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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from __________ to __________
Commission File Number: 0-25023
FIRST CAPITAL, INC.
-----------------------------------------------------------
(Name of small business issuer in its charter)
Indiana 35-2056949
- ----------------------------------------- ---------------------------------
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
220 Federal Drive, N.W., Corydon, Indiana 47112
- ----------------------------------------- ---------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (812) 738-2198
Securities registered under 12(b) of the Exchange Act: None
Securities registered under
Section 12(g) of the Exchange Act: Common Stock, par value $0.01 per share
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
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-KSB
or any amendment to this Form 10-KSB. X
The issuer's revenues for the year ended December 31, 2002 were $20.6
million.
The aggregate market value of the voting common equity held by
non-affiliates as of March 3, 2003 was approximately $49.4 million. This figure
is based on the average of the bid and asked price on the Nasdaq Stock Market
for a share of the issuer's common stock on March 3, 2003, which was $21.13 per
share. For purposes of this calculation, the issuer is assuming that the
issuer's directors and executive officers are affiliates.
As of March 3, 2003, there were 2,538,171 shares of the registrant's
common stock outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year
Ended December 31, 2002 ("Annual Report"). (Parts I and II)
2. Portions of the Proxy Statement for the 2002 Annual Meeting of
Stockholders ("Proxy Statement"). (Part III)
INDEX
PAGE
Part I
Item 1. Description of Business........................................................................3
Item 2. Description of Property.......................................................................24
Item 3. Legal Proceedings.............................................................................24
Item 4. Submission of Matters to a Vote of Security Holders...........................................25
Part II
Item 5. Market for Common Equity and Related Stockholder Matters......................................25
Item 6. Management's Discussion and Analysis..........................................................25
Item 7. Financial Statements..........................................................................25
Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure .........25
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act........................................................25
Item 10. Executive Compensation........................................................................26
Item 11. Security Ownership of Certain Beneficial Owners and Management................................26
Item 12. Certain Relationships and Related Transactions................................................26
Item 13. Exhibits and Reports on Form 8-K..............................................................27
Item 14. Controls and Procedures ......................................................................27
SIGNATURES
CERTIFICATIONS
2
This report contains certain "forward-looking statements" concerning
the future operations of First Capital, Inc. Forward-looking statements are used
to describe future plans and strategies, including expectations of future
financial results. Management's ability to predict results or the effect of
future plans or strategies is inherently uncertain. Factors that could affect
actual results include interest rate trends, the general economic climate in the
market area in which First Capital operates, as well as nationwide, First
Capital's ability to control costs and expenses, competitive products and
pricing, loan delinquency rates, and changes in federal and state legislation
and regulation. These factors should be considered in evaluating the
forward-looking statements and undue reliance should not be placed on such
statements. Except as may be required by applicable law or regulation, First
Capital assumes no obligation to update any forward-looking statements.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
First Capital, Inc. ("Company" or "First Capital") was incorporated
under Indiana law in September 1998. The Company was organized for the purpose
of becoming the holding company for First Federal Bank, A Federal Savings Bank
("Bank") upon the Bank's reorganization as a wholly owned subsidiary of the
Company resulting from the conversion of First Capital, Inc., M.H.C. ("MHC"),
from a federal mutual holding company to a stock holding company ("Conversion
and Reorganization"). The Conversion and Reorganization was completed on
December 31, 1998. In the Conversion and Reorganization, the Company sold
768,767 shares of its common stock to the public at $10 per share in a public
offering and issued 523,057 shares in exchange for the outstanding shares of the
Bank held by the Bank's stockholders other than the MHC. On January 12, 2000,
the Company completed a merger of equals with HCB Bancorp, the former holding
company for Harrison County Bank. The Bank changed its name to First Harrison
Bank in connection with the merger.
On September 25, 2002, the Company and Hometown Bancshares, Inc., the
bank holding company for Hometown National Bank in New Albany, Indiana, entered
into an Agreement and Plan of Merger whereby each of the issued and outstanding
common shares of Hometown will be exchanged for shares of the Company or $46.50
in cash per share. The merger is subject to regulatory and stockholder
approvals. It is anticipated that the merger will be consummated in March 2003.
The Company has no significant assets, other than all of the
outstanding shares of the Bank and the portion of the net proceeds from the
Offering retained by the Company, and no significant liabilities. Management of
the Company and the Bank are substantially similar and the Company neither owns
nor leases any property, but instead uses the premises, equipment and furniture
of the Bank in accordance with applicable regulations.
The Bank is regulated by the Office of Thrift Supervision ("OTS") and
the Federal Deposit Insurance Corporation ("FDIC"). The Bank's deposits are
federally insured by the FDIC under the Savings Association Insurance Fund
("SAIF"). The Bank is a member of the Federal Home Loan Bank ("FHLB") System.
MARKET AREA AND COMPETITION
The Bank considers Harrison, Floyd, and Washington counties in Indiana
as its primary market area. All of our offices are located in these three
counties, which results in most of our loans being made in these three counties.
The main office of the Bank is located in Corydon, Indiana, 35 miles west of
Louisville, Kentucky. The Bank aggressively competes for business with local
banks as well as large regional banks. Its most direct competition for deposit
and loan business has come from the commercial banks operating in these three
counties. The Bank is the leader in deposit market share in Harrison County, its
primary county of operation.
LENDING ACTIVITIES
General. The principal lending activity of the Bank is the origination
of residential mortgage loans. To a lesser extent, the Bank also originates
consumer, commercial business, commercial real estate (including farm
properties) and residential construction loans.
3
Loan Portfolio Analysis. The following table sets forth the
composition of the Bank's loan portfolio by type of loan at the dates indicated.
AT DECEMBER 31,
-----------------------------------------------------------------------------
2002 2001 2000
----------------------- ----------------------- -----------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Mortgage Loans:
Residential (1) ........................... $ 145,467 65.79% $ 132,350 64.35% $ 109,813 59.80%
Land ...................................... 4,821 2.18 4,381 2.13 3,356 1.83
Commercial real estate .................... 16,760 7.58 15,811 7.69 20,372 11.10
Residential construction (2) .............. 9,783 4.42 10,477 5.09 9,665 5.26
---------- ---------- ---------- ---------- ---------- ----------
Total mortgage loans .................... 176,831 79.97 163,019 79.26 143,206 77.99
---------- ---------- ---------- ---------- ---------- ----------
Consumer Loans:
Home equity and second
mortgage loans ............................ 18,640 8.43 12,963 6.30 11,349 6.18
Automobile loans ........................... 9,598 4.34 10,376 5.04 10,156 5.53
Loans secured by savings accounts .......... 1,249 0.56 1,309 0.64 1,554 0.85
Unsecured loans ............................ 1,193 0.54 1,721 0.84 1,609 0.88
Mobile home loans .......................... -- -- -- -- -- --
Other (3) .................................. 4,176 1.89 4,949 2.41 5,920 3.22
---------- ---------- ---------- ---------- ---------- ----------
Total consumer loans .................... 34,856 15.76 31,318 15.23 30,588 16.66
---------- ---------- ---------- ---------- ---------- ----------
Commercial business loans .................. 9,440 4.27 11,339 5.51 9,816 5.35
---------- ---------- ---------- ---------- ---------- ----------
Total loans ............................. 221,127 100.00% 205,676 100.00% 183,610 100.00%
---------- ========== ---------- ========== ---------- ==========
Less:
Due to borrowers on loans in process ...... 3,887 2,727 2,893
Deferred loan fees net of direct
costs .................................... 26 116 229
Allowance for loan losses ................. 1,218 1,103 1,184
---------- ---------- ----------
Total loans receivable, net ............. $ 215,996 $ 201,730 $ 179,304
========== ========== ==========
AT DECEMBER 31,
--------------------------------------------------
1999 1998
----------------------- -----------------------
AMOUNT PERCENT AMOUNT PERCENT
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Mortgage Loans:
Residential (1) ........................... $ 99,797 62.49% $ 89,779 65.10%
Land ...................................... 1,379 0.86 1,735 1.26
Commercial real estate .................... 15,014 9.40 4,890 3.55
Residential construction (2) .............. 8,774 5.49 11,125 8.07
---------- ---------- ---------- ----------
Total mortgage loans .................... 124,964 78.24 107,529 77.98
---------- ---------- ---------- ----------
Consumer Loans:
Home equity and second
mortgage loans ............................ 6,947 4.35 2,668 1.93
Automobile loans ........................... 7,923 4.96 6,798 4.93
Loans secured by savings accounts .......... 1,156 0.72 1,118 0.81
Unsecured loans ............................ 1,084 0.68 728 0.53
Mobile home loans .......................... -- -- -- --
Other (3) .................................. 6,284 3.93 9,454 6.86
---------- ---------- ---------- ----------
Total consumer loans .................... 23,394 14.64 20,766 15.06
---------- ---------- ---------- ----------
Commercial business loans .................. 11,376 7.12 9,590 6.96
---------- ---------- ---------- ----------
Total loans ............................. 159,734 100.00% 137,885 100.00%
---------- ========== ---------- ==========
Less:
Due to borrowers on loans in process ...... 3,307 1,031
Deferred loan fees net of direct
costs .................................... 251 235
Allowance for loan losses ................. 1,194 1,240
---------- ----------
Total loans receivable, net ............. $ 154,982 $ 135,379
========== ==========
- ----------
(1) Includes conventional one- to four-family and multi-family residential
loans.
(2) Includes construction loans for which the Bank has committed to provide
permanent financing.
(3) Includes loans secured by lawn and farm equipment, mobile homes, and other
personal property.
