UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[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
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)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered Pursuant to Section 12(g) of the Act: Common Stock
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 of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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. [X]
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes [ ] No [X]
The aggregate market value of the common stock held by non-affiliates of
the registrant as of June 30, 2004 was approximately $51,259,378. The number of
shares of the registrant's Common Stock outstanding at March 24, 2005 was
2,350,255.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report on Form 10-K, to the extent
not set forth herein, is incorporated herein by reference to the Registrant's
definitive proxy statement to be filed in connection with the annual meeting of
shareholders to be held on June 16, 2005.
Form 10-K Cross Reference Index
Page
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PART I
Item 1. Business 1
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer Repurchase of Securities, 13
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 42
Item 8. Financial Statements and Supplementary Data 43
Item 9. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 84
Item 9A. Controls and Procedures 84
Item 9B. Other Information 85
PART III
Item 10. Directors and Executive Officers of the Registrant 86
Item 11. Executive Compensation 86
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 86
Item 13. Certain Relationships and Related Transactions 86
Item 14. Principal Accounting Fees and Services 86
Part IV
Item 15. Exhibits and Financial Statement Schedules 87
Signatures 89
PART I
Item 1. Business
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The Corporation. The National Bank of Indianapolis Corporation (the
"Corporation") was formed on January 29, 1993, for the purpose of forming a
banking institution in the Indianapolis, Indiana metropolitan area and holding
all of the shares of common stock of such banking institution. The Corporation
formed a national banking association named "The National Bank of Indianapolis"
(the "Bank") as a wholly-owned subsidiary.
The Bank was officially chartered by the OCC on December 8, 1993 and
opened for business to the public on December 21, 1993. The Bank's deposits are
insured by the FDIC. The Bank currently conducts its business through its
downtown headquarters located at 107 North Pennsylvania Street in Indianapolis,
at neighborhood bank offices located at 84th Street and Ditch Road in
northwestern Marion County and 82nd Street and Bash Road in northeastern Marion
County, in the Chamber of Commerce Building and AUL Office Complex in downtown
Indianapolis, at 49th Street and North Pennsylvania Street in northern Marion
County, at Keystone and East Carmel Drive in Hamilton County, at 106th Street
and Michigan Road in Hamilton County and Smith Valley Road and S.R. 135 in
Johnson County.
The Bank provides a full range of deposit, credit, and money management
services to its targeted market, which is small to medium size businesses,
affluent executive and professional individuals, and not-for-profit
organizations. In February 1994, the Bank received full trust powers.
Management has sought to position the Bank to capitalize on the
customer disruption, dissatisfaction, and turn-over which it believes has
resulted from the acquisition of the three largest commercial banks located in
Indianapolis by out-of-state holding companies. On December 31, 2004, the
Corporation had consolidated total assets of $881 million and total deposits of
$693 million.
The key ingredients in the growth of the Bank have been an aggressive
business plan, an experienced Board of Directors and management team and a
seasoned group of bank employees. The basic strategy of the Bank continues to
emphasize the delivery of highly personalized services to the target client base
with an emphasis on quick response and financial expertise.
Business Plan Overview. The business plan of the Bank is based on being
a strong, locally owned bank providing superior service to a small group of
customers, which are primarily corporations with annual sales under $30 million,
executives, professionals, and not-for-profit organizations. The Bank provides
highly personalized banking services with an emphasis on knowledge of the
particular financial needs and objectives of its clients and quick response to
customer requests. Because the management of the Bank is located in
Indianapolis, all credit and related decisions are made locally, thereby
facilitating prompt response. The Bank emphasizes both highly personalized
service at the customer's convenience and non-traditional delivery services that
do not require customers to frequent the Bank. This personal contact has become
a trademark of the Bank and a key means of differentiating the Bank from other
financial service providers.
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The Bank offers a broad range of deposit services typically available
from most banks and savings associations, including checking accounts, NOW
accounts, savings and other kinds of deposits of various types (ranging from
daily money market accounts to longer term certificates of deposit). The Bank
also offers a full range of credit services, including commercial loans (such as
lines of credit, term loans, refinancings, etc.), personal lines of credit,
direct installment consumer loans, credit card loans, residential mortgage
loans, construction loans, and letters of credit. In addition, the Bank offers
full Wealth Management services. The Bank also has formed arrangements with an
outside provider of tax services to better accommodate its customers.
The Bank's growth in deposits is attributable in part to the efforts of
its staff who provide personal banking services to the Bank's customers. In
addition, the Bank has emphasized paying competitive interest rates on deposit
products. Finally, the Bank has offered savings and certificate of deposit
products with competitive rates to larger depositors in an effort to minimize
the operating costs of obtaining these deposits. Lending strategies focus
primarily on commercial loans to small and medium size businesses as well as
personal loans to executives and professionals.
The residential mortgage lending area of the Bank offers conforming,
jumbo, portfolio, and CRA mortgage products. The Bank utilizes secondary market
channels it has developed for sale of those mortgage products described above.
Secondary market channels would include FNMA, as well as private investors
identified through wholesale entities. Consumer lending is directed to executive
and professional clients through residential mortgages, credit cards, and
personal lines of credit to include home equity loans.
The Market. The Bank derives a substantial proportion of its business
from the Indianapolis Metropolitan Statistical Area ("MSA"), Indiana area.
Indianapolis has been ranked by a number of national publications as a "top"
Midwestern city.
Competition. The Bank's service area is highly competitive. There are
numerous financial institutions operating in the Indianapolis MSA marketplace,
which provide strong competition to the Bank. In addition to the challenge of
attracting and retaining customers for traditional banking services offered by
commercial bank competitors, significant competition also comes from savings and
loans associations, credit unions, finance companies, insurance companies,
mortgage companies, securities and brokerage firms, money market mutual funds,
loan production offices, and other providers of financial services in the area.
These competitors with focused products targeted at highly profitable customer
segments, compete across geographic boundaries and provide customers increasing
access to meaningful alternatives to banking services in nearly all significant
products. The increasingly competitive environment is a result primarily of
changes in regulations, changes in technology, product delivery systems and the
accelerating pace of consolidation among financial service providers. These
competitive trends are likely to continue. The Bank's ability to maintain its
history of strong financial performance will depend in part on the Bank's
ability over time to expand its scope of available financial services as needed
to meet the needs and demands of its customers. The Bank competes in this
marketplace primarily on the basis of highly personalized service, responsive
decision making, and competitive pricing.
2
Employees. The Corporation and the Bank has 196 employees, of which 181
are full-time equivalent employees. The Bank has employed persons with
substantial experience in the Indianapolis MSA banking market. The average
banking experience level for all Bank employees is in excess of 14 years.
Lending Activity. The Bank's lending strategy emphasizes a high
quality, well-diversified loan portfolio. The Bank's principal lending
categories are commercial, commercial mortgage, residential mortgage, private
banking/personal, and home equity. Commercial loans include loans for working
capital, machinery and equipment purchases, premises and equipment acquisitions
and other corporate needs. Residential mortgage lending includes loans on first
mortgage residential properties. Private banking loans include secured and
unsecured personal lines of credit as well as home equity loans.
Commercial loans typically entail a thorough analysis of the borrower,
its industry, current and projected economic conditions and other factors.
Credit analysis involves collateral, the type of loan, loan maturity, terms and
conditions, and various loan to value ratios as they relate to loan policy. The
Bank typically requires commercial borrowers to have annual financial statements
prepared by independent accountants and may require such financial statements to
be audited or reviewed by accountants. The Bank generally requires appraisals or
evaluations in connection with loans secured by real estate. Such appraisals or
evaluations are usually obtained prior to the time funds are advanced. The Bank
also often requires personal guarantees from principals involved with
closely-held corporate borrowers.
The Bank requires loan applications and personal financial statements
from its personal borrowers on loans that the Bank originates. Loan officers
complete a debt to income analysis that should meet established standards of
lending policy.
The Bank maintains a comprehensive loan policy that establishes
guidelines with respect to all categories of lending. In addition, loan policy
sets forth lending authority for each loan officer. The Loan Committee of the
Bank reviews all loans in excess of $350,000. Any loan in excess of a lending
officer's lending authority, up to $1,500,000, must receive the approval of the
Chief Executive Officer ("CEO"), Chief Lending Officer ("CLO"), or Senior Vice
President - Corporate Banking ("SVP"). Loans in excess of $1,500,000 but less
than $5,000,000 must be approved by the Loan Committee prior to the Bank making
such loan. The Board of Directors Loan Policy Committee is not required to
approve loans unless they are above $5,000,000 or are loans to directors or
executive officers. All loans are assigned a numerical rating based on
creditworthiness and are monitored for improvement or deterioration.
Loans are made primarily in the Bank's designated market area.
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Regulation And Supervision
Both the Corporation and the Bank operate in highly regulated
environments and are subject to supervision and regulation by several
governmental regulatory agencies, including the Board of Governors of the
Federal Reserve System (the "Federal Reserve"), the Office of the Comptroller of
the Currency (the "OCC"), and the Federal Deposit Insurance Corporation (the
"FDIC"). The laws and regulations established by these agencies are generally
intended to protect depositors, not shareholders. Changes in applicable laws,
regulations, governmental policies, income tax laws and accounting principles
may have a material effect on our business and prospects. The following summary
is qualified by reference to the statutory and regulatory provisions discussed.
The Corporation
The Bank Holding Company Act. Because the Corporation owns all of the
outstanding capital stock of the Bank, it is registered as a bank holding
company under the federal Bank Holding Company Act of 1956 and is subject to
periodic examination by the Federal Reserve and required to file periodic
reports of its operations and any additional information that the Federal
Reserve may require.
Investments, Control, and Activities. With some limited exceptions, the
Bank Holding Company Act requires every bank holding company to obtain the prior
approval of the Federal Reserve before acquiring another bank holding company or
acquiring more than five percent of the voting shares of a bank (unless it
already owns or controls the majority of such shares).
Bank holding companies are prohibited, with certain limited exceptions,
from engaging in activities other than those of banking or of managing or
controlling banks. They are also prohibited from acquiring or retaining direct
or indirect ownership or control of voting shares or assets of any company which
is not a bank or bank holding company, other than subsidiary companies
furnishing services to or performing services for their subsidiaries, and other
subsidiaries engaged in activities which the Federal Reserve Board determines to
be so closely related to banking or managing or controlling banks as to be
incidental to these operations. The Bank Holding Company Act does not place
territorial restrictions on the activities of such nonbanking-related
activities.
Bank holding companies which meet certain management, capital, and CRA
standards may elect to become a financial holding company, which would allow
them to engage in a substantially broader range of nonbanking activities than is
permitted for a bank holding company, including insurance underwriting and
making merchant banking investments in commercial and financial companies.
The Corporation does not currently plan to engage in any activity other
than owning the stock of the Bank.
Capital Adequacy Guidelines for Bank Holding Companies. The Federal
Reserve, as the regulatory authority for bank holding companies, has adopted
capital adequacy guidelines for bank holding companies. Bank holding
4
companies with assets in excess of $150 million must comply with the Federal
Reserve's risk-based capital guidelines which require a minimum ratio of total
capital to risk-weighted assets (including certain off-balance sheet activities
such as standby letters of credit) of 8%. At least half of the total required
capital must be "Tier 1 capital," consisting principally of common stockholders'
equity, noncumulative perpetual preferred stock, a limited amount of cumulative
perpetual preferred stock and minority interest in the equity accounts of
consolidated subsidiaries, less certain goodwill items. The remainder ("Tier 2
capital") may consist of a limited amount of subordinated debt and
intermediate-term preferred stock, certain hybrid capital instruments and other
debt securities, cumulative perpetual preferred stock, and a limited amount of
the general loan loss allowance. In addition to the risk-based capital
guidelines, the Federal Reserve has adopted a Tier 1 (leverage) capital ratio
under which the bank holding company must maintain a minimum level of Tier 1
capital to average total consolidated assets of 3% in the case of bank holding
companies which have the highest regulatory examination ratings and are not
contemplating significant growth or expansion. All other bank holding companies
are expected to maintain a ratio of at least 1% to 2% above the stated minimum.
Certain regulatory capital ratios for the Corporation as of December
31, 2004 are shown below:
Tier 1 Capital to Risk-Weighted Assets 9.0%
Total Risk Based Capital to Risk-Weighted Assets 10.9%
Tier 1 Leverage Ratio 6.8%
Dividends. The Federal Reserve's policy is that a bank holding company
experiencing earnings weakness should not pay cash dividends exceeding its net
income or which could only be funded in ways that weaken the bank holding
company's financial health, such as by borrowing. Additionally, the Federal
Reserve possesses enforcement powers over bank holding companies and their
non-bank subsidiaries to prevent or remedy actions that represent unsafe or
unsound practices or violations of applicable statutes and regulations. Among
these powers is the ability to proscribe the payment of dividends by banks and
bank holding companies.
Source of Strength. In accordance with Federal Reserve Board policy,
the Corporation is expected to act as a source of financial strength to the Bank
and to commit resources to support the Bank in circumstances in which the
Corporation might not otherwise do so.
The Bank
General Regulatory Supervision. The Bank is organized under the laws of
the United States of America and is subject to the supervision of the OCC, whose
examiners conduct periodic examinations of national banks. The Bank must undergo
regular on-site examinations by the OCC and must submit quarterly and annual
reports to the OCC.
The deposits of the Bank are insured by the Bank Insurance Fund ("BIF")
administered by the FDIC and are subject to the FDIC's rules and regulations
respecting the insurance of deposits. See "--Deposit Insurance."
5
Lending Limits. Under federal law, the total loans and extensions of
credit by a national bank to a borrower outstanding at one time and not fully
secured may not exceed 15 percent of the bank's capital and unimpaired surplus.
In addition, the total amount of outstanding loans and extensions of credit to
any borrower outstanding at one time and fully secured by readily marketable
collateral may not exceed ten percent of the unimpaired capital and unimpaired
surplus of the bank (this limitation is separate from and in addition to the
above limitation). If a loan is secured by United States obligations, such as
treasury bills, it is not subject to the bank's legal lending limit.
Deposit Insurance. Deposits in the Bank are insured by the FDIC up to a
maximum amount, which is generally $100,000 per depositor subject to aggregation
rules. The Bank is subject to deposit insurance assessment by the FDIC pursuant
to its regulations establishing a risk-related deposit insurance assessment
system, based upon the institution's capital levels and risk profile. The Bank
is also subject to assessment for the Financial Corporation (FICO) to service
the interest on its bond obligations. The amount assessed on individual
institutions, including the Bank, by FICO is in addition to the amount paid for
deposit insurance according to the risk-related assessment rate schedule.
Increases in deposit insurance premiums or changes in risk classification will
increase the Bank's cost of funds, and we may not be able to pass these costs on
to our customers. The Bank is not currently paying deposit insurance premiums to
the FDIC, but was required to pay $25,500 for the FICO assessment for the first
quarter in 2005.
Transactions with Affiliates and Insiders. The Bank is subject to
limitations on the amount of loans or extensions of credit to, or investments
in, or certain other transactions with, affiliates and on the amount of advances
to third parties collateralized by the securities or obligations of affiliates.
Furthermore, within the foregoing limitations as to amount, each covered
transaction must meet specified collateral requirements. Compliance is also
required with certain provisions designed to avoid the taking of low quality
assets. The Bank is also prohibited from engaging in certain transactions with
certain affiliates unless the transactions are on terms substantially the same,
or at least as favorable to such institution or its subsidiaries, as those
prevailing at the time for comparable transactions with nonaffiliated companies.
Extensions of credit by the Bank to its executive officers, directors,
certain principal shareholders, and their related interests must:
o be made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable
transactions with third parties; and
o not involve more than the normal risk of repayment or present other
unfavorable features.
Dividends. Under federal law, the Bank may pay dividends from its
undivided profits in an amount declared by its Board of Directors, subject to
prior approval of the OCC if the proposed dividend, when added to all prior
dividends declared during the current calendar year, would be greater than the
current year's net income and retained earnings for the previous two calendar
years.
Federal law generally prohibits the Bank from paying a dividend to the
Corporation if the depository institution
6
would thereafter be undercapitalized. The FDIC may prevent an insured bank from
paying dividends if the bank is in default of payment of any assessment due to
the FDIC. In addition, payment of dividends by a bank may be prevented by the
applicable federal regulatory authority if such payment is determined, by reason
of the financial condition of such bank, to be an unsafe and unsound banking
practice. In addition, the Bank is subject to certain restrictions imposed by
the Federal Reserve on extensions of credit to the Corporation, on investments
in the stock or other securities of the Corporation, and in taking such stock or
securities as collateral for loans.
Branching and Acquisitions. Under federal and Indiana law, the Bank may
establish an additional banking location anywhere in Indiana. Federal law also
allows bank holding companies to acquire banks anywhere in the United States
subject to certain state restrictions, and permits an insured bank to merge with
an insured bank in another state without regard to whether such merger is
prohibited by state law. Additionally, an out-of-state bank may acquire the
branches of an insured bank in another state without acquiring the entire bank
if the law of the state where the branch is located permits such an acquisition.
Bank holding companies may merge existing bank subsidiaries located in different
states into one bank.
Community Reinvestment Act. The Community Reinvestment Act requires
that the OCC evaluate the record of the Bank in meeting the credit needs of its
local community, including low and moderate income neighborhoods. These factors
are also considered in evaluating mergers, acquisitions, and applications to
open a branch or facility. Failure to adequately meet these criteria could
result in the imposition of additional requirements and limitations on the Bank.
Capital Regulations. The OCC has adopted risk-based capital ratio
guidelines to which the Bank is subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk.
These guidelines divide a bank's capital into two tiers. The first tier
(Tier 1) includes common equity, certain non-cumulative perpetual preferred
stock (excluding auction rate issues) and minority interests in equity accounts
of consolidated subsidiaries, less goodwill and certain other intangible assets
(except mortgage servicing rights and purchased credit card relationships,
subject to certain limitations). Supplementary (Tier 2) capital includes, among
other items, cumulative perpetual and long-term limited-life preferred stock,
mandatory convertible securities, certain hybrid capital instruments, term
subordinated debt and the allowance for loan and lease losses, subject to
certain limitations, less required deductions. Banks are required to maintain a
total risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. The
OCC may, however, set higher capital requirements when a bank's particular
circumstances warrant. Banks experiencing or anticipating significant growth are
expected to maintain capital ratios, including tangible capital positions, well
above the minimum levels.
7
In addition, the OCC established guidelines prescribing a minimum Tier
1 leverage ratio (Tier 1 capital to adjusted total assets as specified in the
guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of 3%
for banks that meet certain specified criteria, including that they have the
highest regulatory rating and are not experiencing or anticipating significant
growth. All other banks are required to maintain a Tier 1 leverage ratio of 3%
plus an additional cushion of at least 100 to 200 basis points.
Certain regulatory capital ratios under the OCC's risk-based capital
guidelines for the Bank at December 31, 2004 are shown below:
Tier 1 Capital to Risk-Weighted Assets...................... 8.6%
Total Risk-Based Capital to Risk-Weighted Assets............ 10.5%
Tier 1 Leverage Ratio....................................... 6.5%
The federal bank regulators, including the OCC, also have issued a
joint policy statement to provide guidance on sound practices for managing
interest rate risk. The statement sets forth the factors the federal regulatory
examiners will use to determine the adequacy of a bank's capital for interest
rate risk. These qualitative factors include the adequacy and effectiveness of
the bank's internal interest rate risk management process and the level of
interest rate exposure. Other qualitative factors that will be considered
include the size of the bank, the nature and complexity of its activities, the
adequacy of its capital and earnings in relation to the bank's overall risk
profile, and its earning exposure to interest rate movements. The interagency
supervisory policy statement describes the responsibilities of a bank's board of
directors in implementing a risk management process and the requirements of the
bank's senior management in ensuring the effective management of interest rate
risk. Further, the statement specifies the elements that a risk management
process must contain.
