or that elects to conduct a new
activity within a subsidiary, must give the FDIC and the OTS at least 30 days'
advance written notice. The FDIC may, after consultation with the OTS, prohibit
specified activities if it determines such activities pose a serious threat to
the SAIF. Moreover, a savings bank must deduct from capital, for purposes of
meeting the core capital, tangible capital and risk-based capital requirements,
its entire investment in and loans to a subsidiary engaged in activities not
permissible for a national bank (other than exclusively agency activities for
its customers or mortgage banking subsidiaries).
21
Lincoln Bank currently owns three subsidiaries, LF Service Corp. ("LF"),
Citizens Loan and Service Corporation ("CLSC") and LF Portfolio Services, Inc.
("Portfolio"). LF's assets consist of an investment in Family Financial Life
Insurance Company ("Family Financial") and in BHA. See "- Investments in Low-
and Moderate-Income Housing Projects." LF received regulatory approval in
February 1998 to invest in Family Financial, an Indiana stock insurance company.
In May 1998, LF acquired a 16.7% interest in Family Financial for $650,000.
Fifty percent of the common stock of Family Financial is held by Consortium
Partners, a Louisiana general partnership.
Family Financial primarily engages in retail sales of mortgage and credit
insurance products in connection with loans originated by Lincoln Bank's
constituent shareholder financial institutions. Products offered by Family
Financial include group and individual term mortgage life insurance, group
mortgage disability insurance, group accidental death insurance, group credit
life insurance, and group credit accident and disability insurance policies.
Family Financial also markets a variety of tax-deferred annuity contracts which
are wholly reinsured by other insurance companies. LF expects to receive (1)
dividends paid on Family Financial shares owned directly by it, (2) a pro rata
allocation of dividends received on shares held by Consortium Partners, which
are divided among the partners based on the actuarially determined value of
Family Financial's various lines of insurance generated by customers of these
partners, and (3) commissions on sales of insurance products made to customers.
For the period ended December 31, 2004, Lincoln Bank received no dividends from
Family Financial. Operating results for Family Financial were not adequate
during the year to warrant paying a dividend due to lower credit life insurance
sales and a company reorganization.
CLSC 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 Bank 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 to builders, who construct homes for sale to home buyers. CLSC
ordinarily receives payment when title is transferred.
Portfolio is a Delaware corporation with its principal place of business in
Nevada. Portfolio holds and manages a significant portion of Lincoln Bank's
investment portfolio. As of December 31, 2004, Portfolio had investments
available for sale and interest-bearing deposits of $92.2 million, total assets
of $92.6 million, and during the fiscal year ended December 31, 2004, had net
income of $1.8 million.
Employees
As of December 31, 2004, the Company employed 210 persons on a full-time
basis and 22 on a part-time basis. None of the Company's employees are
represented by a collective bargaining group and management considers employee
relations to be good.
Employee benefits for the Company's full-time employees include, among
other things, an employee stock ownership plan, a Pentegra Group (formerly known
as Financial Institutions Retirement Fund) defined benefit pension plan, which
is a noncontributory, multiple-employer comprehensive pension plan (the "Pension
Plan"), and hospitalization/major medical insurance, long-term disability
insurance, life insurance, and participation in the Lincoln Bank 401(k) Plan,
which is administered by Pentegra Group.
The Company considers its employee benefits to be competitive with those
offered by other financial institutions and major employers in its area. See
"Executive Compensation and Related Transactions of Lincoln Bank."
COMPETITION
Lincoln Bank originates most of its loans to and accepts most of its
deposits from residents of Hendricks, Montgomery, Clinton, Johnson, Brown and
Morgan Counties, Indiana. Lincoln Bank is subject to
22
competition from various financial institutions, including state and national
banks, state and federal savings banks and associations, credit unions, and
certain nonbanking consumer lenders that provide similar services in those
counties with significantly larger resources than are available to Lincoln Bank.
Lincoln Bank also competes with money market funds and insurance companies with
respect to deposit accounts and individual retirement accounts.
The primary factors influencing competition for deposits are interest
rates, service and convenience of office locations. Lincoln Bank competes for
loan originations primarily through the efficiency and quality of the services
that it provides borrowers and through interest rates and loan fees charged.
Competition is affected by, among other things, the general availability of
lendable funds, general and local economic conditions, current interest rate
levels, and other factors that management cannot readily predict.
REGULATION
General
As a federally chartered, SAIF-insured savings bank, Lincoln Bank is
subject to extensive regulation by the OTS and the FDIC. For example, Lincoln
Bank must obtain OTS approval before it may engage in certain activities and
must file reports with the OTS regarding its activities and financial condition.
The OTS periodically examines Lincoln Bank's books and records and, in
conjunction with the FDIC in certain situations, has examination and enforcement
powers. This supervision and regulation are intended primarily for the
protection of depositors and federal deposit insurance funds. A savings
association must pay a semi-annual assessment to the OTS based upon a marginal
assessment rate that decreases as the asset size of the savings association
increases, and which includes a fixed-cost component that is assessed on all
savings associations. The assessment rate that applies to a savings association
depends upon the institution's size, condition, and the complexity of its
operations. During 2004, Lincoln Bank's latest semi-annual assessment was
$62,000.
In the fourth quarter of 2004, application was made to the Indiana
Department of Financial Institutions for the purpose of converting the Lincoln
Bank federal savings bank charter to a state bank charter. It is anticipated
this conversion will be accomplished in the second or third quarter of 2005.
Lincoln Bank is also subject to federal and state regulation as to such
matters as loans to officers, directors, or principal shareholders, required
reserves, limitations as to the nature and amount of its loans and investments,
regulatory approval of any merger or consolidation, issuances or retirements of
Lincoln Bank's securities, and limitations upon other aspects of banking
operations. In addition, Lincoln Bank's activities and operations are subject to
a number of additional detailed, complex and sometimes overlapping federal and
state laws and regulations. These include state usury and consumer credit laws,
state laws relating to fiduciaries, the Federal Truth-In-Lending Act and
Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the
Fair Credit Reporting Act, the Community Reinvestment Act, anti-redlining
legislation, antitrust laws and regulations protecting the confidentiality of
consumer financial information.
Savings and Loan Holding Company Regulation
The Holding Company is regulated as a "non-diversified savings and loan
holding company" within the meaning of the Home Owners' Loan Act, as amended
(the "HOLA"), and subject to regulatory oversight of the Director of the OTS. As
such, the Holding Company is registered with the OTS and is thereby subject to
OTS regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, Lincoln Bank is subject to
certain restrictions in its dealings with the Holding Company and with other
companies affiliated with the Holding Company.
In general, the HOLA prohibits a savings and loan holding company, without
obtaining the prior approval of the Director of the OTS, from acquiring control
of another savings association or savings and
23
loan holding company or retaining more than 5% of the voting shares of a savings
association or of another holding company which is not a subsidiary. The HOLA
also restricts the ability of a director or officer of the Holding Company, or
any person who owns more than 25% of the Holding Company's stock, from acquiring
control of another savings association or savings and loan holding company
without obtaining the prior approval of the Director of the OTS.
