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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to
Section 13 or 15(d) of the
Securities Exchange Act of
1934 [NO FEE REQUIRED]
For the Fiscal Year Ended December 31, 1998
OR
[ ] Transition Report Pursuant to
Section 13 or 15(d) of the
Securities Exchange Act of 1934
[NO FEE REQUIRED]
For the transition period from ____________ to _________
Commission File No. 0-25766
Community Bank Shares of Indiana, Inc.
Exact Name of Registrant as Specified in its Charter
United States 35-1938254
State or Other Jurisdiction of I.R.S. Employer
Incorporation or Organization Identification Number
202 East Spring Street, New Albany, Indiana 47150
(Address of Principal Executive Offices) Zip Code
Registrant's telephone number, including area code: (812) 944-2224
Securities Registered pursuant to Section
12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days. YES X NO_.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K, [ ].
As of March 30, 1999, there were issued and outstanding 2,728,298 shares of the
Registrant's Common Stock.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, computed by reference to the asked price of $15.50 per share of such
stock as of March 4, 1998, was approximately $42.3 million. (The exclusion from
such amount of the market value of the shares owned by any person shall not be
deemed an admission by the Registrant that such person is an affiliate of the
Registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
Parts II and IV of Form 10-K - Annual Report to Stockholders for the fiscal year
ended December 31, 1998.
Part III of Form 10-K - Proxy Statement for the 1999 Annual Meeting of
Stockholders.
1
Form 10-K
Index
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Part I: Page
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Item 1. Business 3
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Item 2. Properties 25
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Item 3. Legal Proceedings 25
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Item 4. Submission of Matters to a Vote of Security Holders 25
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Part II:
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Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 26
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Item 6. Selected Financial Data 26
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 26
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk 26
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Item 8. Financial Statements and Supplementary Data 26
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Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 26
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Part III:
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Item 10. Directors and Executive Officers of the Registrant 26
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Item 11. Executive Compensation 26
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Item 12. Security Ownership of Certain Beneficial Owners and Management 26
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Item 13. Certain Relationships and Related Transactions 27
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Part IV:
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 27
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Signatures 29
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2
PART I
ITEM 1. BUSINESS
General
Community Bank Shares of Indiana, Inc. (the Company) is a multi-bank
holding company headquartered in New Albany, Indiana. The Company's wholly-owned
banking subsidiaries are Community Bank of Southern Indiana (Community),
Heritage Bank of Southern Indiana (Heritage), and NCF Bank and Trust Company
(NCF Bank). Community, Heritage, and NCF are state-chartered stock commercial
banks headquartered in New Albany, Indiana, Jeffersonville, Indiana, and
Bardstown, Kentucky, respectively. Community and Heritage are regulated by the
Indiana Department of Financial Institutions and the Federal Deposit Insurance
Corporation. NCF Bank is regulated by the Kentucky Department of Financial
Institutions and the Federal Deposit Insurance Corporation.
Community was founded in 1934 as a federal mutual savings and loan
association. Community converted to a federal mutual savings bank in 1989, and
became a federal stock savings bank on May 1, 1991. On December 2, 1996
Community converted from a federal stock savings bank to a state chartered stock
commercial bank. Community's deposits have been federally insured since 1934 by
the Savings Association Insurance Fund ("SAIF") and its predecessor, the Federal
Savings and Loan Insurance Corporation, and Community has been a member of the
Federal Home Loan Bank system since 1934.
On January 3, 1996, the Company capitalized Heritage Bank of Southern
Indiana, a newly organized state-chartered commercial bank, for a total
investment of $4,150,000. Heritage began operations as of January 8, 1996, and
provides a variety of banking services to individuals and business customers
through its two banking offices in Jeffersonville, Indiana. Heritage joined the
Federal Home Loan Bank system in 1998.
On May 6, 1998, the Company completed its acquisition of NCF Bank and
Trust (NCF Bank) located in Bardstown, Kentucky through a merger with NCF
Financial Corporation (NCF). NCF Bank, a state chartered commercial bank with
total assets of $37.0 million and $35.6 million at May 6, 1998 and December 31,
1997, respectively, became a wholly-owned subsidiary of the Company through the
exchange of 740,974 shares of the Company's common stock for all the outstanding
common stock of NCF. The acquisition was accounted for as a pooling of
interests.
The Company had total assets of $331.9 million, total deposits of
$212.9 million, and stockholders' equity of $41.4 million as of December 31,
1998. The Company's principal executive office is located at 202 East Spring
Street, New Albany, Indiana 47150, and the telephone number at that address is
(812) 944-2224.
Business Strategy
The Company's current business strategy is to operate well-capitalized,
profitable and independent community banks with a significant presence in their
primary market areas. The Company has sought to implement this strategy in
recent years by: (1) emphasizing the origination of residential mortgage loans,
commercial business loans, and consumer loans in the Company's primary market
area; (2) maintaining a conservative interest rate risk exposure profile; (3)
controlling operating expenses; and (4) broadening the scope of services offered
to its customers.
The Company's three subsidiaries are community-oriented financial
institutions offering a variety of financial services to their local market
areas. The subsidiaries are engaged primarily in the business of attracting
deposits from the general public and using such funds to 1) originate 15- and
30-year fixed- and adjustable-rate ("ARM") mortgage loans for the purchase of
single-family homes in Floyd and Clark Counties, Indiana, Nelson County,
Kentucky, and, to a lesser extent, surrounding counties, and 2) originate
secured and unsecured business loans of various terms to local businesses and
professional organizations. Depending on each subsidiary's liquidity, interest
rate risk and balance sheet positions, fixed-rate mortgage loans are originated
either for inclusion in the retained loan portfolio or for sale in the secondary
market, while ARM loans are originated primarily for retention in each
subsidiary's loan portfolio. To a lesser extent, the subsidiaries make home
equity loans secured by the borrower's principal residence and other types of
consumer loans such as auto loans. Although Community holds a
3
small amount of multi-family residential real estate loans in its portfolio, the
Company does not emphasize the origination of such loans. In addition, the
Company invests in mortgage-backed securities issued or guaranteed by GNMA,
FNMA, or FHLMC, and in securities issued by the United States Government and
agencies thereof.
The success of the current business strategy is reflected in the
consistent increases in capital, and a retail growth strategy that has included
upgrading two limited service offices to full service offices, opening two full
service branch offices to attract retail customers, the formation of a second
subsidiary bank, Heritage Bank of Southern Indiana, which in addition to
traditional banking services sells alternative financial products, and the
acquisition of NCF Bank and Trust which allowed for expansion into Kentucky.
Market Area
The Company's primary market area is the counties of Floyd, Clark and
Harrison, which are located in Southern Indiana along the Ohio River. Clark and
Floyd counties are two of the seven counties comprising the Louisville, Kentucky
Standard Metropolitan Statistical Area, which has a population in excess of one
million. The population of the Company's primary market area is approximately
185,000. The Company's secondary market is Nelson County, which is located
approximately 40 miles south east of Louisville, Kentucky. The population of the
Company's secondary market area is approximately 35,000. Surrounding counties of
the Company's Secondary Market include Spencer, Anderson, Hardin, Washington,
Marion, Larue, and Bullitt counties, which together have a population in excess
of 135,000. The Company's headquarters are in New Albany, Indiana, a city of
45,000 located approximately three miles from the center of Louisville.
The Company's business and operating results are significantly affected
by the general economic conditions prevalent in its market area.
Lending Activities
General. At December 31, 1998, the Company's net portfolio of loans
receivable (excluding loans classified as held for sale) totaled $199.6 million,
representing approximately 60.1% of the Company's total assets at that date. The
principal lending activity of the Company is the origination of single-family
residential loans and secured and unsecured commercial business loans to local
business and professional organizations. To a lesser extent the Company also
originates residential construction loans and consumer loans (consisting
primarily of home equity loans secured by the borrower's principal residence.)
Substantially all of the Company's mortgage loan portfolio consists of
conventional mortgage loans.
Since the early 1980's, the Company has worked to make its interest
earning assets more interest rate sensitive by actively originating ARM loans,
adjustable rate second mortgage loans and home equity loans, and short-term or
adjustable consumer loans. Since the early 1990's, the Company has diligently
increased the amount of commercial business loans as a percent of its total loan
portfolio.