The OCC has also issued final regulations further revising its
risk-based capital standards to include a supervisory framework for measuring
market risk. The effect of these regulations is that any bank holding company or
bank which has significant exposure to market risk must measure such risk using
its own internal model, subject to the requirements contained in the
regulations, and must maintain adequate capital to support that exposure. These
regulations apply to any bank holding company or bank whose trading activity
equals 10% or more of its total assets, or whose trading activity equals $1
billion or more. Examiners may require a bank holding company or bank that does
not meet the applicability criteria to comply with the capital requirements if
necessary for safety and soundness purposes. These regulations contain
supplemental rules to determine qualifying and excess capital, calculate
risk-weighted assets, calculate market risk equivalent assets and calculate
risk-based capital ratios adjusted for market risk.
The Bank is also subject to the "prompt corrective action" regulations,
which implement a capital-based regulatory scheme designed to promote early
intervention for troubled banks. This framework contains five categories of
compliance with regulatory capital requirements, including "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized,"
and "critically undercapitalized." As of December 31, 2004, the Bank was
qualified as "well capitalized." It should be noted that a bank's capital
category is determined solely for the
8
purpose of applying the "prompt corrective action" regulations and that the
capital category may not constitute an accurate representation of the bank's
overall financial condition or prospects. The degree of regulatory scrutiny of a
financial institution increases, and the permissible activities of the
institution decrease, as it moves downward through the capital categories. Bank
holding companies controlling financial institutions can be required to boost
the institutions' capital and to partially guarantee the institutions'
performance.
Check Clearing for the 21st Century Act. Effective October 28, 2004,
the Federal Reserve adopted final amendments to Regulation CC and its commentary
to implement the Check Clearing for the 21st Century Act (the "Check 21 Act").
The Check 21 Act was enacted on October 28, 2003 and became effective on October
28, 2004.
To facilitate check truncation and electronic check exchange, the Check
21 Act authorizes a new negotiable instrument called a "substitute check" and
provides that a properly prepared substitute check is the legal equivalent of
the original check for all purposes. A substitute check is a paper reproduction
of the original check that can be processed just like the original check. The
Check 21 Act does not require any bank to create substitute checks or to accept
checks electronically. The Federal Reserve's amendments: (i) set forth the
requirements of the Check 21 Act that apply to all banks, including those that
choose not to create substitute checks; (ii) provide a model disclosure and
model notices relating to substitute checks; and (iii) set forth bank
endorsement and identification requirements for substitute checks. The
amendments also clarify some existing provisions of the rule and commentary.
USA Patriot Act. The Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the
"USA Patriot Act") is intended to strengthen the ability of U. S. Law
Enforcement to combat terrorism on a variety of fronts. The potential impact of
the USA Patriot Act on financial institutions is significant and wide-ranging.
The USA Patriot Act contains sweeping anti-money laundering and financial
transparency laws and requires financial institutions to implement additional
policies and procedures with respect to, or additional measures designed to
address, any or all of the following matters, among others: money laundering,
suspicious activities and currency transaction reporting; and currency crimes.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the
"Sarbanes-Oxley Act") represents a comprehensive revision of laws affecting
corporate governance, accounting obligations and corporate reporting. Among
other requirements, the Sarbanes-Oxley Act established: (i) new requirements for
audit committees of public companies, including independence, expertise, and
responsibilities; (ii) additional responsibilities regarding financial
statements for the chief executive officers and chief financial officers of
reporting companies; (iii) new standards for auditors and regulation of audits;
(iv) increased disclosure and reporting obligations for reporting companies
regarding various matters relating to corporate governance, and (v) new and
increased civil and criminal penalties for violation of the securities laws.
9
Other Regulations.
Federal law extensively regulates other various aspects of the banking
business such as reserve requirements. Current federal law also requires banks,
among other things to make deposited funds available within specified time
periods. In addition, with certain exceptions, a bank and a subsidiary may not
extend credit, lease or sell property or furnish any services or fix or vary the
consideration for the foregoing on the condition that (i) the customer must
obtain or provide some additional credit, property or services from, or to, any
of them, or (ii) the customer may not obtain some other credit, property or
service from a competitor, except to the extent reasonable conditions are
imposed to assure the soundness of credit extended.
An insured bank subsidiary may act as an agent for an affiliated bank
or thrift in offering limited banking services (receive deposits, renew time
deposits, close loans, service loans and receive payments on loan obligations)
both within the same state and across state lines.
Interest and other charges collected or contracted by the Bank are
subject to state usury laws and federal laws concerning interest rates. The
Bank's loan operations are also subject to federal laws applicable to credit
transactions, such as the:
o Truth-In-Lending Act, governing disclosures of credit terms to
consumer borrowers;
o Home Mortgage Disclosure Act of 1975, requiring financial institutions
to provide information to enable the public and public officials to
determine whether a financial institution is fulfilling its obligation
to help meet the housing needs of the community it serves;
o Equal Credit Opportunity Act, prohibiting discrimination on the basis
of race, creed or other prohibited factors in extending credit;
o Fair Credit Reporting Act of 1978, governing the use and provision of
information to credit reporting agencies;
o Fair Debt Collection Act, governing the manner in which consumer debts
may be collected by collection agencies; and
o rules and regulations of the various federal agencies charged with the
responsibility of implementing such federal laws.
The deposit operations of the Bank also are subject to the:
o Customer Information Security Guidelines. The federal bank regulatory
agencies have adopted final guidelines (the "Guidelines") for
safeguarding confidential customer information. The Guidelines require
each financial institution, under the supervision and ongoing
oversight of its Board of Directors, to create a comprehensive written
information security program designed to ensure the security and
confidentiality of customer information, protect against any
anticipated threats or hazards to the security or integrity of such
information; and protect against unauthorized access to or use of such
information that could result in substantial harm or inconvenience to
any customer.
10
o Electronic Funds Transfer Act, and Regulation E. The Electronic Funds
Transfer Act, which is implemented by Regulation E, governs automatic
deposits to and withdrawals from deposit accounts and customers'
rights and liabilities arising from the use of automated teller
machines and other electronic banking service.
The federal banking agencies have established guidelines which
prescribe standards for depository institutions relating to internal controls,
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, asset quality, earnings,
compensation fees and benefits, and management compensation. The agencies may
require an institution which fails to meet the standards set forth in the
guidelines to submit a compliance plan. Failure to submit an acceptable plan or
adhere to an accepted plan may be grounds for further enforcement action.
Enforcement Powers. Federal regulatory agencies may assess civil and
criminal penalties against depository institutions and certain
"institution-affiliated parties," including management, employees, and agents of
a financial institution, as well as independent contractors and consultants such
as attorneys and accountants and others who participate in the conduct of the
financial institution's affairs. In addition, regulators may commence
enforcement actions against institutions and institution-affiliated parties.
Possible enforcement actions include the termination of deposit insurance.
Furthermore, regulators may issue cease-and-desist orders to, among other
things, require affirmative action to correct any harm resulting from a
violation or practice, including restitution, reimbursement, indemnifications or
guarantees against loss. A financial institution may also be ordered to restrict
its growth, dispose of certain assets, rescind agreements or contracts, or take
other actions as determined by the regulator to be appropriate.
Effect of Governmental Monetary Policies. The Corporation's earnings
are affected by domestic economic conditions and the monetary and fiscal
policies of the United States government and its agencies. The Federal Reserve
Bank's monetary policies have had, and are likely to continue to have, an
important impact on the operating results of commercial banks through its power
to implement national monetary policy in order, among other things, to curb
inflation or combat a recession. The monetary policies of the Federal Reserve
Board have major effects upon the levels of bank loans, investments and deposits
through its open market operations in United States government securities and
through its regulation of the discount rate on borrowings of member banks and
the reserve requirements against member bank deposits. It is not possible to
predict the nature or impact of future changes in monetary and fiscal policies.
Available Information
- ---------------------
All reports filed electronically by the Corporation with the United
States Securities and Exchange Commission (SEC), including the Annual Report on
Form 10-K, quarterly reports on Form 10-Q, and current event reports on Form
8-K, as well as any amendments to those reports, are accessible at no cost on
the Corporation's Web site at www.nbofi.com. These filings are also accessible
on the SEC's Web site at www.sec.gov.
11
Item 2. Property
- -----------------
The Bank owns the downtown office building which houses its main office
as well as the Corporation's main office at 107 North Pennsylvania Street,
Indianapolis, Indiana. The Bank and the Corporation utilize six floors of this
ten-story building, and lease the remainder to other business enterprises.
The Bank opened its first neighborhood bank office in February 1995 at
84th and Ditch Road. The Bank also opened a neighborhood bank office at 82nd and
Bash Road on the northeast side of Indianapolis in December 1995. The Bank owns
the land and the premises for both of these offices. In March 1996, the Bank
opened an office in the Chamber of Commerce building at 320 N. Meridian Street
in the downtown Indianapolis area. The Bank leases the premises at this banking
office. In March 1998, the Bank opened an office at 4930 North Pennsylvania
Street and leases the premises at this banking office. In June 1999, the Bank
opened an office in the AUL Office Complex located at One American Square in the
downtown Indianapolis area. The Bank leases the premises at this banking center.
In September 2000, the Bank opened an office at 650 East Carmel Drive in Carmel.
This office is located in Hamilton County which is north of Indianapolis. The
Bank leases the premises at this banking office. In July 1997, the Bank
purchased a parcel of land in Greenwood for future business development. In
October 2001, the Bank opened an office at 1675 West Smith Valley Road in
Greenwood. The Bank leases the premises at this banking office. In 2004, the
bank started construction of an office located at 105th Street and Michigan
Road. This office is located in Hamilton County and opened for business on
January 18, 2005. The bank leases the land on which the building is constructed.
The Bank has installed a remote ATM at the Indianapolis City Market,
Parkwood Crossing, and Meridian Mark II Office Complex. These remote ATMs
provide additional banking convenience for the customers of the Bank, and
generate an additional source of fee income for the Bank.
The Corporation's properties are in good physical condition and are
considered by the Corporation to be adequate to meet the needs of the
Corporation and the Bank and the banking needs of the customers in the
communities served.
Item 3. Legal Proceedings
- --------------------------
Neither the Corporation nor the Bank are involved in any material
pending legal proceedings at this time, other than routine litigation incidental
to its business.
Item 4. Submission of Matters to a Vote of Security Holders.
- -------------------------------------------------------------
None.
12
PART II
Item 5. Market Price for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.
- -------------------------------------------------------------------------
Shares of the common stock of the Corporation are not traded on any
national or regional exchange or in the over-the-counter market. Accordingly,
there is no established market for the common stock. These are occasional trades
as a result of private negotiations which do not always involve a broker or a
dealer. The table below lists the high and low prices per share of which
management is aware of during 2004 and 2003. There may have been other trades at
other prices of which management is not aware. Management does not have
knowledge of the price paid in all transactions and has not verified the
accuracy of those prices that have been reported to it. Because of the lack of
an established market for the common shares of the Corporation, these prices
would not necessarily reflect the prices which the shares would trade in an
active in an active market.
- -----------------------------------------------------------------------------
Price per Share
- -----------------------------------------------------------------------------
Quarter High Low
------- ---- ---
- -----------------------------------------------------------------------------
2004 2003 2004 2003
- -----------------------------------------------------------------------------
First Quarter $33.00 $30.00 $31.25 $29.50
- -----------------------------------------------------------------------------
Second Quarter $33.00 $31.00 $32.50 $30.75
- -----------------------------------------------------------------------------
Third Quarter $33.75 $31.50 $32.75 $31.00
- -----------------------------------------------------------------------------
Fourth Quarter $34.50 $31.88 $33.19 $30.88
- -----------------------------------------------------------------------------
The Corporation had 652 shareholders on record as of March 24, 2005.
The Corporation has not declared or paid any cash dividends on its
shares of common stock since its organization in 1993. The Corporation and the
Bank anticipate that earnings will be retained to finance the Bank's growth in
the immediate future. Future dividend payments by the Corporation, if any, will
be dependent upon dividends paid by the Bank, which are subject to regulatory
limitations, earnings, general economic conditions, financial condition, capital
requirements, and other factors as may be appropriate in determining dividend
policy.
On October 27, 2004 the Corporation sold a total of 2,000 share of
commons stock for an aggregate amount of $30,000 to a director of the
Corporation pursuant to the exercise of stock options. On December 1, 2004 the
Corporation sold a total of 700 shares of common stock for an aggregate amount
of $13,300 to an officer of the Corporation pursuant to the exercise of stock
options. As previously reported in the Corporation's prior filings with the
Securities and Exchange Commission, the Corporation sold pursuant to the
exercise by employees and directors of stock options an aggregate of 42,931
shares for $462,353 during the third quarter of 2004, an aggregate of 50,800
shares for $631,950 during the second quarter of 2004, and an aggregate of 5,500
shares for $55,000 during the first quarter of 2004. All of these shares were
sold in private placements pursuant to Section 4(2) of the Securities Act of
1933.
13
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 of Directors. 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 their stock. Program Two
covers all other shareholders and was initially due to expire December 2004
unless terminated earlier by the Board of Directors. During the fourth quarter
of 2004, the Board authorized the extension of Program Two until December 2005
unless terminated earlier by the Board of Directors. 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. On June 3, 2003, a
letter was sent to all shareholders announcing the Board's authorization of
Program Two. Neither plan was terminated during 2004.
During 2004, the Corporation repurchased in the aggregate, 114,421
shares for an aggregate cost of $3,779,334. The following table provides
information with respect to shares repurchased by the Corporation during fourth
quarter 2004:
- -------------------------------------------------------------------------------------------------------------------
Maximum Number (or
Total Number of Approximate Dollar
Total Number of Shares Purchased as Value) of Shares
Period Shares Purchased Part of Publicly that May Yet Be
during 4th quarter Average Price Paid Announced Plans or Purchased Under the
2004 per Share Programs** Plans or Programs
- -------------------------------------------------------------------------------------------------------------------
10/01/04 -
10/31/04 2,623 $34.00 2,623 $4,611,698
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
11/01/04 -
11/30/04 4,200 $34.00 4,200 $4,472,146
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
12/01/04 -
12/31/04 5,115 $34.50 5,115 $4,295,679
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Total 11,938 * 11,938 $4,295,679
- -------------------------------------------------------------------------------------------------------------------
* The weighted average price per share for the period October
2004 through December 2004 was $33.94.
** All shares repurchased by the Corporation in 2004 were completed
pursuant to Program One and Program Two.
14
Item 6. Selected Financial Data
- --------------------------------
The following table sets forth certain consolidated information
concerning the Corporation for the periods and dates indicated and should be
read in connection with, and is qualified in its entirety by, the detailed
information and consolidated financial statements and related notes set forth in
the Corporation's audited financial statements included elsewhere herein (in
000's), except per share data.
Year Ended December 31
2004 2003 2002 2001 2000 1999
---------------------------------------------------------------------
Consolidated Operating Data:
Interest income $ 38,524 $ 34,560 $ 35,095 $ 38,801 $ 35,319 $ 26,247
Interest expense 12,962 11,950 14,061 20,953 19,786 14,355
Net interest income 25,561 22,610 21,034 17,848 15,533 11,892
Provision for loan losses 1,320 1,200 1,500 1,440 1,440 1,010
Net income after provision for loan losses 24,241 21,410 19,534 16,408 14,093 10,882
Securities losses net (84) (37) -- -- -- --
Other operating income 7,177 7,951 7,475 5,923 4,278 3,363
Other operating expenses 22,602 20,984 19,452 16,821 14,002 11,198
Net income before taxes 8,816 8,377 7,557 5,510 4,369 3,047
Federal and state income tax 3,135 3,213 3,000 2,140 1,719 1,217
Net income 5,681 5,164 4,557 3,370 2,650 1,830
Consolidated Balance Sheet Data (at end of period):
Total assets $ 880,914 $ 812,599 $ 726,514 $ 670,697 $ 533,767 $ 429,501
Total investment securities (including stock
in Federal Banks) 151,799 125,247 117,485 39,049 89,379 55,660
Total loans 656,453 597,063 528,911 452,060 361,602 311,478
Allowance for loan losses (7,796) (8,030) (7,227) (5,987) (4,701) (3,393)
Deposits 693,431 637,537 544,343 506,125 410,434 345,008
Shareholders' equity 46,544 42,678 41,247 28,470 24,660 21,636
Weighted average shares outstanding 2,303 2,343 2,289 1,917 1,908 1,889
Per Share Data:
Basic net income per common share (1) $ 2.47 $ 2.20 $ 1.99 $ 1.76 $ 1.39 $ 0.97
Cash dividends declared 0 0 0 0 0 0
Book value (2) 19.81 18.14 16.89 14.48 12.60 11.09
Other Statistics and Operating Data:
Return on average assets 0.7% 0.7% 0.7% 0.5% 0.6% 0.5%
Return on average equity 12.8% 12.1% 12.2% 12.7% 11.4% 8.9%
Net interest margin (3) 3.1% 3.1% 3.2% 3.0% 3.5% 3.2%
Average loans to average deposits 89.0% 95.7% 90.8% 90.8% 90.3% 83.4%
Allowance for loan losses to loans at end of period 1.2% 1.3% 1.4% 1.3% 1.3% 1.1%
Allowance for loan losses to non-performing loans 255.1% 164.8% 223.8% 717.0% 518.8% 881.5%
Non-performing loans to loans at end of period 0.5% 0.8% 0.6% 0.2% 0.3% 0.1%
Net charge-offs to average loans 0.3% 0.1% 0.1% 0.0% 0.0% 0.1%
Number of offices 9 8 8 8 7 6
Number of full and part-time employees 196 180 176 165 144 127
Number of Shareholders of Record 632 645 647 634 640 619
Capital Ratios:
Average shareholders' equity to average assets 5.2% 5.6% 5.4% 4.3% 4.8% 5.1%
Equity to assets 5.3% 5.3% 5.7% 4.2% 4.6% 5.0%
Total risk-based capital ratio (Bank only) 10.5% 10.2% 10.1% 10.6% 11.1% 10.2%
(1) Based upon weighted average shares outstanding during the period.
(2) Based on Common Stock outstanding at the end of the period.
(3) Net interest income as a percentage of average interest-earning assets.
15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- ------------------------------------------------------------------------
The following discussion and analysis of the Corporation relates to the years
ended December 31, 2004, 2003 and 2002 and should be read in conjunction with
the Corporation's Consolidated Financial Statements and Notes thereto included
elsewhere herein.
Overview
The primary source of the Bank's revenue is net interest income from
loans and deposits, and fees from financial services provided to customers.
Overall economic factors including market interest rates, business spending, and
consumer confidence, as well as competitive conditions within the marketplace
tend to influence business volumes.
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 December 31, 2004 the interest rate risk position of
the Corporation was asset sensitive. Maintaining an asset sensitive interest
rate risk position means that net income should increase as rates rise and
decrease as rates fall.