The Holding Company currently operates as a unitary savings and loan
holding company. Prior to the enactment of the Gramm-Leach-Bliley Act (the "GLB
Act") in November of 1999, there were no restrictions on the permissible
business activities of a unitary savings and loan holding company. The GLB Act
included a provision that prohibits any new unitary savings and loan holding
company, defined as a company that acquires a thrift after May 4, 1999, from
engaging in commercial activities. This provision also includes a grandfather
clause, however, that permits a company that was a savings and loan holding
company as of May 4, 1999, or had an application to become a savings and loan
holding company on file with the OTS as of that date, to acquire and continue to
control a thrift and to continue to engage in commercial activities. Because the
Holding Company qualifies under this grandfather provision, the GLB Act did not
affect the Holding Company's authority to engage in diversified business
activities.
Notwithstanding the above rules as to permissible business activities of
unitary savings and loan holding companies, if the savings association
subsidiary of such a holding company fails to meet the Qualified Thrift Lender
("QTL") test, then such unitary holding company would be deemed to be a bank
holding company subject to all of the provisions of the Bank Holding Company Act
of 1956 and other statutes applicable to bank holding companies, to the same
extent as if the Holding Company were a bank holding company and Lincoln Bank
were a bank. See "-Qualified Thrift Lender." At December 31, 2004, Lincoln
Bank's asset composition was in excess of that required to qualify as a
Qualified Thrift Lender.
If the Holding Company were to acquire control of another savings
association other than through a merger or other business combination with
Lincoln Bank, the Holding Company would thereupon become a multiple savings and
loan holding company. Except where such acquisition is pursuant to the authority
to approve emergency thrift acquisitions and where each subsidiary savings
association meets the QTL test, the activities of the Holding Company and any of
Lincoln Bank's subsidiaries (other than Lincoln Bank or other subsidiary savings
associations) would thereafter be subject to further restrictions. The HOLA
provides that, among other things, no multiple savings and loan holding company
or subsidiary thereof which is not a savings association shall commence or
continue for a limited period of time after becoming a multiple savings and loan
holding company or subsidiary thereof, any business activity other than (i)
furnishing or performing management services for a subsidiary savings
association, (ii) conducting an insurance agency or escrow business, (iii)
holding, managing, or liquidating assets owned by or acquired from a subsidiary
savings association, (iv) holding or managing properties used or occupied by a
subsidiary savings association, (v) acting as trustee under deeds of trust, (vi)
those activities in which multiple savings and loan holding companies were
authorized (by regulation) to directly engage on March 5, 1987, or (vii) those
activities authorized by the Federal Reserve Board (the "FRB") as permissible
for bank holding companies, unless the Director of the OTS by regulation
prohibits or limits such activities for savings and loan holding companies.
Those activities described in (vii) above must also be approved by the Director
of the OTS before a multiple savings and loan holding company may engage in such
activities.
The Director of the OTS may also approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state, if the multiple savings and loan holding
company involved controls a savings association which operated a home or branch
office in the state of the association to be acquired as of March 5, 1987, or if
the laws of the state in which the association to be acquired is located
specifically permit associations to be acquired by state-chartered associations
or savings and loan holding companies located in the state where the acquiring
entity is located (or by a holding company that controls such state-chartered
savings associations). Also, the Director of the
24
OTS may approve an acquisition resulting in a multiple savings and loan holding
company controlling savings associations in more than one state in the case of
certain emergency thrift acquisitions.
Indiana law permits federal and state savings association holding companies
with their home offices located outside of Indiana to acquire savings
associations whose home offices are located in Indiana and savings association
holding companies with their principal place of business in Indiana ("Indiana
Savings Association Holding Companies") upon receipt of approval by the Indiana
Department of Financial Institutions. Moreover, Indiana Savings Association
Holding Companies may acquire savings associations with their home offices
located outside of Indiana and savings association holding companies with their
principal place of business located outside of Indiana upon receipt of approval
by the Indiana Department of Financial Institutions.
No subsidiary savings association of a savings and loan holding company may
declare or pay a dividend or make a capital distribution on its permanent or
nonwithdrawable stock unless it first gives the Director of the OTS 30 days
advance notice of such declaration and payment. Any dividend declared during
such period or without giving notice shall be invalid.
Federal Home Loan Bank System
Lincoln Bank is a member of the FHLB system, which consists of 12 regional
banks. The Federal Housing Finance Board ("FHFB"), an independent agency,
controls the FHLB System including the FHLB of Indianapolis. The FHLB System
provides a central credit facility primarily for member financial institutions.
At December 31, 2004, Lincoln Bank's investment in stock of the FHLB of
Indianapolis was $10.4 million. For the fiscal year ended December 31, 2004, the
FHLB of Indianapolis paid approximately $432,000 in dividends to Lincoln Bank.
All 12 FHLB's are required to provide funds to establish affordable housing
programs through direct loans or interest subsidies on advances to members to be
used for lending at subsidized interest rates for low- and moderate-income,
owner-occupied housing projects, affordable rental housing, and certain other
community projects. These contributions and obligations could adversely affect
the value of FHLB stock in the future. A reduction in the value of such stock
may result in a corresponding reduction in Lincoln Bank's capital.
The FHLB of Indianapolis serves as a reserve or central bank for its member
institutions. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System. It makes advances to members in
accordance with policies and procedures established by the FHLB and the Board of
Directors of the FHLB of Indianapolis.
All FHLB advances must be fully secured by sufficient collateral as
determined by the FHLB. Eligible collateral includes first mortgage loans not
more than 90 days delinquent or securities evidencing interests therein,
securities (including mortgage-backed securities) issued, insured or guaranteed
by the federal government or any agency thereof, cash or FHLB deposits, certain
small business and agricultural loans of smaller institutions and real estate
with readily ascertainable value in which a perfected security interest may be
obtained. Other forms of collateral may be accepted as additional security or,
under certain circumstances, to renew outstanding advances. All long-term
advances are required to provide funds for residential home financing and the
FHLB has established standards of community service that members must meet to
maintain access to long-term advances.
Interest rates charged for advances vary depending upon maturity, the cost
of funds to the FHLB of Indianapolis and the purpose of the borrowing.
Insurance of Deposits
Deposit Insurance. The FDIC is an independent federal agency that insures
the deposits, up to prescribed statutory limits, of banks and thrifts and
safeguards the safety and soundness of the banking and
25
thrift industries. The FDIC administers two separate insurance funds, the BIF
for commercial banks and state savings banks and the SAIF for savings
associations such as Lincoln Bank and banks that have acquired deposits from
savings associations. The FDIC is required to maintain designated levels of
reserves in each fund.
Assessments. The FDIC is authorized to establish separate annual assessment
rates for deposit insurance for members of the BIF and members of the SAIF. The
FDIC may increase assessment rates for either fund if necessary to restore the
fund's ratio of reserves to insured deposits to the target level within a
reasonable time and may decrease these rates if the target level has been met.
