Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 000-21671
THE NATIONAL BANK OF INDIANAPOLIS CORPORATION
(Exact name of Registrant as Specified in its Charter)
Indiana 35-1887991
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
107 North Pennsylvania Street 46204
Indianapolis, Indiana (Zip Code)
(Address of Principal Executive Offices)
(317) 261-9000
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes [ ] No [X]
The number of shares of the registrant's Common Stock outstanding August 9,
2004 was 2,361,891.
Table of Contents
The National Bank of Indianapolis Corporation
Report on Form 10-Q
for Quarter Ended
June 30, 2004
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - June 30, 2004
and December 31, 2003...............................................1
Consolidated Statements of Income - Three Months
ended June 30, 2004 and 2003........................................2
Consolidated Statements of Income - Six Months
ended June 30, 2004 and 2003........................................3
Consolidated Statements of Cash Flows - Six Months
ended June 30 2004 and 2003.........................................4
Consolidated Statements of Shareholders' Equity - Six Months
ended June 31, 2004 and 2003........................................5
Notes to Consolidated Financial Statements.......................6-10
Item 2. Management's Discussion and Analysis............................11-22
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........22
Item 4. Controls and Procedures............................................23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings..................................................24
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases
Equity Securities...............................................24-25
Item 3. Defaults Upon Senior Securities....................................25
Item 4. Submission of Matters to a Vote of Security Holders.............25-26
Item 5. Other Information .................................................26
Item 6. Exhibits and Reports on Form 8-K...................................26
Signatures ...................................................................27
Part I - Financial Information
Item 1. Financial Statements
The National Bank of Indianapolis Corporation
Consolidated Balance Sheets
June 30, December 31,
2004 2003
(Unaudited) (Note)
---------------------------------
Assets
Cash and due from banks $ 47,031,657 $ 44,383,402
Reverse repurchase agreements 5,000,000 15,000,000
Federal funds sold 36,446,913 20,502,386
Investment securities
Available-for-sale securities 72,144,781 115,862,372
Held-to-maturity securities 56,764,223 5,826,468
---------------------------------
Total investment securities 128,909,004 121,688,840
Loans 616,404,638 597,062,744
Less: Allowance for loan losses (8,129,526) (8,029,596)
---------------------------------
Net loans 608,275,112 589,033,148
Premises and equipment 8,810,986 9,148,709
Accrued interest 3,437,236 3,503,401
Stock in federal banks 3,620,100 3,558,200
Other assets 7,443,095 5,780,728
---------------------------------
Total assets $ 848,974,103 $ 812,598,814
================================
Liabilities and shareholders' equity
Deposits:
Noninterest-bearing demand deposits $ 151,819,657 $ 138,087,276
Money market and savings deposits 409,380,854 382,574,081
Time deposits over $100,000 20,329,864 48,219,664
Other time deposits 99,733,076 68,656,059
---------------------------------
Total deposits 681,263,451 637,537,080
Security repurchase agreements 68,860,518 71,557,046
FHLB advances 32,000,000 42,000,000
Subordinated debt 5,000,000 2,000,000
Company obligated mandatorily redeemable preferred capital
securities of subsidiary trust holding solely the junior
subordinated debentures of the parent company -- 13,500,000
Junior subordinated debentures owed to unconsolidated subsidiary trust 13,918,000 --
Other liabilities 4,146,315 3,326,284
---------------------------------
Total liabilities 805,188,284 769,920,410
Shareholders' equity:
Common stock, no par value:
Authorized shares 2004 and 2003 -3,000,000 shares;
issued 2,578,392 in 2004 and 2,517,131 in 2003;
outstanding 2,349,759 in 2004 and 2,352,229 in 2003 21,623,335 22,858,900
Unearned compensation (698,387) (894,679)
Additional paid in capital 3,441,024 3,019,003
Retained earnings 20,255,093 17,684,102
Accumulated other comprehensive income (loss) (835,246) 11,078
---------------------------------
Total shareholders' equity 43,785,819 42,678,404
---------------------------------
Total liabilities and shareholders' equity $ 848,974,103 $ 812,598,814
================================
Note: The balance sheet at December 31, 2003 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. See notes to consolidated financial statements.
1
The National Bank of Indianapolis Corporation
Consolidated Statements of Income
(Unaudited)
Three months ended
June 30,
2004 2003
---------------------------
Interest income:
Interest and fees on loans $ 7,811,452 $ 7,836,100
Interest on investment securities 1,058,075 694,755
Interest on federal funds sold 165,267 137,153
Interest on reverse repurchase agreements 22,691 22,199
---------------------------
Total interest income 9,057,485 8,690,207
Interest expense:
Interest on deposits 2,000,094 1,954,503
Interest on repurchase agreements 70,009 112,516
Interest on FHLB advances 426,500 629,822
Interest on long term debt 406,278 366,372
---------------------------
Total interest expense 2,902,881 3,063,213
---------------------------
Net interest income 6,154,604 5,626,994
Provision for loan losses 300,000 300,000
---------------------------
Net interest income after provision for loan losses 5,854,604 5,326,994
Other operating income:
Trust fees and commissions 641,698 330,622
Building rental income 123,639 126,905
Service charges and fees on deposit accounts 558,109 613,985
Net gain on sale of mortgage loans 3,830 458,615
Interchange income 150,172 139,366
Other income 354,959 381,867
---------------------------
Total operating income 1,832,407 2,051,360
Other operating expenses:
Salaries, wages and employee benefits 3,513,997 2,959,716
Occupancy expense 341,514 345,522
Furniture and equipment expense 210,922 221,416
Professional services 356,828 215,012
Data processing 361,007 338,599
Business development 256,167 229,780
Mortgage servicing rights impairment (recoveries) charges (113,480) 150,787
Other expenses 798,971 917,501
---------------------------
Total other operating expenses 5,725,926 5,378,333
---------------------------
Net income before tax 1,961,085 2,000,021
Federal and state income tax 439,384 794,561
---------------------------
Net income after tax $ 1,521,701 $ 1,205,460
===========================
Basic earnings per share $ 0.66 $ 0.51
===========================
Diluted earnings per share $ 0.64 $ 0.48
===========================
See notes to consolidated financial statements.