Due to record low interest rates in 2003, there was an increase in
refinancing activity and mortgage loan sales by the Corporation. There has been
a significant decrease in mortgage loan refinancing during 2004 resulting in
less sales by the Corporation causing 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. It has been our experience that improved economic strength
generally will translate into better credit quality in the banking industry.
Management believes that the reserve for loan losses are adequate.
The risks and challenges that management believes will be important
during 2005 are price competition for loans and deposits by new market entrants
as well as established competitors, and continued lower mortgage loan volume as
compared to 2003 and 2002, leading to lower gains on sales of mortgage loans.
16
Results of Operations
Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003 and
Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002
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 income of $5,681,049 for the year ended
December 31, 2004 compared to net income of $5,164,200 for the year ended
December 31, 2003 and net income of $4,556,836 for the year ended December 31,
2002. This change is primarily due to the growth of the Bank allowing for more
interest earning assets and net interest income compared to the same period
during 2003 and 2002, thereby offsetting more of the operating expenses.
The Bank experienced growth during the past three years. Total assets
increased $68,314,965 or 8.4% to $880,913,779 for the year ended December 31,
2004 from $812,598,814 for the year ended December 31, 2003 and total assets
increased from $726,514,473 for the year ended December 31, 2002. This growth is
in part due to an increase in customers as a result of local bank
mergers/consolidations and the addition of experienced corporate and private
bankers to the staff.
Net Interest Income
The following table details the components of net interest income for
the years ended December 31, 2004, 2003, and 2002 (in 000's):
The following table details the components of net interest income for the years
ended December 31, 2004, 2003, and 2002 (in 000's):
Year ended Year ended
December 31 $ % December 31 $ %
2004 2003 Change Change 2003 2002 Change Change
------------------------------------------- -------------------------------------------
Interest income:
Interest and fees on loans $ 33,306 $ 31,010 $ 2,296 7.4% $ 31,010 $ 30,593 $ 417 1.4%
Interest on investment securities 4,403 3,020 1,383 45.8% 3,020 3,683 (663) -18.0%
Interest on federal funds sold 725 432 293 67.8% 432 573 (141) -24.6%
Interest on reverse repurchase agreements 90 98 (8) -8.2% 98 245 (147) -60.0%
------------------------------------------- -------------------------------------------
Total interest income $ 38,524 $ 34,560 $ 3,964 11.5% $ 34,560 $ 35,094 $ (534) -1.5%
Interest expense:
Interest on deposits $ 8,975 $ 7,668 $ 1,307 17.0% $ 7,668 $ 9,145 $ (1,477) -16.2%
Interest on repurchase agreements 570 381 189 49.6% 381 752 (371) -49.3%
Interest on FHLB advances 1,775 2,414 (639) -26.5% 2,414 2,721 (307) -11.3%
Interest on long term debt 1,642 1,487 155 10.4% 1,487 1,444 43 3.0%
------------------------------------------- -------------------------------------------
Total interest expense $ 12,962 $ 11,950 $ 1,012 8.5% $ 11,950 $ 14,062 $ (2,112) -15.0%
------------------------------------------- -------------------------------------------
Net interest income $ 25,562 $ 22,610 $ 2,952 13.1% $ 22,610 $ 21,032 $ 1,578 7.5%
=========================================== ===========================================
The increase in interest income is due to the higher yields on federal
funds sold, growth in investment securities portfolio and in the loan portfolio.
During 2004, the prime interest rate increased by 125 basis points to 5.25% as
of December 31, 2004 from 4.00% as of December 31, 2003. The prime rate
increases did not begin until June 30, 2004.
17
The following table shows the prime rate in effect as of each year end
and also shows the significant interest rate decreases by the Federal Reserve in
2001 as well as smaller decreases in 2002 and 2003:
Date Prime Rate
---- ----------
December 31, 2000 9.50%
December 31, 2001 4.75%
December 31, 2002 4.25%
December 31, 2003 4.00%
December 31, 2004 5.25%
Net interest income increased for the year ended December 31, 2004
compared to the year ended December 31, 2003 and 2002. The overall increase
between 2004 and 2003 was 13.1% and between 2003 and 2002 increased by 7.5%. The
overall increase was lower between 2003 and 2002 because of the overall lower
interest rate environment. In 2003 and 2002, there was a compression of the
spread between the yield earned on loans and the yield paid on deposits due to
the lower interest rate environment.
18
The following table details average balances, interest income / expense
and average rates / yields for the Bank's earning assets and interest bearing
liabilities for the years ended December 31, 2004, 2003 and 2002 (in 000's):
2004 2003 2002
Interest Average Interest Average Interest Average
Average Income/ Rate/ Average Income/ Rate/ Average Income/ Rate/
Balance Expense Yield Balance Expense Yield Balance Expense Yield
------------------------------ ------------------------------- --------------------------------
Assets:
Federal Funds $ 42,637 $ 725 1.70% $ 39,961 $ 432 1.08% $ 34,992 $ 573 1.64%
Reverse Repurchase Agreements 9,180 90 0.98% 10,986 98 0.89% 15,548 245 1.58%
Investments 159,795 4,403 2.76% 115,597 3,020 2.61% 130,832 3,683 2.82%
Loans (gross) 612,096 33,306 5.44% 562,587 31,010 5.51% 483,562 30,593 6.33%
------------------------------ ------------------------------- --------------------------------
Total earning assets $ 823,708 $ 38,524 4.68% $ 729,131 $ 34,560 4.74% $ 664,934 $ 35,094 5.28%
Non-earning assets 39,950 37,076 44,413
---------- ---------- -----------
Total assets $ 863,658 $ 766,207 $ 709,347
========== ========== ===========
Liabilities:
Interest bearing DDA $ 84,954 $ 665 0.78% $ 69,194 $ 576 0.83% $ 57,430 $ 574 1.00%
Savings 333,840 4,910 1.47% 275,108 3,764 1.37% 248,487 4,162 1.67%
CD's under $100,000 56,540 1,695 3.00% 54,146 1,752 3.24% 57,954 2,496 4.31%
CD's over $100,000 49,265 1,323 2.69% 40,430 1,186 2.93% 36,840 1,421 3.86%
Individual Retirement Accounts 12,705 382 3.01% 11,848 390 3.29% 10,885 492 4.52%
Repurchase Agreements 74,794 570 0.76% 71,352 381 0.53% 70,121 752 1.07%
FHLB Advances/Other 34,317 1,775 5.17% 46,052 2,414 5.24% 48,926 2,721 5.56%
Subordinated Debt 3,992 154 3.86% 1,145 43 3.76%
Long Term Debt 13,918 1,488 10.69% 13,500 1,444 10.70% 13,500 1,444 10.70%
------------------------------ ------------------------------- --------------------------------
Total Interest Bearing Liabilities $ 664,325 $ 12,962 1.95% $ 582,775 $ 11,950 2.05% $ 544,143 $ 14,062 2.58%
Non-Interest Bearing Liabilities 150,357 136,846 116,295
Other Liabilities 4,460 3,841 3,726
---------- ---------- -----------
Total Liabilities $ 819,142 $ 723,462 $ 664,164
Equity 44,516 42,745 45,183
---------- ---------- -----------
Total Liabilities & Equity $ 863,658 $ 766,207 $ 709,347
========== ========== ===========
Recap:
Interest Income $ 38,524 4.68% $ 34,560 4.74% $ 35,094 5.28%
Interest Expense 12,962 1.95% 11,950 2.05% 14,062 2.58%
-------------------- --------------------- ---------------------
Net Interest Income/Spread $ 25,562 2.73% $ 22,610 2.69% $ 21,032 2.69%
==================== ===================== =====================
Contribution of Non-Interest
Bearing Funds 0.38% 0.41% 0.47%
Net Interest Margin 3.10% 3.10% 3.16%
========== =========== ===========
NOTE: Average balances computed using daily actual balances. The average loan
balance includes non-accrual loans and the interest recognized prior to becoming
non-accrual is reflected in the interest income for loans.
19
The following table sets forth an analysis of volume and rate changes
in interest income and interest expense of the Corporation's average earning
assets and average interest-bearing liabilities. The table distinguishes between
the changes related to average outstanding balances of assets and liabilities
(changes in volume holding the initial average interest rate constant) and the
changes related to average interest rates (changes in average rate holding the
initial average outstanding balance constant). The change in interest due to
both volume and rate has been allocated to volume and rate changes in proportion
to the relationship of the absolute dollar amounts of the change in each.
Net Interest Income Changes Due to Volume and Rates (in 000's):
- ---------------------------------------------------------------
Year Ended December 31
2004 Changes from 2003 2003 Changes from 2002 2002 Changes from 2001
Net Due to Due to Net Due to Due to Net Due to Due to
Change Rate Volume Change Rate Volume Change Rate Volume
Interest earning assets:
Federal funds sold $ 293 $ 247 $ 46 $ (141) $ (195) $ 54 $ (472) $ (593) $ 121
Reverse repurchase agreements (8) 10 (18) (147) (106) (41) (558) (359) (199)
Investment securities 1,383 165 1,218 (663) (265) (398) (2,471) (2,473) 2
Loans 2,296 (398) 2,694 417 (3,939) 4,356 (206) (5,280) 5,074
----------------------------- ----------------------------- -----------------------------
TOTAL $ 3,964 $ 24 $ 3,940 $ (534) $(4,505) $ 3,971 $(3,707) $(8,704) $ 4,997
Interest bearing liabilities:
Demand deposits $ 89 $ (34) $ 123 $ 2 $ (96) $ 98 $ (122) $ (210) $ 88
Savings deposits 1,146 282 864 (398) (762) 364 (2,532) (3,460) 928
CDs under $100,000 (57) (129) 72 (744) (621) (123) (1,129) (939) (190)
CDs over $100,000 137 (100) 237 (235) (340) 105 (905) (776) (129)
Individual retirement accounts (8) (34) 26 (102) (134) 32 (87) (135) 48
Repurchase agreements 189 163 26 (371) (378) 7 (2,404) (2,163) (241)
FHLB Advances (639) (32) (607) (307) (156) (151) 287 (132) 419
Subordinated debt 111 1 110 43 -- 43 -- -- --
Long term debt 44 (1) 45 -- -- -- 1 1 --
----------------------------- ----------------------------- -----------------------------
TOTAL $ 1,012 $ 116 $ 896 $(2,112) $(2,487) $ 375 $(6,891) $(7,813) $ 922
----------------------------- ----------------------------- -----------------------------
Net change in Net Interest Income $ 2,952 $ (92) $ 3,044 $ 1,578 $(2,018) $ 3,596 $ 3,184 $ (891) $ 4,075
============================= ============================= =============================
NOTE: Due to Rate Increase was calculated by taking the change in the rate times
the prior year average balance. Due to volume increase was calculated by taking
the change in average balance times the prior year rate.
Interest on federal funds sold increased for the year ended December
31, 2004 compared to the year ended December 31, 2003; however interest earned
on federal funds sold decreased for the year ended December 31, 2003 as compared
to the year ended December 31, 2002. The increase is due to rising interest
rates during the last six months in 2004 as compared to previous years. The
weighted average rate was 1.70% for the year ended December 31, 2004 compared to
a weighted average rate of 1.08% and 1.64% for the years ended December 31, 2003
and 2002, respectively. The average balance for federal funds sold increased for
the year ended December 31, 2004 compared to the years ended December 31, 2003
and 2002.
Interest on reverse repurchase agreements decreased for the year ended
December 31, 2004 compared to the years ended December 31, 2003 and 2002. The
change is the result of a decrease in the average balance of reverse repurchase
agreements for the year ended December 31, 2004 compared to the years ended
December 31, 2003 and 2002.
20
The weighted average rate was approximately 0.98% for the year ended December
31, 2004 compared to a weighted average rate of .89% and 1.58% for the years
ended December 31, 2003 and 2002, respectively.
Investment portfolio income increased for the year ended December 31,
2004 compared to the years ended December 31, 2003 and 2002. The increase is due
to an increase in volume and an increase in interest rates in 2004 as compared
to previous years. The weighted average rate of the investment portfolio was
2.76% for the year ended December 31, 2004 compared to 2.61% and 2.82% for the
years ended December 31, 2003 and 2002, respectively.
Interest on loans increased for the year ended December 31, 2004
compared to the years ended December 31, 2003 and 2002. Average total loans for
the year ended December 31, 2004 increased compared to the years ended December
31, 2003 and 2002. The increase in the average total loans was partially offset
by lower interest rates during the first six months of 2004. The loan portfolio
produces the highest yield of all earning assets. The increased loan growth is
the result of new clients and the addition of experienced corporate bankers to
the staff.
Total interest expense increased for the year ended December 31, 2004
compared to the year ended December 31, 2003, but was lower compared to the year
ended December 31, 2002. The increase in 2004 as compared to 2003 is due to an
increase in volume and an increase in the interest rates during the last six
months in 2004. The decrease in comparing 2003 to 2002 is due to low interest
rate environment for 2003.
Total average interest bearing liabilities for the year ended December
31, 2004 increased compared to the years ended December 31, 2003 and 2002. The
average cost of interest bearing liabilities for the year ended December 31,
2004 was approximately 2.0% as compared of 2.1% for the year ended December 31,
2003 and 2.6% for the year ended December 31, 2002. This rate decrease is due to
an overall interest rate decrease in the market and due to the run off of higher
priced deposits being replaced by lower priced deposits.
21
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 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. It has been our experience that improved
economic strength generally will translate into better credit quality in the
banking industry. Management believes that our reserves for loan losses are
adequate. Loans are principally to borrowers in central Indiana.
Year ended
December 31,
2004 2003 2002 2001 2000
--------------- ---------------- --------------- --------------- ---------------
Beginning of Period $8,029,596 $ 7,227,000 $ 5,986,965 $4,700,672 $3,392,587
Provision for loan losses 1,320,000 1,200,000 1,500,000 1,440,000 1,440,000
Losses charged to the reserve
Commercial 1,133,994 506,413 207,716 102,315 139,294
Real Estate 280,394 1,297 21,800 18,772 30,168
Installment 132,993 2,185 2,052 10,766 16,052
Credit Cards 65,420 26,922 53,661 46,468 12,351
--------------- ---------------- --------------- --------------- ---------------
1,612,802 536,816 285,229 178,321 197,865
Recoveries
Commercial 16,247 121,918 17,024 23,868 65,281
Real Estate 26,836 16,438 - - -
Installment 12,354 105 266 463 266
Credit Cards 3,572 950 7,974 283 403
--------------- ---------------- --------------- --------------- ---------------
59,009 139,412 25,264 24,614 65,950
--------------- ---------------- --------------- --------------- ---------------
End of Period $7,795,803 $ 8,029,596 $ 7,227,000 $5,986,965 $4,700,672
=============== ================ =============== =============== ===============
Allowance as a % of Loans 1.19% 1.34% 1.37% 1.32% 1.30%
22
Other Operating Income
- ----------------------
The following table details the components of other operating income
for the years ended December 31, 2004, 2003, and 2002 (in 000's):
December 31 $ % December 31 $ %
2004 2003 Change Change 2003 2002 Change Change
---------------------------------------- ----------------------------------------
Wealth Management $ 2,490 $ 1,987 $ 503 25.3% $ 1,987 $ 2,323 $ (336) -14.5%
Service charges and fees on deposit accounts 2,131 2,410 (279) -11.6% 2,410 2,227 183 8.2%
Building rental income 485 548 (63) -11.5% 548 480 68 14.2%
Net gain on sale of mortgage loans 157 1,056 (899) -85.1% 1,056 706 350 49.6%
Interchange income 594 542 52 9.6% 542 526 16 3.0%
Net losses on securities (84) (37) (47) 127.0% (37) - (37) -
Other 1,403 1,445 (42) -2.9% 1,445 1,213 231 19.0%
---------------------------------------- ----------------------------------------
Total operating income $ 7,176 $ 7,951 $ (775) -9.7% $ 7,951 $ 7,475 $ 475 6.4%
======================================== ========================================
Other operating income decreased for the year ended December 31, 2004
compared to the years ended December 31, 2003 and 2002. There are several
components contributing to the overall decrease.
Net gain on sale of mortgage loans decreased for the year ended
December 31, 2004 compared to the years ended December 31, 2003 and 2002. During
2003, as a result of lower interest rates, mortgage originations increased
causing the sale of bulk mortgages to increase. During 2004, long term the
interest rates remained steady and mortgage originations decreased resulting in
decreased mortgage sales. The Mortgage Division originated in excess of $46
million in mortgage loans, while selling over $32 million to the secondary
market during 2004. During 2003, the Mortgage Division originated in excess of
$100 million in mortgage loans, while selling over $70 million to the secondary
market.
Service charges and fees on deposit accounts decreased for the year
ended December 31, 2004 compared to the year ended December 31, 2003. The
decrease is attributable to lower overdraft and NSF fees assessed. Also,
contributing to the decrease was an increase in the earnings credit rate paid on
business demand deposits which decreases the service charges accessed. Service
charges and fees on deposit accounts increased for the year ended December 31,
2003 compared to the year ended December 31, 2002. This increase is attributable
to the increase in average demand deposit accounts for the year ended December
31, 2003 compared to the years ended December 31, 2002.
Building rental income from the other tenants in the Corporation's main
office building decreased for the year ended December 31, 2004 compared to the
year ended December 31, 2003. The decrease is attributable to fewer tenants in
the building and the Corporation occupying more space in the building. Building
rental income increased for the year ended December 31, 2003 as compared to the
year ended December 31, 2002. This is due to new tenants in the building in 2003
compared to the same period in 2002.
During the first quarter of 2004, a net loss on the sale of two
available for sale securities was recorded. During the third quarter of 2003, a
net loss on the sale of four available for sale securities was recorded.
23
The securities were replaced with higher yielding investments to place the
portfolio in a better position for rising interest rates.
Wealth Management fees and commissions increased for the year ended
December 31, 2004 compared to the year ended December 31, 2003. The increase is
attributable to the overall price appreciation in the stock and treasury
markets, an increase in assets under management and a change in accounting
estimate related to the accrual of fees during 2003. Wealth Management fees
decreased for the year ended December 31, 2003 compared to the year ended
December 31, 2002. The decrease is attributable to an overall decline in the
stock and treasury markets and a change in accounting estimate related to the
accrual of fees during 2003.
Other Operating Expenses
The following table details the components of other operating expenses
for the years ended December 31, 2004, 2003, and 2002 (in 000's):
Year ended Year ended
December 31 $ % December 31 $ %
2004 2003 Change Change 2003 2002 Change Change
----------------------------------------- -----------------------------------------
Salaries, wages and employee benefits $ 14,133 $ 12,122 $ 2,011 16.6% $ 12,122 $ 11,278 $ 844 7.5%
Occupancy 1,391 1,409 (18) -1.3% 1,409 1,450 (41) -2.8%
Furniture and equipment 804 891 (87) -9.8% 891 896 (5) -0.6%
Professional services 1,169 886 283 31.9% 886 744 142 19.1%
Data processing 1,439 1,362 77 5.7% 1,362 1,289 73 5.7%
Business development 898 838 60 7.2% 838 735 103 14.0%
Mortgage servicing rights impairment
(recoveries) charges (256) 345 (601) -174.2% 345 261 84 32.2%
Other 3,024 3,131 (107) -3.4% 3,131 2,799 332 11.9%
----------------------------------------- -----------------------------------------
Total other operating expenses $ 22,602 $ 20,984 $ 1,618 7.7% $ 20,984 $ 19,452 $ 1,532 7.9%
========================================= =========================================
Other operating expenses increased for the year ended December 31, 2004
compared to the years ended December 31, 2003 and 2002.