The FDIC has established a risk-based assessment system for both SAIF and BIF
members. Under this system, assessments vary depending on the risk the
institution poses to its deposit insurance fund. An institution's risk level is
determined based on its capital level and the FDIC's level of supervisory
concern about the institution.
In addition to the assessment for deposit insurance, savings institutions
are required to pay on bonds issued in the late 1980s by the Financing
Corporation ("FICO"), which is a federally-chartered corporation that was
organized to provide some of the financing to resolve the thrift crisis in the
1980s. During 1998, FICO payments for SAIF members approximated 6.10 basis
points, while BIF members paid 1.22 basis points. By law, payments on FICO
obligations have been shared equally between BIF members and SAIF members since
January 1, 2000. Legislation is pending before Congress that would increase the
deposit insurance assessments paid by all financial institutions, including
Lincoln Bank.
Although Congress has considered merging the SAIF and the BIF, until then,
savings associations with SAIF deposits may not transfer deposits into the BIF
system without paying various exit and entrance fees. Such exit and entrance
fees need not be paid if a SAIF institution converts to a bank charter or merges
with a bank, as long as the resulting bank continues to pay applicable insurance
assessments to the SAIF, and as long as certain other conditions are met.
Savings Association Regulatory Capital
Currently, savings associations are subject to three separate minimum
capital-to-assets requirements: (i) a leverage limit, (ii) a tangible capital
requirement, and (iii) a risk-based capital requirement. The leverage limit
requires that savings associations maintain "core capital" of at least 3% of
total assets. Core capital is generally defined as common shareholders' equity
(including retained income), noncumulative perpetual preferred stock and related
surplus, certain minority equity interests in subsidiaries, qualifying
supervisory goodwill, purchased mortgage servicing rights and purchased credit
card relationships (subject to certain limits) less nonqualifying intangibles.
The OTS requires a core capital level of 3% of total adjusted assets for savings
associations that receive the highest rating for safety and soundness, and 4% to
5% for all other savings associations. Under the tangible capital requirement, a
savings association must maintain tangible capital (core capital less all
intangible assets except purchased mortgage servicing rights which may be
included after making the above-noted adjustment in an amount up to 100% of
tangible capital) of at least 1.5% of total assets. Under the risk-based capital
requirements, a minimum amount of capital must be maintained by a savings
association to account for the relative risks inherent in the type and amount of
assets held by the savings association. The risk-based capital requirement
requires a savings association to maintain capital (defined generally for these
purposes as core capital plus general valuation allowances and permanent or
maturing capital instruments such as preferred stock and subordinated debt, less
assets required to be deducted) equal to 8.0% of risk-weighted assets. Assets
are ranked as to risk in one of four categories (0-100%). A credit risk-free
asset, such as cash, requires no risk-based capital, while an asset with a
significant credit risk, such as a non-accrual loan, requires a risk factor of
100%. Moreover, a savings association must deduct from capital, for purposes of
meeting the core capital, tangible capital and risk-based capital requirements,
its entire investment in and loans to a subsidiary engaged in activities not
permissible for a national bank (other than exclusively agency activities for
its customers or mortgage
26
banking subsidiaries). At December 31, 2004, Lincoln Bank was in compliance with
all capital requirements imposed by law.
The OTS has revised its standards regarding the management of interest rate
risk to include summary guidelines to assist savings associations in determining
their exposures to interest rate risk. If an association is not in compliance
with the capital requirements, the OTS is required to prohibit asset growth and
to impose a capital directive that may restrict, among other things, the payment
of dividends and officers' compensation. In addition, the OTS and the FDIC
generally are authorized to take enforcement actions against a savings
association that fails to meet its capital requirements. These actions may
include restricting the operating activities of the association, imposing a
capital directive, cease and desist order, or civil money penalties, or imposing
harsher measures such as appointing a receiver or conservator or forcing the
association to merge into another institution.
Prompt Corrective Regulatory Action
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FedICIA") requires, among other things, that federal bank regulatory
authorities take "prompt corrective action" with respect to institutions that do
not meet minimum capital requirements. For these purposes, FedICIA establishes
five capital tiers: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized. At December 31,
2004, Lincoln Bank was categorized as "well capitalized," meaning that its total
risk-based capital ratio exceeded 10%, its Tier I risk-based capital ratio
exceeded 6%, its leverage ratio exceeded 5%, and it was not subject to a
regulatory order, agreement or directive to meet and maintain a specific capital
level for any capital measure.
The FDIC may order savings associations which have insufficient capital to
take corrective actions. For example, a savings association which is categorized
as "undercapitalized" would be subject to growth limitations and would be
required to submit a capital restoration plan, and a holding company that
controls such a savings association would be required to guarantee that the
savings association complies with the restoration plan. "Significantly
undercapitalized" savings associations would be subject to additional
restrictions. Savings associations deemed by the FDIC to be "critically
undercapitalized" would be subject to the appointment of a receiver or
conservator.
Dividend Limitations
The OTS also restricts the amount of "capital distributions" that may be
made by savings associations. The regulation defines a capital distribution as a
distribution of cash or other property to a savings association's owners, made
on account of their ownership. This definition includes a savings association's
payment of cash dividends to shareholders, or any payment by a savings
association to repurchase, redeem, retire, or otherwise acquire any of its
shares or debt instruments that are included in total capital, and any extension
of credit to finance an affiliate's acquisition of those shares or interests.
The amended regulation does not apply to dividends consisting only of a savings
association's shares or rights to purchase such shares.
The regulation exempts certain savings associations from filing either a
notice or an application with the OTS before making any capital distribution and
requires a savings association to file an application for approval of a proposed
capital distribution with the OTS if the association is not eligible for
expedited treatment under OTS's application processing rules, or the total
amount of all capital distributions, including the proposed capital
distribution, for the applicable calendar year would exceed an amount equal to
the savings association's net income for that year to date plus the savings
association's retained net income for the preceding two years (the "retained net
income standard"). Based on Lincoln Bank's retained net income standard at
December 31, 2004, Lincoln Bank would be required to file an application with
the OTS before making any capital distributions. A savings association must also
file an application for approval of a proposed capital distribution if,
following the proposed distribution, the association would not be at least
27
adequately capitalized under the OTS prompt corrective action regulations, or if
the proposed distribution would violate a prohibition contained in any
applicable statute, regulation, or agreement between the association and the OTS
or the FDIC.
The regulation requires a savings association to file a notice of a
proposed capital distribution in lieu of an application if the association or
the proposed capital distribution do not meet the conditions described above,
and: (1) the savings association will not be at least well capitalized (as
defined under the OTS prompt corrective action regulations) following the
capital distribution; (2) the capital distribution would reduce the amount of,
or retire any part of the savings association's common or preferred stock, or
retire any part of debt instruments such as notes or debentures included in the
association's capital under the OTS capital regulation; or (3) the savings
association is a subsidiary of a savings and loan holding company. Because
Lincoln Bank is a subsidiary of a savings and loan holding company, this latter
provision requires, at a minimum, that Lincoln Bank file a notice with the OTS
30 days before making any capital distributions to the Holding Company.