The Company continues to actively originate fixed-rate mortgage loans,
generally with terms to maturity of between 15- to 30- year terms and secured by
one-to-four family residential properties. One-to-four family fixed-rate loans
generally are originated for retention in the loan portfolio or resale in the
secondary mortgage market. The Company sells mortgage loans with servicing
either retained or released. The Company earns service fee income on those loans
where servicing is retained.
The Company also originates interim construction loans on one-to-four
family residential properties, mortgage loans secured by multi-family
residential properties, and consumer loans for a variety of purposes, including
home equity loans, home improvement loans and automobile loans.
4
Analysis of Loan Portfolio
Set forth below is selected data relating to the composition of the
Company's loan portfolio by type of loan and type of security on the dates
indicated. The table does not include mortgage-backed securities as the Company
classifies such securities as investment securities.
Analysis of Loan Portfolio
At December 31,
-------------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
(Dollars in Thousands)
Conventional real estate loans:
Residential interim
Construction loans $ 578 0.29% $ 5,654 3.31% $ 6,498 3.92%
Residential 104,670 52.45% 106,082 62.08% 114,910 69.35%
Commercial real estate 35,424 17.75% 22,432 13.13% 17,269 10.42%
------------- ---------- -------------- ----------- ------------ -----------
Total real estate loans $ 140,672 70.49% $ 134,168 78.52% $ 138,677 83.69%
Commercial business loans (1) $ 48,057 24.08% $ 27,929 16.35% $ 20,191 12.18%
Consumer Loans:
Savings account loans 2,049 1.02% 874 0.51% 593 0.36%
Equity lines of credit (2) 6,760 3.39% 6,846 4.00% 5,215 3.15%
Automobile loans 1,824 0.91% 1,570 0.92% 1,344 0.81%
Other (2) (3) 3,330 1.67% 2,490 1.46% 2,236 1.35%
------------- ---------- -------------- ----------- ------------ -----------
Total consumer loans $ 13,963 6.99% $ 11,780 6.89% $ 9,388 5.67%
Less:
Loans in process 1,844 0.92% 1,969 1.15% 1,726 1.04%
Deferred loan origination fees
and costs, net (3) 0.00% 29 .02% 18 0.01%
Allowance for loan losses 1,276 0.64% 1,014 .59% 816 0.49%
------------- ---------- -------------- ----------- ------------ -----------
Total loans, net $ 199,575 100.00% $ 170,865 100.00% $ 165,696 100.00%
============= ========== ============== =========== ============ ===========
(1) Commercial business loans are made on both a secured and unsecured basis
primarily to small businesses and professional organizations within the
Company's primary market area. These loans are not secured by the
borrower's real estate.
(2) Equity lines of credit and home improvement loans are secured by the
principal residence of the borrower.
(3) Includes home improvement, education and unsecured personal loans.
5
Type of Security
At December 31,
-------------------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Type of Security (Dollars in Thousands)
Residential real estate:
1 to 4 family (1) $101,481 50.85% $107,968 63.19% $117,753 71.06%
Other dwelling units 3,767 1.89% 3,768 2.20% 3,655 2.20%
Commercial real estate 35,424 17.75% 22,432 13.13% 17,269 10.42%
Equity lines of credit 6,760 3.39% 6,846 4.01% 5,215 3.15%
Commercial business 48,057 24.08% 27,929 16.34% 20,191 12.19%
Savings accounts 2,049 1.02% 874 0.51% 593 0.36%
Automobile loans 1,824 0.91% 1,570 0.92% 1,344 0.81%
Other (2) 3,330 1.67% 2,490 1.46% 2,236 1.35%
------------- ----------- -------------- ------------ ------------- ----------
Total $202,692 101.56% $173,877 101.76% $168,256 101.54%
Less:
Loans in process 1,844 0.92% 1,969 1.15% 1,726 1.04%
Deferred loan origination fees
and costs, net (3) 0.00% 29 0.02% 18 0.01%
Allowance for loan losses 1,276 0.64% 1,014 0.59% 816 0.49%
------------- ----------- -------------- ------------ ------------- ----------
Total loans, net $199,575 100.00% $170,865 100.00% $165,696 100.00%
============= =========== ============== ============ ============= ==========
(1) Includes construction loans converted to permanent loans.
(2) Includes unsecured personal loans, education loans and home improvement
loans.
6
Related Party Transactions
The following table represents the indebtedness of certain directors,
officers and their associates as of December 31, 1998. Such indebtedness was
incurred in the ordinary course of business on substantially the same terms as
those prevailing at the time for comparable transactions with other persons and
does not involve more than normal risk of collectibility or present other
unfavorable features.
Loan Balance/
Line of Credit/Loan Line of Credit
Name Position Total Available Disbursed
- -------------------------- ----------------------------------- ------------------------ -----------------------
Robert J. Koetter, Sr. Director 790,468 790,468
Gary L. Libs Director 3,666,672 3,366,672
Gerald Koetter Director 100,000 97,000
James Robinson Director 1,100,000 675,000
Kerry M. Stemler Director 3,293,881 2,187,281
Tim Shea Director 478,147 407,148
C. Thomas Young Chairman of Board of Directors 694,890 521,837
Gordon Huncilman Director 99,225 99,225
Greg Huber Director 500,000 91,000
Dale Orem Director 226,663 216,980
Steven Stemler Director 536,192 356,192
Robert Pullen Director 3,833,732 3,733,732
R. W. Estopinal Director 478,886 144,674
Richard Heaton Director 334,251 334,251
Guthrie Wilson Director 12,410 12,410
M. Diane Murphy Senior Vice President 99,532 68,566
James M. Stutsman Senior Vice President 133,028 125,931
Patrick Daily President 82,259 82,259
Mary Pat Boone Senior Vice President 86,175 82,235
Paul Chrisco Vice President 5,500 5,379
Linda Brock Vice President 65,000 10,177
Brian Brinkworth Vice President 25,000 6,820
Jeff Cash Vice President 72,000 72,000
7
Loan Maturity Schedule
The following table sets forth certain information at December 31, 1998,
regarding the dollar amount of loans maturing in the Company's portfolio based
on their contractual terms to maturity. Demand loans and loans having no stated
schedule of repayments and no stated maturity are reported as due in one year or
less. Adjustable and floating-rate loans are shown as being due in the period in
which interest rates are next scheduled to adjust. Fixed rate loans are shown as
being due in the period in which the contractual repayment is due.
Within one One through Three through Five through Ten through Beyond
year three years five years ten years twenty years twenty years Total
-------------------------------------------------------------------------------------------
Real estate mortgages:
Adjustable ................ $ 2,336 $ 18,256 $ 14,096 $ 13,140 $ 17,914 $ 4,715 $ 70,457
Fixed ..................... 797 6,613 3,118 11,811 10,095 1,406 33,840
Second mortgages ........... 19 379 267 173 114 -- 952
Installment ................ 141 5,217 2,393 3,354 2,803 54 13,962
Commercial business,
financial and agricultural 4,479 34,933 8,276 11,758 22,417 1,618 83,481
--------- --------- --------- --------- --------- --------- ---------
Total ........... $ 7,772 $ 65,398 $ 28,150 $ 40,236 $ 53,343 $ 7,793 $202,692
========= ========= ========= ========= ========= ========= =========
8
The following table sets forth the dollar amount of all loans due after
December 31, 1998, which have fixed rates and have floating or adjustable
interest rates.
Predetermined Floating or
rates Adjustable rates Total
----------------- ------------------- -----------------
Real estate mortgage $ 35,570 $ 69,679 $ 105,249
Commercial business loans 23,034 60,447 83,481
Consumer 12,121 1,841 13,962
----------------- ------------------- -----------------
Total $ 70,725 $131,967 $ 202,692
================= =================== =================
Residential Real Estate Loans. The Company's primary lending activity
consists of the origination of one-to-four family, owner-occupied, residential
mortgage loans secured by property located in the Company's primary market area.