Salaries, wages and employee benefits increased for the year ended
December 31, 2004 compared to the years ended December 31, 2003 and 2002. This
increase is primarily 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 expenses, and
the increase in the number of employees to 181 full time equivalents at December
31, 2004 from 173 full time equivalents at December 31, 2003 and from 167 full
time equivalents at December 31, 2002.
Occupancy expense decreased for the year ended December 31, 2004
compared to the years ended December 31, 2003 and 2002. This is attributable to
lower building maintenance and repair expense.
Furniture and equipment expense decreased for the year ended December
31, 2004 compared to the year ended December 31, 2003 and 2002. This decrease is
primarily due to decreases in expenses related to fully depreciated assets at
the older banking centers and main office.
Professional services expense increased for the year ended December 31,
2004 compared to the year ended December 31, 2003 and 2002. The increase is
primarily due to additional expense incurred for legal fees related to
24
troubled loans and accounting fees related to new regulations mandated by the
Sarbanes-Oxley Act of 2002, advertising agency fees and consulting fees.
Data processing expenses increased for the year ended December 31, 2004
compared to the years ended December 31, 2003 and 2002 primarily due to
increased service bureau fees relating to increased transaction activity by the
Bank and the Wealth Management department.
Business development expenses increased for the year ended December 31,
2004 compared to the years ended December 31, 2003 and 2002 due to increased
customer entertaining and public relations expense.
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 31, 2003, a valuation reserve of $606,276 was recognized for
mortgage servicing rights. The valuation reserve for mortgage servicing rights
decreased to $350,136 as of December 31, 2004. The Corporation recorded a
partial recovery of pervious 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.
Tax (Benefit)/Expense
The Corporation applies a federal income tax rate of 34% and a state
tax rate of 8.5% in the computation of tax expense. The provision for income
taxes consisted of the following:
2004 2003 2002
-------------------------------------
Current tax expense $2,940,441 $3,592,053 $3,636,852
Deferred tax benefit 194,557 (379,263) (636,573)
-------------------------------------
$3,134,998 $3,212,790 $3,000,279
=====================================
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Deferred tax
assets are recognized for the estimated tax effects attributable to deductible
temporary differences and operating loss carryforwards, net of any valuation
allowances for amounts which may not be realized by the Corporation.
25
The components of the Corporation's net deferred tax assets in the
consolidated balance sheet as of December 31, 2004 and 2003 are as follows:
2004 2003
-------------------------------
Deferred tax assets:
Allowance for loan losses $3,087,918 $3,180,523
Other 1,145,500 706,760
-------------------------------
Total deferred tax assets 4,233,418 3,887,283
Deferred tax liability:
Mortgage servicing rights (483,866) (356,080)
Other -- (7,266)
-------------------------------
Total deferred tax liabilities (483,866) (363,346)
-------------------------------
Net deferred tax assets $3,749,552 $3,523,937
===============================
Effects of Inflation
Inflation can have a significant effect on the operating results of all
industries. This is especially true in industries with a high proportion of
fixed assets and inventory. However, management believes that these factors are
not as critical in the banking industry. Inflation does, however, have an impact
on the growth of total assets and the need to maintain a proper level of equity
capital.
Interest rates are significantly affected by inflation, but it is
difficult to assess the impact since neither the timing nor the magnitude of the
changes in the various inflation indices coincides with changes in interest
rates. There is, of course, an impact on longer-term earning assets; however,
this effect continues to diminish as investment maturities are shortened and
interest-earning assets and interest-bearing liabilities shift from fixed rate,
long-term to rate-sensitive, short-term.
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 an adequate liquidity position is accomplished through the
management of the 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 Committee ("ALCO")
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 2004.
Deposits are the most significant funding source and loans are the most
significant use of funds for the years ended December 31, 2004, 2003, and 2002.
The
26
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 December 31, 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 represent the Corporation's primary source of immediate
liquidity and were maintained at a level adequate to meet immediate needs.
Federal funds sold averaged approximately $43,000,000, $40,000,000, and
$35,000,000 for the twelve months ended December 31, 2004, 2003 and 2002
respectively. 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 avoid matching short-term deposits 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 December 31,
2004, the Corporation's rate sensitive assets exceeded rate sensitive
liabilities due within one year by $21,623,861. At December 31, 2003, the
Corporation's rate sensitive assets exceeded rate sensitive liabilities due
within one year by $6,250,723.
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 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.
The Bank holds securities of the U.S. Government and its agencies along
with asset-backed securities, collateralized mortgage obligations, municipals,
and Federal Home Loan Bank and Federal Reserve Bank stock. In order to properly
manage market risk, credit risk and interest rate risk, the Bank has guidelines
it must follow when purchasing investments for the portfolio and adherence to
these policy guidelines are reported monthly to the board of directors.
A portion of the Bank's investment securities consist of collateralized
mortgage obligations. The Bank limits the level of these securities that can be
held in the portfolio to a specified percentage of total average assets. Also,
asset-backed securities collateralized by receivables other than mortgages will
not have a stated final maturity greater than seven years. In addition, only
credit card receivables or mortgage-related securities rated "AA" or better by
Standard & Poor's or an equivalent rating by another rating agency, will be
purchased.
All mortgage-related securities must pass the FFIEC stress test. This
stress test determines if price volatility under a 200 basis point interest rate
shock for each security exceeds a benchmark 30 year mortgage-backed security. If
the security fails the test, it is considered high risk and the Bank will not
purchase it. All mortgage-related securities
27
purchased and included in the investment portfolio will be subject to the FFIEC
test as of December 31 each year to determine if they have become high risk
holdings. If a mortgage-related security becomes high risk, it will be evaluated
by the Bank's Investment Committee to determine if the security should be
liquidated. At December 31, 2004, the Bank did not hold any high risk
mortgage-related securities and at December 31, 2003, the Bank held one high
risk mortgage-related security.
The Bank's investment portfolio also consists of bank-qualified
municipal securities. Municipal securities purchased are limited to the first
three (3) grades of the rating agencies. The grade is reviewed each December 31
to verify that the grade has not deteriorated below the first three (3) grades.
The Bank may purchase non-rated general obligation municipals, but the credit
strength of the municipality must be evaluated by the Bank's Credit Department.
Generally, municipal securities from each issuer will be limited to $1 million,
never to exceed 10% of the Bank's tier 1 capital and will not have a stated
final maturity date of greater than ten (10) years.
The average yield on the Bank's investment portfolio is as follows as
of December 31,
2004 2003 2002
---- ---- ----
U.S. Treasuries 1.70% 1.99% 2.47%
U.S. Government agencies 2.65% 2.72% 2.85%
Collateralized mortgage obligations 3.41% 1.87% 3.31%
Municipals 7.76% 7.32% 7.32%
Other securities 1.71% 1.91% 2.14%
With the exception of securities of the U.S. Government and U.S. Government
agencies and corporations, the Corporation had no other securities with a book
or market value greater than 10% of shareholders' equity as of December 31,
2004, 2003 and 2002.
28
The following is a summary of available-for-sale securities and
held-to-maturity securities:
Available-for-Sale Securities
---------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------------------------------------------------------------
December 31, 2004
U.S. Treasury securities $ 2,016,184 $ -- $ 7,704 $ 2,008,480
U.S. Government agencies 91,000,000 112,700 769,680 90,343,020
Collateralized mortgage obligations 62,486 58 -- 62,544
---------------------------------------------------------------
$ 93,078,670 $ 112,758 $ 777,384 $ 92,414,044
===============================================================
December 31, 2003
U.S. Treasury securities $ 21,840,685 $ 5,646 $ 954 $ 21,845,377
U.S. Government agencies 93,904,140 829,297 815,799 93,917,638
Collateralized mortgage obligations 99,203 154 -- 99,357
---------------------------------------------------------------
$115,844,028 $ 835,097 $ 816,753 $115,862,372
===============================================================
December 31, 2002
U.S. Treasury securities $ 2,100,309 $ 13,230 $ 275 $ 2,113,264
U.S. Government agencies 79,930,066 845,676 -- 80,775,742
Collateralized mortgage obligations 1,097,683 3,646 -- 1,101,329
---------------------------------------------------------------
$ 83,128,058 $ 862,552 $ 275 $ 83,990,335
===============================================================
Held-to-Maturity Securities
---------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------------------------------------------------------------
December 31, 2004
Municipals $ 5,444,198 $ 484,166 $ -- $ 5,928,364
Collateralized mortgage obligations 50,012,255 -- 836,980 49,175,275
Other securities 250,000 4,584 221 254,363
---------------------------------------------------------------
$ 55,706,453 $ 488,750 $ 837,201 $ 55,358,002
===============================================================
December 31, 2003
Municipals $ 5,576,468 $ 531,499 $ -- $ 6,107,967
Other securities 250,000 7,082 -- 257,082
---------------------------------------------------------------
$ 5,826,468 $ 538,581 $ -- $ 6,365,049
===============================================================
December 31, 2002
Municipals $ 5,534,243 $ 552,233 $ -- $ 6,086,476
Collateralized mortgage obligations 24,333,493 339,440 12,644 24,660,289
Other securities 225,000 10,391 -- 235,391
---------------------------------------------------------------
$ 30,092,736 $ 902,064 $ 12,644 $ 30,982,156
===============================================================
29
The Corporation held thirteen investment securities as of December 31,
2004 of which the amortized cost was greater than market value. The majority of
these investment securities were purchased during 2003 and 2004. Management does
not believe any individual unrealized loss as of December 31, 2004 represents an
other-than-temporary impairment. The unrealized losses relate primarily to
securities issued by the U.S. Treasury and FHLMC. These unrealized losses are
primarily attributable to changes in interest rates and individually were 2.3%
or less of their respective amortized cost basis. The Corporation has both the
intent and ability to hold these securities for a time necessary to recover the
amortized cost.
As part of managing liquidity, the Corporation monitors its loan to
deposit ratio on a daily basis. At December 31, 2004 the ratio was 94.7 percent
and as of December 31, 2003 the ratio was 93.7 percent which is within the
Corporation's acceptable range.
The following table shows the composition of the Bank's loan portfolio
as of the dates indicated (in 000's):
December 31,
------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------------------- ------------------- -------------------- --------------------- ---------------------
TYPES OF LOANS
Commercial $ 235,705 35.7% $ 221,846 37.2% $ 182,994 34.6% $ 150,101 33.2% $ 166,881 34.2%
Construction 37,119 5.7% 35,305 5.9% 21,107 4.0% 17,027 3.8% 8,733 2.4%
Commercial Mortgage 127,773 19.5% 120,135 20.1% 113,399 21.4% 82,256 18.2% 53,095 14.7%
Residential Mortgage 206,599 31.5% 183,095 30.7% 163,034 30.8% 151,874 33.6% 116,064 37.8%
Installment 40,534 6.2% 25,183 4.2% 35,934 6.8% 37,493 8.3% 2,320 6.9%
Credit Card 2,480 0.4% 2,360 0.4% 2,056 0.4% 1,811 0.4% 1,709 0.5%
Other 6,243 1.0% 9,139 1.5% 10,387 2.0% 11,498 2.5% 12,800 3.5%
-------------------- ------------------- -------------------- --------------------- ---------------------
Total - Gross $ 656,453 100.0% $ 597,063 100.0% $ 528,911 100.0% $ 452,060 100.0% $ 361,602 100.0%
========== ========= ========== =========== ===========
Allowance (7,796) (8,030) (7,227) (5,987) (4,701)
---------- ---------- ---------- ---------- ----------
Total - Net $ 648,657 $ 589,033 $ 521,684 $ 446,073 $ 356,901
========== ========== ========== ========== ==========
30
The following table shows the composition of the commercial loan
category by industry type as of the dates indicated (in $000's):
December 31,
------------
2004 2003 2002
---- ---- ----
Type Amount % Amount % Amount %
- ---- ------ --- ------ --- ------ ---
Agriculture, Foresty & Fishing $ 258 0.1% $ 1,297 0.6% $ - 0.0%
Mining 2,615 1.1% 1,939 0.9% 794 0.4%
Construction 13,417 5.7% 17,480 7.9% 13,814 7.5%
Manufacturing 30,570 13.0% 18,996 8.6% 12,139 6.6%
Wholesale Trade 29,965 12.7% 26,778 12.1% 21,649 11.8%
Retail Trade 4,870 2.1% 6,387 2.9% 11,372 6.2%
Transportation 9,966 4.2% 5,423 2.4% 4,544 2.5%
Information 1,141 0.5% 1,348 0.6% 1,464 0.8%
Finance & Insurance 4,091 1.7% 6,066 2.7% 5,275 2.9%
Real Estate and Rental & Leasing 46,134 19.6% 38,430 17.3% 29,602 16.2%
Professional, Scientific & Technical Services 30,522 12.9% 33,808 15.2% 22,788 12.5%
Management of Companies & Enterprises 2,199 0.9% - 0.0% - 0.0%
Administrative and Support, Waste Management &
Remediation Services - 0.0% 1,180 0.5% 1,254 0.7%
Educational Services 4,158 1.8% 2,760 1.2% 1,966 1.1%
Health Care & Social Assistance 21,253 9.0% 19,912 9.0% 15,932 8.7%
Arts, Entertainment & Recreation 5,333 2.3% 1,628 0.7% 2,835 1.5%
Accommodation & Food Services 9,026 3.8% 10,752 4.8% 10,385 5.7%
Other Services 20,187 8.6% 27,662 12.5% 27,183 14.9%
------------------------ ------------------------ ------------------------
$ 235,705 100.0% $ 221,846 100.0% $ 182,994 100.0%
======================== ======================== ========================
31
The following table shows the composition of the Bank's deposit portfolio as of
the dates indicated (in 000's):
December 31,
------------
2004 2003 2002
---- ---- ----
% of % of % of
Amount Total Amount Total Amount Total
------------------------- ------------------------- --------------------------
TYPES OF DEPOSITS
Demand $ 153,674 26.64% $ 138,087 26.52% $ 137,576 31.04%
MMDA/Savings 423,255 73.36% 382,574 73.48% 305,605 68.96%
------------------------- ------------------------- --------------------------
Total Demand Deposits 576,929 100.00% 520,661 100.00% 443,181 100.00%
============= ============= =============
CDs < $100,000 55,969 48.04% 57,329 49.05% 53,872 53.25%
CDs > $100,000 47,502 40.77% 47,051 40.26% 35,988 35.57%
Individual Retirement Accounts 13,031 11.19% 12,496 10.69% 11,302 11.17%
------------------------- ------------------------- --------------------------
Total Certificates of Deposit 116,502 100.00% 116,876 100.00% 101,162 100.00%
============= ============= =============
------------ ------------ -------------
Total Deposits $ 693,431 $ 637,537 $ 544,343
============ ============ =============
32
The following table illustrates the projected maturities and the
repricing mechanisms of the major asset/liabilities categories of the
Corporation as of December 31, 2004, based on certain assumptions. Prepayment
rate assumptions have been made for the residential loans secured by real estate
portfolio. Maturity and repricing dates for investments have been projected by
applying the assumptions set forth below to contractual maturity and repricing
dates.
0 - 180 181 - 365 1 - 2 2 - 3 3 -5
days days years years years
------- --------- ----- ----- -----
Interest Earning Assets:
Fed Funds/ Overnight Time $ 31,766,783
Reverse repurchase agreements 5,000,000
Investments 51,563,584 20,343,812 40,583,807 9,190,260 14,364,443
Loans
Commercial & Industrial
Fixed 23,465,694 9,030,491 10,747,428 6,981,184 8,794,357
Variable 164,229,801 578,536 1,874,675 1,164,957 1,164,481
Commercial Loans Secured by
Real Estate
Fixed 14,823,989 13,815,711 19,551,226 11,440,992 10,636,693
Variable 50,136,670 103,723 545,436 989,676 343,353
Residential Loans Secured by
Real Estate
Fixed 2,417,668 2,861,747 6,406,993 5,816,720 9,488,517
Variable 160,724,948 5,492,163 6,783,005 5,622,323 11,380,527
Other
Fixed 634,099 546,318 949,583 678,793 1,099,073
Variable 37,603,302 6,243,488 -- -- --
---------------------------------------------------------------------------------
Total Interest Earning Assets $ 542,366,538 $ 59,015,989 $ 87,442,153 $ 41,884,905 $ 57,271,444
=================================================================================
Non-Interest Earning Assets
---------------------------------------------------------------------------------
Total Assets $ 542,366,538 $ 59,015,989 $ 87,442,153 $ 41,884,905 $ 57,271,444
=================================================================================
Interest Bearing Liabilities:
Demand Deposits $ 169,187
Interest Bearing Demand 95,801,417
Savings Deposits
Money Market Accounts 316,622,183
Certificate of Deposits 22,517,332 15,801,514 9,133,115 9,466,415 6,287,361
Jumbo CDs 18,186,032 13,498,375 4,941,208 6,763,067 2,906,726
Repurchase Agreements 84,162,626
FHLB Advances 8,000,000 10,000,000 11,000,000 3,000,000
Subordinated Debt 5,000,000
Company obligated mandatorily
redeemable preferred capital
securities of subsidiary
trust holding solely the
junior subordinated debentures
of the parent company
---------------------------------------------------------------------------------
Total Interest Bearing Liabilities $ 542,458,777 $ 37,299,889 $ 24,074,323 $ 27,229,482 $ 12,194,087
Non-Interest Bearing Liabilities
Equity
---------------------------------------------------------------------------------
Total Liabilities & Shareholders' Equity $ 542,458,777 $ 37,299,889 $ 24,074,323 $ 27,229,482 $ 12,194,087
=================================================================================
Interest Sensitivy Gap per Period $ (92,239) $ 21,716,100 $ 63,367,830 $ 14,655,423 $ 45,077,357
Cumulative Interest Sensitivity Gap $ (92,239) $ 21,623,861 $ 84,991,691 $ 99,647,114 $ 144,724,471
Interest Sensitivity Gap as a Percentage
of Earning Assets -0.01% 2.57% 7.50% 1.73% 5.33%
Cumulative Sensitivity Gap as a
Percentage of Earning Assets -0.01% 2.56% 10.06% 11.79% 17.13%
5 + Non-interest
years Earning Total
----- ------------ -----
Interest Earning Assets:
Fed Funds/ Overnight Time $ 31,766,783
Reverse repurchase agreements 5,000,000
Investments 15,686,020 66,871 151,798,797
Loans
Commercial & Industrial
Fixed 5,467,326 691,118 65,177,598
Variable -- 1,514,504 170,526,954
Commercial Loans Secured by
Real Estate
Fixed 5,287,012 98,202 75,653,825
Variable -- -- 52,118,858
Residential Loans Secured by
Real Estate
Fixed 20,025,874 -- 47,017,519
Variable 5,881,592 815,356 196,699,914
Other
Fixed -- 1,503,246 5,411,112
Variable -- -- 43,846,790
----------------------------------------------
Total Interest Earning Assets $ 52,347,824 $ 4,689,297 $ 845,018,149
==============================================
Non-Interest Earning Assets 35,895,630 35,895,630
----------------------------------------------
Total Assets $ 52,347,824 $ 40,584,927 $ 880,913,779
==============================================
Interest Bearing Liabilities:
Demand Deposits $ 11,783,060 $ 141,721,968 $ 153,674,215
Interest Bearing Demand 95,801,417
Savings Deposits 10,831,226 10,831,226
Money Market Accounts 316,622,183
Certificate of Deposits 4,372,846 20,574 67,599,157
Jumbo CDs 2,607,439 48,902,847
Repurchase Agreements 84,162,626
FHLB Advances 32,000,000
Subordinated Debt 5,000,000
Company obligated mandatorily
redeemable preferred capital
securities of subsidiary
trust holding solely the
junior subordinated debentures
of the parent company 13,918,000 13,918,000
----------------------------------------------
Total Interest Bearing Liabilities $ 43,512,571 $ 141,742,542 $ 828,511,671
Non-Interest Bearing Liabilities 5,858,421 5,858,421
Equity 46,543,687 46,543,687
----------------------------------------------
Total Liabilities & Shareholders' Equity $ 43,512,571 $ 194,144,650 $ 880,913,779
==============================================
Interest Sensitivy Gap per Period $ 8,835,253 $(153,559,723)
Cumulative Interest Sensitivity Gap $ 153,559,724 $ 0
Interest Sensitivity Gap as a Percentage
of Earning Assets 1.05% -18.17%
Cumulative Sensitivity Gap as a
Percentage of Earning Assets 18.17% 0.00%
Of the $18,186,032 Jumbo CDs maturing in 0 - 180 days, $14,554,066 will
mature in three months or less.