In addition to these regulatory restrictions, Lincoln Bank's Plan of
Conversion imposes additional limitations on the amount of capital distributions
it may make to the Holding Company. The Plan of Conversion requires Lincoln Bank
to establish and maintain a liquidation account for the benefit of Eligible
Account Holders and Supplemental Eligible Account Holders and prohibits Lincoln
Bank from making capital distributions to the Holding Company if its net worth
would be reduced below the amount required for the liquidation account.
Limitations on Rates Paid for Deposits
Regulations promulgated by the FDIC pursuant to FedICIA place limitations
on the ability of insured depository institutions to accept, renew or roll over
deposits by offering rates of interest which are significantly higher than the
prevailing rates of interest on deposits offered by other insured depository
institutions having the same type of charter in the institution's normal market
area. Under these regulations, "well-capitalized" depository institutions may
accept, renew or roll such deposits over without restriction, "adequately
capitalized" depository institutions may accept, renew or roll such deposits
over with a waiver from the FDIC (subject to certain restrictions on payments of
rates) and "undercapitalized" depository institutions may not accept, renew or
roll such deposits over. The regulations contemplate that the definitions of
"well-capitalized," "adequately-capitalized" and "undercapitalized" will be the
same as the definition adopted by the agencies to implement the corrective
action provisions of FedICIA. Management does not believe that these regulations
will have a materially adverse effect on Lincoln Bank's current operations.
Liquidity
The Financial Regulatory Relief and Economic Efficiency Act of 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 a rule 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.
Safety and Soundness Standards
The federal banking agencies have adopted final safety and soundness
standards for all insured depository institutions. The standards, which were
issued in the form of guidelines rather than regulations, relate to internal
controls, information systems, internal audit systems, loan underwriting and
documentation, compensation, interest rate exposure, asset quality and earnings
standards. In general, the standards are designed to assist the federal banking
agencies in identifying and addressing problems at insured depository
institutions before capital becomes impaired. If an institution fails to meet
these
28
standards, the appropriate federal banking agency may require the institution to
submit a compliance plan. Failure to submit a compliance plan may result in
enforcement proceedings.
Real Estate Lending Standards
OTS regulations require savings associations to establish and maintain
written internal real estate lending policies. Each association's lending
policies must be consistent with safe and sound banking practices and be
appropriate to the size of the association and the nature and scope of its
operations. The policies must establish loan portfolio diversification
standards; establish prudent underwriting standards, including loan-to-value
limits, that are clear and measurable; establish loan administration procedures
for the association's real estate portfolio; and establish documentation,
approval, and reporting requirements to monitor compliance with the
association's real estate lending policies. The association's written real
estate lending policies must be reviewed and approved by the association's Board
of Directors at least annually. Further, each association is expected to monitor
conditions in its real estate market to ensure that its lending policies
continue to be appropriate for current market conditions.
Loans to One Borrower
Under OTS regulations, Lincoln Bank may not make a loan or extend credit to
a single or related group of borrowers in excess of 15% of its unimpaired
capital and surplus. Additional amounts may be lent, not in excess of 10% of
unimpaired capital and surplus, if such loans or extensions of credit are fully
secured by readily marketable collateral, including certain debt and equity
securities but not including real estate. In some cases, a savings association
may lend up to 30% of unimpaired capital and surplus to one borrower for
purposes of developing domestic residential housing, provided that the
association meets its regulatory capital requirements and the OTS authorizes the
association to use this expanded lending authority. Lincoln Bank has established
an "in-house" lending limit of $3 million to a single or related group of
borrowers, which is significantly lower than the regulatory lending limit
described above. Any loan that exceeds this "in-house" lending limit up to the
regulatory lending limit must first be approved by Lincoln Bank's board of
directors. Lincoln Bank did not have any loans or extensions of credit to a
single or related group of borrowers in excess of its regulatory lending limits
at December 31, 2004. Management does not believe that the loans-to-one-borrower
limits will have a significant impact on Lincoln Bank's business operations or
earnings.
Qualified Thrift Lender
Savings associations must meet a QTL test that requires the association to
maintain an appropriate level of qualified thrift investments ("QTIs")
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise to qualify as a QTL. The required
percentage of QTIs is 65% of portfolio assets (defined as all assets minus
intangible assets, property used by the association in conducting its business
and liquid assets equal to 10% of total assets). Certain assets are subject to a
percentage limitation of 20% of portfolio assets. In addition, savings
associations may include shares of stock of the FHLBs, FNMA, and FHLMC as QTIs.
Compliance with the QTL test is determined on a monthly basis in nine out of
every twelve months. As of December 31, 2004, Lincoln Bank was in compliance
with its QTL requirement, with approximately 70.9% of its assets invested in
QTIs.
A savings association which fails to meet the QTL test must either convert
to a bank (but its deposit insurance assessments and payments will be those of
and paid to the SAIF) or be subject to the following penalties: (i) it may not
enter into any new activity except for those permissible for a national bank and
for a savings association; (ii) its branching activities shall be limited to
those of a national bank; and (iii) it shall be bound by regulations applicable
to national banks respecting payment of dividends. Three years after failing the
QTL test the association must dispose of any investment or activity not
permissible for a national bank and a savings association. If such a savings
association is controlled by a savings and loan holding company, then such
holding company must, within a prescribed time period, become registered as a
bank holding
29
company and become subject to all rules and regulations applicable to bank
holding companies (including restrictions as to the scope of permissible
business activities).
Acquisitions or Dispositions and Branching
The Bank Holding Company Act specifically authorizes a bank holding
company, upon receipt of appropriate regulatory approvals, to acquire control of
any savings association or holding company thereof wherever located. Similarly,
a savings and loan holding company may acquire control of a bank. Moreover,
federal savings associations may acquire or be acquired by any insured
depository institution. Regulations promulgated by the FRB restrict the
branching authority of savings associations acquired by bank holding companies.
Savings associations acquired by bank holding companies may be converted to
banks if they continue to pay SAIF premiums, but as such they become subject to
branching and activity restrictions applicable to banks.
Subject to certain exceptions, commonly-controlled banks and savings
associations must reimburse the FDIC for any losses suffered in connection with
a failed bank or savings association affiliate. Institutions are commonly
controlled if one is owned by another or if both are owned by the same holding
company. Such claims by the FDIC under this provision are subordinate to claims
of depositors, secured creditors, and holders of subordinated debt, other than
affiliates.
The OTS has adopted regulations which permit nationwide branching to the
extent permitted by federal statute. Federal statutes permit federal savings
associations to branch outside of their home state if the association meets the
domestic building and loan test in ss. 7701(a)(19) of the Code or the asset
composition test of ss. 7701(c) of the Code. Branching that would result in the
formation of a multiple savings and loan holding company controlling savings
associations in more than one state is permitted if the law of the state in
which the savings association to be acquired is located specifically authorizes
acquisitions of its state-chartered associations by state-chartered associations
or their holding companies in the state where the acquiring association or
holding company is located. Moreover, Indiana banks and savings associations are
permitted to acquire other Indiana banks and savings associations and to
establish branches throughout Indiana.