4
Residential Loans. The Bank's lending activities have concentrated on
the origination of residential mortgages, primarily for retention in the Bank's
loan portfolio. Residential mortgages secured by multi-family properties are an
immaterial portion of the residential loan portfolio. Substantially all
residential mortgages are collateralized by properties within the Bank's market
area.
The Bank offers both fixed-rate mortgage loans and adjustable rate
mortgage ("ARM") loans typically with terms of 15 to 30 years. Although the Bank
originates all residential mortgage loans for investment, the Bank uses loan
documents approved by the Federal National Mortgage Corporation ("Fannie Mae")
and the Federal Home Loan Mortgage Corporation ("Freddie Mac"). ARM loans
originated have interest rates that adjust at regular intervals of one year,
with 1.5% annual and 6% lifetime caps, and at intervals of five years with 1.5%
per adjustment period and 6% lifetime caps, based upon changes in the prevailing
interest rates on U.S. Treasury Bills. The Bank may occasionally use below
market interest rates and other marketing inducements to attract ARM loan
borrowers. The majority of ARM loans provide that the amount of any increase or
decrease in the interest rate is limited to 1.5% (upward or downward) per
adjustment period and generally contain minimum and maximum interest rates.
Borrower demand for ARMs versus fixed-rate mortgage loans is a function of the
level of interest rates, the expectations of changes in the level of interest
rates and the difference between the interest rates and loan fees offered for
fixed-rate mortgage loans and interest rates and loan fees for ARM loans. The
relative amount of fixed-rate and ARM loans that can be originated at any time
is largely determined by the demand for each in a competitive environment.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on fixed-rate and ARM loans to 80% of the lesser of the appraised value or
purchase price of the underlying residential property unless private mortgage
insurance to cover the excess over 80% is obtained, in which case the mortgage
is limited to 90% (or 97% under a Freddie Mac program) of the lesser of
appraised value or purchase price. The loan-to-value ratio, maturity and other
provisions of the loans made by the Bank are generally reflected in the policy
of making less than the maximum loan permissible under federal regulations, in
accordance with established lending practices, market conditions and
underwriting standards maintained by the Bank. The Bank requires title, fire and
extended insurance coverage on all mortgage loans originated. All of the Bank's
real estate loans contain due on sale clauses. The Bank obtains appraisals on
all its real estate loans from outside appraisers.
Construction Loans. Although the Bank originates construction loans
that are repaid with the proceeds of a limited number of mortgage loan obtained
by the borrower from another lender, the majority of the construction loans that
the Bank originates are construction/permanent loans, which are originated with
one loan closing at either a fixed or variable rate of interest and for terms up
to 30 years. Construction loans originated without a commitment by the Bank to
provide permanent financing are generally originated for a term of six to 12
months and at a fixed interest rate based on the prime rate. In the case of
construction/permanent loans, the construction loan is also generally for a term
of six to 12 months and the rate charged is the rate chosen by the borrower for
the permanent loan. Accordingly, if the borrower chooses a fixed interest rate
for the permanent loan, the construction loan rate is also fixed at the same
rate.
The Bank originates speculative construction loans to a limited number
of builders operating and based in the Bank's primary market area and with whom
the Bank has well-established business relationships. At December 31, 2002,
speculative construction loans, for which there is not a commitment for
permanent financing in place at the time the construction loan was originated,
amounted to $1.2 million. The Bank generally limits the number of speculative
construction loans outstanding at any one time to any one builder to two loans.
All construction loans are originated with a loan-to-value ratio not
to exceed 80% of the appraised estimated value of the completed property. The
construction loan documents require the disbursement of the loan proceeds in
increments as construction progresses. Disbursements are based on periodic
on-site inspections by an independent appraiser and/or Bank personnel approved
by the Board of Directors.
Construction lending is inherently riskier than one- to four-family
mortgage lending. Construction loans, on average, generally have higher loan
balances than one- to four-family mortgage loans. In addition, the potential for
cost overruns because of the inherent difficulties in estimating construction
costs and, therefore, collateral values and the difficulties and costs
associated with monitoring construction progress, among other things, are major
contributing factors to this greater credit risk. Speculative construction loans
have the added risk that there is not an identified buyer for the completed home
when the loan is originated, with the risk that the builder will have to service
the construction loan debt and finance the other carrying costs of the completed
home for an extended time period until a buyer is identified. Furthermore, the
demand for construction loans and the ability of construction loan borrowers to
service their debt depends highly on the state of the general economy, including
market interest rate levels, and the state of the economy
5
of the Bank's primary market area. A material downturn in economic conditions
would be expected to have a material adverse effect on the credit quality of the
construction loan portfolio.
Commercial Real Estate Loans. Commercial real estate loans are
generally secured by small retail stores, professional office space and, in
certain instances, farm properties. Commercial real estate loans are generally
originated with a loan-to-value ratio not to exceed 75% of the appraised value
of the property. Property appraisals are performed by independent appraisers
approved by the Bank's Board of Directors. The Bank attempts to originate
commercial real estate loans at variable interest rates based on the U.S.
Treasury Bill rate for terms not to exceed five years. However, in the current
low interest rate environment, borrower demand for variable rate loans is low
and the Bank is generally originating commercial real estate loans with fixed
interest rates for terms ranging between ten and 15 years over which principal
and interest is fully amortized. These loans are generally written as five year
balloon loans to help manage interest risk.
Commercial real estate lending affords the Bank an opportunity to
receive interest at rates higher than those generally available from one- to
four-family residential lending. However, loans secured by such properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family residential
mortgage loans. Because payments on loans secured by multi-family and commercial
properties are often dependent on the successful operation and management of the
properties, repayment of such loans may be affected by adverse conditions in the
real estate market or the economy. The Bank seeks to minimize these risks by
limiting the maximum loan-to-value ratio to 75% and strictly scrutinizing the
financial condition of the borrower, the quality of the collateral and the
management of the property securing the loan. The Bank also obtains loan
guarantees from financially capable parties based on a review of personal
financial statements.
Commercial Business Loans. Commercial business loans are generally
secured by inventory, accounts receivable, and business equipment such as trucks
and tractors. Many commercial business loans also have real estate as
collateral. The Bank generally requires a personal guaranty of payment by the
principals of a corporate borrower, and reviews the personal financial
statements and income tax returns of the guarantors. Commercial business loans
are generally originated with loan-to-value ratios not exceeding 75%.
Aside from lines of credit, commercial business loans are generally
originated for terms not to exceed seven years with variable interest rates
based on the Bank's cost of funds. Approved credit lines totaled $6.9 million at
December 31, 2002, of which $4.1 million was outstanding. Lines of credit are
originated at fixed interest rates for one year renewable terms.
A director of the Bank is a shareholder of a farm implement dealership
that has contracted with the Bank to provide sales financing to the dealership's
customers. The Bank does not grant preferential credit under this arrangement.
All sales contracts are presented to the Bank on a 50% recourse basis, with the
dealership responsible for the sale and disposition of any repossessed
equipment. During the year ended December 31, 2002, the Bank granted
approximately $1.8 million of credit to customers of the dealership and such
loans had an aggregate outstanding balance of $3.3 million at December 31, 2002.
At December 31, 2002, 15 loans were delinquent 30 days or more with an aggregate
outstanding balance of $135,000.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral-based lending with loan amounts
based on predetermined loan-to-collateral values and liquidation of the
underlying real estate collateral is viewed as the primary source of repayment
in the event of borrower default. Although commercial business loans are often
collateralized by equipment, inventory, accounts receivable or other business
assets, the liquidation of collateral in the event of a borrower default is
often an insufficient source of repayment because accounts receivable may be
uncollectible and inventories and equipment may be obsolete or of limited use,
among other things. Accordingly, the repayment of a commercial business loan
depends primarily on the creditworthiness of the borrower (and any guarantors),
while liquidation of collateral is a secondary and often insufficient source of
repayment.
Consumer Loans. The Bank offers a variety of secured or guaranteed
consumer loans, including automobile and truck loans (both new and used), home
equity loans, home improvement loans, boat loans, mobile home loans, and loans
secured by savings deposits. In addition, the Bank offers unsecured consumer
loans. Consumer loans are generally originated at fixed interest rates and for
terms not to exceed seven years. The largest portion of the Bank's consumer loan
portfolio consists of home equity and second mortgage loans followed by
automobile and truck loans. Automobile
6
and truck loans are originated on both new and used vehicles. Such loans are
generally originated at fixed interest rates for terms up to five years and at
loan-to-value ratios up to 80% of the blue book value in the case of used
vehicles and 80% of the purchase price in the case of new vehicles.
Home equity and second mortgage loans are generally originated for
terms not to exceed five years and at adjustable rates of interest. The
loan-to-value ratio on such loans is limited to 95%, taking into account the
outstanding balance on the first mortgage loan.
The Bank's underwriting procedures for consumer loans includes an
assessment of the applicant's payment history on other debts and ability to meet
existing obligations and payments on the proposed loans. Although the
applicant's creditworthiness is a primary consideration, the underwriting
process also includes a comparison of the value of the security, if any, to the
proposed loan amount. The Bank underwrites and originates the majority of its
consumer loans internally, which management believes limits exposure to credit
risks relating to loans underwritten or purchased from brokers or other outside
sources.
Consumer loans generally entail greater risk than do residential
mortgage loans, particularly in the case of consumer loans which are unsecured
or secured by assets that depreciate rapidly, such as automobiles. In the latter
case, repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment for the outstanding loan and the remaining
deficiency often does not warrant further substantial collection efforts against
the borrower. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy and insolvency laws, may limit the amount which can
be recovered on such loans. Such loans may also give rise to claims and defenses
by the borrower against the Bank as the holder of the loan, and a borrower may
be able to assert claims and defenses which it has against the seller of the
underlying collateral.