The majority of the Company's residential mortgage loans consist of loans
secured by owner-occupied, single family residences. At December 31, 1998, the
Company had $101.5 million, or 50.9 percent of its net loan portfolio, invested
in loans secured by one-to-four family residences.
The Company currently offers residential mortgage loans for terms up to
30 years, with adjustable or fixed interest rates. Origination of fixed-rate
mortgage loans versus ARM loans is monitored continuously and is affected
significantly by the level of market interest rates, customer preference, and
loan products offered by the Company's competitors. Therefore, even if
management's strategy is to emphasize ARM loans, market conditions may be such
that there is greater demand for fixed-rate mortgage loans.
The primary purpose of offering ARM loans is to make the Company's loan
portfolio more interest rate sensitive. However, as the interest income earned
on ARM loans varies with prevailing interest rates, such loans do not offer the
Company predictable cash flows as would long-term, fixed-rate loans. ARM loans,
however, can carry increased credit risk associated with potential higher
monthly payments by borrowers as general market interest rates increase. It is
possible, therefore, that during a period of rising interest rates, the risk of
default on ARM loans may increase due to the upward adjustment of interest costs
to the borrower.
The Banks' fixed-rate mortgage loans are amortized on a monthly basis
with principal and interest due each month. Residential real estate loans often
remain outstanding for significantly shorter periods than their contractual
terms because borrowers may refinance or prepay loans at their option.
The Company's ARM loans adjust annually with interest rate adjustment
limitations of two percentage points per year and six percentage points over the
life of the loan. The Company also makes ARM loans with interest rates that
adjust every one, three or five years. The interest rate on ARM loans is based
on the one-year, three-year or five-year U.S. Treasury Constant Maturity Index
commensurate with the applicable like term mortgage plus 275 basis points. The
Company's policy is to qualify borrowers for ARM loans based on the fully
indexed rate of the ARM loan. That is, a borrower is qualified for an ARM loan
by evaluating the borrower's ability to service the loan at an interest rate
equal to the maximum annual rate increase added to the current index. ARM loans
totaled $70.5 million, or 35.3 percent of the Bank's total loan portfolio at
December 31, 1998.
The Company has used different indices for its ARM loans such as the
National Average Median Cost of Funds, the Sixth District Net Cost of Funds
Monthly Index, the National Average Contract Rate for Previously Occupied Homes,
the Average three year Treasury Bill Rate, and the Eleventh District Cost of
Funds. Consequently, the adjustments in the Company's portfolio of ARM loans
tend not to reflect any one particular change in any specific interest rate
index, but general interest rate trends overall.
The Company has limited its real estate loan originations to properties
within its primary market area since 1988. However, during the five year period
through 1988, the Company purchased at par approximately $45 million of
one-to-four family residential loans from its wholly owned service corporation
subsidiary, First Community Service Corp. (the "Service Corporation"). Of this
original $45 million, $8.1 million was still outstanding as of December 31,
1998. The Service Corporation operated loan production offices in Port St.
Lucie, Naples, and West Palm Beach, Florida and Louisville, Kentucky. The
offices originated primarily one-year ARM
9
loans with 30-year terms, and to a lesser extent, one-year ARM loans with
15-year terms. During this same period, the Company purchased for its portfolio
approximately $15.0 million of one-to-four family mortgage loans in several
packages from various savings associations and mortgages companies. Of this
original $15 million, $4.8 million was still outstanding as of December 31,
1998. The mortgages purchased were predominantly ARM loans with annual rate
adjustments. These purchased loans, both from the Service Corporation and from
outside sources, accounted for the majority of the Company's variable rate,
one-to-four family residential mortgage loans from 1983 through 1988.
Regulations limit the amount that a bank may lend via conforming loans
qualifying for sale in the secondary market in relationship to the appraised
value of the real estate securing the loan, as determined by an appraisal at the
time of loan origination. Such regulations permit a maximum loan-to-value ratio
of 95 percent for residential property and from 65 to 90 percent for all other
real estate related loans. The Company's lending policies, however, generally
limit the maximum loan-to-value ratio on both fixed-rate and ARM loans to 80
percent of the lesser of the appraised value or the purchase price of the
property to serve as security for the loan, unless insured by a private mortgage
insurer.
The Company occasionally makes real estate loans with loan-to-value
ratios in excess of 80 percent. For real estate loans with loan-to-value ratios
of between 80 and 90 percent, the Company requires the first 20 percent of the
loan to be covered by private mortgage insurance. For real estate loans with
loan-to-value ratios of between 90 percent and 95 percent, the Company requires
private mortgage insurance to cover the first 25 to 30 percent of the loan
amount. The Company requires fire and casualty insurance, as well as title
insurance or an opinion of counsel regarding good title, on all properties
securing real estate loans made by the Company.
Construction Loans. The Company originates loans to finance the
construction of owner-occupied residential property. At December 31, 1998, the
Company had $578,000 or 0.3 percent of its total gross loan portfolio invested
in interim construction loans. The Company makes construction loans to private
individuals for the purpose of constructing a personal residence or to local
real estate builders and developers. Construction loans generally are made with
either adjustable or fixed-rate terms of up to six months. Loan proceeds are
disbursed in increments as construction progresses and as inspections warrant.
Construction loans are structured to be converted to permanent loans originated
by the Company at the end of the construction period or to be terminated upon
receipt of permanent financing from another financial institution.
Commercial Real Estate Loans. Loans secured by commercial real estate
constituted approximately $35.4 million, or 17.8 percent, of the Company's total
net loan portfolio at December 31, 1998. The Company's permanent commercial real
estate loans are secured by improved property such as offices, small business
facilities, apartment buildings, nursing homes, warehouses and other
non-residential buildings, most of which are located in the Company's primary
market area and most of which are to be used or occupied by the borrowers.
Commercial real estate loans have been offered at adjustable interest rates and
at fixed rates with balloon provisions at the end of the term financing. The
Company continues to originate commercial real estate loans, commercial real
estate construction loans and land loans.
Loans secured by commercial real estate generally involve a greater
degree of risk than residential mortgage loans and carry larger loan balances.
This increased credit risk is a result of several factors, including the
concentrations of principal in a limited number of loans and borrowers, the
effects of general economic conditions on income producing properties, and the
increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by multifamily and commercial real
estate is typically dependent upon the successful operation of the related real
estate project. If the cash flow from the project is reduced, the borrower's
ability to repay the loan may be impaired. The Company has increased its
origination of multi-family residential or commercial real estate loans over the
last few years, but feels that it is well protected against the increased credit
risk associated with these loans through its underwriting standards of imposing
stringent loan-to-value ratios, requiring conservative debt coverage ratios, and
continually monitoring the operation and physical condition of the collateral.
Commercial Business Loans. The Company also originates non-real estate
related business loans to local small businesses and professional organizations.
Commercial business loans accounted for approximately $48.1 million or 24.1
percent of the Company's loan portfolio of December 31, 1998. This type of
commercial loan has been offered at both variable rates and fixed rates with
balloon payments required at maturity.
10
The Company has increased its origination of commercial business loans
over the last few years. Such loans generally have shorter terms and higher
interest rates than mortgage loans. However, commercial business loans also
involve a higher level of credit risk because of the type and nature of the
collateral.
Consumer Loans. As of December 31, 1998, consumer loans totaled $14.0 million or
7.0 percent of the Company's total loan portfolio. The principal types of
consumer loans offered by the Company are equity lines of credit, auto loans,
home improvement loans, and loans secured by deposit accounts. Equity lines of
credit are predominately made at rates which adjust periodically and are indexed
to the prime rate. Some consumer loans are offered on a fixed-rate basis
depending upon the borrower's preference. The Company's equity lines of credit
are generally secured by the borrower's principal residence and a personal
guarantee. At December 31, 1998, equity lines of credit totaled $ 6.8 million,
or 48.4 percent of consumer loans.
The underwriting standards employed by the Company for consumer loans
include a determination of the applicant's credit history and an assessment of
ability to meet existing obligations and payments on the proposed loan. The
stability of the applicant's monthly income may be determined by verification of
gross monthly income from primary employment, and additionally from any
verifiable secondary income. Credit worthiness of the applicant is of primary
consideration, however. The underwriting process also includes a comparison of
the value of the security in relation to the proposed loan amount.