2
The National Bank of Indianapolis Corporation
Consolidated Statements of Income
(Unaudited)
Six months ended
June 30,
2004 2003
-----------------------------
Interest income:
Interest and fees on loans $ 15,483,925 $ 15,465,073
Interest on investment securities 2,008,493 1,533,908
Interest on federal funds sold 271,036 225,886
Interest on reverse repurchase agreements 52,958 35,996
-----------------------------
Total interest income 17,816,412 17,260,863
Interest expense:
Interest on deposits 3,997,830 3,838,370
Interest on repurchase agreements 148,123 234,673
Interest on FHLB advances 944,277 1,252,723
Interest on long term debt 792,746 727,247
-----------------------------
Total interest expense 5,882,976 6,053,013
-----------------------------
Net interest income 11,933,436 11,207,850
Provision for loan losses 600,000 600,000
-----------------------------
Net interest income after provision for loan losses 11,333,436 10,607,850
Other operating income:
Trust fees and commissions 1,214,802 895,715
Building rental income 256,371 265,029
Service charges and fees on deposit accounts 1,127,626 1,238,104
Net gain on sale of mortgage loans 94,737 821,471
Interchange income 282,155 272,401
Securities losses net (83,739) --
Other 673,372 658,682
-----------------------------
Total operating income 3,565,324 4,151,402
Other operating expenses:
Salaries, wages and employee benefits 6,731,914 5,982,952
Occupancy expense 710,120 716,795
Furniture and equipment expense 424,204 435,628
Professional services 659,537 438,981
Data processing 719,470 668,126
Business development 537,801 473,333
Mortgage servicing rights impairment (recoveries) charges (158,652) 277,176
Other expenses 1,578,363 1,623,516
-----------------------------
Total other operating expenses 11,202,757 10,616,507
-----------------------------
Net income before tax 3,696,003 4,142,745
Federal and state income tax 1,125,012 1,640,459
-----------------------------
Net income after tax $ 2,570,991 $ 2,502,286
=============================
Basic earnings per share $ 1.12 $ 1.06
=============================
Diluted earnings per share $ 1.08 $ 0.99
=============================
See notes to consolidated financial statements.
3
The National Bank of Indianapolis Corporation
Consolidated Statements of Cash Flows
(Unaudited)
Six months ended
June 30,
2004 2003
--------------------------------
Operating Activities
Net Income $ 2,570,991 $ 2,502,286
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 600,000 600,000
Depreciation and amortization 651,918 544,668
Mortgage servicing rights impairment (recoveries) charges (158,652) 277,176
Loss on sales of investment securities available for sale 83,739 --
Gain on sale of loans (94,737) (821,471)
Income tax benefit from exercise of warrants & options 422,021 112,152
Net accretion of investments 146,117 690,643
Unearned compensation amortization 172,592 197,130
(Increase) decrease in:
Accrued interest receivable 66,165 359,266
Other assets (1,488,678) 26,524
Increase (decrease) in:
Other liabilities 1,238,031 (1,872,521)
--------------------------------
Net cash provided by operating activities 4,209,507 2,615,853
--------------------------------
Investing Activities
Net change in federal funds sold (15,944,527) (23,287,072)
Net change in reverse repurchase agreements 10,000,000 (10,000,000)
Proceeds from maturities of investment securities held
to maturity 226,550 19,281,948
Proceeds from maturities of investment securities available
for sale 23,666,446 36,628,711
Proceeds from sales of investment securities available for sale 19,952,500 --
Purchases of investment securities held to maturity (51,343,150) (93,100)
Purchases of investment securities available for sale (995,321) (31,010,625)
Net increase in loans (19,747,227) (37,151,273)
Purchases of bank premises and equipment (194,501) (537,841)
--------------------------------
Net cash used by investing activities (34,379,230) (46,169,252)
--------------------------------
Financing Activities
Net increase in deposits 43,726,371 51,947,619
Net decrease in security repurchase agreements (2,696,528) (3,609,022)
Net change in FHLB borrowings (10,000,000) --
Proceeds from issuance of long-term debt 3,000,000 2,000,000
Proceeds from issuance of stock 880,922 416,494
Repurchase of stock (2,092,787) (529,210)
--------------------------------
Net cash provided by financing activities 32,817,978 50,225,881
--------------------------------
Increase in cash and cash equivalents 2,648,255 6,672,482
Cash and cash equivalents at beginning of year 44,383,402 45,889,548
--------------------------------
Cash and cash equivalents at end of period $ 47,031,657 $ 52,562,030
================================
Interest paid $ 5,919,253 $ 6,226,080
================================
Income taxes paid $ 1,172,136 $ 2,393,413
================================
See notes to consolidated financial statements.
4
The National Bank of Indianapolis Corporation
Consolidated Statement of Shareholders' Equity
(Unaudited)
Accumulated
Additional and Other
Common Unearned Paid In Retained Comprehensive
Stock Compensation Capital Earnings Income TOTAL
------------------------------------------------------------------------------------
Balance at December 31, 2002 $26,862,276 $ (1,218,746) $ 2,562,990 $12,519,902 $ 520,729 $41,247,151
Comprehensive income:
Net income 2,502,286 2,502,286
Other comprehensive income
Net unrealized loss on investments,
net of tax of $102,134 (155,715) (155,715)
--------------
Total comprehensive income 2,346,571
Income tax benefit from exercise of options 112,152 112,152
Issuance of stock (24,055 shares) 466,644 (50,150) 416,494
Repurchase of stock (17,152 shares) (529,210) (529,210)
Compensation earned 197,130 197,130
-----------------------------------------------------------------------------------
Balance at June 30, 2003 $26,799,710 $ (1,071,766) $ 2,675,142 $15,022,188 $ 365,014 $43,790,288
===================================================================================
Balance at December 31, 2003 $22,858,900 $ (894,679) $ 3,019,003 $17,684,102 $ 11,078 $42,678,404
Comprehensive income:
Net income 2,570,991 2,570,991
Other comprehensive income
Net unrealized loss on investments,
net of tax of $395,862 (592,459) (592,459)
Net unrealized loss on swap
net of tax $166,511 (253,865) (253,865)
--------------
Total comprehensive income 1,724,667
Income tax benefit from exercise of options 422,021 422,021
Issuance of stock (61,261 shares) 857,222 23,700 880,922
Repurchase of stock (63,731 shares) (2,092,787) (2,092,787)
Compensation earned 172,592 172,592
-----------------------------------------------------------------------------------
Balance at June 30, 2004 $21,623,335 $ (698,387) $ 3,441,024 $20,255,093 $ (835,246) $43,785,819
===================================================================================
See notes to consolidated financial statements.
5
The National Bank of Indianapolis
Corporation
Notes to Consolidated Financial Statements
June 30, 2004
Note 1: Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include
the accounts of The National Bank of Indianapolis Corporation ("Corporation")
and its wholly-owned subsidiary The National Bank of Indianapolis ("Bank"). The
presentation of the 2003 financial statement also includes the accounts of the
NBIN Statutory Trust I. All intercompany transactions between the Corporation
and its subsidiary have been properly eliminated. The consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the six month period ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2004. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Corporation's Form 10-K for the
year ended December 31, 2003.
Note 2: Trust Preferred Securities
In September 2000, NBIN Statutory Trust I ("the Trust"), a Connecticut statutory
business trust owned by the Corporation, issued $13,500,000 of company obligated
mandatorily redeemable capital securities. The proceeds from the issuance of the
capital securities and the proceeds from the issuance of the common securities
of $418,000 were used by the Trust to purchase from the Corporation $13,918,000
Fixed Rate Junior Subordinated Debentures. The capital securities mature
September 7, 2030, or upon earlier redemption as provided by the Indenture. The
Corporation has the right to redeem the capital securities, in whole or in part,
but in all cases in a principal amount with integral multiples of $1,000, on any
March 7 or September 7 on or after September 7, 2010 at a premium, declining
ratably to par on September 7, 2020. The capital securities have a fixed
interest rate of 10.60%, and are guaranteed by the Bank. The subordinated
debentures are the sole assets of the Trust and the Corporation owns all of the
common securities of the Trust. The net proceeds received by the Corporation
from the sale of capital securities were used for general corporate purposes.