LOAN MATURITY AND REPRICING
The following table sets forth certain information at December 31,
2002 regarding the dollar amount of loans maturing in the Bank's portfolio based
on their contractual terms to maturity, but does not include potential
prepayments. Demand loans, loans having no stated schedule of repayments and no
stated maturity, and overdrafts are reported as due in one year or less. Loan
balances do not include undisbursed loan proceeds, unearned income and allowance
for loan losses.
AFTER AFTER AFTER AFTER
ONE YEAR 3 YEARS 5 YEARS 10 YEARS
WITHIN THROUGH THROUGH THROUGH THROUGH AFTER
ONE YEAR 3 YEARS 5 YEARS 10 YEARS 15 YEARS 15 YEARS TOTAL
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
Mortgage loans:
Residential ...................... $ 7,600 $ 13,243 $ 14,222 $ 35,066 $ 31,443 $ 43,893 $ 145,467
Commercial real estate and
land loans ...................... 3,971 3,045 4,650 5,078 3,490 1,347 21,581
Residential construction (1) ..... 7,022 100 7 22 31 2,601 9,783
Consumer loans ...................... 9,142 9,927 13,305 2,386 48 48 34,856
Commercial business ................. 4,251 3,477 1,118 481 57 56 9,440
--------- --------- --------- --------- --------- --------- ---------
Total gross loans ............. $ 31,986 $ 29,792 $ 33,302 $ 43,033 $ 35,069 $ 47,945 $ 221,127
========= ========= ========= ========= ========= ========= =========
- ----------
(1) Includes construction loans for which the Bank has committed to provide
permanent financing. The contractual maturities reflect the principal
payments due following the period of construction.
7
The following table sets forth the dollar amount of all loans due
after December 31, 2003, which have fixed interest rates and have floating or
adjustable interest rates.
FLOATING
OR
FIXED ADJUSTABLE
RATES RATES
---------- ----------
(IN THOUSANDS)
Mortgage loans:
Residential ......................... $ 114,792 $ 23,075
Commercial real estate and land loans 8,448 9,162
Residential construction ............ 2,761 --
Consumer loans ......................... 11,545 14,169
Commercial business .................... 3,687 1,502
---------- ----------
Total gross loans ................ $ 141,233 $ 47,908
========== ==========
Loan Solicitation and Processing. A majority of the loans originated
by the Bank are made to existing customers. Walk-ins and customer referrals are
also a source of loans originations. Upon receipt of a loan application, a
credit report is ordered to verify specific information relating to the loan
applicant's employment, income and credit standing. A loan applicant's income is
verified through the applicant's employer or from the applicant's tax returns.
In the case of a real estate loan, an appraisal of the real estate intended to
secure the proposed loan is undertaken, generally by an independent appraiser
approved by the Bank. The mortgage loan documents used by the Bank conform to
secondary market standards.
The Bank requires that borrowers obtain certain types of insurance to
protect its interest in the collateral securing the loan. The Bank requires
either a title insurance policy insuring that the Bank has a valid first lien on
the mortgaged real estate or an opinion by an attorney regarding the validity of
title. Fire and casualty insurance is also required on collateral for loans.
The Bank's lending practices generally limit the maximum loan to value
ratio on conventional residential mortgage loans to 80% (or 90% under a Freddie
Mac program) of the appraised value of the property as determined by an
independent appraisal or the purchase price, whichever is less, and 75% for
commercial real estate loans.
Loan Commitments and Letters of Credit. The Bank issues commitments
for fixed- and adjustable-rate single-family residential mortgage loans
conditioned upon the occurrence of certain events. Such commitments are made in
writing on specified terms and conditions and are honored for up to 60 days from
the date of application, depending on the type of transaction. The Bank had
outstanding loan commitments of approximately $5.8 million at December 31, 2002.
As an accommodation to its commercial business loan borrowers, the
Bank issues standby letters of credit or performance bonds usually in favor of
municipalities for whom its borrowers are performing services. At December 31,
2002, the Bank had outstanding letters of credit of $689,000.
Loan Origination and Other Fees. The Bank, in most instances, receives
loan origination fees and discount "points." Loan fees and points are a
percentage of the principal amount of the mortgage loan that are charged to the
borrower for funding the loan. The Bank usually charges a fixed origination fee
on one- to four-family residential real estate loans and long-term commercial
real estate loans. On residential construction loans the bank usually charges
one point. Current accounting standards require loan origination fees and
certain direct costs of underwriting and closing loans to be deferred and
amortized into interest income over the contractual life of the loan. Deferred
fees and costs associated with loans that are sold are recognized as income at
the time of sale. The Bank had $26,000 of net deferred loan fees at December 31,
2002.
Delinquencies. The Bank's collection procedures provide for a series
of contacts with delinquent borrowers. A late charge is assessed and a late
charge notice is sent to the borrower after the 15th day of delinquency. After
20 days the collector will place a phone call to the borrower. When a payment
becomes 60 days past due, the collector will issue a default letter. If a loan
continues in a delinquent status for 90 days or more, the Bank generally
initiates foreclosure or other litigation proceedings.
8
Nonperforming Assets. Loans are reviewed regularly and when loans
become 90 days delinquent, the loan is placed in nonaccrual status and the
previously accrued interest income is reversed. Typically, payments received on
a nonaccrual loan are applied to the outstanding principal and interest as
determined at the time of collection of the loan.
The following table sets forth information with respect to the Bank's
nonperforming assets for the periods indicated. At the dates indicated, the Bank
had no restructured loans within the meaning of SFAS No. 15.
AT DECEMBER 31,
--------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Loans accounted for on a nonaccrual basis:
Residential real estate ............... $ 494 $ 172 $ 241 $ 197 $ 189
Commercial real estate ................ 36 566 -- -- 25
Commercial business ................... -- 49 -- -- 78
Consumer .............................. 77 -- 10 -- --
-------- -------- -------- -------- --------
Total .............................. 607 787 251 197 292
-------- -------- -------- -------- --------
Loans past due 90 days on accrual status:
Residential real estate ............... 373 375 280 -- 19
Commercial real estate ................ 203 -- -- 6 --
Commercial business ................... 7 -- -- -- --
Consumer............................... 147 97 41 5 54
-------- -------- -------- -------- --------
Total .............................. 730 472 321 11 73
-------- -------- -------- -------- --------
Foreclosed real estate, net .............. 102 212 119 256 --
-------- -------- -------- -------- --------
Total nonperforming assets ............... $ 1,439 $ 1,471 $ 691 $ 464 $ 365
======== ======== ======== ======== ========
Total loans delinquent 90 days or
more to net loans ....................... 0.62% 0.62% 0.32% 0.13% 0.27%
Total loans delinquent 90 days or more
to total assets ......................... 0.43% 0.45% 0.23% 0.09% 0.19%
Total nonperforming assets to
total assets ............................ 0.47% 0.52% 0.28% 0.21% 0.19%
The Bank accrues interest on loans over 90 days past due when, in the
opinion of management, the estimated value of collateral and collection efforts
are deemed sufficient to ensure full recovery. The Bank recognized $82,000 in
interest income on nonaccrual loans for the fiscal year ended December 31, 2002.
Classified Assets. The OTS has adopted various regulations regarding
problem assets of savings institutions. The regulations require that each
insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets: substandard,
doubtful and loss. Substandard assets have one or more defined weaknesses and
are characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover possible losses related to assets
classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention" and monitored by the Bank.
9
Current accounting rules require that impaired loans be measured based
on the present value of expected future cash flows discounted at the loan's
effective interest rate, or if expedient, at the loan's observable market price
or the fair value of collateral if the loan is collateral dependent. A loan is
classified as impaired by management when, based on current information and
events, it is probable that the Bank will be unable to collect all amounts due
in accordance with the terms of the loan agreement. If the fair value, as
measured by one of these methods, is less than the recorded investment in the
impaired loan, the Bank establishes a valuation allowance with a provision
charged to expense. Management reviews the valuation of impaired loans on a
quarterly basis to consider changes due to the passage of time or revised
estimates. Assets that do not expose the Bank to risk sufficient to warrant
classification in one of the aforementioned categories, but which possess some
weaknesses, are required to be designated "special mention" by management.
An insured institution is required to establish and maintain an
allowance for loan losses at a level that is adequate to absorb estimated credit
losses associated with the loan portfolio, including binding commitments to
lend. General allowances represent loss allowances which have been established
to recognize the inherent risk associated with lending activities. When an
insured institution classifies problem assets as "loss," it is required either
to establish an allowance for losses equal to 100% of the amount of the assets,
or charge off the classified asset. The amount of its valuation allowance is
subject to review by the OTS which can order the establishment of additional
general loss allowances. The Bank regularly reviews the loan portfolio to
determine whether any loans require classification in accordance with applicable
regulations.
At December 31, 2002, 2001 and 2000, the aggregate amounts of the
Bank's classified assets at those dates and the general loss allowances for the
periods then ended, were as follows:
AT DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
(IN THOUSANDS)
Classified assets:
Loss ...................... $ -- $ -- $ --
Doubtful (impaired) ....... 1,158 806 251
Substandard ............... 798 1,148 888
Special mention ........... -- 426 3,010
General loss allowances:
Impaired loans ............ 420 166 --
Other ..................... 798 937 1,184
Foreclosed Real Estate. Foreclosed real estate held for sale is
carried at the lower of fair value minus estimated costs to sell, or cost. Costs
of holding foreclosed real estate are charged to expense in the current period,
except for significant property improvements, which are capitalized. Valuations
are periodically performed by management and an allowance is established by a
charge to non-interest expense if the carrying value exceeds the fair value
minus estimated costs to sell. The net income from operations of foreclosed real
estate held for sale is reported in non-interest income. At December 31, 2002,
the Bank had foreclosed real estate totaling $102,000.