Loan Solicitation and Processing. Loan originations are derived from a
number of sources such as loan sales staff, real estate broker referrals,
existing customers, borrowers, builders, attorneys and walk-in customers. Upon
receipt of a loan application, a credit report is made to verify specific
information relating to the applicant's employment, income, and credit standing.
In the case of a real estate loan, an independent appraiser approved by the
Company undertakes an appraisal of the real estate intended to secure the
proposed loan. A loan application file is first reviewed by the Company's loan
department and then, depending on the amount of the loan, is submitted for
approval to a loan committee consisting of at least two senior officers of the
Company, or their designee, and subsequently ratified by the full Board of
Directors. One-to-four family residential mortgage loans with principal balances
in excess of $500,000 and multi-family and commercial real estate loans with
principal balances in excess of $500,000 must be submitted by the loan
department directly to the Executive Loan Committee of the Board of Directors
for approval. Once the Board of Directors ratifies or approves a loan, a loan
commitment is promptly issued to the borrower.
If the loan is approved, the commitment letter specifies the terms and
conditions of the proposed loan including the amount of the loan, interest rate,
amortization term, a brief description of the required collateral, and required
insurance coverage. The borrower must provide proof of fire and casualty
insurance on the property serving as collateral and such insurance must be
maintained during the full term of the loan. Title insurance or an attorney's
opinion based on a title search of the property is required on all loans secured
by real property.
Loan Commitments. The Company issues standby loan origination
commitments to qualified borrowers primarily for the construction and purchase
of residential real estate and commercial real estate. Such commitments are made
with specified terms and conditions for periods of up to 60 days, during which
time the interest rate is locked-in. If a loan is not scheduled to close
immediately after approval, the Company charges a fee for a loan commitment
based on a percentage of the loan amount. The loan commitment fee is credited
towards the closing costs of the loan if the borrower receives the loan from the
Company. If the potential borrower chooses to borrow funds from another
institution, the commitment fee is forfeited. At December 31, 1998, the Company
had commitments to originate loans of $4.9 million, as well as commitments to
fund the undisbursed portion of construction loans in process of $1.8 million
and commitments to fund commercial and personal lines of credit of $34.8
million.
Loan Origination and Other Fees. In addition to interest earned on
loans, the Company generally receives loan origination fees. The Financial
Accounting Standards Board ("FASB issued SFAS No. 91 ") in December 1986 that
deals with the accounting for non-refundable fees and costs associated with
originating or acquiring loans. To the extent that loans are originated or
acquired for the portfolio, SFAS No. 91 requires that the Company defer loan
origination fees and costs and amortize such amounts as an adjustment of yield
over the life of the loan by use of the level yield method. Fees and costs
deferred under SFAS No. 91 are recognized in income immediately upon the sale of
the related loan. At December 31, 1998, the Company had $3,000 of outstanding
net deferred loan fees and costs.
11
In addition to loan origination fees, the Company also receives other
fees and service charges that consist primarily of late charges and loan
servicing fees on loans sold. The Company recognized loan servicing fees on
loans sold and late charges of $203,000, $214,000, and $220,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
Loan origination and commitment fees are volatile sources of income.
Such fees vary with the volume and type of loans and commitments made and
purchased and with competitive conditions in the mortgage markets, which in turn
respond to the demand and availability of money.
Loans to One Borrower. Under FIRREA, current regulations limit loans to
one borrower in an amount equal to 15 percent of unimpaired capital and
unimpaired surplus on an unsecured basis, and an additional amount equal to 10
percent of unimpaired capital and unimpaired surplus if the loan is secured by
readily marketable collateral (generally, financial instruments, but not real
estate). Under FIRREA, the Company's subsidiaries had maximum loan to one
borrower limits of approximately $3.6 million, $690,000, and $1.3 million at
December 31, 1998, for Community Bank, Heritage Bank, and NCF Bank respectively.
The Company's subsidiaries are in compliance with the loans-to-one borrower
limitations.
Delinquencies. The Company's collection procedures provide that when a
loan is 15 days past due, a late charge is added and the borrower is contacted
by mail and payment is requested. If the delinquency continues, subsequent
efforts are made to contact the delinquent borrower. Additional late charges may
be added and, if the loan continues in a delinquent status for 90 days or more,
the Company generally initiates foreclosure proceedings.
Non-Performing Assets and Asset Classification. Loans are reviewed on a
regular basis and are placed in a non-accrual status when, in the opinion of
management, the collection of additional interest is doubtful. Residential and
commercial mortgage loans are placed on non-accrual status generally when either
principal or interest is 90 days or more past due and management considers the
interest uncollectible, or when the Company commences foreclosure proceedings.
Interest accrued and unpaid at the time a loan is placed on non-accrual status
is charged against interest income.
Real estate acquired by the Company as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate owned ("REO") until
such time as it is sold. When REO is acquired, it is recorded at the lower of
the unpaid principal balance of the related loan or its fair market value, less
costs to sell. After the date of acquisition, all costs incurred in maintaining
the property are expensed and costs incurred for the improvement or development
of such property are capitalized up to the extent of their fair value. At
December 31, 1998, the Company owns $200,000 in property acquired as the result
of foreclosure or by deed in lieu or foreclosure.
The following table sets forth information regarding non-accrual loans
and other non-performing assets at the dates indicated. At December 31, 1998,
the Company had no restructured loans within the meaning of SFAS No. 15. It is
the Company's policy to generally not accrue interest on loans delinquent more
than 90 days.
At December 31,
-----------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands)
Loans accounted for on a non-accrual basis:
Residential mortgage loans $ 102 $ 294 $ 1,557 $ 27 $ 1,203
Commercial real estate 368 - - - -
Consumer - 22 - - 2
============ ============ ============= ============= =============
Total $ 470 $ 316 $ 1,557 $ 27 $ 1,205
============ ============ ============= ============= =============
Non-accrual loans as a
percentage of total loans 0.23% 0.18% 0.93% 0.02% 0.91%
============ ============ ============= ============= =============
Foreclosed real estate (1) $ 200 $ 724 $ 101 $ -- $ 102
============ ============ ============= ============= =============
(1) Represents the book value of property acquired by the Company through
foreclosure or deed in lieu of foreclosure. Foreclosed real estate acquired
through foreclosure or deed in lieu of foreclosure is recorded at the lower of
its fair value less estimated cost to sell or cost.
12
The following is a summary of gross interest income that would have
been recorded if all loans accounted for on a non-accrual basis were current in
accordance with their original terms and gross interest income that was actually
recorded during the periods.
Year Ended December 31,
(In thousands)
1998 1997 1996
---- ---- ----
Gross interest income that would
have been recorded if all non-accrual
loans were on a current basis $ 28 $ 111 $ 29
============ ============ =============
Gross interest income actually recorded $ - $ - $ 63
============ ============ =============
The following table sets forth information with respect to loans which
are still accruing interest but are contractually past due 90 days or more at
December 31, 1998:
At December 31, 1998 Number of loans
-------------------------- --------------------
(In thousands)
Residential real estate $ 267 3
Commercial real estate and business 0 0
Consumer loans 0 0
========================== ====================
Total $ 267 3
========================== ====================
Classified Assets. Loans and other assets such as debt and equity
securities considered to be of lesser quality are classified as "substandard" or
"impaired" assets. A loan or other asset is considered substandard if it is
inadequately protected by the current net worth and paying capacity of the
obligor and by the collateral pledged, if any. "Substandard" assets include
those characterized by the "distinct possibility" that the Bank will sustain
"some loss" if the deficiencies are not corrected. For debt and equity
securities, permanent impairments in value are recognized by a write-down of the
security to fair value with a corresponding charge to other income.
On January 1, 1995, the Company adopted SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan" which requires 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 monthly basis to consider changes due to the passage of time or revised
estimates. Assets that do not expose the Banks to risk sufficient to warrant
classification in one of the aforementioned categories, but which poses 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 that 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 allowances is
subject to review by the FDIC, which can order the establishment of additional
general loss allowances. The Banks regularly review the loan portfolio to
determine whether any loans require classification in accordance with applicable
regulations.