In January of 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51" (FIN 46, or the
Interpretation). The Interpretation requires the consolidation of entities in
which an enterprise absorbs a majority of the entity's expected losses, receives
a majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity. Prior to the
adoption of FIN 46, entities are generally consolidated by an enterprise when it
has a controlling interest through ownership of a majority voting interest in
the entity.
6
Under the provisions of the Interpretation, except in certain circumstances,
trust preferred capital securities by design are considered variable interest
entities with no variable interest holder being considered the primary
beneficiary, thus requiring the reporting enterprise to deconsolidate the trust
upon adoption. However, in certain circumstances, the Interpretation initially
allowed the parent to continue consolidating the trust.
In December 2003 a revised interpretation was issued which effectively removed
the ability for a reporting enterprise to continue consolidating the trust.
Therefore, a reporting enterprise must deconsolidate its trust as soon as
practicable, but no later than March 31, 2004. The Corporation had previously
applied the provision of FIN 46 to the Trust, which allowed the Corporation to
continue consolidating the Trust. However, the Corporation was required to adopt
the provisions of the revised interpretation and to deconsolidate the Trust no
later than March 31, 2004.
In the first quarter of 2004, as a result of applying the provisions of FIN 46,
the Corporation was required to deconsolidate the Trust from its financial
statements. The deconsolidation of the net assets and results of operations of
the Trust had virtually no impact on the Corporation's financial statements or
liquidity position since the Corporation continues to be obligated to repay the
debentures held by the Trust and guarantees repayment of the capital securities
issued by the Trust. The debt obligation related to the Trust increased from
$13,500,000 to $13,918,000 upon deconsolidation with the difference representing
the Corporation's common equity ownership interest in the Trust.
The capital securities held by the Trust qualify as Tier 1 capital for the
Corporation under Federal Reserve Board guidelines. As a result of the issuance
of FIN 46, the Federal Reserve Board completed an evaluation and determined that
the deconsolidation of the Trust will not affect the qualifications of the
capital securities as Tier 1 capital.
Consolidated debt related to the Trust holding solely debentures of the
Corporation:
June 30, December 31,
2004 2003
---------------------------
10.60% junior subordinated debentures owed to NBIN
Statutory Trust I due September 7, 2030 $13,918,000 $ --
- --------------------------------------------------------------------------------
10.60% capital securities of NBIN Statutory Trust I
due September 7, 2030 $ -- $13,500,000
- --------------------------------------------------------------------------------
$13,918,000 $13,500,000
================================================================================
Interest payments made on the capital securities or the junior subordinated
debentures are reported as a component of interest expense on long-term debt.
7
Note 3: Derivative Instruments and Hedging Activities
During the second quarter of 2004, the Corporation entered into an interest rate
swap to reduce the volatility of variable interest payments received on a
portion of its overnight federal funds sold. This interest rate swap qualified
as and is being accounted for as a cash flow hedge pursuant to Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities", (SFAS133). SFAS 133 requires changes in the fair value
of cash flow hedges to be reported as a component of Other Comprehensive Income,
net of deferred taxes.
June 30, 2004 December 31, 2003
Net Ineffective Net Ineffective
Notional Derivative Hedge Gain Notional Derivative Hedge Gain
Amount Liability (Losses) Amount Liability (Losses)
- -------------------------------------------------------------------------------- -----------------------------------------
Cash Flow Hedge
Overnight Federal Funds Sold
Receive fixed interest rate swap $20,000,000 $420,376 $ -- $ -- $ -- $ --
Note 4: Exercise of Options
During the first quarter of 2004, one director and one officer of the
Corporation exercised options to purchase 5,500 common shares in aggregate. The
weighted average exercise price was $10.00 and the weighted average fair market
value of the stock was $33.00.
During the second quarter of 2004, two directors and six officers of the
Corporation exercised options to purchase 50,800 common shares in aggregate. The
weighted average exercise price was $12.28 per share and the weighted average
fair market value of the stock was $32.88.
Due to the exercise of these options for the six month period ending June 30,
2004, the Corporation will receive a deduction for tax purposes for the
difference between the fair value of the stock at the date of exercise and the
exercise price. In accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock-Based Compensation," (APB 25) the Corporation has recorded
the income tax benefit of $456,228 as additional paid in capital for the six
month period ending June 30, 2004.
8
Note 5: Earnings per Share
The following table sets forth the computation of basic and diluted earnings per
share:
Three months ended Six months ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
Basic average shares outstanding 2,298,626 2,368,562 2,298,490 2,364,954
========== ========== ========== ==========
Net income $1,521,701 $1,205,460 $2,570,991 $2,502,286
========== ========== ========== ==========
Basic net income per common share $ 0.66 $ 0.51 $ 1.12 $ 1.06
========== ========== ========== ==========
Diluted
Average shares outstanding 2,298,626 2,368,562 2,298,490 2,364,954
Nonvested restricted stock 29,160 49,200 29,160 49,200
Common stock equivalents
Net effect of the assumed exercise of stock options 58,263 88,074 58,263 88,074
Net effect of the assumed exercise of warrants -- 15,445 -- 15,445
---------- ---------- ---------- ----------
Diluted average shares 2,386,049 2,521,281 2,385,913 2,517,673
========== ========== ========== ==========
Net income $1,521,701 $1,205,460 $2,570,991 $2,502,286
========== ========== ========== ==========
Diluted net income per common share $ 0.64 $ 0.48 $ 1.08 $ 0.99
========== ========== ========== ==========
Note 6: Comprehensive Income
The following table sets forth the computation of comprehensive income:
Three months ended Six months ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income $ 1,521,701 $ 1,205,460 $ 2,570,991 $ 2,502,286
Unrealized losses on securities, net of tax (1,123,167) (56,984) (592,459) (155,715)
Unrealized losses on swap, net of tax (253,865) -- (253,865) --
----------- ----------- ----------- -----------
Comprehensive income $ 144,669 $ 1,148,476 $ 1,724,667 $ 2,346,571
=========== =========== =========== ===========
9
Note 7: Stock Based Compensation
The Corporation follows APB 25 in accounting for its stock option plans. Under
APB 25, compensation expense is generally not recognized if the exercise price
of the option equals the fair value of the stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the Corporation had applied the fair value recognition provisions of Statement
No. 123 to stock-based compensation. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over their vesting
periods.
Three months ended Six months ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income, as reported $ 1,521,701 $ 1,205,460 $ 2,570,991 $ 2,502,286
Add: stock-based compensation expense, net of
related taxes 52,203 59,523 104,228 119,047
Less: total stock-based compensation expense
determined under fair-value based method, net
of taxes (104,931) (114,276) (212,655) (228,467)
----------- ----------- ----------- -----------
Pro forma net income $ 1,468,973 $ 1,150,707 $ 2,462,564 $ 2,392,866
=========== =========== =========== ===========
Earnings per share:
Basic, as reported $ 0.66 $ 0.51 $ 1.12 $ 1.06
Basic, pro forma $ 0.64 $ 0.49 $ 1.07 $ 1.01
Diluted, as reported $ 0.64 $ 0.48 $ 1.08 $ 0.99
Diluted, pro forma $ 0.61 $ 0.46 $ 1.03 $ 0.95
Note 8: Subsequent Events
On July 14, 2004 an individual who is an Officer and a director of the
Corporation exercised 35,000 common stock options with an exercise price $10.00.