Allowance for Loan Losses. Loans are the Company's largest
concentration of assets and continue to represent the most significant potential
risk. In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
made, the creditworthiness of the borrower over the term of the loan, general
economic conditions and, in the case of a secured loan, the quality of the
collateral. The Bank maintains an allowance for loan losses to absorb losses
inherent in the loan portfolio. The allowance for loan losses represents
management's estimate of probable loan losses based on information available as
of the date of the financial statements. The allowance for loan losses is based
on management's evaluation of the loan portfolio, including historical loan loss
experience, delinquencies, known and inherent risks in the nature and volume of
the loan portfolio, information about specific borrower situations, estimated
collateral values, and economic conditions.
The loan portfolio is reviewed quarterly by management to evaluate the
adequacy of the allowance for loan losses to determine the amount of any
adjustment required after considering the loan charge-offs and recoveries for
the quarter. Management applies a systematic methodology that incorporates it
current judgments about the credit quality of the loan portfolio. In addition,
the OTS, as an integral part of their examination process, periodically review
the
10
Bank's allowance for loan losses and may require the Bank to make additional
provisions for estimated losses based on their judgments about information
available to them at the time of their examination.
The methodology used in determining the allowance for loan losses
includes segmenting the loan portfolio by identifying risk characteristics
common to groups of loans, determining and measuring impairment of individual
loans based on the present value of expected future cash flows or the fair value
of collateral, and determining and measuring impairment for groups of loans with
similar characteristics by applying loss factors that consider the qualitative
factors which may effect the loss rates. The Allowance for Loan Loss Analysis
table that follows shows changes in the break down of the allowance for loan
losses by loan category. Management continues to refine the methodology used to
allocate loan losses by category. Based on the Bank's low historical charge
offs, management is continuing to refine their methodology for allocating loan
loss reserves by type of loan.
Specific allowances related to impaired loans and other classified
loans are established where management has identified significant conditions or
circumstances related to a loan that management believes indicate that a loss
has been incurred. The identification of these loans results from the loan
review process that identifies and monitors credits with weaknesses or
conditions which call into question the full collection of the contractual
payments due under the terms of the loan agreement. Factors considered by
management include payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when due.
For loans evaluated on a group basis, management applies loss factors
to groups of loans with common risk characteristics (i.e. residential mortgage
loans, home equity loans, credit card loans). The loss factors are derived from
the Bank's historical loss experience or, where the Bank does not have loss
experience, the peer group loss experience. Peer group loss experience is used
after evaluating the attributes of the Bank's loan portfolio as compared to the
peer group. Loss factors are adjusted for significant environmental factors
that, in management's judgment, affect the collectibility of the loan portfolio
segment. The significant environmental factors include the levels and trends in
charge-offs and recoveries, trends in volume and terms of loans, levels and
trends in delinquencies, the effects of changes in underwriting standards and
other lending practices or procedures, the experience and depth of the lending
management and staff, effects of changes in credit concentration, changes in
industry and market conditions and national and local economic trends and
conditions. Management evaluates these conditions on a quarterly basis and
evaluates and modifies the assumptions used in establishing the loss factors.
The allowance for loan losses was $1.2 million at December 31, 2002,
$1.1 million at December 31, 2001 and $1.2 million at December 31, 2000.
Management has deemed these amounts as adequate on those dates based on its
evaluation methodology. At December 31, 2002, nonperforming loans totaled $1.3
million or 0.43% of total assets. Included in nonperforming loans are loans over
90 days past due secured by one-to-four family residential real estate in the
amount of $373,000, commercial real estate loans totaling $203,000, commercial
business loans totaling $7,000 and consumer loans in the amount of $147,000.
These loans are accruing interest as the estimated value of the collateral and
collection efforts are deemed sufficient to ensure full recovery.
11
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Allowance at beginning of period ................. $ 1,103 $ 1,184 $ 1,194 $ 1,240 $ 1,222
Provision for loan losses ........................ 305 66 48 142 83
---------- ---------- ---------- ---------- ----------
1,408 1,250 1,242 1,382 1,305
---------- ---------- ---------- ---------- ----------
Recoveries:
Residential real estate ........................ -- 8 3 13 79
Commercial business ............................ 22 -- -- 2 --
Consumer ....................................... 35 67 15 21 23
---------- ---------- ---------- ---------- ----------
Total recoveries ............................. 57 75 18 36 102
---------- ---------- ---------- ---------- ----------
Charge-offs:
Residential real estate ........................ 78 2 13 -- 10
Commercial business ............................ 2 114 3 79 --
Consumer ....................................... 167 106 60 145 157
---------- ---------- ---------- ---------- ----------
Total charge-offs ............................ 247 222 76 224 167
---------- ---------- ---------- ---------- ----------
Net (charge-offs) recoveries ................. (190) (147) (58) (188) (65)
---------- ---------- ---------- ---------- ----------
Balance at end of period ......................... $ 1,218 $ 1,103 $ 1,184 $ 1,194 $ 1,240
========== ========== ========== ========== ==========
Ratio of allowance to total loans outstanding
at the end of the period ........................ 0.55% 0.54% 0.64% 0.75% 0.90%
Ratio of net charge-offs to average loans
outstanding during the period .................. 0.09% 0.08% 0.03% 0.13% 0.05%
12
Allowance for Loan Losses Analysis
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated.
AT DECEMBER 31,
------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
PERCENT OF PERCENT OF PERCENT OF
OUTSTANDING OUTSTANDING OUTSTANDING
LOANS LOANS LOANS
AMOUNT IN CATEGORY AMOUNT IN CATEGORY AMOUNT IN CATEGORY
---------- ----------- ---------- ----------- ---------- -----------
Residential real estate (1) .... $ 375 70.21% $ 199 69.44% $ 614 65.06%
Commercial real estate
and land loans............... 18 9.76 120 9.82 226 12.93
Commercial business ............ 297 4.27 294 5.51 90 5.35
Consumer ....................... 528 15.76 490 15.23 254 16.66
Unallocated .................... -- -- -- -- -- --
---------- ----------- ---------- ----------- ---------- -----------
Total allowance for
loan losses ................. $ 1,218 100.00% $ 1,103 100.00% $ 1,184 100.00%
========== =========== ========== =========== ========== ===========
AT DECEMBER 31,
---------------------------------------------------
1999 1998
------------------------ ------------------------
PERCENT OF PERCENT OF
OUTSTANDING OUTSTANDING
LOANS LOANS
AMOUNT IN CATEGORY AMOUNT IN CATEGORY
---------- ----------- ---------- -----------
Residential real estate (1) .... $ 504 67.98% $ 481 68.65%
Commercial real estate
and land loans............... 190 10.26 253 9.33
Commercial business ............ 150 7.12 96 6.96
Consumer ....................... 350 14.64 410 15.06
Unallocated .................... -- -- -- --
---------- ----------- ---------- -----------
Total allowance for
loan losses .................. $ 1,194 100.00% $ 1,240 100.00%
========== =========== ========== ===========
- ----------
(1) Includes residential construction loans.
13
INVESTMENT ACTIVITIES
Federally chartered savings institutions have authority to invest in
various types of liquid assets, including U.S. Treasury obligations, securities
of various federal agencies and of state and municipal governments, deposits at
the applicable FHLB, certificates of deposit of federally insured institutions,
certain bankers' acceptances and federal funds. Subject to various restrictions,
such savings institutions may also invest a portion of their assets in
commercial paper, corporate debt securities and mutual funds, the assets of
which conform to the investments that federally chartered savings institutions
are otherwise authorized to make directly. Savings institutions are also
required to maintain minimum levels of liquid assets that vary from time to
time. The Bank may decide to increase its liquidity above the required levels
depending upon the availability of funds and comparative yields on investments
in relation to return on loans.
The Bank is required under federal regulations to maintain a minimum
amount of liquid assets and is also permitted to make certain other securities
investments. The balance of the Bank's investments in short-term securities in
excess of regulatory requirements reflects management's response to the
significantly increasing percentage of deposits with short maturities. It is the
intention of management to hold securities with short maturities in the Bank's
investment portfolio in order to enable the Bank to match more closely the
interest-rate sensitivities of its assets and liabilities.
The Bank periodically invests in mortgage-backed securities, including
mortgage-backed securities guaranteed or insured by Ginnie Mae, Fannie Mae or
Freddie Mac. Mortgage-backed securities generally increase the quality of the
Bank's assets by virtue of the guarantees that back them, are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations of the Bank. Of the Bank's total mortgage-backed securities
portfolio, securities with a book value of $368,000 have adjustable rates as of
December 31, 2002.
At December 31, 2002, neither the Company nor the Bank had an
investment in securities (other than U.S. Government and agency securities and
mutual funds that invest in such securities), which exceeded 10% of the
Company's stockholders' equity at that date.
During 2002 and 2001, the Bank sold non-rated municipal securities
classified as held to maturity with an amortized cost of $150,000 and $356,000,
respectively and recognized gross gains of $900 and $16,000, respectively. These
securities were sold following a recent examination by the OTS which has
required divestiture of these holdings within three years. The OTS limits the
holdings of non-rated municipal securities to those issued by a municipality in
which the institution has an office. Through the merger with HCB Bancorp, the
Bank acquired certain non-rated municipal securities issued by municipalities in
which the Bank does not have an office. At December 31, 2002, the Bank did not
hold any non-rated municipal securities subject to the OTS limitation.
14
The following tables sets forth the securities portfolio at the dates
indicated.