Finally, the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "Riegle-Neal Act") permits bank holding companies to acquire banks in
other states and, with state consent and subject to certain limitations, allows
banks to acquire out-of-state branches either through merger or de novo
expansion. The State of Indiana enacted legislation establishing interstate
branching provisions for Indiana state-chartered banks consistent with those
established by the Riegle-Neal Act (the "Indiana Branching Law"). The Indiana
Branching Law, which became effective in 1996, authorizes Indiana banks to
branch interstate by merger or de novo expansion, provided that such
transactions are not permitted to out-of-state banks unless the laws of their
home states permit Indiana banks to merge or establish de novo banks on a
reciprocal basis.
Transactions with Affiliates
Lincoln Bank is subject to Sections 22(h), 23A and 23B of the Federal
Reserve Act, which limits credit transactions between a bank or savings
association and its executive officers and its affiliates. These provisions also
prescribe terms and conditions for bank affiliate transactions deemed to be
consistent with safe and sound banking practices, and restrict the types of
collateral security permitted in connection with a bank's extension of credit to
an affiliate.
Federal Securities Law
The shares of Common Stock of the Holding Company have been registered with
the SEC under the 1934 Act and, as a result, the Holding Company is subject to
the information, proxy solicitation, insider trading restrictions and other
requirements of the 1934 Act and the rules of the SEC thereunder. After three
30
years following Lincoln Bank's conversion to stock form, if the Holding Company
has fewer than 300 shareholders, it may deregister its shares under the 1934 Act
and cease to be subject to the foregoing requirements.
Shares of Common Stock held by persons who are affiliates of the Holding
Company may not be resold without registration unless sold in accordance with
the resale restrictions of Rule 144 under the 1933 Act. If the Holding Company
meets the current public information requirements under Rule 144, each affiliate
of the Holding Company who complies with the other conditions of Rule 144
(including those that require the affiliate's sale to be aggregated with those
of certain other persons) would be able to sell in the public market, without
registration, a number of shares not to exceed, in any three-month period, the
greater of (i) 1% of the outstanding shares of the Holding Company or (ii) the
average weekly volume of trading in such shares during the preceding four
calendar weeks.
Sarbanes-Oxley Act of 2002
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of
2002 (the "Sarbanes-Oxley" Act). The Sarbanes-Oxley Act's stated goals include
enhancing corporate responsibility, increasing penalties for accounting and
auditing improprieties at publicly traded companies and protecting investors by
improving the accuracy and reliability of corporate disclosures pursuant to the
securities laws. The Sarbanes-Oxley Act generally applies to all companies that
file or are required to file periodic reports with the Securities and Exchange
Commission under the 1934 Act.
Among other things, the Sarbanes-Oxley Act creates the Public Company
Accounting Oversight Board as an independent body subject to SEC supervision
with responsibility for setting auditing, quality control and ethical standards
for auditors of public companies. The Sarbanes-Oxley Act also requires public
companies to make faster and more-extensive financial disclosures, requires the
chief executive officer and chief financial officer of public companies to
provide signed certifications as to the accuracy and completeness of financial
information filed with the SEC, and provides enhanced criminal and civil
penalties for violations of the federal securities laws.
The Sarbanes-Oxley Act also addresses functions and responsibilities of
audit committees of public companies. The statute makes the audit committee
directly responsible for the appointment, compensation and oversight of the work
of the company's outside auditor, and requires the auditor to report directly to
the audit committee. The Sarbanes-Oxley Act authorizes each audit committee to
engage independent counsel and other advisors, and requires a public company to
provide the appropriate funding, as determined by its audit committee, to pay
the company's auditors and any advisors that its audit committee retains. The
Sarbanes-Oxley Act also requires public companies to include an internal control
report and assessment by management, along with an attestation to this report
prepared by the company's registered public accounting firm, in their annual
reports to stockholders.
Although the Holding Company will incur additional expense in complying
with the provisions of the Sarbanes-Oxley Act and the resulting regulations,
management does not expect that such compliance will have a material impact on
the Holding Company's results of operations or financial condition.
Fair Credit Reporting Act Amendment
The Fair and Accurate Credit Transactions Act of 2003 (the "FACT Act") was
signed into law by President Bush on December 4, 2003. The FACT Act amends the
Fair Credit Reporting Act and makes permanent certain federal preemptions that
form the basis for a national credit reporting system. The FACT Act is also
intended to (i) address identity theft, (ii) increase access to credit
information, (iii) enhance the accuracy of credit reporting, (iv) facilitate the
opt-out by consumers from certain marketing solicitations, (v) protect medical
information, and (vi) promote financial literacy. The statute will affect credit
reporting agencies (commonly referred to as "credit bureaus"), financial
institutions, other users of credit reports and
31
those who furnish information to credit bureaus. The Bank does not anticipate
that this legislation will have a significant adverse effect on its business.
Community Reinvestment Act Matters
Federal law requires that ratings of depository institutions under the
Community Reinvestment Act of 1977 ("CRA") be disclosed. The disclosure includes
both a four-unit descriptive rating -- outstanding, satisfactory, needs to
improve, and substantial noncompliance -- and a written evaluation of an
institution's performance. Each FHLB is required to establish standards of
community investment or service that its members must maintain for continued
access to long-term advances from the FHLBs. The standards take into account a
member's performance under the CRA and its record of lending to first-time home
buyers. The OTS has designated Lincoln Bank's record of meeting community credit
needs as satisfactory.
Predatory Lending
The Federal Reserve Board issued a regulation that became effective on
October 1, 2002 that is aimed at curbing "predatory lending." The term
"predatory lending" encompasses a variety of practices, but the term generally
is used to refer to abusive lending practices involving fraud, deception or
unfairness. Predatory lending typically involves one or more of the following:
(i) making unaffordable loans based on the assets of the borrower rather than on
the borrower's ability to repay an obligation ("asset-based lending"); (ii)
inducing a borrower to refinance a loan repeatedly in order to charge high
points and fees each time the loan is refinanced ("loan flipping"); or (iii)
engaging in fraud or deception to conceal the true nature of the loan obligation
from an unsuspecting or unsophisticated borrower. The Federal Reserve Board's
new regulation, which amends Regulation Z, broadens the scope of loans subject
to the protections of the Home Ownership and Equity Protection Act of 1994
("HOEPA"). Among other things, the regulation brings within the scope of HOEPA
first-lien mortgage loans with interest rates that are at least 8 percentage
points above Treasury securities having a comparable maturity. In addition, the
regulation requires that the cost of optional insurance and similar debt
protection products paid by a borrower at closing be included in calculating the
finance charge paid by the borrower. HOEPA coverage is triggered if such finance
charges exceed 8 percent of the total loan. Finally, the regulation restricts
creditors from engaging in repeated refinancings of their own HOEPA loans over a
short time period when the transactions are not in the borrower's interest.
Lenders that violate the rules face cancellation of loans and penalties equal to
the finance charges paid. The Bank is unable at this time to determine the
impact that these new regulations, or any similar state predatory lending
regulations, may have on its financial condition or results of operation.