The options were set to expire on July 15, 2004.
In January 2003, the Board of Directors of the Corporation authorized a stock
repurchase program entitled "Program One" to provide liquidity to shareholders.
Under Program One, the Corporation may spend up to $5,500,000 in individually
negotiated transactions to repurchase its shares from employees and directors
who wish to sell. On July 14, 2004, the Corporation repurchased 21,000 shares
from an individual for an aggregate of $693,000, or $33.00 per share.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Corporation Overview:
The primary source of The National Bank of Indianapolis Corporation's revenue is
net interest income from loans and deposits and fees from financial services
provided to customers. Business volumes tend to be influenced by overall
economic factors including market interest rates, business spending, and
consumer confidence, as well as competitive conditions within the marketplace.
The Corporation monitors the impact of changes in interest rates on its net
interest income. One of the primary goals of asset/liability management is to
maximize net interest income and the net value of future cash flows within
authorized risk limits. At June 30, 2004 the interest rate risk position of the
Corporation was liability sensitive. Maintaining a liability sensitive interest
rate risk position means that net income should decrease as rates rise and
increase as rates fall. The Corporation maintains a slight liability sensitive
interest rate risk position so that if rates would fall, net income will not be
negatively affected to the same extent as if the Corporation maintained an asset
sensitive interest rate risk position. Since the Corporation maintains a slight
liability sensitive interest rate risk position, net income should still
increase if rates rise, but not as much if it maintained an asset sensitive
interest rate risk position.
Due to record low interest rates in 2003, there was an increase in refinancing
activity and mortgage loan sales by the Corporation. Management expects a
decrease in 2004 from 2003 in mortgage loan refinancing due to rising interest
rates and this will cause a decrease in other income.
Net income is affected by the provision for loan losses. Management performs an
evaluation as to the amounts required to maintain an allowance adequate to
provide for potential losses inherent in the loan portfolio. The level of this
allowance is dependent upon the total amount of past due and non-performing
loans, general economic conditions and management's assessment of potential
losses based upon internal credit evaluations of loan portfolios and particular
loans. Most sectors of the economy are showing signs of improvement over last
year. It has been our experience that improved economic strength generally will
translate into better credit quality in the banking industry. Management
believes that the quality of our loan portfolio continues to remain excellent
and our reserves for loan losses are adequate.
The risks and challenges that management believes will be important in 2004 are
continued spread compression if interest rates remain low, price competition for
loans and deposits by new market entrants, and lower mortgage loan volume
leading to lower gains on sales of mortgage loans.
Forward Looking Information
This section contains forward looking statements. Forward looking statements
give current expectations or forecasts of future events and are not guarantees
of future performance. The forward looking statements are based on management's
expectations and are subject to a number of risks and uncertainties. Although
management believes the expectations reflected in such forward looking
statements are reasonable, actual results may differ materially from those
expressed or implied in such statements. Risks and uncertainties that could
cause actual results to differ materially include, without limitation, the
Corporation's ability to execute its business plans; changes in general economic
and financial market conditions; changes in interest rates; changes in
competitive conditions; continuing consolidation in the financial services
industry; new litigation or changes in existing litigation; losses,
11
customer bankruptcy, claims and assessments; changes in banking regulations or
other regulatory or legislative requirements that impact the Corporation's
business; and changes in accounting policies and procedures as may be required
by the Financial Accounting Standards Board or other regulatory agencies.
Additional information concerning factors that could cause actual results to
differ materially from those expressed or implied in the forward-looking
statements is available in the Corporation's Annual Report on Form 10-K for the
year ended December 31, 2003.
Critical Accounting Policies
The Corporation's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States and follow
general practices within the industries in which it operates. Application of
these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements could reflect different
estimates, assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions, and judgments and as such
have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets are based either on quoted
market prices or are provided by other third-party sources, when available. When
third-party information is not available, valuation adjustments are estimated in
good faith by management primarily through the use of internal cash flow
modeling techniques.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions, and estimates underlying those
amounts, management has identified the determination of the allowance for loan
losses and the valuation of the mortgage servicing asset, to be the accounting
areas that require the most subjective or complex judgments, and as such could
be most subject to revision as new information becomes available.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for loan losses
charged against income. Loans deemed to be uncollectible are charged against the
allowance for loan losses, and subsequent recoveries, if any, are credited to
the allowance. The allowance for loan losses related to loans that are
identified as impaired is based on discounted cash flows using the loan's
initial effective interest rate, or the fair value of the collateral for certain
collateral dependent loans. The Corporation collectively evaluates consumer
loans and loans secured by real estate for impairment as homogeneous loan
groups.
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable losses in the loan portfolio. The determination of
the allowance is based on factors which, in management's judgment, deserve
recognition under existing economic conditions in estimating possible loan
losses. This evaluation is inherently subjective as it requires material
estimates including the amounts and timing of future cash flows expected to be
received on impaired loans that may be susceptible to significant change.
12
The allowance for loan losses is allocated to each loan category based on the
Bank's peer median charge off percentages by loan category added to actual
reserves maintained for non-performing or specifically identified loans needing
a reserve. Any remaining allowance is then allocated back to each loan category
based on that category's percentage of the total loan portfolio. Although the
loan loss reserve is allocated by loan category, the entire allowance is
available to cover any loan loss that may occur.
Mortgage Servicing Assets
The mortgage servicing asset is established and accounted for based on
discounted cash flow modeling techniques which require management to make
estimates regarding the amount and timing of expected future cash flows,
including assumptions about loan repayment rates, credit loss experience, and
costs to service, as well as discount rates that consider the risk involved.
Because the values of these assets are sensitive to changes in assumptions, the
valuation of the mortgage servicing asset is considered a critical accounting
estimate.
Off Balance Sheet Arrangements
During the first quarter of 2004, the Corporation adopted FIN 46, which governs
when certain variable interests should be consolidated in the financial
statements of the Corporation. As a result, the Corporation deconsolidated the
Trust which removed $13,500,000 of Mandatorily Redeemable Capital Securities
issued by the Trust while adding $13,918,000 of junior subordinated debentures
to the consolidated balance sheet. See Note 2 Trust Preferred Securities in the
Notes to the Consolidated Financial Statements under Item 1 of this report for
further information.
Derivative Instruments and Hedging Activities
During the second quarter of 2004, the Corporation entered into an interest rate
swap to protect the risk of adverse interest rate movements on the value of
future cash flows related to its investment in overnight Federal Funds sold.
Pursuant to SFAS 133, cash flow hedges are accounted for by recording the fair
value of the derivative instrument on the balance sheet as either an asset or
liability, with a corresponding offset recorded in other comprehensive income
within shareholders' equity, net of tax.