AT DECEMBER 31,
-------------------------------------------------------------------------------------
2002 2001
----------------------------------------- -----------------------------------------
PERCENT WEIGHTED PERCENT WEIGHTED
FAIR AMORTIZE OF AVERAGE FAIR AMORTIZE OF AVERAGE
VALUE COST PORTFOLIO YIELD(2) VALUE COST PORTFOLIO YIELD(2)
-------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Securities Held to Maturity
Debt securities:
U.S. agency:
Due after five years
through ten years................... $ -- $ -- --% --% $ -- $ -- --% --%
Municipal:
Due in one year or less ............ 114 113 0.17 8.87 830 827 1.47 5.93
Due after one year
through five years............... 194 189 0.29 8.59 539 525 0.93 8.65
Due after five years
through ten years................ 74 74 0.11 10.23 91 91 0.16 10.23
Due after ten years ................ 876 800 1.23 8.33 -- -- -- --
Mortgage-backed securities (3) ........ 295 298 0.46 4.66 390 393 0.70 5.63
-------- -------- -------- -------- -------- --------
$ 1,553 $ 1,474 2.26% $ 1,850 $ 1,836 3.26%
======== ======== ======== ======== ======== ========
Securities Available for Sale
Debt securities:
U.S. agency:
Due in one year or less ............ $ 4,131 $ 4,004 6.17% 5.65% $ 3,570 $ 3,492 6.20% 6.56%
Due after one year
through five years ................ 38,105 37,074 57.18 4.73 31,450 31,157 55.30 5.08
Due after five years
through ten years ................. -- -- -- -- 5,053 5,013 8.90 6.06
Due after ten years
through fifteen years ............. -- -- -- -- -- -- -- --
Mortgage-backed securities ............ 10,963 10,833 16.71 3.96 6,591 6,609 11.73 5.09
Municipal:
Due in one year or less ............ 145 140 0.22 7.89 427 425 0.75 5.91
Due after one year
through five years ................ 1,885 1,769 2.73 6.79 1,093 1,055 1.87 7.02
Due after five years
through ten years ................. 5,503 5,335 8.23 6.55 4,035 4,041 7.17 6.47
Due after ten years ................ 3,001 2,979 4.59 6.97 1,506 1,541 2.73 7.00
Equity securities:
Mutual fund ........................ 1,247 1,238 1.91 N/A 1,166 1,176 2.09 N/A
-------- -------- -------- -------- -------- --------
$ 64,980 $ 63,372 97.74% $ 54,891 $ 54,509 96.74%
======== ======== ======== ======== ======== ========
AT DECEMBER 31,
-----------------------------------------
2000
-----------------------------------------
PERCENT WEIGHTED
FAIRE AMORTIZED OF AVERAGE
VALUE COST PORTFOLIO YIELD(2)
-------- -------- -------- -------
Securities Held to Maturity
Debt securities:
U.S. agency:
Due after five years
through ten years................... $ 8,388 $ 8,485 18.35% 6.44%
Municipal:
Due in one year or less ............ 308 307 0.66 8.89
Due after one year
through five years ................ 1,505 1,473 3.19 9.06
Due after five years
through ten years ................. 455 440 0.95 9.67
Due after ten years ................ 14 14 0.03 10.23
Mortgage-backed securities (3) 492 510 1.10 6.07
-------- -------- --------
$ 11,162 $ 11,229 24.28%
======== ======== ========
Securities Available for Sale
Debt securities:
U.S. agency:
Due in one year or less ............ $ 3,774 $ 3,781 8.18% 5.75%
Due after one year
through five years .............. 8,737 8,667 18.74 6.58
Due after five years
through ten years .............. 9,853 10,000 21.62 6.58
Due after ten years
through fifteen years ........... 2,912 3,000 6.49 6.69
Mortgage-backed securities (3)......... 3,470 3,511 7.59 6.50
Municipal:
Due in one year or less ............ 100 100 0.22 5.99
Due after one year
through five years .............. 857 854 1.85 6.51
Due after five years
through ten years ............... 2,909 2,911 6.29 6.41
Due after ten years ................ 1,077 1,089 2.35 7.19
Equity securities:
Mutual fund ........................ 1,090 1,106 2.39 N/A
-------- -------- --------
$ 34,779 $ 35,019 75.72%
======== ======== ========
- ----------
(1) Securities held to maturity are carried at amortized cost.
(2) Yields are calculated on a fully taxable equivalent basis using a marginal
federal income tax rate of 34%.
(3) The expected maturities of mortgage-backed securities may differ from
contractual maturities because the mortgages underlying the obligations may
be prepaid without penalty.
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
General. Deposits and loan repayments are the major source of the
Bank's funds for lending and other investment purposes. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are significantly influenced by general interest rates and money
market conditions. Borrowing may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources or may also be used
on a longer term basis for interest rate risk management.
Deposit Accounts. Deposits are attracted from within the Bank's
primary market area through the offering of a broad selection of deposit
instruments, including negotiable order of withdrawal ("NOW") accounts, money
market accounts, regular savings accounts, certificates of deposit and
retirement savings plans. Deposit account terms vary, according to the minimum
balance required, the time periods the funds must remain on deposit and the
interest rate, among other factors. In determining the terms of its deposit
accounts, the Bank considers the rates offered by its competition, profitability
to the Bank, matching deposit and loan products and its customer preferences and
concerns. The Bank generally reviews its deposit mix and pricing weekly.
15
The following table presents the maturity distributions of time
deposits of $100,000 or more as of December 31, 2002.
AMOUNT AT
MATURITY PERIOD DECEMBER 31, 2002
----------------------------- ------------------
(IN THOUSANDS)
Three months or less........... $ 5,216
Over three through six months.. 2,653
Over six through 12 months..... 6,194
Over twelve months............. 11,066
------------------
Total $ 25,129
==================
The following tables set forth the balances of deposits in the various
types of accounts offered by the Bank at the dates indicated.
AT DECEMBER 31,
-------------------------------------------------------------------------------------------
2002 2001
------------------------------------------- --------------------------------------------
PERCENT PERCENT
OF INCREASE OF INCREASE
AMOUNT TOTAL (DECREASE) AMOUNT TOTAL (DECREASE)
------------ ------------ ------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS)
Non-interest-bearing demand .. $ 20,052 9.27% $ 1,423 $ 18,629 9.13% $ 1,506
NOW accounts ................. 33,778 15.62 3,147 30,631 15.01 3,855
Savings accounts ............. 20,075 9.29 2,801 17,274 8.46 2,490
Money market accounts ........ 34,597 16.00 1,136 33,461 16.39 1,905
Fixed rate time deposits
which mature:
Within one year ............. 50,758 23.48 (9,253) 60,011 29.40 14,936
After one year, but
within three years.......... 30,407 14.06 1,268 29,139 14.28 (9,994)
After three years, but
within five years........... 25,732 11.90 11,487 14,245 6.98 3,935
After five years ............ 701 0.32 43 658 0.32 124
Club accounts ................ 102 0.06 28 74 0.03 (3)
------------ ------------ ------------ ------------ ------------ ------------
Total .................... $ 216,202 100.00% $ 12,080 $ 204,122 100.00% $ 18,754
============ ============ ============ ============ ============ ============
AT DECEMBER 31,
2000
---------------------------
PERCENT
OF
AMOUNT TOTAL
------------ ------------
(DOLLARS IN THOUSANDS)
Non-interest-bearing demand .. $ 17,123 9.24%
NOW accounts ................. 26,776 14.44
Savings accounts ............. 14,784 7.98
Money market accounts ........ 31,556 17.02
Fixed rate time deposits
which mature:
Within one year ............. 45,075 24.32
After one year, but
within three years.......... 39,133 21.11
After three years, but
within five years........... 10,310 5.56
After five years ............ 534 0.29
Club accounts ................ 77 0.04
------------ ------------
Total .................... $ 185,368 100.00%
============ ============
The following table sets forth the amount and maturities of time
deposits by rates at December 31, 2002.
AMOUNT DUE PERCENT
--------------------------------------------------------- OF TOTAL
LESS THAN 1 - 3 3 - 5 AFTER 5 TIME
ONE YEAR YEARS YEARS YEARS TOTAL DEPOSITS
------------ ------------ ------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS)
Below 2.00% .................. $ 9,228 $ 1,540 $ - $ - $ 10,768 10.01%
2.00% -- 2.99% ............... 15,649 4,495 10 - 20,154 18.73
3.00% -- 3.99% ............... 9,955 5,335 5,186 14 20,490 19.04
4.00% -- 4.99% ............... 2,764 6,388 8,035 249 17,436 16.20
5.00% -- 5.99% ............... 4,224 4,091 11,559 268 20,142 18.72
6.00% -- 6.99% ............... 6,187 6,292 890 160 13,529 12.57
7.00% -- 7.99% ............... 2,733 2,266 52 1 5,052 4.70
8.00% -- 8.99% ............... 18 - - 9 27 0.03
------------ ------------ ------------ ------------ ------------ ------------
Total ..................... $ 50,758 $ 30,407 $ 25,732 $ 701 $ 107,598 100.00%
============ ============ ============ ============ ============ ============
Borrowings. Deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes. The
Bank has at times relied upon advances from the FHLB of Indianapolis to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB of Indianapolis are
16
secured by certain first mortgage loans and investment and mortgage-backed
securities. The Bank also uses retail repurchase agreements as a source of
borrowings.
The FHLB functions as a central reserve bank providing credit for
savings and loan associations and certain other member financial institutions.