33
Contractual Obligations
The following table presents, as of December 31, 2004, significant
fixed and determinable contractual obligations to third parties by payment date.
Further discussion of the nature of each obligation is included in the
referenced notes to the Consolidated Financial Statements under Item 8 of this
report.
Contractual Obligations
- ---------------------------------------------------------------------------------------------------------------
Payments Due In
----------------------------------------------------------------------
Note One Year One to Three to Over
(In Thousands) Reference or Less Three Years Five Years Five Years Total
- ---------------------------------------------------------------------------------------------------------------
Deposits without a stated maturity(a) 10 $ 576,929 $ -- $ -- $ -- $576,929
Consumer certificates of deposits (a) 10 70,025 30,303 9,194 6,980 116,502
FHLB Advances(a) 11 8,000 21,000 3,000 -- 32,000
Security repurchase agreements(a) 11 84,163 -- -- -- 84,163
Long-term debt (a) 11 -- -- -- 18,918 18,918
Operating leases 8 356 516 435 1,062 2,369
- ---------------------------------------------------------------------------------------------------------------
(a) Excludes Interest
The Corporation's operating lease obligations represent rental payments
for banking center offices.
Critical Accounting Policy
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.
34
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 Financial
Accounting Standards Board Interpretation No.46, "Consolidation of Variable
Interest Entities, an interpretation of Accounting Research Bulletin No. 51"
(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 NBIN Statutory Trust I, a wholly-owned subsidiary of the
Corporation, which removed $13,500,000 of Mandatory Redeemable Capital
Securities issued by the Trust while adding $13,918,000 of junior subordinated
debentures to the consolidated balance sheet. See Note 4 Trust Preferred
Securities in the Notes to the Consolidated Financial Statements under Item 8 of
this report for further information.
Derivative Instruments and Hedging Activities
- ---------------------------------------------
During the second quarter of 2004, the Corporation entered into a
3-year interest rate swap to mitigate 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 Financial Accounting Standard Board
(FASB) Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities", 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. See Note 6 Derivative Instruments and Hedging
Activities in the Notes to the Consolidated Financial Statements under Item 8 of
this report for further information.
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.
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 allocated to loans that
are identified as impaired is based on cash flows using the loan's initial
effective interest rate or the fair value of the collateral for collateral
dependent loans.
The allowance for loan losses is maintained at a level believed
adequate by management to absorb inherent 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
35
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. The allowance is increased by provisions for
loan losses charged against income and reduced by net charge-offs.
The allowance for loan losses is allocated to each loan category based
on the Bank's blended median and peer worst case 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.
The following table shows the dollar amount of the allowance for loan
losses using management's estimate by loan category (in $000's):
December 31,
------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Commercial $5,094 $6,519 $5,173 $4,792 $3,092
Construction 155 77 82 21 49
Commercial Mortgage 618 261 437 104 297
Residential Mortgage 1,108 639 906 499 779
Consumer 745 318 391 322 198
Credit Card 11 63 61 55 70
Other 65 153 177 194 216
----------------------------------------------
$7,796 $8,030 $7,227 $5,987 $4,701
==============================================
Management considers the present allowance to be appropriate and
adequate to cover losses inherent in the loan portfolio based on the current
economic environment. However, future economic changes cannot be predicted.
Deterioration in economic conditions could result in an increase in the risk
characteristics of the loan portfolio and an increase in the provision for loan
losses.
36
The following table presents a summary of non-performing assets as of
December 31, (in 000's):
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
--------------- --------------- --------------- --------------- ---------------
Non-Accrual Loans
- -----------------
Commercial $1,800 57.7% $4,063 83.4% $1,605 49.7% $ 335 40.1% $ 595 65.7%
Construction -- 0.0% -- 0.0% -- 0.0% -- 0.0% -- 0.0%
Commercial Mortgage -- 0.0% -- 0.0% -- 0.0% 184 22.0% -- 0.0%
Residential Mortgage 815 26.1% 808 16.6% 1,624 50.3% 303 36.3% 288 31.8%
Installment -- 0.0% -- 0.0% -- 0.0% 13 1.6% 23 2.5%
Credit Card -- 0.0% -- 0.0% -- 0.0% -- 0.0% -- 0.0%
Other 504 16.2% -- 0.0% -- 0.0% -- 0.0% -- 0.0%
--------------- --------------- --------------- --------------- ---------------
Total $3,119 100.0% $4,871 100.0% $3,229 100.0% $ 835 100.0% $ 906 100.0%
=============== =============== =============== =============== ===============
Loans 90 Days Past Due -
Still Accruing $ 73 $ 517 $ 9 $ 5 $ --
Restructured due to troubled
conditions of the borrower $ -- $ -- $2,902 $ -- $ --
The following table presents a summary of non-performing loans as of
December 31:
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Loan Type
- ---------
Commercial
# of loans 14 28 11 7 11
Interest income recognized $ 73,795 $ 112,102 $ 111,591 $ 9,534 $ 55,432
Additional interest income if loan had been accruing $ 101,190 $ 168,426 $ 54,952 $ 25,191 $ 65,435
Installment
# of loans 3 -- -- 1 3
Interest income recognized $ 20,155 $ -- $ -- $ -- $ 1,760
Additional interest income if loan had been accruing $ 36,531 $ -- $ -- $ 1,545 $ 2,176
Residential mortgage loans
# of loans 15 13 12 6 5
Interest income recognized $ 8,737 $ 42,539 $ 18,650 $ 1,925 $ 7,095
Additional interest income if loan had been accruing $ 68,942 $ 22,527 $ 34,598 $ 24,785 $ 16,454
Credit cards
# of loans -- -- -- -- 4
Interest income recognized $ -- $ -- $ -- $ -- $ 167
Additional interest income if loan had been accruing $ -- $ -- $ -- $ -- $ 1,821
Restructured loans -- -- $2,901,600 $ -- $ --
Capital Resources
The Corporation's only source of capital since commencing operations
has been from issuance of common stock, results of operations, issuance of long
term debt to a non-affiliated third party, and the issuance of junior
subordinated debentures.
37
The Corporation maintains a Revolving Credit Agreement with Harris
Trust and Savings Bank in the amount of $5,000,000, of which none has been
drawn, that will mature September 28, 2005.
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 Bank can make up to two advances against the term loan prior
to June 6, 2004. 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; however, prepayment of the principal balance is
permitted prior to maturity with prior consent from the Federal Reserve.
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 4.16% at December 31,
2004. 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 later
on page 39.
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 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
=============
During 2004 the maximum amount outstanding at any month-end during the
year was $42,000,000. The Bank may add indebtedness of this nature in the future
if determined to be in the best interest of the Bank.
38
Security repurchase agreements are short-term borrowings that generally
mature within one to three days from the transaction date. At December 31, 2004
and 2003 the weighted average interest rate on these borrowings was 0.74% and
0.53%, respectively. During 2004 the maximum amount outstanding at any month-end
during the year was $101,509,403.
Capital for the Bank is above well-capitalized regulatory requirements
at December 31, 2004. Pertinent capital ratios for the Bank as of December 31,
2004 are as follows:
Well Adequately
Actual Capitalized Capitalized
------ ----------- -----------
Tier 1 risk-based capital ratio 8.6% 6.0% 4.0%
Total risk-based capital ratio 10.5% 10.0% 8.0%
Leverage ratio 6.5% 5.0% 4.0%
Dividends from the Bank to the Corporation may not exceed the net
undivided profits of the Bank (included in consolidated retained earnings) for
the current calendar year and the two previous calendar years without prior
approval of the OCC. In addition, Federal banking laws limit the amount of loans
the Bank may make to the Corporation, subject to certain collateral
requirements. No loans were made during 2004 or 2003 by the Bank to the
Corporation. A dividend of $1,000,000 was declared and made during 2004 and a
dividend of $1,650,000 was declared and made during 2003 by the Bank to the
Corporation.
In January 2003, the Board of Directors of the Corporation authorized a
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.
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.
At December 31, 2004, the remaining authority under Program One was
approximately $1,077,123.
In January 2003, the Board of the Corporation authorized a separate
repurchase program entitled "Program Two" which covers all other shareholders
and was set to expire at December 31, 2004, however, during the 4th quarter of
2004, the Board of the Corporation authorized the effective date to be extended
through December 2005 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
39
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.
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.
At December 31, 2004, the remaining authority under Program Two was
approximately $3,218,556.
Recent Accounting Pronouncements and Developments
Note 2 to the Consolidated Financial Statements under Item 8 discusses
new accounting policies adopted by the Corporation during 2004 and the expected
impact of accounting policies. Note 2 also discusses recently issued or proposed
new accounting policies but not yet required to be adopted and the impact of the
accounting policies if known. To the extent the adoption of new accounting
standards materially affects financial conditions; results of operations, or
liquidity, the impacts if known are discussed in the applicable section(s) of
notes to consolidated financial statements.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This discussion contains certain forward-looking statements that are
subject to risks and uncertainties and includes information about possible or
assumed future results of operations. Many possible events or factors could
affect our future financial results and performance. This could cause results or
performance to differ materially from those expressed in our forward-looking
statements. Words such as "expects," "anticipates," "believes," "estimates,"
variations of such words and other similar expressions are intended to identify
such forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions which are
difficult to predict. Therefore, actual outcomes and results may differ
materially from what is expressed or forecasted in, or implied by, such
forward-looking statements. Readers should not rely solely on the
forward-looking statements and should consider all uncertainties and risks
discussed throughout this discussion. These statements are representative only
on the date hereof.
The possible events or factors include, but are not limited to, the
following matters. Our loan growth is dependent on economic conditions, as well
as various discretionary factors, such as decisions to sell or purchase certain
loans or loan portfolios; participations of loans; retention of residential
mortgage loans; the management of a borrower; industry, product and geographic
concentrations and the mix of the loan portfolio. The rate of charge-offs and
provision expense can be affected by local, regional and international
40
economic and market conditions, concentrations of borrowers, industries,
products and geographic locations, the mix of the loan portfolio and
management's judgments regarding the collectibility of loans. Liquidity
requirements may change as a result of fluctuations in assets and liabilities
and off-balance sheet exposures, which will impact our capital and debt
financing needs and the mix of funding sources. Decisions to purchase, hold or
sell securities are also dependent on liquidity requirements and market
volatility, as well as on- and off-balance sheet positions. Factors that may
impact interest rate risk include local, regional and international economic
conditions, levels, mix, maturities, yields or rates of assets and liabilities,
and the wholesale and retail funding sources of the Bank. We are also exposed to
the potential of losses arising from adverse changes in market rates and prices
which can adversely impact the value of financial products, including
securities, loans, deposits, debt and derivative financial instruments, such as
futures, forwards, swaps, options and other financial instruments with similar
characteristics.
In addition, the banking industry in general is subject to various
monetary and fiscal policies and regulations, which include those determined by
the Federal Reserve Board, the Office of the Comptroller of the Currency
("OCC"), and the Federal Deposit Insurance Corporation ("FDIC"), whose policies
and regulations could affect our results. Other factors that may cause actual
results to differ from the forward-looking statements include the following:
competition with other local, regional and international banks, thrifts, credit
unions and other non-bank financial institutions, such as investment banking
firms, investment advisory firms, brokerage firms, investment companies and
insurance companies, as well as other entities which offer financial services,
located both within and outside the United States and through alternative
delivery channels such as the World Wide Web; interest rate, market and monetary
fluctuations; inflation; market volatility; general economic conditions and
economic conditions in the geographic regions and industries in which we
operate; introduction and acceptance of new banking-related products, services
and enhancements; fee pricing strategies, mergers and acquisitions and our
ability to manage these and other risks.
41
Item 7A. 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 Committee (the "ALCO"). The ALCO 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.
Interest rate risk is monitored through earnings simulation modeling.
The earnings simulation model projects changes in net interest income caused by
the effect of changes in interest rates. The model requires management to make
assumptions about how the balance sheet is likely to behave through time in
different interest rate environments. Loan and deposit balances remain static
and maturities reprice at the current market rate. The investment portfolio
maturities and prepayments are assumed to be reinvested in similar instruments.
Mortgage loan prepayment assumptions are developed from industry median
estimates of prepayment speeds. Non-maturity deposit pricing is modeled on
historical patterns. The Corporation performs a 200 basis point upward and
downward interest rate shock and makes sure that there is not an adverse impact
on its annual net interest income and that it is within the established policy
limits. The earnings simulation model as of December 31, 2004 projects an
approximate decrease of 10.4% in net interest income in a 200 basis point
downward interest rate shock and an approximate increase of 1.7% in net interest
income in a 200 basis point upward interest rate shock. Though the change
downward is slightly above the policy limits, rates do not decline a full 200
basis points due to floors being in place. The upward change is well within the
policy limits established by the ALCO policy.
At December 31, 2004, the interest rate risk position of the
Corporation was asset sensitive, meaning net income should increase as rates
rise and decrease as rates fall. During 2004, the Corporation maintained an
asset sensitive interest rate risk position due to management's expectation that
rates would rise.
See further discussion on interest rate sensitivity on page 26.
42
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
Report of Independent Registered Public Accounting Firm
Board of Directors
The National Bank of Indianapolis Corporation
We have audited the accompanying consolidated balance sheets of The National
Bank of Indianapolis Corporation and subsidiaries as of December 31, 2004 and
2003, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2004. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The National Bank
of Indianapolis Corporation and subsidiaries at December 31, 2004 and 2003, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles.
Indianapolis, Indiana /s/ Ernst & Young LLP
January 24, 2005
43
The National Bank of Indianapolis Corporation
Consolidated Balance Sheets
December 31
2004 2003
------------------------------
Assets
Cash and due from banks $ 22,824,622 $ 44,383,402
Reverse repurchase agreements 5,000,000 15,000,000
Federal funds sold 31,766,783 20,502,386
Available-for-sale securities 92,414,044 115,862,372
Held-to-maturity securities 55,706,453 5,826,468
------------------------------
Total investment securities 148,120,497 121,688,840
Loans 656,452,569 597,062,744
Less: Allowance for loan losses (7,795,803) (8,029,596)
------------------------------
Net loans 648,656,766 589,033,148
Premises and equipment 9,676,268 9,148,709
Accrued interest receivable 4,000,738 3,503,401
Stock in federal banks 3,678,300 3,558,200
Other assets 7,189,805 5,780,728
------------------------------
Total assets $ 880,913,779 $ 812,598,814
==============================
Liabilities and shareholders' equity
Deposits:
Noninterest-bearing demand deposits $ 153,674,215 $ 138,087,276
Money market and saving deposits 423,254,826 382,574,081
Time deposits over $100,000 49,039,847 48,219,664
Other time deposits 67,462,157 68,656,059
------------------------------
Total deposits 693,431,045 637,537,080
Security repurchase agreements 84,162,626 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 5,858,421 3,326,284
------------------------------
Total liabilities 834,370,092 769,920,410
Shareholders' equity:
Common stock, no par value:
Authorized shares; 2004 and 2003-3,000,000 shares;
issued 2,628,497 in 2004 and 2,517,131 in 2003;
outstanding 2,349,174 in 2004 and 2,352,229 in 2003 20,595,989 22,858,900
Unearned compensation (624,543) (894,679)
Additional paid in capital 3,836,613 3,019,003
Retained earnings 23,365,151 17,684,102
Accumulated other comprehensive income (loss) (629,523) 11,078
------------------------------
Total shareholders' equity 46,543,687 42,678,404
------------------------------
Total liabilities and shareholders' equity $ 880,913,779 $ 812,598,814
==============================
See accompanying notes.
44
The National Bank of Indianapolis Corporation
Consolidated Statements of Income
Years Ended December 31
2004 2003 2002
--------------------------------------------
Interest income:
Interest and fees on loans $ 33,305,992 $ 31,010,185 $ 30,593,437
Interest on investment securities 4,402,788 3,020,337 3,683,093
Interest on federal funds sold 725,134 432,019 573,328
Interest on reverse repurchase agreements 89,643 97,600 245,442
--------------------------------------------
Total interest income 38,523,557 34,560,141 35,095,300
Interest expense:
Interest on deposits 8,974,760 7,668,254 9,144,476
Interest on repurchase agreements 570,295 381,077 752,464
Interest on FHLB advances 1,774,835 2,413,952 2,720,963
Interest on long-term debt 1,642,416 1,486,637 1,443,674
--------------------------------------------
Total interest expense 12,962,306 11,949,920 14,061,577
--------------------------------------------
Net interest income 25,561,251 22,610,221 21,033,723
Provision for loan losses 1,320,000 1,200,000 1,500,000
--------------------------------------------
Net interest income after provision for loan losses 24,241,251 21,410,221 19,533,723
Other operating income:
Trust fees and commissions 2,489,875 1,987,400 2,323,032
Service charges and fees on deposit accounts 2,130,994 2,409,577 2,226,686
Rental income 485,241 548,060 480,375
Net gain on sale of mortgage loans 157,145 1,056,418 705,611
Interchange income 594,093 542,221 526,067
Securities gain (losses) net (83,739) (36,891) 498
Other income 1,402,899 1,444,290 1,213,193
--------------------------------------------
Total other operating income 7,176,508 7,951,075 7,475,462
Other operating expenses:
Salaries, wages, and employee benefits 14,132,773 12,122,238 11,278,361
Occupancy 1,390,658 1,409,226 1,450,186
Furniture and equipment 804,492 891,328 895,505
Professional services 1,169,109 885,595 743,508
Data processing 1,439,248 1,362,202 1,288,961
Business development 898,072 838,132 735,212
Mortgage servicing rights impairment (recoveries) charges (256,140) 345,102 261,174
Other 3,023,500 3,130,483 2,799,163
--------------------------------------------
Total other operating expenses 22,601,712 20,984,306 19,452,070
--------------------------------------------
Net income before tax 8,816,047 8,376,990 7,557,115
Federal and state income tax 3,134,998 3,212,790 3,000,279
--------------------------------------------
Net income after tax $ 5,681,049 $ 5,164,200 $ 4,556,836
============================================
Basic earnings per share $ 2.47 $ 2.20 $ 1.99
============================================
Diluted earnings per share $ 2.37 $ 2.08 $ 1.88
============================================
See accompanying notes.