Under the cash flow hedge accounting method, derivative gains and losses not
effective in hedging the change in expected cash flows of the hedged item are
recognized immediately in the income statement. At the hedge's inception and
quarterly thereafter, a formal assessment is performed to determine whether
changes in cash flows of the derivative instrument have been highly effective in
offsetting changes in the cash flows of the hedged item and whether they are
expected to be highly effective in the future. If it is determined a derivative
instrument has not been or will not continue to be highly effective as a hedge,
hedge accounting is discontinued. See Note 3 Derivative Instruments in the Notes
to the Consolidated Financial Statements under Item 1 of this report for further
information.
13
Results of Operations
Net Interest Income
- -------------------
This section should be reviewed in conjunction with the daily average earning
assets balances and interest bearing liabilities and funding tables found on
page 18.
Six months ended June 30, 2004 compared to the six months ended June 30, 2003:
The Corporation's results of operations depend primarily on the level of its net
interest income, its non-interest income and its operating expenses. Net
interest income depends on the volume of and rates associated with interest
earning assets and interest bearing liabilities which results in the net
interest spread. The Corporation had net interest income of $11,933,436, for the
six months ended June 30, 2004 compared to net interest income of $11,207,850,
for the six months ended June 30, 2003. This growth in net interest income was
the result of earning asset growth and lower funding costs. Reduced asset yields
and narrower spreads on deposits, a reflection of the ongoing effect of low
market interest rates, led to a lower net interest margin for the six month
period ended June 30, 2004 compared to the six month period ended June 30, 2003.
Provision for Loan Losses
- -------------------------
The amount charged to the provision for loan losses by the Bank is based on
management's evaluation as to the amounts required to maintain an allowance
adequate to provide for probable losses inherent in the loan portfolio. The
level of this allowance is dependent upon the total amount of past due and
non-performing loans, general economic conditions and management's assessment of
potential losses based upon internal credit evaluations of loan portfolios and
particular loans. Loans are principally to borrowers in central Indiana.
The provision for loan losses was $600,000 for the six months ended June 30,
2004 and June 30, 2003. Based on management's risk assessment and evaluation of
the potential losses of the loan portfolio, management believes that the current
allowance for loan losses is adequate to provide for potential losses in the
loan portfolio.
14
The following table sets forth the roll forward of the allowance for loan
losses:
Six months ended
June 30,
2004 2003
---------- ----------
Beginning of Period $8,029,596 $7,227,000
Provision for loan losses 600,000 600,000
Losses charged to the reserve
Commercial 150,646 285,000
Real Estate 273,966 --
Consumer 79,367 2,185
Credit Cards 6,924 7,778
---------- ----------
510,903 294,963
Recoveries
Commercial 7,794 77,435
Real Estate -- 2,350
Consumer 989 62
Credit Cards 2,050 950
---------- ----------
10,833 80,797
---------- ----------
End of Period $8,129,526 $7,612,834
========== ==========
Allowance as a % of Loans 1.32% 1.34%
Loans past due over 30 days totaled $ 3,320,823 or .54% of total loans at June
30, 2004 compared to $3,944,697 or .70% of total loans at June 30, 2003.
15
Other Operating Income
- ----------------------
The following table details the components of other operating income:
Six months ended
June 30, $ %
2004 2003 Change Change
-------------------------------------------------
Trust fees and commissions $ 1,214,802 $ 895,715 $ 319,087 35.6%
Service charges and fees on deposit accounts 256,371 265,029 (8,658) -3.3%
Building rental income 1,127,626 1,238,104 (110,478) -8.9%
Net gain on sale of mortgage loans 94,737 821,471 (726,734) -88.5%
Interchange income 282,155 272,401 9,754 3.6%
Net loss on securities (83,739) - (83,739) -
Other 673,372 658,682 14,690 2.2%
-------------------------------------------------
Total operating income $ 3,565,324 $ 4,151,402 $ (586,078) -14.1%
-------------------------------------------------
Other operating income for the six months ended June 30, 2004 decreased as
compared to the six months ended June 30, 2003.
Trust fees and commissions increased for the six months ended June 30, 2004 as
compared to the six months ended June 30, 2003. The net increase in trust income
is attributable to the overall price appreciation in the stock and treasury
markets and an increase in assets under management. Trust fees and commissions
for the six months ended June 30, 2003 was lower due to a change in accounting
estimate related to the accrual of fees.
Service charges and fees on deposit accounts decreased for the six months ended
June 30, 2004 as compared to the six months ended June 30, 2003 and is
attributable to lower overdraft and NSF fees assessed.
Rental income from the other tenants in the Corporation's main office building
decreased for the six months ended June 30, 2004 as compared to the six months
ended June 30, 2003 due to fewer tenants in the building in 2004 compared to the
same period the previous year and the Corporation occupying more space in the
building.
Due to the sale of bulk mortgages that were generated during 2003 as a result of
lower interest rates, the net gain on the sale of mortgages decreased for the
six months ended June 30, 2004 as compared to the six months ended June 30,
2003.
During the first quarter of 2004, a net loss on the sale of two available for
sale securities was recorded. The securities were replaced with higher yielding
investments to place the portfolio in a better position during a period of
rising interest rates.
16
Other Operating Expenses
- ------------------------
The following table details the components of other operating expense:
Six months ended
June 30, $ %
2004 2003 Change Change
---------------------------------------------
Salaries, wages and employee benefits $ 6,731,914 $ 5,982,952 $ 748,962 12.5%
Occupancy expense 710,120 716,795 (6,675) -0.9%
Furniture and equipment expense 424,204 435,628 (11,424) -2.6%
Professional services 659,537 438,981 220,556 50.2%
Data processing 719,470 668,126 51,344 7.7%
Business development 537,801 473,333 64,468 13.6%
Mortgage servicing rights impairment
(recoveries) charges (158,652) 277,176 (435,828) -157.2%
Other expenses 1,578,363 1,623,516 (45,153) -2.8%
---------------------------------------------
Total other operating expenses $11,202,757 $10,616,507 $ 586,250 5.5%
---------------------------------------------
Other operating expenses for the six months ended June 30, 2004 increased as
compared to the six months ended June 30, 2003.
Salaries, wages and employee benefits increased due to annual merit increases of
employees, increased FICA expense related to the cliff vesting of restricted
stock for officers of the Bank, increase in bonus accrual, employee relations,
and training expense.
Professional services expense increased due to increased accounting fees related
to the implementation of the Sarbanes-Oxley Act of 2002, legal fees and courier
costs.
Data processing expenses increased primarily due to increased service bureau
fees relating to increased transaction activity by the Bank and trust
department.
Business development expenses increased due to increased advertising, customer
entertainment and customer relations costs.
Due to the overall lower interest rates in 2002 and 2003, there were many
mortgage loan refinances and the Corporation had increased mortgage sales. As of
December 2003, a valuation reserve of $606,276 was recognized for mortgage
servicing rights. The valuation reserve for mortgage servicing rights decreased
as of June 30, 2004 as compared to June 30, 2003. The Corporation recorded a
partial recovery of previous period impairments of the mortgage servicing rights
due to higher interest rates which caused a significant slow down in mortgage
refinances and prepayments of existing mortgages.