At December 31, 1998, the Banks had $1.7 million classified as special
mention assets, $636,000 classified as substandard assets, and $158,000
classified as impaired assets.
13
Allowance for Loan Losses. Management's policy is to provide for
estimated losses in the Banks' loan portfolio based on management's evaluation
of the probable losses that may be incurred. The allowance for loan losses is
maintained at a level believed adequate by management to absorb credit losses
inherent in the portfolio. Such evaluation, which includes a review of all loans
for which full collectibility of interest and principal may not be reasonably
assured, considers, among other matters, the estimated fair market value of the
underlying collateral, past loss experience, volume, growth, and composition of
the portfolio.
Analysis of the Allowance For Loan Losses. The following table sets
forth information with respect to the Bank's allowance for loan losses at the
dates indicated.
At December 31,
1998 1997 1996
(In thousands)
Total loans outstanding $199,575 $170,866 $165,696
Average loans outstanding 193,725 169,651 156,895
Balance at beginning of period $ 1,014 $ 816 $ 700
Adjustment to conform pooled
affiliate's fiscal year end 8 --- ---
Provisions
Residential 88 86 68
Commercial 242 132 17
Consumer 24 8 43
------------- ------------- ------------
354 226 128
------------- ------------- ------------
Charge-offs
Residential (32) (11) -
Commercial (52) (10) -
Consumer (20) (13) (17)
------------- ------------- ------------
(104) (34) (17)
------------- ------------- ------------
Recoveries
Residential 1 - 4
Commercial 3 - -
Consumer - 6 1
------------- ------------- ------------
4 6 5
------------- ------------- ------------
Balance at end of period $ 1,276 $ 1,014 $ 816
============= ============= ============
Allowance for loans losses as a percent
of total loans outstanding .64% .59% 0.49%
Net loans charged off as a percent
of average loans outstanding .05% .02% 0.01%
14
The following table sets forth the breakdown of the allowance for loan
losses by loan category for the periods indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation to the allowance by category is not necessarily indicative of further
losses and does not restrict the use of the allowance to absorb losses in any
category.
At December 31,
1998 1997 1996
---- ---- ----
(dollars in thousands)
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
Residential loans $ 425 51.9% $ 360 64.2% $ 358 72.1%
Commercial loans 754 41.2% 561 29.0% 393 22.3%
Consumer loans 97 6.9% 93 6.8% 65 5.6%
============================= ============================ ============================
Total $ 1,276 100.0% $ 1,014 100.0% $ 816 100.0%
============================= ============================ ============================
Investment Activities
In recent years, the Company has sought to increase the percentage of
its assets invested in securities issued or guaranteed by the U.S. Government or
an agency thereof. The emphasis on the Company's investment portfolio has been
to (i) improve the Banks' interest rate sensitivity by reducing the average term
to maturity of the Banks assets, (ii) improve liquidity, and (iii) effectively
reinvest excess funds.
Each subsidiary banks' investment securities portfolio is managed by
the president of each bank in accordance with a comprehensive investment policy
which addresses strategies, types and levels of allowable investments and which
is reviewed and approved by the Board of Directors on an annual basis. The
management of the investment securities portfolio is set in accordance with
strategies developed by the Company's Asset and Liability Committee. The
Company's investment securities currently consist primarily of U.S. agency and
government securities.
Liquidity levels may be increased or decreased depending upon the yields on
available investment alternatives and upon management's judgment as to the
attractiveness of the yields then available in relation to other opportunities
and its expectation of yields that will be available in the future, as well as
management's projections as to the short term demand for funds to be used in
each banks' loan origination and other activities.
15
Securities Analysis
The following table sets forth the securities portfolio as of
December 31 for the years indicated.
1998 1997
-------------------------------- -------------------------------
Weighted Weighted
Fair Amortized Average Fair Amortized Average
Value Cost Yield Value Cost Yield
Securities Held to Maturity (1)
Debt securities:
Federal Agency:
Due in one year or less $994 $1,000 2.95% $6,434 $6,500 5.35%
Due after one year through five years $2,979 $3,000 5.57% $7,500 $7,500 6.16%
Due after five years through ten years $39,151 $39,174 6.49% $38,060 $38,006 7.05%
Due after ten years $16,006 $16,085 6.61% $11,942 $12,000 7.39%
Municipal
Due in one year or less $ - $ - 0.00% $ - $ - 0.00%
Due after one year through five years $640 $633 4.05% $635 $635 4.05%
Due after five years through ten years $ - $ - 0.00% $ - $ - 0.00%
Due after ten years $2,806 $2,696 5.59% $2,104 $2,013 5.59%
Mortgage backed securities (3) $29,197 $29,194 6.31% $23,717 $23,519 6.53%
-------------------------------- -------------------------------
Total securities held to maturity $91,773 $91,782 6.34% $90,392 $90,173 6.71%
Securities available for sale(2)
Mortgage backed securities (3) $666 $666 6.38% $883 $878 6.40%
Common stock $250 $250 0.60% $ - $ - 0.00%
-------------------------------- -------------------------------
Total securities available for sale $916 $916 4.80% $883 $878 6.40%
Nonmarketable equity securities
FHLB stock $3,346 $3,346 8.00% $1,575 $1,575 8.00%
(1) Securities held to maturity are carried at amortized cost.
(2) Securities available for sale are carried at fair value.
(3) The expected maturities of mortgage-backed securities may differ from
contractual maturities because the mortgages underlying the obligations may
be prepaid without penalty.
16
Sources of Funds
General. The major source of funds for the Company is dividends from
its subsidiary Banks, which are limited by FDIC regulations. See "Limitations of
Capital Distributions." The following discusses the sources of funds for the
Banks. Deposits are the major source of the Banks' funds for lending and other
investment purposes. In addition to deposits, the Banks derive funds from the
amortization and prepayment of loans and mortgage-backed securities, the sale or
maturity of investment securities, continuing operations, and advances from the
FHLB of Indianapolis. Scheduled loan principal repayments are a relatively
stable source of funds, while deposit inflows and outflows and loan prepayments
are significantly influenced by general interest rates and market conditions.
Borrowings may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources or on a longer-term basis for general
business purposes.
Deposits. Consumer and commercial deposits are attracted principally
from within the Bank's primary market area through the offering of a broad
selection of deposit instruments including checking, regular savings, money
market deposit, term certificate accounts (including negotiated jumbo
certificates in denominations of $100,000 or more) and individual retirement
accounts. 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. The Banks regularly evaluate the internal cost of funds, survey
rates offered by competing institutions, review cash flow requirements for
lending and liquidity, assess the interest rate risk position, and execute rate
changes when deemed appropriate. The Banks do not obtain funds through brokers,
nor do they actively solicit funds outside their primary market area.
Jumbo certificates of deposit with principal amounts of $100,000 or more
constituted $21.4 million, or 10.1 percent of the Company's total deposit
portfolio at December 31, 1998. Jumbo deposits include deposits from various
business entities, individuals and local governments and authorities. Jumbo
deposits make the Banks susceptible to large deposit withdrawals if one or more
depositors withdraw deposits. Such withdrawals may adversely impact the Banks'
cost of funds, liquidity and funds available for lending. However, as part of
the Banks' asset/liability management strategy, each entity and the Company as a
whole attempts to reduce this risk by matching the maturities of its jumbo
deposits with the maturities or repricing intervals of a similar amount of
assets such as investment securities or mortgage-backed securities.
The table below presents the average balance, interest expense, and average rate
paid by period for each major deposit category.
Year Ended December 31,
------------------------------------------------------------------
1998 1997 1996
--------------------- ------------------ ----------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Cost Balance Cost
(Dollars
in Thousands)
Deposits:
Demand deposits 37,843 2.31% 34,799 2.65% 32,476 2.78%
Savings 36,616 3.21 33,899 3.33 34,093 2.82
Time 129,407 5.62 137,449 5.52 136,419 5.54
-------------------- ------------------- ---------------------
Total deposits 203,866 4.58 206,146 4.68 202,987 4.64
-------------------- ------------------- ---------------------
17
Time Deposits. The following table indicates the amount of jumbo
certificates of deposits (i.e. $100,000 or greater balance) by time remaining
until maturity as of December 31, 1998.