As a member, the Bank is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to creditworthiness have been met. Advances are made pursuant to several
different programs. Each credit program has its own interest rate and range of
maturities. Depending on the program, limitations on the amount of advances are
based either on a fixed percentage of an institution's net worth or on the
FHLB's assessment of the institution's creditworthiness. Under its current
credit policies, the FHLB generally limits advances to 20% of a member's assets,
and short-term borrowing of less than one year may not exceed 10% of the
institution's assets. The FHLB determines specific lines of credit for each
member institution.
The following table sets forth certain information regarding the
Bank's use of FHLB advances.
AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
2002 2001 2000
----------- ---------- ----------
(DOLLARS IN THOUSANDS)
Maximum balance at any month end $ 53,320 $ 43,575 $ 30,074
Average balance ................ 46,750 34,918 19,159
Period end balance ............. 53,320 42,825 30,074
Weighted average interest rate:
At end of period .............. 5.49% 5.87% 6.30%
During period ................. 5.80% 6.19% 6.43%
The following table sets forth certain information regarding the
Bank's use of retail repurchase agreements during the periods indicated.
AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
2002 2001 2000
----------- ---------- ----------
(DOLLARS IN THOUSANDS)
Maximum balance at any month end $ 457 $ 579 $ --
Average balance.................. 186 91
--
Period end balance............... 457 284
--
Weighted average interest rate:
At end of period................ 0.93% 1.50% N/A
During period................... 1.39% 3.12% N/A
17
SUBSIDIARY ACTIVITIES
As of December 31, 2002, the Bank was the Company's only insured
subsidiary, and was wholly owned by the Company. The Bank's sole subsidiary,
First Harrison Financial Services, Inc., is involved with the sale of property
and casualty insurance, life insurance and non-deposit investment products.
PERSONNEL
As of December 31, 2002, the Bank had 104 full-time employees and 18
part-time employees. A collective bargaining unit does not represent the
employees and the Bank considers its relationship with its employees to be good.
REGULATION AND SUPERVISION
GENERAL
As a savings and loan holding company, the Company is required by
federal law to file reports with, and otherwise comply with, the rules and
regulations of the OTS. The Bank is subject to extensive regulation, examination
and supervision by the OTS, as its primary federal regulator, and the FDIC, as
the deposit insurer. The Bank is a member of the Federal Home Loan Bank System
and, with respect to deposit insurance, of the Savings Association Insurance
Fund managed by the FDIC. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other savings institutions. The OTS and/or the FDIC
conduct periodic examinations to test the Bank's safety and soundness and
compliance with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations. Certain of the
regulatory requirements applicable to the Bank and to the Company are referred
to below or elsewhere herein. The description of statutory provisions and
regulations applicable to savings institutions and their holding companies set
forth in this Form 10-KSB does not purport to be a complete description of such
statutes and regulations and their effects on the Bank and the Company.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding
company within the meaning of federal law. Under prior law, a unitary savings
and loan holding company, such as the Company was not generally restricted as to
the types of business activities in which it may engage, provided that the Bank
continued to be a qualified thrift lender. See "Federal Savings Institution
Regulation - QTL Test." The Gramm-Leach-Bliley Act of 1999 provides that no
company may acquire control of a savings association after May 4, 1999 unless it
engages only in the financial activities permitted for financial holding
companies under the law or for multiple savings and loan holding companies as
described below. Further, the Gramm-Leach-Bliley Act specifies that existing
savings and loan holding companies may only engage in such activities. The
Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for
activities with respect to unitary savings and loan holding companies existing
prior to May 4, 1999, so long as the Bank continues to comply with the QTL Test
the Company does not qualify for the grandfather. Upon any non-supervisory
acquisition by the Company of another savings institution or savings bank that
meets the qualified thrift lender test and is deemed to be a savings institution
by the OTS, the Company would become a multiple savings and loan holding company
(if the acquired institution is held as a separate subsidiary) and would
generally be limited to activities permissible for bank holding companies under
the Bank Holding Company Act, subject to the prior approval of the OTS, and
certain activities authorized by OTS regulation. However, the OTS has issued an
interpretation concluding that multiple savings and loan holding companies may
also engage in activities permitted for financial holding companies.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution or savings and loan holding company, without prior written approval
of the OTS and from acquiring or retaining control of a depository institution
that is not insured by the FDIC. In evaluating applications by holding companies
to acquire savings institutions, the OTS considers the financial and managerial
18
resources and future prospects of the Company and institution involved, the
effect of the acquisition on the risk to the deposit insurance funds, the
convenience and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies; and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to
specific capital requirements or specific restrictions on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions as described below. The Bank
must notify the OTS 30 days before declaring any dividend to the Company. In
addition, the financial impact of a holding company on its subsidiary
institution is a matter that is evaluated by the OTS and the agency has
authority to order cessation of activities or divestiture of subsidiaries deemed
to pose a threat to the safety and soundness of the institution.
Acquisition of the Company. Under the Federal Change in Bank Control
Act ("CIBCA"), a notice must be submitted to the OTS if any person (including a
company), or group acting in concert, seeks to acquire 10% or more of the
Company's outstanding voting stock, unless the OTS has found that the
acquisition will not result in a change of control of the Company. Under the
CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking
into consideration certain factors, including the financial and managerial
resources of the acquirer and the anti-trust effects of the acquisition. Any
company that so acquires control would then be subject to regulation as a
savings and loan holding company.
FEDERAL SAVINGS INSTITUTION REGULATION
Business Activities. Federal law and regulations govern the activities
of federal savings institutions. These laws and regulations delineate the nature
and extent of the activities in which federal associations may engage. In
particular, many types of lending authority for federal association, e.g.,
commercial, non-residential real property loans and consumer loans, are limited
to a specified percentage of the institution's capital or assets.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on
the CAMELS rating system) and an 8% risk-based capital ratio. In addition, the
prompt corrective action standards discussed below also establish, in effect, a
minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions
receiving the highest rating on the CAMEL financial institution rating system),
and, together with the risk-based capital standard itself, a 4% Tier 1
risk-based capital standard. The OTS regulations also require that, in meeting
the tangible, leverage and risk-based capital standards, institutions must
generally deduct investments in and loans to subsidiaries engaged in activities
as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core (Tier 1) capital is defined as
common stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of
unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
The OTS also has authority to establish individual minimum capital
requirements in appropriate cases upon a determination that an institution's
capital level is or may become inadequate in light of the particular
circumstances. At December 31, 2002, the Bank met each of its capital
requirements.
19
The following table presents the Bank's capital position at December
31, 2002.
Capital
-------------------
Actual Required Excess Actual Required
Capital Capital Amount Percent Percent
-------- --------- -------- -------- ---------
(Dollars in thousands)
Tangible................ $ 33,564 $ 4,612 $ 28,952 10.92% 1.50%
Core (Leverage)......... 33,564 12,299 21,265 10.92 4.00
Risk-based.............. 34,782 14,257 20,525 19.52 8.00
Prompt Corrective Regulatory Action. The OTS is required to take
certain supervisory actions against undercapitalized institutions, the severity
of which depends upon the institution's degree of undercapitalization.
Generally, a savings institution that has a ratio of total capital to risk
weighted assets of less than 8%, a ratio of Tier 1 (core) capital to
risk-weighted assets of less than 4% or a ratio of core capital to total assets
of less than 4% (3% or less for institutions with the highest examination
rating) is considered to be "undercapitalized." A savings institution that has a
total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than
3% or a leverage ratio that is less than 3% is considered to be "significantly
undercapitalized" and a savings institution that has a tangible capital to
assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the OTS is required to appoint
a receiver or conservator for an institution that is "critically
undercapitalized." The regulation also provides that a capital restoration plan
must be filed with the OTS within 45 days of the date a savings institution
receives notice that it is "undercapitalized," "significantly undercapitalized"
or "critically undercapitalized." Compliance with the plan must be guaranteed by
any parent holding company. In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. The OTS could also take any one of a number
of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The Bank is a member of the Savings
Association Insurance Fund. The FDIC maintains a risk-based assessment system by
which institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon the
categories to which it is assigned. Assessment rates for Savings Association
Insurance Fund member institutions are determined semi-annually by the FDIC and
currently range from zero basis points for the healthiest institutions to 27
basis points for the riskiest.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation ("FICO") to recapitalize the predecessor to the Savings Association
Insurance Fund. During 2002, FICO payments for Savings Association Insurance
Fund members approximated 1.75 basis points of assessable deposits.
The Bank's risk-based classifications resulted in no assessments
during 2002. The FDIC has authority to increase insurance assessments. A
significant increase in Savings Association Insurance Fund insurance premiums
would likely have an adverse effect on the operating expenses and results of
operations of the Bank. Management cannot predict what insurance assessment
rates will be in the future.
The FDIC upon a finding that the institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, rule, order or condition imposed
by the FDIC or the OTS, may terminate insurance of deposits. The management of
the Bank does not know of any practice, condition or violation that might lead
to termination of deposit insurance.
Loans to One Borrower. Federal law provides that savings institutions
are generally subject to the limits on loans to one borrower applicable to
national banks. A savings institution may not make a loan or extend credit to a
single
20
or related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral. At December
31, 2002, the Bank's limit on loans to one borrower was $5.2 million, and the
Bank's largest aggregate outstanding balance of loans to one borrower was $1.7
million.
QTL Test. The Home Owners' Loan Act requires savings institutions to
meet a qualified thrift lender test. Under the test, a savings association is
required to either qualify as a "domestic building and loan association" under
the Internal Revenue Code or maintain at least 65% of its "portfolio assets"
(total assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed securities)
in at least 9 months out of each 12 month period.