17
AVERAGE EARNING ASSETS
The following table is a summary of the daily average of earning assets:
Six months ended
June 30, $ %
2004 2003 Change Change
----------------------------------------------------------
Loans
Commercial $317,700,000 $280,200,000 $37,500,000 13.4%
Real Estate - Commercial 119,000,000 122,000,000 (3,000,000) -2.5%
Real Estate - Residential 145,100,000 127,800,000 17,300,000 13.5%
Other 12,700,000 14,500,000 (1,800,000) -12.4%
----------------------------------------------------------
Total loans 594,500,000 544,500,000 50,000,000 9.2%
Investments 153,400,000 116,700,000 36,700,000 31.4%
Federal Funds Sold 41,800,000 37,600,000 4,200,000 11.2%
Reverse Repurchase Agreements 13,400,000 7,000,000 6,400,000 91.4%
----------------------------------------------------------
Total Earning Assets $803,100,000 $705,800,000 $97,300,000 13.8%
==========================================================
AVERAGE INTEREST BEARING LIABILITIES AND FUNDING
The following table is a summary of the daily average of interest bearing
liabilities and funding:
Six months ended
June 30, $ %
2004 2003 Change Change
---------------------------------------------------------
Noninterest bearing deposits $ 145,100,000 $ 132,700,000 $ 12,400,000 9.3%
Interest bearing deposits 526,700,000 435,900,000 90,800,000 20.8%
---------------------------------------------------------
Total core deposits 671,800,000 568,600,000 103,200,000 18.1%
Security repurchase agreements 72,900,000 71,700,000 1,200,000 1.7%
FHLB advances 36,600,000 48,000,000 (11,400,000) -23.8%
Subordinated debt 3,000,000 300,000 2,700,000 900.0%
Long-term debt 13,900,000 13,500,000 400,000 3.0%
Shareholders' equity 53,700,000 49,900,000 3,800,000 7.6%
---------------------------------------------------------
Total funding $ 851,900,000 $ 752,000,000 $ 99,900,000 13.3%
=========================================================
Total interest bearing liabilities $ 653,100,000 $ 569,400,000 $ 83,700,000 14.7%
Total interest bearing liabilities
/ total interest expense 1.8% 2.1%
18
Liquidity and Interest Rate Sensitivity
The Corporation must maintain an adequate liquidity position in order to respond
to the short-term demand for funds caused by withdrawals from deposit accounts,
extensions of credit and for the payment of operating expenses. Maintaining this
position of adequate liquidity is accomplished through the management of a
combination of liquid assets - those which can be converted into cash - and
access to additional sources of funds. The Corporation must monitor its
liquidity ratios as established in the Asset/Liability ("ALCO") Committee
Policy. In addition, the Corporation has established a contingency funding plan
to address liquidity needs in the event of depressed economic conditions. The
liquidity position is continually monitored and reviewed by ALCO.
The Corporation has many sources of funds available, they include: overnight
federal funds sold, investments available for sale, maturity of investments held
for sale, deposits, Federal Home Loan Bank ("FHLB") advances, and issuance of
debt. Funding sources did not change significantly during the first six months
of 2004. Deposits are the most significant funding source and loans are the most
significant use of funds for the six months ended June 30, 2004 and 2003. The
Corporation maintains a $5,000,000 revolving credit agreement with Harris Trust
and Savings Bank to provide additional liquidity support to the Bank, if needed.
There were no borrowings under this agreement at June 30, 2004 or 2003.
Primary liquid assets of the Corporation are cash and due from banks, federal
funds sold, investments held as available for sale, and maturing loans. Federal
funds sold represented the Corporation's primary source of immediate liquidity
and were maintained at a level adequate to meet immediate needs. Federal funds
sold averaged approximately $41,800,000 for the six months ended June 30, 2004,
an increase of approximately $4,200,000 from $37,600,000 for the six months
ended June 30, 2003. Reverse repurchase agreements may serve as a source of
liquidity, but are primarily used as collateral for customer balances in
overnight repurchase agreements. Maturities in the Corporation's loan and
investment portfolios are monitored regularly to manage the maturity dates of
deposits to coincide with long-term loans and investments. Other assets and
liabilities are also monitored to provide the proper balance between liquidity,
safety, and profitability. This monitoring process must be continuous due to the
constant flow of cash which is inherent in a financial institution.
The Corporation's management believes its liquidity sources are adequate to meet
its operating needs and does not know of any trends, events or uncertainties
that may result in a significant adverse effect on the Corporation's liquidity
position.
The Corporation actively manages its interest rate sensitive assets and
liabilities to reduce the impact of interest rate fluctuations. At June 30,
2004, the Corporation's rate sensitive liabilities exceeded rate sensitive
assets due within one year by $7,234,000.
As part of managing liquidity, the Corporation monitors its loan to deposit
ratio on a daily basis. At June 30, 2004 the ratio was 90.5 percent.
The Corporation experienced an increase in cash and cash equivalents, another
primary source of liquidity, of $2,648,255 during the first six months of 2004.
The primary financing activity of deposit growth provided net cash of
$43,726,371. Lending used $19,747,227, investments used $8,409,236 and
increasing federal funds sold used $15,944,527 and decreasing reverse repurchase
agreements provided $10,000,000.
The purpose of the Bank's Investment Committee is to manage and balance interest
rate risk, to provide a readily available source of liquidity to cover deposit
runoff and loan growth, and to provide a portfolio
19
of safe, secure assets of high quality that generate a supplemental source of
income in concert with the overall asset/liability policies and strategies of
the Bank.
Capital Resources
The Corporation's only sources of capital since commencing operations have been
from issuance of common stock, results of operations, issuance of long-term debt
to a non-affiliated third party, and the issuance of company obligated
mandatorily redeemable preferred capital securities.
The Corporation maintains a Revolving Credit Agreement with Harris Trust and
Savings Bank in the amount of $5,000,000 that will mature September 28, 2004.
In September 2000, the Trust, which is wholly owned by the Corporation, issued
$13,500,000 of company obligated mandatorily redeemable capital securities. The
proceeds from the issuance of the capital securities and the proceeds from the
issuance of the common securities of $418,000 were used by the Trust to purchase
from the Corporation $13,918,000 Fixed Rate Junior Subordinated Debentures. The
capital securities mature September 7, 2030, or upon earlier redemption as
provided by the Indenture. The Corporation has the right to redeem the capital
securities, in whole or in part, but in all cases in a principal amount with
integral multiples of $1,000, on any March 7 or September 7 on or after
September 7, 2010 at a premium, declining ratably to par on September 7, 2020.
The capital securities have a fixed interest rate of 10.60%, and are guaranteed
by the Bank. The net proceeds received by the Corporation from the sale of
capital securities were used for general corporate purposes.
The Bank entered into an agreement in the amount of $5,000,000 pursuant to a
Subordinated Term Loan Agreement with Harris Trust and Savings Bank dated June
6, 2003. The first advance was made in the amount of $2,000,000 on June 6, 2003.
The second advance was made in the amount of $3,000,000 on May 3, 2004. The
final maturity date of the loan is June 6, 2010. The outstanding principal
balance is due at maturity, but prepayment of the principal balance is permitted
prior to maturity with prior consent from the Federal Reserve.