Certificates
Maturity Period of Deposits
(in thousands)
Three months or less $ 6,150
Three through six months 5,875
Six through twelve months 6,489
Over twelve months 2,912
=============
Total $21,426
=============
In the unlikely event of liquidation of either of the Banks, depositors
will be entitled to full payment of their deposit accounts prior to any payment
being made to the Company as sole stockholder of the Banks.
Borrowings. Deposits are the primary source of funds of the Banks'
lending and investment activities and for its general business purposes. The
Banks, if the need arises, may rely upon advances from the Federal Home Loan
Banks (FHLB) of Indianapolis and Cincinnati as well as the Federal Reserve Bank
discount window to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. Advances from the FHLB are secured by a blanket
collateral pledge of the unpaid principal balance of permanent 1-4 family
residential mortgage loans, the outstanding balance of U.S. Government and
Agency securities (including FHLMC, FNMA, and GNMA mortgage-backed securities),
and the outstanding balance of securities representing a whole interest in 1-4
family residential mortgage loans. At December 31, 1998, the Banks had $56.0
million in advances outstanding from the FHLB's of Indianapolis and Cincinnati.
The FHLB system functions as a central reserve bank providing credit
for the Banks and other member financial institutions. All members are required
to own capital stock in the FHLB and are authorized to apply for advances on the
security of such stock and certain of its home mortgages 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.
Short-term Borrowings. The Banks also obtain funds through the offering
of retail repurchase agreements. Retail repurchase agreements represent
overnight borrowings from deposit customers secured by debt securities under the
control of the Banks. As of December 31, 1998, the Banks had $19.5 million of
retail repurchase agreements outstanding. In the event of a need for funds in an
overnight capacity, Community Bank maintains a $2.0 million line of credit and
Heritage maintains a $500,000 line of credit with the FHLB of Indianapolis, and
NCF maintains a $500,000 line of credit with the FHLB of Cincinnati.
18
The following table sets forth certain information regarding borrowings
by the Company at the end of and during the periods indicated:
At December 31,
1998 1997 1996
(Dollars in thousands)
Weighted average rate paid on:
FHLB advances 5.11% 5.77% 5.65%
Retail repurchase agreements 4.10% 4.77% 4.47%
Amount of retail repurchase agreements $19,499 $12,142 $10,702
During the Year Ended
December 31,
1998 1997 1996
(Dollars in thousands)
Weighted average rate paid on:
Retail repurchase agreements 4.59% 4.83% 4.11%
Maximum amount of borrowings outstanding
at any month end:
FHLB Advances $56,000 $29,500 $21,099
Retail repurchase agreements $19,499 $13,913 $12,496
Approximate average short-term
borrowings outstanding with respect to:
FHLB Advances(1) $41,208 $12,625 $ 9,354
Retail repurchase agreements $14,902 $12,141 $2,864
(1) Average balances are derived from month-end balances.
Competition
There is strong competition both in attracting deposits and in
originating real estate and other loans. The most direct competition for
deposits has come historically from other commercial banks, savings associations
and credit unions in the Banks' market area. The Banks expect continued strong
competition from such financial institutions in the foreseeable future. The
Banks' market area includes branches of several commercial banks which are
substantially larger than the Banks in terms of state-wide deposits. The Banks
compete for savings by offering depositors a high level of personal service in
conjunction with a wide range of financial services.
The competition for real estate and other loans comes principally from
other commercial banks, mortgage banking companies and savings associations.
This competition for loans has increased substantially in recent years as a
result of the large number of institutions choosing to compete in the Banks'
market area.
The Banks compete for loans primarily through the interest rates and
loan fees charged and the efficiency and quality of services provided to
borrowers, real estate brokers and builders. Factors that affect competition
include general and local economic conditions, current interest rate levels and
volatility of the mortgage markets.
Regulation
As state chartered commercial banks, Community, Heritage, and NCF Bank
are subject to examination, supervision and extensive regulation by the FDIC and
their respective Departments of Financial Institutions (DFI). Community and
Heritage are members of and own stock in the FHLB of Indianapolis, while NCF
Bank is a member of and owns stock in the FHLB of Cincinnati. The FHLB
institutions located in Indianapolis and Cincinnati are
19
each one of the twelve regional banks in the Federal Home Loan Bank System.
Community, Heritage, and NCF Bank are also subject to regulation by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"), which
governs reserves to be maintained against deposits and regulates certain other
matters.
The FDIC and DFI regularly examine the Banks and prepare a report for
the consideration of each Bank's Board of Directors on any deficiencies that it
may find in the Bank's operations. Each Bank's relationship with its depositors
and borrowers also is regulated to a great extent by both federal and state
laws, especially in such matters as the ownership of savings accounts and the
form and content of the Bank's mortgage documents.
Federal Regulation of Commercial Banks. The FDIC has extensive
authority over the operations of all insured commercial banks. As part of this
authority, the Banks are required to file periodic reports with the FDIC and DFI
and are subject to periodic examinations by both agencies. In the course of
these examinations the examiners may require the Banks to provide for higher
general loan loss reserves. Financial institutions in various regions of the
United States have been called upon by examiners to write down assets to their
fair market values and to establish increased levels of reserves, primarily as a
result of perceived weaknesses in real estate values and a more restrictive
regulatory climate.
The investment and lending authority of a state-chartered bank is
prescribed by federal laws and regulations, and such banks are prohibited from
engaging in any activities not permitted by such laws and regulations. These
laws and regulations generally are applicable to all state chartered banks.
State banks are subject to the same current national bank limits on
maximum loans to one borrower. Generally, banks may not lend to a single or
related group of borrowers on an unsecured basis an amount in excess of the
greater of $500,000 or 15 percent of the bank's unimpaired capital and surplus.
An additional amount may be lent, equal to 10 percent of unimpaired capital and
surplus, if such loan is secured by readily marketable collateral, which is
defined to include certain securities, but generally does not include real
estate. See "Lending Activities -- Loans to One Borrower" for a discussion of
the effect of this requirement on the Bank.
Proposed Federal Legislation. Currently, Congress has under
consideration a proposal that, if implemented, could have a material effect on
financial institutions in general and the Banks in particular. Consolidation of
the four federal banking agencies (the Federal Reserve Board, OTS, FDIC and the
Office of the Comptroller of the Currency) has been and will continue to be
considered. The outcome of this proposal is uncertain and the Company is unable
to determine the extent to which the legislation if enacted, would affect its
business.
Federal Regulations
Section 22(h) and (g) of the Federal Reserve Act places restrictions on
loans to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, an executive officer and to a greater than 10%
stockholder of a bank, and certain affiliated interest of either, may not
exceed, together with all other outstanding loans to such person and affiliated
interests, the institution's loans to one borrower limit (generally equal to 15%
of the institution's unimpaired capital and surplus). Section 22(h) also
requires that loans to directors, executive officers and principal stockholders
be made on terms substantially the same as offered in comparable transactions to
other persons and also requires prior board approval for certain loans. In
addition, the aggregate amount of extensions of credit to all insiders cannot
exceed the institution's unimpaired capital and surplus. At December 31, 1998
the Bank was in compliance with the above restrictions.
Safety and Soundness. On November 18, 1993, a joint notice of proposed
rulemaking was issued by the OTS, the FDIC, the Office of the Comptroller of the
Currency and the Federal Reserve Board (collectively, the "agencies") concerning
standards for safety and soundness required to be prescribed by regulation
pursuant to Section 39 of the FDIA. In general, the standards relate to (1)
operational and managerial matters; (2) asset quality and earnings; and (3)
compensation. The operational and managerial standards cover (a) internal
controls and information systems, (b) internal audit system, (c) loan
documentation, (d) credit underwriting, (e) interest rate risk exposure, (f)
asset growth, and (g) compensation, fees and benefits. Under the proposed asset
quality and earnings standards, the Bank would be required to maintain (1) a
maximum ratio of classified assets (assets classified substandard, doubtful and
to the extent that related losses have not been recognized, assets classified
loss) to total capital of 1.0, and (2) minimum earnings sufficient to absorb
losses without impairing capital. The last ratio concerning market value to book
value was determined by the agencies not to be feasible. Finally, the proposed
20
compensation standard states that compensation will be considered excessive if
it is unreasonable or disproportionate to the services actually performed by the
individual being compensated. If an insured depository institution or its
holding company fail to meet any of the standards promulgated by regulation,
then such institution or company will be required to submit a plan within 30
days to the FDIC specifying the steps it will take to correct the deficiency. In
the event that an institution or company fails to submit or fails in any
material respect to implement a compliance plan within the time allowed by the
agency, Section 39 of the FDIA provides that the FDIC must order the institution
or company to correct the deficiency and may (1) restrict asset growth; (2)
require the institution or company to increase its ratio of tangible equity to
assets; (3) restrict the rates of interest that the institution or company may
pay; or (4) take any other action that would better carry out the purpose of
prompt corrective actions.