A savings institution that fails the qualified thrift lender test is
subject to certain operating restrictions and may be required to convert to a
bank charter. As of December 31, 2002, the Bank maintained 83.3% of its
portfolio assets in qualified thrift investments and, therefore, met the
qualified thrift lender test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose
limitations upon all capital distributions by a savings institution, including
cash dividends, payments to repurchase its shares and payments to shareholders
of another institution in a cash-out merger. Under the regulations, an
application to and the prior approval of the OTS is required prior to any
capital distribution if the institution does not meet the criteria for
"expedited treatment" of applications under OTS regulations (i.e., generally,
examination ratings in the two top categories), the total capital distributions
for the calendar year exceed net income for that year plus the amount of
retained net income for the preceding two years, the institution would be
undercapitalized following the distribution or the distribution would otherwise
be contrary to a statute, regulation or agreement with OTS. If an application is
not required, the institution must still provide prior notice to the OTS of the
capital distribution if, like the Bank, it is a subsidiary of a holding company.
In the event the Bank's capital fell below its regulatory requirements or the
OTS notified it that it was in need of more than normal supervision, the Bank's
ability to make capital distributions could be restricted. In addition, the OTS
could prohibit a proposed capital distribution by any institution, which would
otherwise be permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice.
Assessments. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessments, paid on a
semi-annual basis, are computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
thrift financial report. The assessments paid by the Bank for the fiscal year
ended December 31, 2002 totaled $70,000.
Transactions with Related Parties. The Bank's authority to engage in
transactions with "affiliates" (e.g., any company that controls or is under
common control with an institution, including the Company and its non-savings
institution subsidiaries) is limited by federal law. The aggregate amount of
covered transactions with any individual affiliate is limited to 10% of the
capital and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in federal law. The
purchase of low quality assets from affiliates is generally prohibited. The
transactions with affiliates must be on terms and under circumstances, that are
at least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies. In addition, savings
institutions are prohibited from lending to any affiliate that is engaged in
activities that are not permissible for bank holding companies and no savings
institution may purchase the securities of any affiliate other than a
subsidiary.
The recently enacted Sarbanes-Oxley Act generally prohibits loans by
the Company to its executive officers and directors. However, that act contains
a specific exception for loans by the Bank to its executive officers and
directors in compliance with federal banking laws. Under such laws, the Bank's
authority to extend credit to executive officers, directors and 10% shareholders
("insiders"), as well as entities such persons control, is limited. The law
limits both the individual and aggregate amount of loans the Bank may make to
insiders based, in part, on the Bank's capital position and requires certain
board approval procedures to be followed. Such loans are required to be made on
terms substantially
21
the same as those offered to unaffiliated individuals and not involve more than
the normal risk of repayment. There is an exception for loans made pursuant to a
benefit or compensation program that is widely available to all employees of the
institution and does not give preference to insiders over other employees.
Enforcement. The OTS has primary enforcement responsibility over
savings institutions and has the authority to bring actions against the
institution and all institution-affiliated parties, including stockholders, and
any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution. Formal enforcement action may range from the issuance of a capital
directive or cease and desist order to removal of officers and/or directors to
institution of receivership, conservatorship or termination of deposit
insurance. Civil penalties cover a wide range of violations and can amount to
$25,000 per day, or even $1 million per day in especially egregious cases. The
FDIC has the authority to recommend to the Director of the OTS that enforcement
action to be taken with respect to a particular savings institution. If action
is not taken by the Director, the FDIC has authority to take such action under
certain circumstances. Federal law also establishes criminal penalties for
certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines prescribing Standards for Safety and Soundness.
The guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the OTS determines that a
savings institution fails to meet any standard prescribed by the guidelines, the
OTS may require the institution to submit an acceptable plan to achieve
compliance with the standard.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the Federal Home Loan Bank System, which
consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank
provides a central credit facility primarily for member institutions. The Bank,
as a member of the Federal Home Loan Bank, is required to acquire and hold
shares of capital stock in that Federal Home Loan Bank in an amount at least
equal to 1.0% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank, whichever is greater.
The Bank complied with this requirement with an investment in Federal Home Loan
Bank stock at December 31, 2002 of $2.7 million.
The Federal Home Loan Banks are required to provide funds for the
resolution of insolvent thrifts in the late 1980s and to contribute funds for
affordable housing programs. These requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. If dividends were reduced, or interest on future
Federal Home Loan Bank advances increased, the Bank's net interest income would
likely also be reduced. Recent legislation has changed the structure of the
Federal Home Loan Banks funding obligations for insolvent thrifts, revised the
capital structure of the Federal Home Loan Banks and implemented entirely
voluntary membership for Federal Home Loan Banks. Management cannot predict the
effect that these changes may have with respect to its Federal Home Loan Bank
membership.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally provide
that reserves be maintained against aggregate transaction accounts as follows: a
3% reserve ratio is assessed on net transaction accounts up to and including
$42.1 million; and a 10% reserve ratio is applied above $42.1 million. The first
$6.0 million of otherwise reservable balances are exempted from the reserve
requirements. The amounts are adjusted annually. The Bank complied with the
foregoing requirements at December 31, 2002.
22
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the Internal Revenue
Service ("IRS") in the past five years.
Bad Debt Reserve. For taxable years beginning after December 31, 1995,
the Bank is entitled to take a bad debt deduction for federal income tax
purposes which is based on its current or historic net charge-offs. For tax
years beginning prior to December 31, 1995, the Bank as a qualifying thrift had
been permitted to establish a reserve for bad debts and to make annual additions
to such reserve, which were deductible for federal income tax purposes. Under
such prior tax law, generally the Bank recognized a bad debt deduction equal to
8% of taxable income.
Under the 1996 Tax Act, the Bank is required to recapture all or a
portion of its additions to its bad debt reserve made subsequent to the base
year (which is the Bank's last taxable year beginning before January 1, 1988).
This recapture is required to be made, after a deferral period based on certain
specified criteria, ratably over a six-year period commencing in the Bank's
calendar 1998 tax year. The Bank, in fiscal 1997, recorded a deferred tax
liability for this bad debt recapture. As a result, the recapture is not
anticipated to effect the Bank's future net income or federal income tax expense
for financial reporting purposes.
Potential Recapture of Base Year Bad Debt Revenue. The Bank's bad debt
reserve as of the base year is not subject to automatic recapture as long as the
Bank continues to carry on the business of banking. If the Bank no longer
qualifies as a bank, the balance of the pre-1988 reserves (the base year
reserves) are restored to income over a six-year period beginning in the tax
year the Bank no longer qualifies as a bank. Such base year bad debt reserve is
subject to recapture to the extent that the Bank makes "non-dividend
distributions" that are considered as made from the base year bad debt. To the
extent that such reserves exceed the amount that would have been allowed under
the experience method ("Excess Distributions"), then an amount based on the
amount distributed will be included in the Bank's taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock, and
distributions in partial or complete liquidation. However, dividends paid out of
the Bank's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a distribution
from the Bank's bad debt reserve. Thus, any dividends to the Company that would
reduce amounts appropriated to the Bank's bad debt reserve and deducted for
federal income tax purposes would create a tax liability for the Bank. The
amount of additional taxable income created from an Excess Distribution is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. The Bank makes a "non-dividend distribution," then
approximately one and one-half times the amount so used would be includable in
gross income for federal income tax purposes, assuming a 34% corporate income
tax rate (exclusive of state and local taxes). The Bank does not intend to pay
dividends that would result in a recapture of any portion of its bad debt
reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code imposes a
tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess
of the bad debt reserve deduction claimed by the Bank over the deduction that
would have been allowable under the experience method is treated as a preference
item for purposes of computing the AMTI. Only 90% of AMTI can be offset by net
operating loss carryovers of which the Bank currently has none. AMTI is
increased by an amount equal to 75% of the amount by which the Bank's adjusted
current earnings exceeds its AMTI (determined without regard to this preference
and prior to reduction for net operating losses). In addition, for taxable years
beginning after June 30, 1986 and before January 1, 1996, an environmental tax
of 0.12% of the excess of AMTI (with certain modifications) over $2.0 million is
imposed on corporations, including the Bank, whether or not an Alternative
Minimum Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may
exclude from its income 100% of dividends received from the Bank as a member of
the same affiliated group of corporations. The corporate dividends received
deduction is generally 70% in the case of dividends received from unaffiliated
corporations with which the
23
Company and the Bank will not file a consolidated tax return, except that if the
Company or the Bank own more than 20% of the stock of a corporation distributing
a dividend, then 80% of any dividends received may be deducted.
INDIANA TAXATION
Indiana imposes an 8.5% franchise tax based on a financial
institution's adjusted gross income as defined by statute. In computing adjusted
gross income, deductions for municipal interest, U.S. Government interest, the
bad debt deduction computed using the reserve method and pre-1990 net operating
losses are disallowed. The Bank's state income tax returns were audited for the
years ended December 31, 1993, 1994 and 1995 without amendment and without
additional tax liability. The Bank's state income tax returns have not been
audited for any subsequent period.
ITEM 2. DESCRIPTION OF PROPERTY.
The following table sets forth certain information regarding the
Bank's offices as of December 31, 2002.