Under the terms of the agreement, there are many different interest rate options
available. Each floating rate option is available for a fixed term of 1-3
months. The Bank is currently paying Adjusted 3-month LIBOR plus 2.0% which
equates to 3.18%. Interest payments are due at the expiration of the fixed term
option. During June 2004, the Bank made a $1,000,000 dividend to the Corporation
from the loan proceeds to accommodate the stock repurchase program as discussed
on page 21 and in Item 2 (e) on page 24 - 25.
20
The Bank has incurred indebtedness pursuant to FHLB advances as follows:
Amount Rate Maturity
------ ---- --------
$5,000,000 5.14% 08/01/2005
3,000,000 5.39% 10/03/2005
5,000,000 5.43% 03/16/2006
5,000,000 5.32% 05/08/2006
8,000,000 4.19% 07/24/2007
3,000,000 5.57% 08/13/2007
3,000,000 5.55% 10/02/2008
-------------
$32,000,000
The Bank may add indebtedness of this nature in the future if determined to be
in the best interest of the Bank.
Capital for the Bank is at or above the well-capitalized regulatory requirements
at June 30, 2004. Pertinent capital ratios for the Bank as of June 30, 2004 are
as follows:
Well Adequately
Actual Capitalized Capitalized
------ ----------- -----------
Tier 1 risk-based capital ratio 8.48% 6.0% 4.0%
Total risk-based capital ratio 10.51% 10.0% 8.0%
Leverage ratio 6.41% 5.0% 4.0%
Dividends from the Bank to the Corporation may not exceed the undivided profits
of the Bank (included in consolidated retained earnings) without prior approval
of a federal regulatory agency. In addition, Federal banking laws limit the
amount of loans the Bank may make to the Corporation, subject to certain
collateral requirements. The Bank declared and made a $1,000,000 dividend to the
Corporation during the six months period ended June 2004 and a dividend of
$1,325,000 was declared and made during the six months period ended June 30,
2003. No loans were made during the six month period ended June 30, 2004 or
2003.
In January 2003, the Board of Directors of the Corporation authorized a stock
repurchase program entitled "Program One" which covers employees and directors
and is effective through December 2005 unless terminated earlier by the Board.
Under Program One, the Corporation may spend up to $5,500,000 in individually
negotiated transactions to repurchase its shares from employees and directors
who wish to sell. The repurchase program may be suspended or discontinued at any
time if management determines that additional purchases are not warranted or if
the cost of the repurchase program reaches $5,500,000.
In January 2003, the Board of the Corporation authorized a separate stock
repurchase program entitled "Program Two" which covers all other shareholders
and is effective through December 2004 unless terminated earlier by the Board.
Under Program Two, the Corporation may spend up to $7,600,000 in individually
negotiated transactions to repurchase its shares from shareholders who wish to
sell. The repurchase program may be suspended or discontinued at any time if
management determines that additional purchases are not warranted or if the cost
of the repurchase program reaches $7,600,000.
21
The amount and timing of shares repurchased under the repurchase program, as
well as the specific price, will be determined by management after considering
market conditions, company performance and other factors.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss due to adverse changes in market prices and
rates. The Corporation's market risk arises primarily from interest rate risk
inherent in its lending and deposit taking activities. Management actively
monitors and manages its interest rate exposure and makes monthly reports to the
Asset/Liability ("ALCO") Committee. The ALCO Committee is responsible for
reviewing the interest rate sensitivity position and establishing policies to
monitor and limit exposure to interest rate risk. The guidelines established by
ALCO are reviewed by the ALCO/Investment Committee of the Corporation's Board of
Directors.
The Corporation's profitability is affected by fluctuations in interest rates. A
sudden and substantial increase in interest rates may adversely impact the
Corporation's earnings to the extent that the interest rates earned by assets
and paid on liabilities do not change at the same speed, to the same extent, or
on the same basis. The Corporation monitors the impact of changes in interest
rates on its net interest income. The Corporation attempts to maintain a
relatively neutral gap between earning assets and liabilities at various time
intervals to minimize the effects of interest rate risk. One of the primary
goals of asset/liability management is to maximize net interest income and the
net value of future cash flows within authorized risk limits. Net interest
income is affected by changes in the absolute level of interest rates. Net
interest income is also subject to changes in the shape of the yield curve. In
general, a flattening of the yield curve would result in a decline in earnings
due to the compression of earning asset yields and funding rates, while a
steepening would result in increased earnings as investment margins widen.
Earnings are also affected by changes in spread relationships between certain
rate indices, such as prime rate.
At June 30, 2004 the interest rate risk position of the Corporation was
liability sensitive. Maintaining a liability sensitive interest rate risk
position means that net income should decrease as rates rise and increase as
rates fall. The Corporation maintains a slight liability sensitive interest rate
risk position so that if rates would fall, net income will not be negatively
affected to the same extent as if the Corporation maintained an asset sensitive
interest rate risk position. Since the Corporation maintains a slight liability
sensitive interest rate risk position, net income should still increase if rates
rise, but not as much if it maintained an asset sensitive interest rate risk
position.
See further discussion liquidity and interest rate sensitivity on pages 19 - 20
of this report.
There have been no material changes in the quantitative analysis used by the
Corporation since filing the 2003 Form 10-K, for further discussion of the
quantitative analysis used by the Corporation refer to page 38 of the 2003 Form
10-K filed on March 26, 2004.
22
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. The Corporation's principal
executive officer and principal financial officer have concluded that the
Corporation's disclosure controls and procedures (as defined under Rules
13a-15(e) or Rules 15d-15(e) under the Securities Exchange Act of 1934, as
amended), based on their evaluation of these controls and procedures as of the
end of the period covered by this Form 10-Q, are effective.
Changes in Internal Controls. There have been no significant changes in the
Corporation's internal controls or in other factors that could significantly
affect these controls subsequent to the date of the evaluation thereof,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
Limitations on the Effectiveness of Controls. The Corporation's management,
including its principal executive officer and principal financial officer, does
not expect that the Corporation's disclosure controls and procedures and other
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Corporation have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can only be
reasonable assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
CEO and CFO Certifications. Appearing as an exhibit to this report there are
Certifications of the Corporation's principal executive officer and principal
financial officer. The Certifications are required in accord with Section 302 of
the Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). This Item of
this report which you are currently reading is the information concerning the
evaluation referred to in the Section 302 Certifications and this information
should be read in conjunction with the Section 302 Certifications for a more
complete understanding of the topics presented.
23
Part II - Other Information.
Item 1. Legal Proceedings
Neither The National Bank of Indianapolis Corporation nor its
subsidiaries are involved in any pending legal proceedings at this
time, other than routine litigation incidental to its business.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securites
(a) Not applicable.
(b) Not applicable.
(c) On February 12, 2004, the Corporation sold a total of 3,000 shares of
common stock for an aggregate amount of $30,000 to one officer of the
Corporation pursuant to the exercise of stock options by the officer.
On February 18, 2004, the Corporation sold a total of 2,500 shares of
common stock for an aggregate amount of $25,000 to one director of the
Corporation pursuant to the exercise of stock options by the director.