45
The National Bank of Indianapolis Corporation
Consolidated Statements of Shareholders' Equity
Accumulated
Additional Other
Common Unearned Paid in Retained Comprehensive
Stock Compensation Capital Earnings Income (Loss) Total
----------------------------------------------------------------------------------------------
Balance at December 31, 2001 $ 20,883,428 $ (439,790) $ -- $ 7,963,066 $ 63,298 $ 28,470,002
Comprehensive income:
Net income -- -- -- 4,556,836 -- 4,556,836
Other comprehensive income
Net unrealized gain on
investments, net of tax
of $300,031 -- -- -- -- 457,431 457,431
------------
Total comprehensive income 5,014,267
Income tax benefit from exercise of
warrants & options -- -- 2,562,990 -- -- 2,562,990
Issuance of stock (477,479 shares) 6,009,648 (1,061,450) -- -- -- 4,948,198
Repurchase of stock (1,100 shares) (30,800) -- -- -- -- (30,800)
Compensation earned -- 282,494 -- -- -- 282,494
----------------------------------------------------------------------------------------------
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 -- -- -- 5,164,200 -- 5,164,200
Other comprehensive income
Net unrealized loss on
investments, net of tax
of $334,282 -- -- -- -- (509,651) (509,651)
------------
Total comprehensive income 4,654,549
Income tax benefit from exercise of
warrants & options -- -- 456,013 -- -- 456,013
Issuance of stock (69,907 shares) 1,051,171 (72,025) -- -- -- 979,146
Repurchase of stock (160,002 shares) (5,054,547) -- -- -- -- (5,054,547)
Compensation earned -- 396,092 -- -- -- 396,092
----------------------------------------------------------------------------------------------
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 -- -- -- 5,681,049 -- 5,681,049
Other comprehensive income
Net unrealized loss on
investments, net of tax
of $270,524 -- -- -- -- (412,445) (412,445)
Net unrealized loss on
swap, net of tax
of $149,648 -- -- -- -- (228,156) (228,156)
------------
Total comprehensive income 5,040,448
Income tax benefit from exercise of
warrants & options -- -- 817,610 -- -- 817,610
Issuance of stock (111,366 shares) 1,516,423 (29,859) -- -- -- 1,486,564
Repurchase of stock (114,421 shares) (3,779,334) -- -- -- -- (3,779,334)
Compensation earned -- 299,995 -- -- -- 299,995
----------------------------------------------------------------------------------------------
Balance at December 31, 2004 $ 20,595,989 $ (624,543) $ 3,836,613 $ 23,365,151 $ (629,523) $ 46,543,687
==============================================================================================
See accompanying notes.
46
The National Bank of Indianapolis Corporation
Consolidated Statements of Cash Flows
Years Ended December 31
2004 2003 2002
-----------------------------------------------
Operating activities
Net income $ 5,681,049 $ 5,164,200 $ 4,556,836
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 1,320,000 1,200,000 1,500,000
Depreciation and amortization 1,281,526 1,099,026 1,056,034
Mortgage servicing rights impairment(recoveries) charges (256,140) 345,102 261,174
(Gain) loss on sale of investment securities available for sale 83,739 36,891 (498)
Gain on sale of loans (157,145) (1,056,418) (705,611)
Gain on sale of fixed assets (2,150) -- --
Income tax benefit from exercise of warrants & options 817,610 456,013 2,562,990
Stock compensation 99,990 110,000 109,918
Net accretion of investments 294,755 841,086 1,151,094
Unearned compensation amortization 299,995 396,092 282,494
(Increase) decrease in:
Accrued interest receivable (497,337) 470,857 (1,147,427)
Other assets (1,355,428) (735,424) (1,224,833)
Increase (decrease) in:
Other liabilities 2,950,137 (1,824,744) 900,935
-----------------------------------------------
Net cash provided by operating activities 10,560,601 6,502,681 9,303,106
Investing activities
Net change in federal funds sold (11,264,397) (2,324,923) (3,923,259)
Net change in reverse repurchase agreements 10,000,000 (10,000,000) 115,000,000
Proceeds from maturities of investment
securities held to maturity 1,165,586 24,124,021 1,797,727
Proceeds from maturities of investment
securities available for sale 24,186,692 48,297,884 62,376,100
Proceeds from sales of investment securities available for sale 19,952,500 25,330,500 9,999,000
Purchases of investment securities held to maturity (51,426,350) (181,700) (23,796,563)
Purchases of investment securities available for sale (21,491,649) (107,055,082) (129,205,346)
Net increase in loans (93,781,818) (143,204,249) (127,569,056)
Proceeds from sale of loans 32,995,345 75,711,736 51,163,788
Purchases of premises and equipment (1,562,075) (999,445) (1,047,088)
-----------------------------------------------
Net cash used by investing activities (91,226,166) (90,301,258) (45,204,697)
Financing activities
Net increase in deposits 55,893,965 93,194,560 38,217,157
Net change in security repurchase agreements 12,605,580 (2,716,728) 5,922,142
Net change in FHLB advances (10,000,000) (6,000,000) (2,000,000)
Proceeds from issuance of long-term debt 3,000,000 2,000,000 --
Repurchase of stock (3,779,334) (5,054,547) (30,800)
Proceeds from issuance of stock 1,386,574 869,146 4,838,280
-----------------------------------------------
Net cash provided by financing activities 59,106,785 82,292,431 46,946,779
-----------------------------------------------
Increase (decrease) in cash and cash equivalents (21,558,780) (1,506,146) 11,045,188
Cash and cash equivalents at beginning of year 44,383,402 45,889,548 34,844,360
-----------------------------------------------
Cash and cash equivalents at end of year $ 22,824,622 $ 44,383,402 $ 45,889,548
===============================================
Interest paid $ 12,959,914 $ 12,149,305 $ 14,144,085
===============================================
Income taxes paid $ 1,368,989 $ 4,268,861 $ 405,325
===============================================
See accompanying notes.
47
1. Organization and Significant Accounting Policies
Organization
The National Bank of Indianapolis Corporation (the Corporation) was incorporated
in the State of Indiana on January 29, 1993. The Corporation subsequently formed
a de novo national bank, The National Bank of Indianapolis (the Bank), and a
statutory trust, NBIN Statutory Trust I (the Trust). The Bank is a wholly owned
subsidiary and commenced operations in December, 1993. The Trust was formed in
September, 2000 as part of the issuance of trust preferred capital securities.
The Corporation and the Bank engage in a wide range of commercial, personal
banking, and trust activities primarily in Central Indiana.
The consolidated financial statements include the accounts of the Corporation,
the Bank, and the Trust with intercompany balances and transactions eliminated
for years 2003 and 2002, however during the first quarter of 2004, as a result
of applying Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletin No. 51" (FIN 46), the Corporation was required to
deconsolidate the Trust from its financial statements. See Note 4 Trust
Preferred Securities in the Notes to the Consolidated Financial Statements of
this report for further information.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and interest-bearing deposits.
Interest-bearing deposits are available on demand.
Investment Securities
Investments in debt securities are classified as held-to-maturity or
available-for-sale. Management determines the appropriate classification of the
securities at the time of purchase per Board-approved policy.
Debt securities are classified as held-to-maturity when the Corporation has the
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost.
48
1. Organization and Signficant Accounting Policies (continued)
Debt securities not classified as held-to-maturity are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
the unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity.
The amortized cost of debt securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Interest and dividends are included in interest income from
investments. Realized gains and losses, and declines in value judged to be
other-than-temporary are included in other income. The cost of securities sold
is based on the specific identification method.
Loans
Interest income on commercial, mortgage and certain installment loans are
accrued on the principal amount of such loans outstanding. Loans are placed on
nonaccrual status when significant doubt exists as to the collectibility of
principal or interest. Interest continues to accrue on the loan, but no income
is recognized. All payments, principal and interest, received are applied to the
outstanding principal balance.
Deferred loan fees are amortized over the life of the loan.
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 allocated to loans that are
identified as impaired is based on cash flows using the loan's initial effective
interest rate or the fair value of the collateral for collateral dependent
loans.
49
1. Organization and Significant Accounting Policies (continued)
The allowance for loan losses is maintained at a level believed adequate by
management to absorb inherent 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. The
allowance is increased by provisions for loan losses charged against income and
reduced by net charge-offs.
The allowance for loan losses is allocated to each loan category based on
management's estimate of expected losses, which is determined by, among other
things, the Bank's historical loss experience and peer median charge off
percentages by loan category added to actual reserves maintained for
non-performing or specifically identified loans requiring a reserve. 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 Rights
Mortgage servicing rights are recognized as separate assets when rights are
acquired through sale of mortgage loans. Capitalized servicing rights are
reported in other assets and are amortized into other operating expenses in
proportion to, and over the period of, the estimated future net servicing income
of the underlying financial assets. Mortgage servicing rights are evaluated for
impairment based upon the fair value of the rights as compared to amortized
cost. Impairment is determined by stratifying rights by predominant
characteristics, such as loan type, interest rates, maturities and other terms.
Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Estimates of fair value include assumptions about loan
prepayment speeds, servicing costs and revenues, interest rates and other
factors which may change over time. Impairment is recognized through a valuation
allowance for an individual stratum, to the extent that fair value is less than
the cost of the rights for each stratum.
50
1. Organization and Significant Accounting Policies (continued)
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 4 Trust Preferred Securities in the
Notes to the Consolidated Financial Statements of this report for further
information.
Derivative Instruments and Hedging Activities
During the second quarter of 2004, the Corporation entered into a 3-year
interest rate swap to mitigate 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 Financial Accounting Standard Board (FASB) Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities", 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. See Note 6 Derivative Instruments and Hedging Activities in
the Notes to the Consolidated Financial Statements of this report for further
information.
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.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation computed
by the straight-line method over their useful lives or, for leasehold
improvements, the remaining lease term.
51
1. Organization and Significant Accounting Policies (continued)
Comprehensive Income
Comprehensive income is defined as net income plus other comprehensive income,
which, under existing accounting standards includes unrealized gains and losses
on certain investments in debt securities and unrealized gains or losses on
interest rate swap. Comprehensive income is reported by the Corporation in the
consolidated statements of shareholders' equity.
Earnings Per Share
Basic earnings per share is computed by dividing net income applicable to common
shareholders by the weighted average numbers of shares of common shares
outstanding for the period. Diluted earnings per share is computed by dividing
an adjusted net income by the sum of the weighted average number of shares and
the potentially dilutive shares that could be issued through stock award
programs or convertible securities.
Fair Values of Financial Instruments
The fair values of financial instruments are estimated using relevant market
information and other assumptions. Fair value estimates involve uncertainties
and matters of significant judgment concerning several factors, especially in
the absence of broad markets for particular items.
Stock Based Compensation
The Corporation has granted stock options to certain employees and directors.
The stock options are for a fixed number of shares with an exercise price which
approximates the fair value of shares at the date of grant. As discussed further
in Note 12 Stock Option and Award and Employee Benefit Programs, expense for
director and employee compensation under stock option plans is based on
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," (APB 25), with expense reported only if options are granted with an
exercise price below market price on the grant date. Pro forma disclosures of
net income and earnings per share are provided as if the fair value method of
FASB Statement No. 123 "Accounting for Stock Based Compensation", as amended by
FASB Statement No. 148, were used for stock-based compensation.
52
1. Organization and Significant Accounting Policies (continued)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over their vesting periods. The following table
illustrates the effect on net income and earnings per share if the fair value
recognition provisions of Statement No. 123, as amended by FASB Statement No.
148, to stock-based compensation had been applied.
2004 2003 2002
-----------------------------------------
Net income, as reported $ 5,681,049 $ 5,164,200 $ 4,556,836
Add: stock-based compensation expense, net of related
taxes 181,167 239,200 170,598
Less: total stock-based compensation expense
determined under fair-value-based method, net of
taxes (358,475) (459,052) (529,881)
-----------------------------------------
Pro forma net income $ 5,503,741 $ 4,944,348 $ 4,197,553
=========================================
Earnings per share:
Basic, as reported $ 2.47 $ 2.20 $ 1.99
Basic, pro forma $ 2.39 $ 2.11 $ 1.83
Diluted, as reported $ 2.37 $ 2.08 $ 1.88
Diluted, pro forma $ 2.30 $ 1.99 $ 1.73
Reportable Segments
The Corporation has determined that it has one reportable segment, banking
services. The Bank provides a full range of deposit, credit, and money
management services to its targeted market, which is small to medium size
businesses, affluent executive and professional individuals, and not-for-profit
organizations.
53
1. Organization and Significant Accounting Policies (continued)
Reclassifications
Certain amounts in the 2003 and 2002 financial statements have been reclassified
to conform with the 2004 presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
2. New Accounting Pronouncements
In March 2004, The Emerging Issues Task Force (EITF), a standard setting body
working under the auspices of the FASB, issued EITF No. 03-1, "The Meaning of
Other than Temporary Impairments and its Application to Certain Investments". In
the revised guidance the EITF reached a Consensus regarding the model to be used
in determining whether an investment is other-than-temporarily impaired, and the
required disclosures about unrealized losses on available-for-sale debt and
equity securities. In September 2004, The FASB announced that the effective date
for applying Paragraph 16 will be delayed pending further discussion. Paragraph
16 of the Consensus relates to debt securities that cannot be contractually
prepaid or otherwise settled for an amount less than the investor's cost. The
effective date for the recognition and measurement portion of the Consensus
remains June 15, 2004. Management continues to evaluate the impact of adopting
EITF 03-1 and it is not expected to have a material impact on the Corporation's
financial condition, results of operations, or cash flow.
In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based
Payment, which is a revision of Statement No. 123, "Accounting for Stock-Based
Compensation". Statement 123(R) supersedes APB 25 and amends FASB Statement No.
95, Statement of Cash Flows. Statement 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be recognized in
the income statement based on their fair values. Pro forma disclosure is no
longer an alternative.
54
2. Accounting Pronouncements (continued)
Statement 123(R) must be adopted no later than for July 1, 2005. Early adoption
will be permitted in periods in which financial statements have not yet been
issued. The Corporation expects to adopt Statement 123(R) on July 1, 2005.
Statement 123(R) permits public companies to adopt its requirements using one of
two methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the
requirements of Statement 123(R) for all share-based payments
granted after the effective date and (b) based on the
requirements of Statement 123 for all awards granted to
employees prior to the effective date of Statement 123(R) that
remain unvested on the effective date.
2. A "modified retrospective" method which includes the
requirements of the modified prospective method described
above, but also permits entities to restate based on the
amounts previously recognized under Statement 123 for purposes
of pro forma disclosures either (a) all prior periods
presented or (b) prior interim periods of the year of
adoption.
Management is currently evaluating the effect of this guidance on the
Corporation's financial condition, results of operations, and cash flow and has
not yet determined the method that will be adopted.
As permitted by Statement 123, the Corporation currently accounts for
share-based payments to employees using APB 25's intrinsic value method and, as
such, generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have an
impact on our results of operations and it will have an immaterial impact on our
overall financial position. The impact of adoption of Statement 123(R) cannot be
predicted at this time because it will depend on levels of share-based payments
granted in the future. However, had we adopted Statement 123(R) in prior
periods, the impact of that standard would have approximated the impact of
Statement 123 as described in the disclosure of pro forma net income and
earnings per share in Note 1 to our consolidated financial statements. Statement
123(R) also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce reported net operating cash flows and increase net financing cash flows
in periods after adoption. While the Corporation cannot estimate what those
amounts will be in the future (because they depend on, among other
55
2. Accounting Pronouncements (continued)
things, when employees exercise stock options), the amount of operating cash
flows recognized in prior periods for such excess tax deductions were $817,610,
$456,013, and $2,562,990 in 2004, 2003 and 2002, respectively.
3. Restrictions on Cash and Due From Bank Accounts
The Corporation is required to maintain average reserve balances with the
Federal Reserve Bank or as cash on hand or on deposit with a correspondent bank.
The required amount of reserve was approximately $25,000 at December 31, 2004
and 2003.
4. Trust Preferred Securities
In September 2000, the Corporation established the Trust, a Connecticut
statutory business trust, which subsequently issued $13,500,000 of company
obligated mandatorily redeemable capital securities and $418,000 of common
securities. The proceeds from the issuance of both the capital and common
securities 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.
The indenture, dated September 7, 2000, requires compliance with certain
non-financial covenants.
In January of 2003, the FASB issued FIN 46 which 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.
56
4. Trust Preferred Securities (continued)
Under the provisions of the FIN 46, 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, in 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 junior subordinated debt obligation issued to the Trust
of $13,918,000 is reflected in the Corporation's balance sheet.
The junior subordinated debentures owed to the Trust and held by the Corporation
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
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:
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
==========================
57
4. Trust Preferred Securities (continued)
Interest payments made on the capital securities or the junior subordinated
debentures are reported as a component of interest expense on long-term debt.
5. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities:
Available-for-Sale Securities
---------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
---------------------------------------------------------------
December 31, 2004
U.S. Treasury securities $ 2,016,184 $ -- $ 7,704 $ 2,008,480
U.S. Government agencies 91,000,000 112,700 769,680 90,343,020
Collateralized mortgage obligations 62,486 58 -- 62,544
---------------------------------------------------------------
$ 93,078,670 $ 112,758 $ 777,384 $ 92,414,044
===============================================================
December 31, 2003
U.S. Treasury securities $ 21,840,685 $ 5,646 $ 954 $ 21,845,377
U.S. Government agencies 93,904,140 829,297 815,799 93,917,638
Collateralized mortgage obligations 99,203 154 -- 99,357
---------------------------------------------------------------
$115,844,028 $ 835,097 $ 816,753 $115,862,372
===============================================================
58
5. Investment Securities (continued)
Held-to-Maturity Securities
-----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
-----------------------------------------------------------
December 31, 2004
- -----------------
Municipals $ 5,444,198 $ 484,166 $ -- $ 5,928,364
Collateralized mortgage obligations 50,012,255 -- 836,980 49,175,275
Other securities 250,000 4,584 221 254,363
-----------------------------------------------------------
$55,706,453 $ 488,750 $ 837,201 $55,358,002
===========================================================
December 31, 2003
- -----------------
Municipals $ 5,576,468 $ 531,499 $ -- $ 6,107,967
Other securities 250,000 7,082 -- 257,082
-----------------------------------------------------------
$ 5,826,468 $ 538,581 $ -- $ 6,365,049
===========================================================
The amortized cost, fair value, and weighted-average yield of investment
securities at December 31, 2004, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because the issuers
of the securities may have the right to call and/or prepay obligations without
prepayment penalties.