APPROXIMATE
YEAR NET BOOK OWNED/ SQUARE
LOCATION OPENED VALUE (1) LEASED FOOTAGE
- ----------------------------------- ------ -------------- --------- -----------
(In thousands)
MAIN OFFICE:
220 Federal Drive, N.W.
Corydon, Indiana 47112 ............. 1997 $ 2,131 Owned 12,000
BRANCH OFFICES:
391 Old Capitol Plaza, N.W.
Corydon, Indiana 47112 ............. 1997 12 Leased/(2)/ 425
8095 State Highway 135, N.W.
New Salisbury, Indiana 47161 ....... 1999 1,006 Owned 3,500
710 Main Street
Palmyra, Indiana 47114 ............ 1991 1,452 Owned 6,000
6040 Main Street NE
Crandall, Indiana 47114 ........... 1938 92 Owned 1,000
9849 Highway 150
Greenville, Indiana 47124 ......... 1986 231 Owned 2,484
1058 North Luther Road
Georgetown, Indiana 47122 ......... 1995 110 Leased/(3)/ 1,800
State Road 150
Hardinsburg, Indiana 47125 ........ 1996 110 Owned 1,834
4303 Charlestown Road
New Albany, Indiana 47150 ......... 1999 988 Owned 3,500
- ----------
(1) Represents the net value of land, buildings, furniture, fixtures and
equipment owned by the Bank.
(2) Lease expires on November 30, 2003.
(3) Lease expires November 2005.
ITEM 3. LEGAL PROCEEDINGS.
At December 31, 2002, neither the Company nor the Bank was involved in
any pending legal proceedings that are believed by management to be material to
the Company's financial condition or results of operations. In addition, from
time to time, the Bank is involved in legal proceeding occurring in the ordinary
course of business. Such routine legal proceedings, in the aggregate, are
believed by management to be immaterial to the Company's financial condition or
results of operations.
24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2002.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information contained in the section captioned, "Corporate
Information" in the Annual Report is incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS.
. Independent Auditors' Report*
. Consolidated Balance Sheets as of December 31, 2002 and 2001*
. Consolidated Statements of Stockholders Equity for the Years
Ended December 31, 2002 and 2001*
. Consolidated Statements of Income for the Years Ended December
31, 2002 and 2001*
. Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002 and 2001*
. Notes to Consolidated Financial Statements*
- ----------
*Contained in the Annual Report to Stockholders filed as an exhibit
hereto and incorporated herein by reference. All schedules have been
omitted as the required information is either inapplicable or
contained in the Consolidated Financial Statements or related Notes
contained in the Annual Report to Stockholders.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information required by this Item with respect to Directors is
incorporated herein by reference to the Proxy Statement under the heading
"Proposal 1--Election of Directors." The information contained under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement is incorporated herein by reference.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
NAME AGE(1) POSITION
- ------------------------------------ ------ ------------------------------------------------------------
M. Chris Frederick ................. 35 Senior Vice President, Chief Financial Officer and Treasurer
Joel E. Voyles ..................... 50 Senior Vice President - Retail and Corporate Secretary
Dennis L. Thomas ................... 46 Senior Vice President - Lending
Bradley B. Backherms ............... 52 Senior Vice President - Operations
- ----------
(1) As of December 31, 2002.
25
BIOGRAPHICAL INFORMATION
M. Chris Frederick has been affiliated with the Bank since 1990 and
has served in his present position since 1997.
Joel E. Voyles has been affiliated with the Bank since December 1996
and has served in his present position since 1997.
Dennis L. Thomas has been affiliated with the Bank since January 2000.
He was employed by Harrison County Bank from 1981 until the merger with the
Bank.
Bradley B. Backherms has been affiliated with the Bank since January
2000. He was employed by Harrison County Bank from 1982 until the merger with
the Bank.
ITEM 10. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated herein by
reference to the Proxy Statement under the heading "Executive Compensation" and
"Proposal 1 -- Election of Directors."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated herein by
reference to the Proxy Statement under the heading "Stock Ownership."
EQUITY COMPENSATION PLAN INFORMATION AS OF DECEMBER 31, 2002
PLAN CATEGORY NUMBER OF SECURITIES WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES
TO BE ISSUED UPON EXERCISE PRICE OF OUTSTANDING REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS RIGHTS EQUITY COMPENSATION PLANS
(EXCLUDING SECURITIES
REFLECTED IN COLUMN (a))
(a) (b) (c)
- ----------------------------- -------------------------- ------------------------- ----------------------------
Equity compensation plans 73,923 $ 10.68 39,292
approved by security holders
- ----------------------------- -------------------------- ------------------------- ----------------------------
Equity compensation plans
not approved by security - - -
holders
- ----------------------------- -------------------------- ------------------------- ----------------------------
Total 73,923 $ 10.68 39,292
- ----------------------------- -------------------------- ------------------------- ----------------------------
The Company does not maintain any equity compensation plans that have
not been approved by security holders.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated herein by
reference to the Proxy Statement under the heading "Proposal 1 -- Election of
Directors" and "Transactions with Management."
26
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
3.1 Articles of Incorporation of First Capital, Inc. (1)
3.2 Second Amended and Restated Bylaws of First Capital, Inc.(6)
10.1 Employment Agreement with James G. Pendleton (3)
10.2 Employment Agreement with Samuel E. Uhl (2)
10.3 Employment Agreement with M. Chris Frederick (2)
10.4 Employment Agreement with Joel E. Voyles (2)
10.5 Employee Severance Compensation Plan (3)
10.6 First Federal Bank, A Federal Savings Bank 1994 Stock Option
Plan (as assumed by First Capital, Inc. effective December 31,
1998) (4)
10.7 First Capital, Inc. 1999 Stock-Based Incentive Plan (5)
10.8 1998 Officers' and Key Employees' Stock Option Plan for HCB
Bancorp (5)
10.9 Employment Agreement with William W. Harrod (2)
13.0 Annual Report to Stockholders
21.0 Subsidiaries of the Registrant (incorporated by reference to
Part I, "Business--Subsidiary Activities" of this Form
10-KSB).
23.0 Consent of Monroe Shine and Co., Inc.
99.1 Chief Executive Officer Certification Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
99.2 Chief Financial Officer Certification Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference from the Exhibits filed with the
Registration Statement on Form SB-2, and any amendments thereto,
Registration No. 333-63515.
(2) Incorporated by reference to the Annual Report on Form 10-KSB for
the year ended December 31, 1999.
(3) Incorporated by reference to the Quarterly Report on Form 10-QSB
for the quarter ended December 31, 1998.
(4) Incorporated by reference from the Exhibits filed with the
Registration Statement on Form S-8, and any amendments thereto,
Registration Statement No. 333-76543.
(5) Incorporated by reference from the Exhibits filed with the
Registration Statement on Form S-8, and any amendments thereto,
Registration Statement No. 333-95987.
(6) Incorporated by reference to the Annual Report on Form 10-KSB for
the year ended December 31, 2001.
(b) REPORTS ON FORM 8-K
No Forms 8-K were filed during the quarter ended December 31, 2002.
ITEM 14. CONTROLS AND PROCEDURES.
(a) Evaluation of disclosure controls and procedures. The Company
maintains controls and procedures designed to ensure that information required
to be disclosed in the reports that the Company files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the Securities and
Exchange Commission. Based upon their evaluation of those controls and
procedures performed within 90 days of the filing date of this report, the Chief
Executive Officer and the Chief Financial Officer of the Company concluded that
the Company's disclosure controls and procedures were adequate.
(b) Changes in internal controls. The Company made no significant
changes in its internal controls or in other factors that could significantly
affect these controls subsequent to the date of the evaluation of those controls
by the Chief Executive Officer and the Chief Financial Officer.
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST CAPITAL, INC.
/s/ William W. Harrod
--------------------------
William W. Harrod
President, Chief Executive Officer and Director
In accordance with the requirements of the Securities Act of 1933,
this Registration Statement was signed by the following persons in the
capacities and on the dates stated.
Name Title Date
- ---------------------------- ----------------------------- --------------
/s/ William W. Harrod President, Chief Executive March 28, 2003
- ---------------------------- Officer and Director
William W. Harrod (principal executive officer)
/s/ J. Gordon Pendleton Chairman March 28, 2003
- ----------------------------
J. Gordon Pendleton
/s/ Michael C. Frederick Chief Financial Officer and March 28, 2003
- ---------------------------- Treasurer
Michael C. Frederick (principal accounting
and financial officer)
/s/ Samuel E. Uhl Director March 28, 2003
- ----------------------------
Samuel E. Uhl
/s/ Mark D. Shireman Director March 28, 2003
- ----------------------------
Mark D. Shireman
/s/ Dennis L. Huber Director March 28, 2003
- ----------------------------
Dennis L. Huber
/s/ Kenneth R. Saulman Director March 28, 2003
- ----------------------------
Kenneth R. Saulman
/s/ John W. Buschemeyer Director March 28, 2003
- ----------------------------
John W. Buschemeyer
/s/ Gerald L. Uhl Director March 28, 2003
- ----------------------------
Gerald L. Uhl
/s/ James S. Burden Director March 28, 2003
- ----------------------------
James S. Burden
/s/ James E. Nett Director March 28, 2003
- ----------------------------
James E. Nett
/s/ Michael L. Shireman Director March 28, 2003
- ----------------------------
Michael L. Shireman
/s/ Kathy Ernstberger Director March 28, 2003
- ----------------------------
Kathy Ernstberger
CERTIFICATIONS
I, William W. Harrod, President and Chief Executive Officer, of First Capital,
Inc., certify that:
(1) I have reviewed this annual report on Form 10-KSB of First Capital, Inc.;
(2) Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
(4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of the
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 28, 2003 /s/ William W. Harrod
-------------------------------------
William W. Harrod
President and Chief Executive Officer
(principal executive officer)
CERTIFICATIONS
I, Michael C. Frederick, Senior Vice President, Chief Financial Officer and
Treasurer of First Capital, Inc., certify that:
(1) I have reviewed this annual report on Form 10-KSB of First Capital, Inc.;
(2) Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
(4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of the
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 28, 2003 /s/ Michael C. Frederick
--------------------------------------------
Michael C. Frederick
Senior Vice President, Chief
Financial Officer and Treasurer
(principal financial and accounting officer)