Regulatory Capital. The Company and subsidiary Banks are subject to
various regulatory capital requirements administered by the federal banking
agencies. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company must meet specific capital guidelines.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and subsidiaries to maintain minimum amounts and
ratios of total and Tier I Capital to risk weighted assets and of Tier I capital
to average assets. As of December 31, 1998, the Company met all capital adequacy
requirements to which it is subject.
The following table sets forth the Company's capital position at
December 31, 1998, as compared to the minimum capital requirements.
For Capital
Actual Adequacy Purposes: Excess
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 1998
Total Capital (to Risk
Weighted Assets):
Consolidated $42,620 20.4% $16,704 8.0% $25,916 12.4%
Tier I Capital (to Risk
Weighted Assets):
Consolidated $41,344 19.8% $ 8,352 4.0% $32,992 15.8%
Tier I Capital (to Average
Assets):
Consolidated $41,344 12.7% $ 12,958 4.0% $28,386 8.7%
The FDIC generally is authorized to take enforcement action against a
financial institution that fails to meet its capital requirements; such action
may include restrictions on operations and banking activities, the imposition of
a capital directive, a cease and desist order, civil money penalties or harsher
measures such as the appointment of a receiver or conservator or a forced merger
into another institution. In addition, under current regulatory policy, an
institution that fails to meet its capital requirements is prohibited from
paying any dividends. Except under certain circumstances, further disclosure of
final enforcement action by the FDIC is required.
Prompt Corrective Action. Under Section 38 of the FDIA, as added by the
Improvement Act, each federal banking agency was required to implement a system
of prompt corrective action for institutions which it regulates. The federal
banking agencies, including the FDIC, adopted substantially similar regulations
to implement Section 38 of the FDIA, effective as of December 19, 1992. Under
the regulations, an institution is deemed to be (i) "well-capitalized" if it has
total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio
of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure, (ii) "adequately-capitalized" if it has a
total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital
ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0%
under certain circumstances) and does not meet the definition of "well
capitalized,"
21
(iii) "undercapitalized" if it has a total risk-based capital ratio that is less
than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1
leverage capital ratio that is less than 4.0% ( 3.0% under certain
circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a
ratio of tangible equity to total assets that is equal to or less than 2.0%.
Section 38 of the FDIA and the regulations promulgated thereunder also specify
circumstances under which a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category (except that the
FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized). At December 31, 1998, the Company and each of the
subsidiary Banks was deemed well-capitalized for purposes of the above
regulations.
Federal Home Loan Bank System. Community and Heritage are both members
of the FHLB of Indianapolis, and NCF is a member of the FHLB of Cincinnati. The
FHLB of Indianapolis and the FHLB of Cincinnati are each one of the 12 regional
FHLB's that, prior to the enactment of FIRREA, were regulated by the FHLBB.
FIRREA separated the home financing credit function of the FHLB's from the
regulatory functions of the FHLB's regarding savings institutions and their
insured deposits by transferring oversight over the FHLB's from the FHLBB to a
new federal agency, the Federal Home Financing Board ("FHFB").
As members of the FHLB Banking system, Community, Heritage, and NCF
Bank are required to purchase and maintain stock in the FHLB of Indianapolis in
an amount equal to the greater of one percent of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year, or 1/20 (or such greater fraction as established by
the FHLB) of outstanding FHLB advances. At December 31, 1998, $2.4 million,
$429,000, and $492,000 of FHLB stock were outstanding for Community, Heritage,
and NCF Bank, respectively, which was in compliance with this requirement. In
past years, Community, Heritage, and NCF Bank have received dividends on its
FHLB stock.
Certain provisions of FIRREA require all 12 FHLB's to provide financial
assistance for the resolution of troubled savings institutions and to contribute
to affordable housing programs through direct loans or interest subsidies on
advances targeted for community investment and low-and moderate-income housing
projects. These contributions could cause rates on the FHLB advances to increase
and could affect adversely the level of FHLB dividends paid and the value of
FHLB stock in the future.
Each FHLB serves as a reserve or central bank for its members within
its assigned region. It is funded primarily from proceeds derived from the sale
of consolidated obligations of the FHLB System. It makes loans to members (i.e.,
advances) in accordance with policies and procedures established by the board of
directors of the FHLB. At December 31, 1998, the Company had $56 million in
advances from the FHLB.
Accounting. An FDIC policy statement applicable to all banks clarifies
and re-emphasizes that the investment activities of a bank must be in compliance
with approved and documented investment policies and strategies, and must be
accounted for in accordance with GAAP. Under the policy statement, management
must support its classification of and accounting for loans and securities
(i.e., whether held to maturity, available for sale or available for trading)
with appropriate documentation. The Bank is in compliance with these amended
rules.
Insurance of Accounts. Each Bank's deposits are insured up to $100,000
per insured member (as defined by law and regulation). Deposits of Community and
NCF Bank are insured by the Savings Association Insurance Fund (SAIF), while
Heritage's deposits are insured by the Bank Insurance Fund (BIF). This insurance
is backed by the full faith and credit of the United States Government. The SAIF
and the BIF are both administered and managed by the FDIC. As insurer, the FDIC
is authorized to conduct examinations of and to require reporting by SAIF and
BIF insured institutions. It also may prohibit any insured institution from
engaging in any activity the FDIC determines by regulation or order to pose a
serious threat to either fund. The FDIC also has the authority to initiate
enforcement actions against financial institutions. The annual assessment for
deposit insurance is based on a risk-related premium system. Each insured
institution is assigned to one of three capital groups, well capitalized,
adequately capitalized or under capitalized. Within each capital group,
institutions are assigned to one of three subgroups (A, B, or C) on the basis of
supervisory evaluations by the institution's primary federal supervisor and if
applicable, state supervisor. Assignment to one of the three capital groups,
coupled with assignment to one of three supervisory subgroups, will determine
which of the nine risk classifications is appropriate for an institution.
Institutions are assessed insurance rates based on their assigned risk
classifications. The well capitalized, subgroup "A" category institutions are
assessed the lowest insurance rate, while institutions assigned to the under
capitalized
22
subgroup "C" category are assessed the highest insurance rate. As of December
31, 1998 all banks were assigned to the well-capitalized, subgroup "A" category.
During 1998, Community Bank paid an annual insurance rate of 6.1 cents per $100
of deposits, Heritage Bank paid an annual insurance rate of 1.22 cents per $100
of deposits, while NCF Bank paid an annual insurance rate of $2.98 cents per
$100 of deposits.
In August 1995, the FDIC substantially reduced the deposit insurance
premiums for well-capitalized, well-managed financial institutions that are
members of the BIF. Under the new assessment schedule, approximately 92% of BIF
members paid a minimum assessment of $1,000 per year while SAIF members
continued to be assessed under the existing rate schedule of 23 cents to 31
cents per $100 of insured deposits.
On September 30, 1996, all SAIF member institutions were charged a
one-time assessment to increase SAIF's reserves to $1.25 per $100 of insured
deposits. The aggregate one-time assessment paid by Community Bank and NCF Bank
amounted to $1.3 million with an after tax impact of approximately $779,000.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines, after a hearing, that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations or has violated any applicable law, regulation,
order or any condition imposed by an agreement with the FDIC. The FDIC also may
suspend deposit insurance temporarily for any financial institution during the
hearing process for the permanent termination of insurance, if the Bank has no
tangible capital. If insurance of accounts is terminated, the insured accounts
at the institution at the time of the termination, less subsequent withdrawals,
shall continue to be insured for a period of six months to two years, as
determined by the FDIC.