Available-for-Sale Securities
--------------------------------------------------------------------------
Weighted-
Within 1 5 to 10 Average
Year 1 to 5 Years Years Total Yield
--------------------------------------------------------------------------
U.S. Treasury and
U.S. Government agency debentures $ 1,494,737 $91,521,447 $ -- $93,016,184 2.72%
Collateralized mortgage obligations -- 62,486 -- 62,486 1.46%
-----------------------------------------------------------
Amortized cost $ 1,494,737 $91,583,933 $ -- $93,078,670
===========================================================
Fair value $ 1,492,425 $90,921,619 $ -- $92,414,044
===========================================================
Weighted-average yield 2.00% 2.73% -- 2.72%
===========================================================
59
5. Investment Securities (continued)
Held-to Maturity Securities
--------------------------------------------------------------------------
Weighted-
Within 1 5 to 10 Average
Year 1 to 5 Years Years Total Yield
--------------------------------------------------------------------------
Other Securities $ 50,000 $ 175,000 $ 25,000 $ 250,000 5.06%
Municipals -- 3,227,568 2,216,630 5,444,198 4.92%
Collateral mortgage obligations -- -- 50,012,255 50,012,255 3.45%
------------------------------------------------------------
Amortized costs $ 50,000 $ 3,402,568 $52,253,885 $55,706,453
============================================================
Fair value $ 50,293 $ 3,713,039 $51,594,670 $55,358,002
============================================================
Weighted-average yield 6.63% 4.96% 3.51% 3.61%
============================================================
The Corporation held thirteen investment securities as of December 31, 2004 of
which the amortized cost was greater than market value. The majority of these
investment securities were purchased during 2003 and 2004. Management does not
believe any individual unrealized loss as of December 31, 2004 represents an
other-than-temporary impairment. The unrealized losses relate primarily to
securities issued by the U.S. Treasury and FHLMC. These unrealized losses are
primarily attributable to changes in interest rates and individually were 2.3%
or less of their respective amortized cost basis. The Corporation has both the
intent and ability to hold these securities for a time necessary to recover the
amortized cost.
Available-for-Sale Securities
Less than 6 months Greater than 6 months
In an unrealized loss position In an unrealized loss position
--------------------------------------------------------------------------
Total Total
Unrealized Number Unrealized Number Unrealized Estimated
Loss of Estimated Loss of Estimated Loss Fair
Amount Securities Fair Value Amount Securities Fair Value Amount Value
---------------------------------------------------------------------------------------------------
U.S. Treasury
Securities $ (2,103) 2 $ 992,580 $ (5,601) 2 $1,015,900 $ (7,704) $ 2,008,480
U.S. Government
Agencies (280,200) 1 19,719,800 (489,480) 2 25,510,520 (769,680) 45,230,320
---------------------------------------------------------------------------------------------------
Total $ (282,303) 3 $20,712,380 $(495,081) 4 $26,526,420 $(777,384) $47,238,800
===================================================================================================
60
5. Investment Securities (continued)
Held-to-Maturity Securities
Less than 6 months Greater than 6 months
In an unrealized loss position In an unrealized loss position
------------------------------------ -----------------------------------
Total Total
Unrealized Number Unrealized Number Unrealized Estimated
Loss Of Estimated Loss of Estimated Loss Fair
Amount Securities Fair Value Amount Securities Fair Value Amount Value
----------------------------------------------------------------------------------------------------
Collateralized Mortgage
Obligations $ - - $ - $(836,980) 3 $49,175,275 $(836,980) $49,175,275
Other Securities - - $ - (221) 3 74,779 (221) 74,779
----------------------------------------------------------------------------------------------------
Total $ - - $ - $ (837,201) 6 $49,250,054 $ (837,201) $49,250,054
====================================================================================================
Investment securities with a carrying value of approximately $81,000,000 and
$73,000,000 at December 31, 2004 and 2003, respectively, were pledged as
collateral for bankruptcy accounts to the U.S. Department of Justice, Treasury
Tax and Loan, and securities sold under agreements to repurchase.
6. Derivative Instruments and Hedging Activities
During the second quarter of 2004, the Corporation entered into a 3-year
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
FASB Statement No. 133. Statement 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.
December 31, 2004 December 31, 2003
Net Net
Notional Amount Derivative Ineffectiveness Notional Derivative Ineffectiveness
Liability Hedge Gains Amount Liability Hedge Gains
(Losses) (Losses)
Cash flow hedge
Overnight federal funds
sold
Receive fixed
interest rate swap $20,000,000 $377,804 $ -- $ -- $ -- $ --
61
7. Loans and Allowance for Loan Losses
Loans consist of the following at December 31:
2004 2003
--------------------------------
Residential loans secured by real estate $ 243,717,433 $ 218,400,660
Commercial loans secured by real estate 127,772,683 120,135,105
Other commercial and industrial loans 235,704,551 221,845,611
Consumer loans 49,257,902 36,681,368
--------------------------------
Total loans 656,452,569 597,062,744
Less: allowance for loan losses (7,795,803) (8,029,596)
--------------------------------
Total loans, net $ 648,656,766 $ 589,033,148
================================
Activity in the allowance for loan losses was as follows:
2004 2003 2002
------------------------------------------
Beginning balance $ 8,029,596 $7,227,000 $5,986,965
Loans charged off (net) (1,553,793) (397,404) (259,965)
Provision for loan losses 1,320,000 1,200,000 1,500,000
------------------------------------------
Ending balance $ 7,795,803 $8,029,596 $7,227,000
==========================================
A loan is considered delinquent when a payment has not been made more than 30
days past its contractual due date.
Loans past due over 30 days totaled $3,019,524, or .46% of total loans at
December 31, 2004 compared to $5,215,093 or .87% of total loans at December 31,
2003.
Loans are considered to be impaired if a loan is greater than 90 days past due
and not accruing interest. At December 31, 2004 thirty-two loans with a combined
balance of $3,119,000 were considered to be impaired. At December 31, 2003
forty-one loans with a combined balance of $4,871,000 were considered to be
impaired. The average combined balance of impaired loans during 2004 and 2003
was $3,542,000 and $4,180,000, respectively. For loans classified as impaired at
December 31, 2004, the contractual interest due and the actual interest
recognized on those loans during 2004 was $309,350 and $102,687, respectively
and the related allowance on impaired loans at December 31, 2004 was $836,000.
62
7. Loans and Allowance for Loan Losses (continued)
At December 31, 2004 and 2003, there were approximately $73,000 and $517,000 of
loans greater than 90 days past due and still accruing interest.
Loans are principally to borrowers in the Central Indiana area.
8. Premises and Equipment
Premises and equipment consist of the following at December 31:
2004 2003
--------------------------
Land and improvements $ 2,270,444 $ 2,270,444
Building and improvements 5,426,385 5,358,751
Construction in progress 1,109,187 70,444
Leasehold improvements 1,628,213 1,614,621
Furniture and equipment 7,276,869 6,832,616
--------------------------
17,711,098 16,146,876
Less accumulated depreciation and amortization (8,034,830) (6,998,167)
--------------------------
Net premises and equipment $ 9,676,268 $ 9,148,709
==========================
Certain Corporation facilities and equipment are leased under various operating
leases. Rental expense under these leases was $260,378, $247,822, and $245,629
for 2004, 2003, and 2002, respectively.
Future minimum rental commitments under noncancelable leases are:
2005 $ 356,477
2006 271,733
2007 243,711
2008 238,027
2009 197,326
Thereafter 1,062,292
-----------
$ 2,369,566
===========
63
9. Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage loans
serviced for others were $96,362,758 and $82,210,074 at December 31, 2004 and
2003, respectively.
The following table is a breakdown of mortgage servicing rights:
2004 2003
-----------------------------
Balance at January 1 $ 1,505,241 $ 1,041,267
Plus: additions 311,332 685,428
Less: amortization (244,861) (221,454)
-----------------------------
Balance at December 31 1,571,712 1,505,241
Less: valuation allowance (350,136) (606,276)
-----------------------------
Balance, net $ 1,221,576 $ 898,965
=============================
Projected amortization of mortgage servicing rights is based on current
assumptions related to market conditions. Future amortization expense may be
different depending on changes in the mortgage servicing pool, interest rates
and market conditions.
10. Deposits
Deposits are summarized as follows:
December 31
2004 2003
--------------------------------
Demand accounts:
Non-interest-bearing $ 153,674,215 $ 138,087,276
Interest bearing 96,248,216 78,061,429
--------------------------------
Total demand accounts 249,922,431 216,148,705
Money market accounts 316,175,384 294,969,565
Savings accounts 10,831,226 9,543,087
Certificate accounts:
Over $100,000 49,039,847 48,219,664
Under $100,000 67,462,157 68,656,059
--------------------------------
Total deposits $ 693,431,045 $ 637,537,080
================================
64
10. Deposits (continued)
At December 31, 2004 the stated maturities of time deposits are as follows:
Greater
Less than Than
$100,000 $100,000
---------------------------
Mature in three months or less $13,363,981 $14,554,066
Mature after three months through six months 9,173,926 3,631,966
Mature after six months through twelve months 15,801,514 13,498,375
Mature in 2005 9,133,116 4,941,208
Mature in 2006 9,466,415 6,763,067
Thereafter 10,523,205 5,651,165
---------------------------
$67,462,157 $49,039,847
===========================
11. Other Borrowings
Security repurchase agreements are short-term borrowings that generally mature
within one to three days from the transaction date. At December 31, 2004 and
2003 the weighted average interest rate on these borrowings was 0.74% and 0.53%,
respectively.
All of the FHLB advances have a fixed interest rate and require monthly interest
payments. The principal balances for each of the advances is due at maturity.
The advances are collateralized by a pledge covering certain of the
Corporation's mortgage loans.
65
11. Other Borrowings (continued)
A schedule of the FHLB advances as of December 31, 2004 and 2003 is as follows:
2004 2003
------------------------------------- -------------------------------------
Amount Rate Maturity Amount Rate Maturity
------------------------------------- -------------------------------------
$5,000,000 5.14% 08/01/2005 $ 5,000,000 5.39% 02/26/2004
3,000,000 5.39% 10/03/2005 5,000,000 5.15% 04/23/2004
5,000,000 5.43% 03/16/2006 5,000,000 5.14% 08/01/2005
5,000,000 5.32% 05/08/2006 3,000,000 5.39% 10/03/2005
8,000,000 4.19% 07/24/2007 5,000,000 5.43% 03/16/2006
3,000,000 5.57% 08/13/2007 5,000,000 5.32% 05/08/2006
3,000,000 5.55% 10/02/2008 8,000,000 4.19% 07/24/2007
3,000,000 5.57% 08/13/2007
3,000,000 5.55% 10/02/2008
----------- -----------
$2,000,000 $42,000,000
=========== ===========
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, 2005. At
December 31, 2004 and 2003, $0 was outstanding. The Corporation pays a
commitment fee of .25% per annum on the average daily unused portion of the line
of credit.
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 permitted to be repaid prior to maturity with prior consent from the
Federal Reserve. 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 4.16% at
December 31, 2004. Interest payments are due at the expiration of the fixed term
option.
66
12. Stock Option and Award and Employee Benefit Programs
The Board of Directors and the shareholders of the Corporation adopted stock
option plans for directors and key employees at the initial formation of the
Bank in 1993. The Board of Directors authorized 130,000 shares in 1993, 90,000
shares in 1996, 150,000 shares in 1999, and an additional 120,000 during 2002 to
be reserved for issuance under the Corporation's stock option plan. All of the
options in these plans remain exercisable for a period of 10 years from the date
of issuance, subject to the terms and conditions of the plans.
Shares subject to outstanding options are summarized as follows:
2004 2003 2002
---------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
---------------------------------------------------------------------------------
Options outstanding at
beginning of year 379,695 $19.15 391,557 $18.75 315,500 $14.75
New options
granted 6,892 33.92 5,800 29.98 115,057 27.58
Options exercised (101,931) 11.70 (17,662) 13.79 (37,800) 12.25
Options forfeited (6,600) 28.52 - - (1,200) 19.00
---------- --------- ----------
Options outstanding at
end of year 278,056 $21.99 379,695 $19.15 391,557 $18.75
========== ========= ==========
Exercisable at year end
187,321 $19.17 266,881 $16.25 260,300 $15.72
The weighted-average fair value of the options granted during 2004, 2003 and
2002 was $12.19, $10.43, and $11.06, respectively.
As of December 31, 2004 total shares which may be purchased under the plans is
278,056 with option prices ranging from $10.00 to $34.50. The weighted-average
remaining contractual life of those options is six years.
67
12. Stock Option and Award and Employee Benefit Programs (continued)
The following table is a breakdown of the available options which can be
exercised with their respective weighted average exercise price and weighted
average contractual life:
# of Options Weighted Average Contractual Life
Outstanding Range Weighted Average Exercise Price (Years)
---------------------------------------------------------------------------------------------------------------
126,800 $10.00 - $19.00 $16.50 3.5
144,364 $20.00 - $29.50 $26.24 7.0
6,892 $31.25 - $34.50 $33.75 9.6
---------------------------------------------------------------------------------------------------------------
278,056 $10.00 - $34.50 $21.99 5.5
The Board of Directors also approved a restricted stock plan in 1993. Shares
reserved by the Corporation for the restricted stock plan include 50,000 shares
in 1993, 20,000 shares in 1996, 40,000 in 1999 and an additional 55,000 shares
in 2002. Under this plan, shares were issued in the proceeding years as detailed
in the following table. The Corporation recorded each stock issuance in
shareholders' equity with an offsetting contra-equity account, unearned
compensation, equal to the fair market value of the shares at the grant date.
The unearned compensation is amortized over the vesting period.
Fiscal Year Number of Shares Unearned Vesting Date Fully
Ended Shares Issued Forfeited Compensation Schedule Vested
- -------------------------------------------------------------------------------------------
1997 19,500 700 $242,332 20% per year January 1, 2002
1998 1,000 - 14,000 20% per year January 1, 2003
1999 36,000 2,000 646,000 5 yr. cliff June 30, 2004
2000 5,000 - 100,000 5 yr. cliff March 16, 2005
2001 3,000 - 69,000 5 yr. cliff January 26, 2006
2002 1,500 - 37,500 5 yr. cliff June 11, 2006
2002 6,500 - 178,750 4 yr. Cliff August 31, 2006
2002 30,800 500 845,200 5 yr. Cliff June 20, 2007
2003 1700 - 50,150 5 yr. Cliff January 8, 2008
2003 700 - 21,875 5 yr. Cliff July 17, 2008
2004 3,100 700 82,800 5 yr. Cliff December 16, 2009
68
12. Stock Option and Award and Employee Benefit Programs (continued)
During 2004, certain officers/directors of the Corporation exercised their
options to purchase 101,931 shares of common stock. The exercise price ranged
from $10.00 to $27.50 with a weighted average exercise price of $11.70 and a
weighted average fair market value of the stock was $32.99.
During 2003, certain officers/directors of the Corporation exercised their
warrants/options to purchase 55,662 shares of common stock. The exercise price
ranged from $10.00 to $27.50 with a weighted average exercise price of $11.20
and a weighted average fair market value of the stock was $31.40.
Due to the exercise of the options, the Corporation received a deduction for tax
purposes for the difference between the fair value of the stock at the date of
the exercise and the exercise price. In accordance with APB 25, the Corporation
has recorded an income tax benefit of $817,610 and $456,013 as additional paid
in capital during 2004 and 2003, respectively.
The Corporation has elected to follow APB 25 and related Interpretations in
accounting for its director and employee stock options and restricted stock.
Under APB 25, because the exercise price of the Corporation's director and
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
The fair value for the options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted- average
assumptions: a dividend yield of 0%; volatility factor of the expected market
price of the Corporation's common stock of .054485; and an expected life of the
options of 10 years. The risk-free interest rate was estimated to be 4.4%, 4.3%
to 4.4%, and 5.2% to 5.66% for 2004, 2003, and 2002, respectively. The fair
value for the restricted stock is estimated to equal the fair value of
unrestricted stock and to be restricted for five years.
69
12. Stock Option and Award and Employee Benefit Programs (continued)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility.
The Corporation has a trusteed 401(k) retirement savings plan covering
substantially all employees and encouraging employee contributions. Employer
contributions include Board of Director discretionary contributions and the
matching of a portion of employee contributions. The Corporation expensed
approximately $201,000, $211,000, and $167,000 for employer contributions to the
plan during 2004, 2003, and 2002, respectively.
13. Dividend and Loan Limitation and Regulatory Capital Ratios
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. No loans were made during 2004 or 2003 by the Bank to
the Corporation. The Bank declared a $1,000,000 and $1,650,000 dividend to the
Corporation during 2004 and 2003, respectively.
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory-and possibly additional discretionary-actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain amounts and ratios (set forth in the table below)
of total and Tier 1 capital (as defined in the regulations) to risk-weighted
assets (as defined), and of total qualifying capital to total adjusted asset (as
defined). Management believes, as of December 31, 2004 and 2003, that the Bank
meets all capital adequacy requirements to which it is subject.
70
13. Dividend and Loan Limitation and Regulatory Capital Ratios (continued)
As of December 31, 2004, the most recent notification from the Comptroller of
the Currency categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
the Bank must maintain minimum total risk-based, Tier 1 risk-based, and
leveraged capital ratios as set forth in the following table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the following
table.
To be well
capitalized under prompt
For capital corrective action
Actual adequacy purposes provisions
-----------------------------------------------------------------------------------
As of December 31, 2004 Amount Ratio Amount Ratio Amount Ratio
----------------- ------------------------- ------------------------- ----------
Tier 1 Risk-Based Capital $57,978,004 8.6% $26,995,059 4.0% $40,492,588 6.0%
Total Risk-Based Capital 70,773,807 10.5% $53,990,118 8.0% $67,487,647 10.0%
Leveraged Capital 57,978,004 6.5% $35,705,850 4.0% $44,632,312 5.0%
As of December 31, 2003
Tier 1 Risk-Based Capital $52,254,914 8.6% $24,309,136 4.0% 36,463,703 6.0%
Total Risk-Based Capital 61,856,864 10.2% 48,618,271 8.0% 60,772,839 10.0%
Leveraged Capital 52,254,914 6.4% 32,699,306 4.0% 40,874,133 5.0%
71
14. Related Parties
Certain directors and principal shareholders of the Corporation, including their
families and companies in which they are principal owners, are loan customers of
and have other transactions with the Corporation or its subsidiary in the
ordinary course of business. The aggregate dollar amount of these loans was
approximately $7,129,516 and $8,847,920 on December 31, 2004 and 2003,
respectively. All of the loans made were on substantially the same terms,
including interest rate and collateral, as those prevailing at the time for
comparable transactions with unrelated parties. The amounts do not include loans
made in the ordinary course of business to companies in which officers or
directors of the Corporation are either officers or directors, but are not
principal owners, of such companies. During 2004, new loans to these parties
amounted to $429,364 and repayments amounted to $2,147,768.
15. Income Taxes
The Corporation applies a federal income tax rate of 34% and a state tax rate of
8.5% in the computation of tax expense or benefit. The provision for income
taxes consisted of the following:
2004 2003 2002
---------------------------------------
Current tax expense $2,940,441 $3,592,053 $3,636,852
Deferred tax (benefit) expense 194,557 (379,263) (636,573)
---------------------------------------
$3,134,998 $3,212,790 $3,000,279
=======================================
72
15. Income Taxes (continued)
The statutory tax rate reconciliation is as follows:
2004 2003 2002
----------------------------------------------------
Income before provision for income tax $8,816,047 $8,376,990 $7,557,115
====================================================
Tax expense at federal statutory rate $2,997,456 $2,848,177 $2,569,419
Increase (decrease) in taxes resulting from:
State income taxes 454,644 485,239 438,511
Deferred compensation (154,275) - (816)
Tax exempt interest (95,303) (96,360) (93,970)
Other (67,524) (24,266) 87,135
----------------------------------------------------
$3,134,998 $3,212,790 $3,000,279
====================================================
Effective tax rate 35.56% 38.35% 39.70%
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Deferred tax assets are
recognized for the estimated tax effects attributable to deductible temporary
differences and operating loss carryforwards, net of any valuation allowances
for amounts which may not be realized by the Corporation.