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001. The
Patriot Act is intended is to strengthen U.S. law enforcement's and the
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Act on financial institutions of
all kinds is significant and wide ranging. The Act contains sweeping anti-money
laundering and financial transparency laws. On April 30, 2003, the Treasury
Department issued final regulations requiring institutions to incorporate into
their written money laundering plans a board-approved customer identification
program implementing reasonable procedures for: (i) verifying the identity of
any person seeking to open an account, to the extent reasonable and practicable;
(ii) maintaining records of the information used to verify the person's
identity; and (iii) determining whether the person appears on any list of known
or suspected terrorists or terrorist organizations. The Bank does not anticipate
that these requirements will materially affect its operations.
32
TAXATION
Federal Taxation
Historically, savings associations, such as Lincoln Bank, have been
permitted to compute bad debt deductions using either the bank experience method
or the percentage of taxable income method. However, for years beginning after
December 31, 1995, no savings association may use the percentage of taxable
income method of computing its allowable bad debt deduction for tax purposes.
Instead, all savings associations are required to compute their allowable
deduction using the experience method. The pre-1988 reserve, for which no
deferred taxes have been recorded, need not be recaptured into income unless (i)
the savings association no longer qualifies as a bank under the Code, or (ii)
the savings association pays out excess dividends or distributions. Although
Lincoln Bank does have some reserves from before 1988, Lincoln Bank is not
required to recapture these reserves.
Depending on the composition of its items of income and expense, a savings
association may be subject to the alternative minimum tax. A savings association
must pay an alternative minimum tax on the amount (if any) by which 20% of
alternative minimum taxable income ("AMTI"), as reduced by an exemption varying
with AMTI, exceeds the regular tax due. AMTI equals regular taxable income
increased or decreased by certain tax preferences and adjustments, including
depreciation deductions in excess of that allowable for alternative minimum tax
purposes, tax-exempt interest on most private activity bonds issued after August
7, 1986 (reduced by any related interest expense disallowed for regular tax
purposes), the amount of the bad debt reserve deduction claimed in excess of the
deduction based on the experience method and 75% of the excess of adjusted
current earnings over AMTI (before this adjustment and before any alternative
tax net operating loss). AMTI may be reduced only up to 90% by net operating
loss carryovers, but alternative minimum tax paid can be credited against
regular tax due in later years.
For federal income tax purposes, the Company has been reporting its income
and expenses on the accrual method of accounting. The Company's federal income
tax returns were audited in 2000 and no adjustments were made.
State Taxation
The Company is subject to Indiana's Financial Institutions Tax ("FIT"),
which is imposed at a flat rate of 8.5% on "apportioned adjusted gross income."
"Apportioned adjusted gross income," for purposes of FIT, begins with taxable
income as defined by Section 63 of the Code and, thus, incorporates federal tax
law to the extent that it affects the computation of taxable income. Federal
taxable income is then adjusted by several Indiana modifications. Other
applicable state taxes include generally applicable sales and use taxes plus
real and personal property taxes.
The Company's state income tax returns have not been audited in recent
years.
Item 2. Properties.
The following table provides certain information with respect to Lincoln
Bank's offices as of December 31, 2004:
33
Net Book Value
of Property, Approximate
Description Owned or Year Total Furniture Square
and Address Leased Opened Deposits & Fixtures Footage
- ---------------------------- -------- ------ -------- -------------- ------------
(Dollars in Thousands)
1121 East Main Street Owned 1970 $124,879 $1,116 9,925
Plainfield, IN 46168
134 South Washington Street Owned 1962 47,906 349 9,340
Crawfordsville, IN 47933
1900 East Wabash Street Owned 1974 24,688 255 2,670
Frankfort, IN 46041
60 South Main Street Owned 2000 44,817 736 11,750
Frankfort, IN 46041
975 East Main Street Owned 1981 33,919 529 2,890
Brownsburg, IN 46112
7648 East U.S. Highway 36 Owned 1999 27,153 810 2,800
Avon, IN 46123
590 S. State Road 67 Leased 1999 12,484 158 1,500
Mooresville, IN 46158
648 Treybourne Drive Owned 2000 16,756 887 2,550
Greenwood, IN 46142
18 Providence Drive Owned 2002 27,323 1,102 2,800
Greenwood, IN 46143
250 N. State Road 135* Leased 2004 7,185 255 1,100
Bargersville, IN 46106
2259 N. Morton* Owned 2003 22,187 1,263 3,750
Franklin, IN 46131
1266 N. Madison Avenue* Leased 1999 12,219 95 2,150
Greenwood, IN 46142
996 S. State Road 135* Leased 2000 36,416 379 5,000
Greenwood, IN 46143
180 W. Washington Street* Owned 1894 33,418 567 4,000
Morgantown, IN 46160
189 Commercial Drive* Leased 2001 23,818 121 3,000
Nashville, IN 47448
110 N. State Road 135* Owned 1997 21,160 198 1,100
Trafalgar, IN 46181
905 Southfield Drive Owned 2004 --+ 5,502 24,500
Plainfield, IN 46168
Mortgage Office:
3195 W. Fairview Road* Leased 2002 -- 90 4,800
Suite A
Greenwood, IN 46142
* Offices acquired in acquisition of First Shares.
+ No deposits are reflected at this location due to the branch not opening until
March 2005. This location will also be the new corporate headquarters for
Lincoln Bancorp in 2005.
34
Lincoln Bank owns computer and data processing equipment which it uses for
transaction processing, loan origination, and accounting. The net book value of
Lincoln Bank's electronic data processing equipment was approximately $854,000
at December 31, 2004.
Lincoln Bank currently operates 17 automatic teller machines ("ATMs"), with
one ATM located at its main office and each of its branch offices plus one cash
dispenser at a supermarket. Lincoln Bank's ATMs participate in the Star(R)
network.
Lincoln Bank has also contracted for data processing, item processing,
electronic banking and ATM processing with Fidelity Information Services,
located in Plano, Texas. The cost of these services is approximately $144,000
per month.
Item 3. Legal Proceedings.
Although the Holding Company and Lincoln Bank are involved, from time to
time, in various legal proceedings in the normal course of business, there are
no material legal proceedings to which they presently are a party or to which
any of the Holding Company's or Lincoln Bank's property is subject.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of the Company's shareholders during the
quarter ended December 31, 2004.
Item 4.5. Executive Officers of the Registrant.
The executive officers of the Holding Company are identified below. The
executive officers are elected annually by the Holding Company's Board of
Directors and the Bank's Board of Directors.
T. Tim Unger (age 64) has been Chairman of the Board, President and Chief
Executive Officer of the Holding Company since December 1998. Mr. Unger also
serves as the President and Chief Executive Officer of the Bank since January
1996. Mr. Unger has served the banking industry since 1966.
Jerry R. Engle (age 59) has been the Executive Vice President and Chief
Operating Officer of the Bank, and Vice Chairman of the Board of Directors of
the Holding Company, since the merger of First Shares in August 2004. Formerly,
he was the President and Chief Executive Officer of First Shares and First Bank
from March 1999 until joining the Company. Prior to that time, he was chief
executive officer of Citizens Bank of Central Indiana, a position he assumed in
1992 when Indiana Bancshares, Inc., of which he was chief executive officer,
merged into CNB Bancshares, Inc., the holding company for Citizens Bank.