On May 7, 2004, the Corporation sold a total of 2,000 shares of common
stock for an aggregate amount of $25,000 to one director of the Corporation
pursuant to the exercise of stock options by the director.
On May 17, 2004, the Corporation sold a total of 25,000 shares of common
stock for an aggregate amount of $250,000 to one officer of the Corporation
pursuant to the exercise of stock options by the officer.
On June 9, 2004, the Corporation sold a total of 11,000 shares of common
stock for an aggregate amount of $176,750 to one director of the
Corporation pursuant to the exercise of stock options by the director.
On June 17, 2004, the Corporation sold a total of 4,800 shares of common
stock for an aggregate amount of $55,200 to two officers of the Corporation
pursuant to the exercise of stock options by the officers.
On June 18, 2004, the Corporation sold a total of 3,000 shares of common
stock for an aggregate amount of $57,000 to one officer of the Corporation
pursuant to the exercise of stock options by the officer.
On June 28, 2004, the Corporation sold a total of 5,000 shares of common
stock for an aggregate amount of $60,000 to two officers of the Corporation
pursuant to the exercise of stock options by the officers.
All of these shares were sold in private placements pursuant to Section
4(2) of the Securities Act of 1933.
(d) Not applicable.
(e) The following table sets forth the issuer repurchases of equity securities
that are registered by the corporation pursuant to Section 12 of the 1934
Act during the second quarter of 2004:
24
- ----------------------------------------------------------------------------------------
Total Number of Maximum Number
Shares (or Unites (or Appropriate
Purchased as Part Dollar Value) of
of Publicly Shares that May
Total Number Announced Yet Be Purchased
of Shares Average Price Plans or Under the Plans
Period Purchased Paid per Share Programs Programs
- ----------------------------------------------------------------------------------------
04/01/04 - 04/30/04 1,112 $32.50 171,112 $7,679,498
- ----------------------------------------------------------------------------------------
05/01/04 - 05/31/04 27,000 $33.00 198,112 $6,788,498
- ----------------------------------------------------------------------------------------
06/01/04 - 06/30/04 24,619 $32.75 222,731 $5,982,226
- ----------------------------------------------------------------------------------------
In January 2003 the Board of Directors of the Corporation authorized a
repurchase program entitled "Program One" and "Program Two". Program
One covers employees and directors and is effective through December
2005 unless terminated earlier by the Board. Under Program One, the
Corporation may spend up to $5,500,000 in individually negotiated
transactions to repurchase its shares from employees and directors who
wish to sell. Under Program Two, which covers all other shareholders,
is effective through December 2004 unless terminated earlier by the
Board. Under Program Two, the Corporation may spend up to $7,600,000
in individually negotiated transactions to repurchase its shares from
shareholders who wish to sell. Neither plan was terminated during the
first six months of 2004.
Item 3. Defaults Upon Senior Securities - Not applicable
Item 4. Submission of Matters to a Vote of Security Holders On June 17,
2004, at 3:00 p.m. at the Corporation's offices at 107 North
Pennsylvania Street, Indianapolis, Indiana the annual meeting of
shareholders was held. Four items were presented for consideration of
the shareholders.
The first item was the election of James M. Cornelius, G. Benjamin
Lantz, Jr., and Michael S. Maurer to the Board of Directors to serve
for a term of three years and until their successors are duly elected
and qualified. The vote tabulation for the election of Mr. Cornelius
was 1,731,081 "for" and 686 shares against; Dr. Lantz was 1,728,895
"for" and 2,186 shares against; and Mr. Maurer was 1,730,995 "for" and
86 shares against. The following director's terms continued after the
meeting: Ms. Kathryn G. Betley; Mr. James M. Cornelius; Mr. David R.
Frick; Mr. Andre B. Lacy; Dr. G. Benjamin Lantz, Jr; Mr. Michael S.
Maurer; Mr. Morris L. Maurer; Mr. Philip R. Roby; and Mr. Todd Stuart.
The second item was a proposed amendment to the 1993 Employee's Stock
Option Plan which would grant to the Administrative Committee of such
plan the discretion to allow an option to immediately vest and
continue to be exercisable in accordance with is original schedule
upon retirement of an employee to whom the option was granted. The
proposed amendment was passed by a vote of 1,685,215 "for", 29,969
shares against, and 15,897 shares abstained.
25
The third item was a proposed amendment to the 1993 Restricted Stock
Plan which would grant to the Administrative Committee of such plan
the discretion to immediately vest any unvested shares of restricted
stock upon the retirement of the employee to whom the unvested shares
of restricted stock were awarded. The proposed amendment was passed by
a vote of 1,674,810 "for", 30,500 shares against, and 255,772 shares
abstained.
The fourth item was the ratification of Ernst & Young LLP as the
Corporation's public accountants. This matter was approved by a vote
of 1,716,137 shares "for", 5,864 shares against, and 9,081 shares
abstained.
Item 5. Other Information - Not applicable
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
3.1 Articles of Incorporation of the Corporation, filed as Exhibit
3(i) to the Corporation's Form 10-QSB filed as of September 30,
1995 and Articles of Amendment filed as Exhibit 3(i) to the
Corporation's Form 10-K as of December 31, 2001 are incorporated
by reference.
3.2 Bylaws of the Corporation, filed as Exhibit 3(ii) to the
Corporation's Form 10-Q as of September 30, 1996 are incorporated
by reference.
10.1 1993 Key Employees' Stock Option Plan of the Corporation, as
amended, filed as Exhibit 10(a) to the Corporation's Form 10-Q as
of June 30, 2002 are incorporated by reference.
10.2 1993 Directors' Stock Option Plan of the Corporation, as amended.
10.3 1993 Restricted Stock Plan of the Corporation, as amended.
31.1 Certificate of Chief Executive Officer pursuant to Rule
13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934,
as amended
31.2 Certificate of Chief Financial Officer pursuant to Rule
13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934,
as amended
32.1 Chief Executive Officer Certification pursuant to 18 U.S.C.
Section 1350
32.2 Chief Financial Officer Certification pursuant to 18 U.S.C.
Section 1350
(b) The registrant filed the following Current Reports on
Form 8-K during the quarter ended June 30, 2004.
Date Item Reported
---- -------------
May 19, 2004 Letter to Shareholders of the Registrant, dated
May 19, 2004
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: July 27, 2004
THE NATIONAL BANK OF INDIANAPOLIS CORPORATION
/s/ Debra L. Ross
---------------------------------------------
Debra L. Ross
Chief Financial Officer
27
EXHIBIT INDEX
- -------------
3(i) Articles of Incorporation of The National Bank of Indianapolis Corporation
and Articles of Amendment*
3(ii) By-laws of The National Bank of Indianapolis Corporation*
10.1 1993 Key Employee's Stock Option Plan
10.2 1993 Directors' Stock Option Plan*
10.3 1993 Restricted Stock Plan
31.1 Chief Executive Officer Certification pursuant to Rule 13a-14(a)/Rule
15d-14(a)
31.2 Chief Financial Officer Certification pursuant to Rule 13a-14(a)/Rule
15d-14(a)
32.1 Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350
32.2 Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350
*previously filed