73
15. Income Taxes (continued)
The components of the Corporation's net deferred tax assets in the consolidated
balance sheet as of December 31 are as follows:
2004 2003
--------------------------------
Deferred tax assets:
Allowance for loan losses $3,087,918 $3,180,523
Other 1,145,500 706,760
--------------------------------
Total deferred tax assets 4,233,418 3,887,283
Deferred tax liability:
Mortgage servicing rights (483,866) (356,080)
Other -- (7,266)
--------------------------------
Total deferred tax liabilities (483,866) (363,346)
--------------------------------
Net deferred tax assets $3,749,552 $3,523,937
================================
16. Commitments and Contingencies
A summary of the contractual amount of commitments to extend credit is as
follows:
2004 2003
------------------------------
Commercial credit lines $181,996,327 $150,011,250
Revolving home equity and credit card lines 82,362,909 76,386,307
Standby letters of credit 13,538,965 12,053,320
Other loans 2,811,446 2,655,819
------------------------------
$280,709,647 $241,106,696
==============================
Commitments to extend credit are agreements to lend. Since many of the
commitments to extend credit may expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash-flow requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. Standby letters of credit generally
are contingent upon the failure of the customer to perform according to the
terms of the underlying contract with the third party.
74
16. Commitments and Contingencies (continued)
The credit risk associated with loan commitments and standby letters of credit
is essentially the same as that involved in extending loans to customers and is
subject to normal credit policies. Collateral may be obtained based on
management's credit assessment of the customer.
17. Fair Value of Financial Instruments
FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. Statement No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Corporation.
The following methods and assumptions were used by the Corporation in estimating
its fair value disclosures for financial instruments:
Cash and short-term investments: The carrying amounts reported in the
balance sheet for cash and short-term investments approximate those assets'
fair values due to the short maturity of those assets.
Investment securities (including collateraizedl mortgage obligations and
stock in federal banks): Fair values for investment securities are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
Loans receivable: For variable-rate loans that re-price frequently and with
no significant change in credit risk, fair values are based on carrying
values. The fair values for all other loans are estimated using discounted
cash flow analyses, using interest rates currently being offered for loans
with similar terms to borrowers of similar credit quality. The carrying
amount of accrued interest approximates its fair value.
75
17. Fair Value of Financial Instruments (continued)
Deposits: The fair values disclosed for demand deposits, including
interest-bearing and non-interest bearing accounts, passbook savings, and
certain types of money market accounts are, by definition, equal to the
amount payable on demand at the reporting date (i.e., their carrying
amounts). Fair values for fixed-rate certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
Security repurchase agreements: The carrying amounts of borrowings under
repurchase agreements approximate their fair values due to variable
interest rates.
FHLB advances: The fair value of FHLB advances are based upon discounted
cash flows using rates for similar advances with the same maturities.
Subordinated debt: The carrying amounts of borrowings under subordinated
debt approximate their fair values due to variable interest rates.
Capital securities: The fair value of the preferred capital securities are
based upon discounted cash flows using rates for similar securities with
the same maturities.
Junior subordinated debt: The fair value of the preferred capital
securities are based upon discounted cash flows using rates for similar
securities with the same maturities.
Off-balances-sheet instruments: Due to variable interest rates, the fair
value of commitments to extend credit approximate the carrying value. Fair
values for derivative instruments are based on cash flow projection models
acquired from third parties.
76
17. Fair Value of Financial Instruments (continued)
The estimated fair values of the Corporation's financial instruments at December
31 are as follows:
2004 2003
----------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------------------------------
Assets
Cash and due from banks $22,824,622 $22,824,622 $44,383,402 $44,383,402
Federal funds sold 31,766,783 31,766,783 20,502,386 20,502,386
Reverse repurchase agreements 5,000,000 5,000,000 15,000,000 15,000,000
Investment securities
available-for-sale 92,414,044 92,414,044 115,862,372 115,862,372
Investment securities
held-to-maturity 55,706,453 55,358,002 5,826,468 6,365,049
Net loans 648,656,766 650,492,553 589,033,148 598,495,968
Stock in federal banks 3,678,300 3,678,300 3,558,200 3,558,200
Liabilities
Deposits 693,431,045 692,209,547 637,537,080 643,909,939
Security repurchase agreements 84,162,626 84,162,626 71,557,046 71,557,046
FHLB advances 32,000,000 32,753,126 42,000,000 43,781,955
Subordinated debt 5,000,000 4,997,851 2,000,000 2,000,000
Capital securities -- -- 13,500,000 15,290,047
Junior subordinated debentures
13,918,000 15,571,225 -- --
Off-Balance-Sheet Instruments
Interest Rate Swap -- 188,540 -- --
Commitments to extend credit -- -- -- --
77
18. Shareholders' Equity
The following is a summary of activity in accumulated other comprehensive
income:
2004 2003 2002
-----------------------------------
Accumulated unrealized gains on securities $ 11,078 $ 520,729 $ 63,298
available for sale at January 1, net of tax
Net unrealized gains (losses) for period (599,230) (807,042) 756,964
Tax benefit (expense) 237,355 319,669 (299,834)
Reclassification adjustment of gains (losses)
included in net income (83,739) (36,891) 498
Tax benefit (expense) 33,169 14,613 (197)
-----------------------------------
Ending other comprehensive income (loss) at
December 31, net of tax $(401,367) $ 11,078 $ 520,729
===================================
Accumulated unrealized gains on swap at January 1,
net of tax $ -- $ -- $ --
Net unrealized loss for period (377,804) -- --
Tax benefit 149,648 -- --
-----------------------------------
Ending other comprehensive loss at December 31, net
of tax $(228,156) $ -- $ --
===================================
Accumulated other comprehensive income at January
1, net of tax $ 11,078 $ 520,729 $ 63,298
Other comprehensive income (loss), net of tax (640,601) (509,651) 457,431
-----------------------------------
Accumulated other comprehensive income (loss) at
December 31, net of tax $(629,523) $ 11,078 $ 520,729
===================================
78
19. Earnings Per Share
Basic net income per common share is computed by dividing net income applicable
to common stock by the weighted average number of shares of common stock
outstanding during the period. Diluted net income per common share is computed
by dividing net income applicable to common stock by the weighted average number
of shares, nonvested stock and dilutive common stock equivalents outstanding
during the period. Common stock equivalents consist of common stock issuable
under the assumed exercise of warrants and stock options granted under the
Corporation's stock plans, using the treasury stock method. A computation of
earnings per share follows:
2004 2003 2002
-----------------------------------------------
Basic average shares outstanding 2,302,522 2,343,460 2,288,715
===============================================
Net income $ 5,681,049 $5,164,200 $4,556,836
===============================================
Basic net income per common share $2.47 $2.20 $1.99
===============================================
Diluted
Average shares outstanding 2,302,522 2,343,460 2,288,715
Nonvested restricted stock 30,206 49,620 48,300
Common stock equivalents
Net effect of the assumed exercise of stock options
61,643 89,919 77,518
Net effect of the assumed exercise of warrants -- -- 14,581
-----------------------------------------------
Diluted average shares 2,394,371 2,482,999 2,429,114
===============================================
Net income $ 5,681,049 $5,164,200 $4,556,836
===============================================
Diluted net income per common share $2.37 $2.08 $1.88
===============================================
79
20. Parent Company Financial Statements
The condensed financial statements of the Corporation, prepared on a parent
company unconsolidated basis, are presented as follows:
Balance Sheet
December 31
2004 2003
-------------------------
Assets
Cash $ 2,449,327 $ 3,584,877
Investment in subsidiaries 57,470,639 52,920,721
Other assets 1,296,944 732,942
-------------------------
Total assets $61,216,910 $57,238,540
=========================
Liabilities and shareholders' equity
Other liabilities $ 755,223 $ 642,136
Subordinated debt 13,918,000 13,918,000
-------------------------
Total liabilities 14,673,223 14,560,136
Shareholders' equity 46,543,687 42,678,404
-------------------------
Total liabilities and shareholders' equity $61,216,910 $57,238,540
=========================
80
20. Parent Company Financial Statements (continued)
Statements of Income
Years Ended December 31
2004 2003 2002
-----------------------------------------
Interest income $ 26,579 $ 76,863 $ 65,119
Interest expense 1,488,053 1,590,506 1,443,674
Other income 44,308 -- --
Other operating expenses:
Unearned compensation amortization 299,995 396,092 282,494
Other expenses 306,430 305,923 316,483
-----------------------------------------
Total other operating expenses 606,425 702,015 598,977
-----------------------------------------
Net loss before tax benefit and equity in
undistributed net income of subsidiaries (2,023,591) (2,215,658) (1,977,532)
Tax benefit 949,289 817,343 782,338
-----------------------------------------
Net loss before equity in undistributed net
income of subsidiaries (1,074,302) (1,398,315) (1,195,194)
Equity in undistributed net income of
subsidiaries 6,755,351 6,562,515 5,752,030
-----------------------------------------
Net income $ 5,681,049 $ 5,164,200 $ 4,556,836
=========================================
81
20. Parent Financial Statements (continued)
Statements of Cash Flows
Years Ended December 31
2004 2003 2002
-----------------------------------------
Operating activities
Net income $ 5,681,049 $ 5,164,200 $ 4,556,836
Adjustments to reconcile net income to net cash provided by
(used by) operating activities:
Undistributed net income of subsidiaries (6,755,351) (6,562,516) (5,752,030)
Income tax benefit from exercise of options and warrants 817,610 456,013 2,562,990
Stock compensation 99,990 110,000 109,918
Unearned compensation amortization 299,995 396,092 282,494
Increase(decrease) in other assets 830 (337,378) (6,564)
Increase (decrease) in other liabilities 113,087 (419,942) 460,651
-----------------------------------------
Net cash provided by (used by) operating activities 257,210 (1,193,531) 2,214,295
Investing activities
Capital contribution to The National Bank of Indianapolis -- -- (1,000,000)
Dividends from The National Bank of Indianapolis 1,000,000 1,650,000 650,000
-----------------------------------------
Net cash provided by (used by) investing activities 1,000,000 1,650,000 (350,000)
Financing activities
Proceeds from issuance of stock 1,386,574 869,146 4,838,280
Repurchase of stock (3,779,334) (5,054,547) (30,800)
-----------------------------------------
Net cash provided by (used by) financing activities (2,392,760) (4,185,401) 4,807,480
-----------------------------------------
Increase (decrease) in cash and cash equivalents (1,135,550) (3,728,932) 6,671,775
Cash and cash equivalents at beginning of year 3,584,877 7,313,809 642,034
-----------------------------------------
Cash and cash equivalents at end of year $ 2,449,327 $ 3,584,877 $ 7,313,809
=========================================
82
21. Quarterly Results of Operations (Unaudited)
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 2004 and 2003:
March 31 June 30 September 30 December 31
------------------------------------------------------------------------------
2004
Interest income $ 8,758,927 $ 9,057,485 $ 9,894,386 $10,812,759
Interest expense 2,980,095 2,902,881 3,323,504 3,755,826
------------------------------------------------------------------------------
Net interest income 5,778,832 6,154,604 6,570,882 7,056,933
Provision for loan losses 300,000 300,000 330,000 390,000
Other operating income 1,732,917 1,832,407 1,816,372 1,794,812
Other operating expense 5,476,831 5,725,926 5,672,721 5,726,234
------------------------------------------------------------------------------
Net income before tax 1,734,918 1,961,085 2,384,533 2,735,511
Federal and state income tax 685,628 439,384 910,503 1,099,483
------------------------------------------------------------------------------
Net income after tax $ 1,049,290 $ 1,521,701 $ 1,474,030 $ 1,636,028
==============================================================================
Basic earnings per share $ 0.46 $ 0.66 $ 0.64 $ 0.71
Diluted earnings per share $ 0.43 $ 0.64 $ 0.61 $ 0.69
2003
Interest income $8,570,656 $8,690,207 $8,531,746 $8,767,532
Interest expense 2,989,800 3,063,213 2,932,884 2,964,023
------------------------------------------------------------------------------
Net interest income 5,580,856 5,626,994 5,598,862 5,803,509
Provision for loan losses 300,000 300,000 300,000 300,000
Other operating income 2,100,042 2,051,360 2,033,451 1,766,222
Other operating expense 5,238,174 5,378,333 5,190,847 5,176,952
------------------------------------------------------------------------------
Net income before tax 2,142,724 2,000,021 2,141,466 2,092,779
Federal and state income tax 845,898 794,561 846,068 726,263
------------------------------------------------------------------------------
Net income after tax $1,296,826 $1,205,460 $1,295,398 $1,366,516
==============================================================================
Basic earnings per share $ 0.55 $ 0.51 $ 0.55 $ 0.59
Diluted earnings per share $ 0.52 $ 0.48 $ 0.51 $ 0.57
83
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
- ------------------------------------------------------------------------
None.
Item 9A. Controls and Procedures
- ---------------------------------
(a) 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 13(a)-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 period covered by this Form 10-K, are
effective.
(b) 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.
(c) 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 company
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.
(d) CEO and CFO Certifications. Appearing immediately following the
Signatures section of 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
84
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.
Item 9B. Other Information
- ---------------------------
On December 16, 2004, the Company set the 2005 estimated annual base
salaries of all employees, other than Morris L. Maurer and Philip B. Roby, whose
salaries are adjusted, if appropriate, on July 1 of each year. For the fiscal
year ending December 31, 2005, Debra L. Ross will receive a salary of $140,000.
The Corporation also has determined that the Directors will be
compensated on the same basis in 2005 as they were compensated in 2004. The
components for Director compensation are set forth on Exhibit 10(f) to this Form
10-K.
On December 16, 2004, the Company also approved the bonus amounts
payable to the named executive officers for 2004 under the 2004 Bank Incentive
Plan ("Bonus Plan"). Because the Bank had achieved its profit goal for net
income after taking into account the full accrual of all suggested bonuses in
2004, under the Bonus Plan this triggered a payout of 18% of salary for all
employees, including the named executive officers. The bonus amounts paid to the
named executive officers were $46,146 for Morris L. Maurer; $39,705 for Philip
B. Roby; and, $20,441 for Debra L. Ross.
Ms. Ross was also awarded $4,000 under the Bank's Discretionary Bonus
Plan. Mr. Maurer and Roby do not participate in the Discretionary Bonus Plan.
Morris L. Maurer and Philip B. Roby were also awarded bonus payments
under the 2004 Top Management Bonus Plan. Under this bonus plan, Mr. Maurer was
awarded a bonus equal to $37,671, and Mr. Roby was awarded a bonus equal to
$33,329.
85
PART III
Items 10. 11, 12, 13 and 14
- ----------------------------
In accordance with the provisions of General Instruction G to Form
10-K, the information required for the required disclosures under Items 10, 11,
12, 13 and 14 are not set forth herein because the Corporation intends to file
with the Securities and Exchange Commission a definitive Proxy Statement
pursuant to Regulation 14A not later than 120 days following the end of its 2004
fiscal year, which Proxy Statement will contain such information. The
information required by Items 10, 11, 12, 13 and 14 is incorporated herein by
reference to such Proxy Statement.
86
Part IV
Item 15. Exhibits and Financial Statement Schedules
- ----------------------------------------------------
(a) (1) The following consolidated financial statements are included in
Item 8:
Page Number in
10-K
Independent Auditors' Report on Consolidated Financial Statements 43
Consolidated Balance Sheets December 31, 2004 and 2003 44
Consolidated Statements of Income 45
For the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Shareholders' Equity 46
For the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows 47
For the years ended December 31, 2004, 2003, and 2002
Notes to consolidated Financial Statements 48
(2) See response to Item 15 (a)(1). All other financial statement
schedules have been omitted because they are not applicable,
or the required information is shown in the consolidated
financial statements or notes thereto.
(3) List of Exhibits
87
Exhibit Number Description
3(i) Articles of Incorporation of the Corporation, filed as Exhibit
3(i) to the Corporation's Form 10-QSB as of September 30, 1995
are incorporated by reference and Articles of Amendment filed
as Exhibit 3(i) to the Form 10-K for the fiscal year ended
December 31, 2001
3(ii) 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(a)* Amended and restated 1993 Key Employees' Stock Option Plan of
the Corporation
10(b)* 1993 Directors' Stock Option Plan of the Corporation, as
amended, filed as Exhibit 10(b) to the Corporation's Form 10-Q
as of June 30, 2001 are incorporated by reference
10(c)* Amended and restated 1993 Restricted Stock Plan of the
Corporation
10 (d)* Form of agreement under the 1993 Key Employees Stock
Option Plan
10 (e)* Form of agreement under the 1993 Restricted Stock Plan
10 (f)* Schedule of Directors Compensation Arrangements
10 (g)* Schedule of Executive Officers Compensation Arrangements
21 Subsidiaries of the Corporation
31.1 Certificate of Chief Executive Officer pursuant to Rule
15d-14(a) of the Securities Exchange Act of 1934, as amended
31.2 Certificate of Chief Financial Officer pursuant to 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
* Management Contract or Compensatory plan
(b) See the list of exhibits in Item 15 (a) (3).
(c) No other financial statement schedules are required to be submitted.
88
Signatures
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
(Registrant) The National Bank of Indianapolis Corporation
------------------------------------------------------------------
By (Signature and Title) /S/ Morris L. Maurer March 24,2005
-------------------------------------- -------------
Morris L. Maurer, President
(Principal Executive Officer) Date
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title) /S/ Morris L. Maurer March 24, 2005
------------------------------------------------------------ -----------------
Morris L. Maurer, President (Principal Executive Officer) Date
By (Signature and Title) /S/ Philip B. Roby March 24, 2005
------------------------------------------------------------ -----------------
Philip B. Roby, Executive Vice President Date
By (Signature and Title) /S/ Debra L. Ross March 24, 2005
------------------------------------------------------------ -----------------
Debra L. Ross, Senior Vice President (Principal Financial Date
and Accounting Officer)
By (Signature and Title) /S/ Michael S. Maurer March 24, 2005
------------------------------------------------------------ -----------------
Michael S. Maurer, Chairman of the Board Date
By (Signature and Title) /S/ Kathryn G. Betley March 24, 2005
------------------------------------------------------------ -----------------
Kathryn G. Betley, Director Date
By (Signature and Title) /S/ James M. Cornelius March 24, 2005
------------------------------------------------------------ -----------------
James M. Cornelius, Director Date
By (Signature and Title) /S/ David R. Frick March 24, 2005
------------------------------------------------------------ -----------------
David R. Frick, Director Date
By (Signature and Title) /S/ Andre B. Lacy March 24, 2005
------------------------------------------------------------ -----------------
Andre B. Lacy, Director Date
By (Signature and Title) /S/ G. Benjamin Lantz March 24, 2005
------------------------------------------------------------ -----------------
G. Benjamin Lantz, Director Date
By (Signature and Title) /S/ Todd H. Stuart March 24, 2005
------------------------------------------------------------ -----------------
Todd H. Stuart, Director Date
89