John M. Baer (age 56) has served as the Holding Company's Secretary and
Treasurer since December 1998 and as Lincoln Bank's Senior Vice President, Chief
Financial Officer, Secretary and Treasurer since June 1997. From October 1989
through June 1996 he served as Senior Vice President and Chief Financial Officer
of Bank One, Merrillville, NA, in Merrillville, Indiana. Mr. Baer has served the
banking industry since 1978.
Rebecca J. Morgan (age 54) has served as the Holding Company's Vice
President since January 2002 and as the Bank's Senior Vice president and Retail
Sales Manager since June 1999. Prior to joining the Company, Ms. Morgan was
Senior Vice President and a Retail Sales Manager for First of America Bank.
John B. Ditmars (age 48) has served the Bank as the Senior Vice President
of Administration since the merger of First Shares in August 2004. Prior to that
time, he served from March 1999 until the merger as Executive Vice President of
First Bank.
Jonathan D. Slaughter (age 54) has served the Bank as the Senior Vice
President, Credit Administration, since June 2004. Prior to that time, he served
First Bank as a Senior Vice President and Commercial Loan Manager from April
2003 until June 2004, as a Market President for Irwin Financial for two years
and CNB Bancshares for five years. He has served the banking industry for over
28 years.
35
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and
Issuer Purchases of Equity Securities.
The information required by this item is contained in the material under
the heading "Shareholder Information" on page 39 of the Holding Company's 2004
Shareholder Annual Report (the "Shareholder Annual Report"), which is
incorporated herein by this reference.
There were no repurchases of equity securities by the Holding Company
during the fourth quarter of 2004.
Item 6. Selected Financial Data.
The information required by this item is contained in the material under
the heading "Selected Consolidated Financial Data of Lincoln Bancorp and
Subsidiary" on pages 6 and 7 of the Shareholder Annual Report, which is
incorporated herein by this reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation.
The information required by this item is contained on pages 7 through 20 of
the Shareholder Annual Report, which is incorporated herein by this reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is contained on pages 19 and 20 of
the Shareholder Annual Report, which is incorporated herein by this reference.
Item 8. Financial Statements and Supplementary Data.
The Holding Company's Consolidated Financial Statements and Notes thereto
contained on pages 22 through 38 in the Shareholder Annual Report are
incorporated herein by reference. The Company's unaudited quarterly results of
operations contained on page 19 in the Shareholder Annual Report are
incorporated herein by reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not applicable.
Item 9A. Controls and Procedures.
An evaluation was carried out under the supervision and with the
participation of the Holding Company's management, including its Chief Executive
Officer and Treasurer, of the effectiveness of the Holding Company's disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) as of the end of the fourth
quarter of the 2004 fiscal year covered by this report. Based on their
evaluation, the Holding Company's Chief Executive Officer and Treasurer have
concluded that the Holding Company's disclosure controls and procedures are, to
the best of their knowledge, effective to ensure that information required to be
disclosed by the Holding Company in reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms, except
as provided in the next paragraph.
With respect to the last quarter of 2004, our independent registered public
accounting firm noted a material weakness in the design or operation of the
Company's internal controls that could adversely affect the Company's ability to
record, process, summarize and report financial data consistent with the
assertions of management in the financial statements. The material weakness
identified by management and our independent auditors was the lack of timely
reconciliation of the Company's primary correspondent
36
account. Management of the Company has reviewed this item with the Audit
Committee of the Board and has implemented procedures and plans to timely
reconcile the correspondent account.
The Holding Company's management, including its Chief Executive Officer and
Treasurer, also have concluded that during the Holding Company's fiscal quarter
ended December 31, 2004, there have been no significant changes in the Holding
Company's internal controls or in other factors that could significantly affect
the internal controls, including any corrective action with regard to material
weaknesses, other than the matter disclosed in the paragraph above.
Item 9B. Other Information.
None.
PART III
Certain information in this Part III is incorporated by reference to the
Holding Company's Proxy Statement for its Annual Meeting of Shareholders to be
held May 17, 2005, to be filed within 120 days after the year ended December 31,
2004 (the "2005 Proxy Statement").
Item 10. Directors and Executive Officers of the Registrant.
The Holding Company has adopted a Code of Ethics that applies to all
employees, including the principal executive, financial and accounting officers,
and to all directors. A copy of the Code of Ethics is attached to this Annual
Report on Form 10-K as Exhibit 14. The other information required by this item
is incorporated by reference to the sections of the 2005 Proxy Statement with
the captions "Proposal I - Election of Directors" and "Section 16(a) Beneficial
Ownership Reporting Compliance."
Item 11. Executive Compensation.
The information required by this item is incorporated by reference to the
section of the 2005 Proxy Statement with the caption "Proposal I - Election of
Directors -- Management Remuneration and Related Transactions."
37
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
Equity Compensation Plan Information
The following table provides information, as of December 31, 2004,
regarding the securities authorized for issuance under the Company's equity
compensation plans.
Number of securities
Number of remaining available for
securities to be Weighted-average future issuance under
issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
- --------------------- ----------------------- -------------------- -------------------------
Equity compensation
plans approved by
security holders 641,294 (1) $12.71 35,930
6,400 (2) -- 43,046
Equity compensation
plans not approved
by security holders -- -- --
------- ------ ------
Total 647,694 $12.71 (3) 78,976
======= ====== ======
- ------------------
(1) The Lincoln Bancorp Stock Option Plan.
(2) The Lincoln Bancorp Recognition and Retention Plan and Trust ("RRP").
Column (a) includes 6,400 shares granted to management that have not yet
vested.
(3) The total in column (b) includes only the weighted-average price of stock
options, as the restricted shares awarded under the RRP have no exercise
price.
Security Ownership of Management and Certain Beneficial Owners
The information on the security ownership of management and certain
beneficial owners is incorporated by reference to the sections of the 2005 Proxy
Statement with the captions "Voting Securities and Principal Holders Thereof"
and "Proposal I - Election of Directors."
Item 13. Certain Relationships and Related Transactions.
The information required by this item is incorporated by reference to the
section of the 2005 Proxy Statement with the caption "Proposal I - Election of
Directors -- Transactions with Certain Related Persons."
Item 14. Principal Accountant Fees and Servicer.
The information required by this item is incorporated by reference to the
section of the 2005 Proxy Statement with the caption "Accountants."
38
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a) The following documents are filed as part of this Annual Report on
Form 10-K:
(1) Financial Statements:
Report of Independent Registered Public Accounting
Firm ..................................................... See Shareholder Annual Report
Page 21
Consolidated Balance Sheets at December 31, 2004
and 2003.................................................. See Shareholder Annual Report
Page 22
Consolidated Statements of Income for the Years
Ended December 31, 2004, 2003 and 2002.................... See Shareholder Annual Report
Page 23
Consolidated Statements of Comprehensive Income
for the Years Ended December 31, 2004, 2003
and 2002.................................................. See Shareholder Annual Report
Page 24
Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 2004, 2003
and 2002.................................................. See Shareholder Annual Report
Page 25
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2004, 2003 and 2002.................... See Shareholder Annual Report
Page 26
Notes to Consolidated Financial Statements.................... See Shareholder Annual Report
Page 27-38
(2) Financial Statement Schedules:
(3) Exhibits:
The exhibits listed in the Exhibit Index are filed with or
incorporated herein by reference.
(b) The exhibits filed herewith or incorporated by reference herein are
set forth on the Exhibit Index on page E-1.
(c) All schedules are omitted as the required information either is not
applicable or is included in the Consolidated Financial Statements or
related notes.
39
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) 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.
LINCOLN BANCORP
Date: March 31, 2005 By: /s/ T. Tim Unger
------------------------------------
T. Tim Unger, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities indicated on this 31st day of March 2005.
Signatures Title Date
---------------------------- ----------------------- ---------------
(1) Principal Executive Officer: )
)
)
)
/s/ T. Tim Unger )
-------------------------- )
T. Tim Unger President and )
Chief Executive Officer )
)
)
(2) Principal Financial and )
Accounting Officer: )
)
)
/s/ John M. Baer Secretary and Treasurer )
-------------------------- )
John M. Baer ) March 31, 2005
)
)
(3) The Board of Directors: )
)
)
/s/ Lester N. Bergum, Jr. Director )
-------------------------- )
Lester N. Bergum, Jr. )
)
)
/s/ Dennis W. Dawes Director )
-------------------------- )
Dennis W. Dawes )
40
)
)
/s/ Jerry R. Engle Director )
-------------------------- )
Jerry R. Engle )
)
)
/s/ W. Thomas Harmon Director )
-------------------------- )
W. Thomas Harmon )
)
)
/s/ Jerry R. Holifield Director )
-------------------------- )
Jerry R. Holifield )
)
)
/s/ David E. Mansfield Director )
-------------------------- )
David E. Mansfield )
)
)
/s/ R.J. McConnell Director )
-------------------------- )
R.J. McConnell ) March 31, 2005
)
)
/s/ John C. Milholland Director )
-------------------------- )
John C. Milholland )
)
)
/s/ Frank A. Rogers Director )
-------------------------- )
Frank A. Rogers )
)
)
/s/ T. Tim Unger Director )
-------------------------- )
T. Tim Unger )
)
)
/s/ John L. Wyatt Director )
-------------------------- )
John L. Wyatt )
)
41
EXHIBIT INDEX
Exhibit No. Description
----------- ------------
3(1) Registrant's Articles of Incorporation (incorporated by
reference to Exhibit (1)to the Registrant's Registration
Statement on Form S-1 filed with the Commission on September 14,
1998 (the "S-1 Registration Statement")).
(2) Registrant's Code of By-Laws (incorporated by reference to
Exhibit 3(2) to the Pre-Effective No. 1 to the Form S-1
Registration Statement filed with the Commission on November 2,
1998 (the "Amendment No. 1 to Form S-1")).
10(1)* Lincoln Bancorp Stock Option Plan (incorporated by reference to
Exhibit 10(2) to the S-1 Registration Statement).
(2)* Lincoln Federal Savings Bank Recognition and Retention Plan and
Trust (incorporated by reference to Exhibit 10(3) to the S-1
Registration Statement).
(3)* Employment Agreement between Lincoln Federal Savings Bank and T.
Tim Unger (incorporated by reference to Exhibit 10(4) to the S-1
Registration Statement).
(4) Lincoln Federal Savings Bank Employee Stock Ownership Plan and
Trust Agreement (incorporated by reference to Exhibit 10(5) to
the S-1 Registration Statement).
(5) ESOP Loan Commitment by Lincoln Bancorp and Exempt Loan and
Share Purchase Agreement, effective as of July 1, 1998, between
Trust under Lincoln Bancorp Exempt Stock Ownership Plan and
Trust Agreement and Lincoln Bancorp (incorporated by reference
to Exhibit 10(6) to the Amendment No. 1 to Form S-1).
(6)* Unfunded Deferred Compensation Plan for the Directors of Lincoln
Federal Savings Bank (as Amended and Restated Effective January
1, 1999) (incorporated by reference to Exhibit 10(7) to the
Registrant's Registration Statement on Form S-4 filed with the
Commission on June 21, 2000 (the "S-4 Registration Statement")).
(7)* Lincoln Federal Savings Bank Deferred Director Supplemental
Retirement Plan (Effective December 1, 1997) (incorporated by
reference to Exhibit 10(8) to the S-1 Registration Statement).
(8) First Amendment to the Lincoln Federal Savings Bank Employee
Stock Ownership Plan and Trust Agreement (incorporated by
reference to Exhibit 10(a) to the S-4 Registration Statement).
(9) Second Amendment to the Lincoln Federal Savings Bank Employee
Stock Ownership Plan and Trust Agreement (incorporated by
reference to Exhibit 10(10) to the S-4 Registration Statement).
(10)* Employment Agreement, between Lincoln Federal Savings Bank and
John M. Baer (incorporated by reference to Exhibit 10(11) to the
2000 Annual Report on Form 10-K filed with the Commission on
April 2, 2001 (the "2000 10-K")).
(11)* Employment Agreement, dated January 16, 2001, between Lincoln
Federal Savings Bank and Rebecca J. Morgan (incorporated by
reference to Exhibit 10(12) to the 2000 10-K).
(12)* Employment Agreement, dated August 2, 2004, between Lincoln Bank
and Jerry R. Engle.
(13)* Employment Agreement, dated August 2, 2004, between Lincoln Bank
and John B. Ditmars.
E-1
(14)* First Amendment to Restated Lincoln Bank Deferred Director
Supplemental Retirement Plan (incorporated by reference to
Exhibit 10.1 to the Current Report on Form 8-K filed with the
Commission on March 21, 2005).
(15)* Unfunded Deferred Compensation Plan for the Directors of Lincoln
Bank (As Amended and Restated Effective January 1, 2005)
(incorporated by reference to Exhibit 10.2 to the Current Report
on Form 8-K filed with the Commission on March 21, 2005).
(16) Form of Incentive Stock Option Agreement Under the Lincoln
Bancorp Stock Option Plan.
(17) Form of Non-Qualified Stock Option Agreement Under the Lincoln
Bancorp Stock Option Plan.
(18) Form of Award Notification Under the Lincoln Federal Savings
Bank Recognition and Retention Plan and Trust.
13 2004 Shareholder Annual Report.
14 Ethics Policy (incorporated by reference to Exhibit 14 to the
2004 10-K).
21 Subsidiaries of Registrant.
23 Consent of Independent Registered Public Accounting Firm.
31(1) Certification.
31(2) Certification.
32 Certification.
* Compensation plans or arrangements in which directors or executive officers
are eligible to participate.
E-2