The FDIC has passed regulations, under the Federal Deposit Insurance
Act, that generally prohibit payments to directors, officers and employees
contingent upon termination of their affiliation with an FDIC-insured
institution or its holding company (i.e., "golden parachute payments") if the
payment is received after or in contemplation of, among other things,
insolvency, a determination that the institution or holding company is in
"troubled condition", or the assignment of a composite examination rating of "4"
or "5" for the institution. Certain types of employee benefit plans are not
subject to the prohibition. The regulations, which are not currently applicable
to the Company, would also generally prohibit certain indemnification payments
regarding any administrative proceeding instituted against a person that results
in a final order pursuant to which the person is assessed civil money penalties
or subjected to other enforcement action. The Company has no such agreements
with any directors or employees.
The Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain reserves against their transaction accounts
and non-personal time deposits. As of December 31, 1998, no reserves were
required to be maintained on the first $4.9 million of transaction accounts,
reserves of 3% were required to be maintained against the next $41.6 million of
net transaction accounts (with such dollar amounts subject to adjustment by the
Federal Reserve Board), and a reserve of 10% (which is subject to adjustment by
the Federal Reserve Board to a level between 8% and 14%) against all remaining
net transaction accounts. Because required reserves must be maintained in the
form of vault cash or a non-interest-bearing account at a Federal Reserve Bank,
the effect of this reserve requirement is to reduce an institution's earning
assets.
Banks are authorized to borrow from the Federal Reserve Bank "discount
window," but Federal Reserve Board regulations require banks to exhaust other
reasonable alternative sources of funds, including FHLB advances, before
borrowing from the Federal Reserve Bank.
Federal Taxation. For federal income tax purposes, the Company and its
subsidiaries file a consolidated federal income tax return on a calendar year
basis. Consolidated returns have the effect of eliminating intercompany
distributions, including dividends, from the computation of consolidated taxable
income for the taxable year in which the distributions occur.
The Company and its subsidiaries are subject to the rules of federal
income taxation generally applicable to corporations under the Internal Revenue
Code of 1986, as amended (the "Code").
The Company is subject to the corporate alternative minimum tax which
is imposed to the extent it exceeds the Company's regular income tax for the
year. The alternative minimum tax will be imposed at the rate of 20 percent of a
specially computed tax base. Included in this base will be a number of
preference items, including the
23
following: (i) 100 percent of the excess of a financial institution's bad debt
deduction over the amount that would have been allowable on the basis of actual
experience; (ii) interest on certain tax-exempt bonds issued after August 7,
1986; and (iii) for years beginning in 1988 and 1989 an amount equal to one-half
of the amount by which a institution's "book income" (as specially defined)
exceeds its taxable income with certain adjustments, including the addition of
preference items (for taxable years commencing after 1989 this adjustment item
is replaced with a new preference item relating to "adjusted current earnings"
as specially computed). In addition, for purposes of the new alternative minimum
tax, the amount of alternative minimum taxable income that may be offset by net
operating losses is limited to 90 percent of alternative minimum taxable income.
The Company has not been audited by the Internal Revenue Service for
the past ten years.
Indiana Taxation. Effective January 1, 1990, the State of Indiana
imposed a franchise tax assessed on the net income (adjusted gross income as
defined in the statute) of financial institutions. The new tax replaced the
gross receipts tax, excise tax and supplemental net income tax imposed prior to
1990. This new financial institution's tax is imposed at the rate of 8.5 percent
of the Company's adjusted gross income. In computing adjusted gross income, no
deductions are allowed for municipal interest, U.S. Government interest and
pre-1990 net operating losses. The Company's state franchise tax returns have
been audited through the tax year ended December 31, 1997.
Personnel
As of December 31, 1998, the Company had 95 full-time employees.
Community employed 36 full-time and 7 part-time employees as of December 31,
1998. Heritage employed 15 full-time and 1 part-time employees as of December
31, 1998. Finally, NCF Bank employed 10 full-time and 1 part-time employees as
of December 31, 1998. None of these entity's employees are represented by a
collective bargaining group. The Company and three subsidiary Banks believe
their respective relationships with their employees to be good.
24
ITEM 2. PROPERTIES
The Company conducts its business through the main office and an
operations center located in New Albany, Indiana, and eight branch offices of
its subsidiaries Community Bank and Heritage Bank located in Clark and Floyd
Counties, Indiana, and two branch offices of its NCF Bank subsidiary in Nelson
County, Kentucky. The following table sets forth certain information concerning
the main offices and each branch office at December 31, 1998. The aggregate net
book value of premises and equipment was $7.9 million at December 31, 1998.
Lease Expiration
Location Year Opened Owned or Leased Date
Community Bank of Southern Indiana:
202 East Spring St. - Main Branch 1937 Owned ---
New Albany, IN 47150
147 East Spring Street - Operations Center 1990 Leased Month to month
New Albany, IN 47150
2626 Charlestown Road 1995 Owned ---
New Albany, IN 47150
480 New Albany Plaza 1974 Leased 1999
New Albany, IN 47130
901 East Highway 131 1981 Owned ---
Clarksville, IN 47130
701 Highlander Point Drive 1990 Owned ---
Floyds Knobs, IN 47119
102 Heritage Square 1992 Owned ---
Sellersburg, IN 47172
Community Bank Shares of Indiana, Inc.:
201 W. Court Ave. 1996 Owned ---
Jeffersonville, IN 47130
Heritage Bank of Southern Indiana:
5112 Highway 62 1997 Owned ---
Jeffersonville, IN 47130
NCF Bank and Trust:
106A West John Rowan Blvd. 1997 Owned ---
Bardstown, KY 40004
119 East Stephen Foster Ave. 1972 Owned ---
Bardstown, KY 40004
ITEM 3. LEGAL PROCEEDINGS
There are various claims and law suits in which the Company or its
subsidiaries are periodically involved, such as claims to enforce liens,
condemnation proceedings on properties in which the Banks hold security
interests, claims involving the making and servicing of real property loans and
other issues incident to the Banks' business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
1998.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
See page 18 of the 1998 Annual Report to Stockholders incorporated
herein as Exhibit 13.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
See pages 7 and 11 of the 1999 Annual Report to Stockholders
incorporated herein as Exhibit 13.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
See pages 6-19 of the 1999 Annual Report to Stockholders incorporated
herein as Exhibit 13.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See pages 16-17 of the 1999 Annual Report to Stockholders incorporated
herein as Exhibit 13.
ITEM 8. FINANCIAL STATEMENTS
See pages 20-44 of the 1999 Annual Report to Stockholders incorporated
herein as Exhibit 13.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
There has been no Current Report on Form 8-K filed within 24 months
prior to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Information concerning Directors and executive officers of the Registrant
is incorporated herein by reference from the Bank's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held on April 23, 1999 a copy of
which will be filed no later than 120 days after the close of the fiscal year.
Steven Stemler, a Director of the Registrant, failed to file Form 5 by
February 15, 1999. The appropriate Form 5 was filed on behalf of Mr. Stemler on
March 9, 1999 and reported 2 transactions: 1) the purchase in the open market of
400 shares of common stock of the Registrant on May 18, 1998 for direct
ownership at $23.50 per share, and 2) the purchase in the open market of 300
shares of common stock of the Registrant on May 19, 1998 for direct ownership at
$23.50 per share. After these transactions, Mr. Stemler's total beneficial
ownership amounted to 1,950 shares of common stock
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference from the Bank's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on April 23, 1999 a copy of which will be filed no later
than 120 days after the close of the fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information concerning security ownership of certain owners and management
is incorporated herein by reference from the Bank's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held on April 23, 1999 a copy of
which will be filed no later than 120 days after the close of the fiscal year.
26
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning relationships and transactions is incorporated
herein by reference from the Bank's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held on April 23, 1999 a copy of which will be
filed no later than 120 days after the close of the fiscal year.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a)(1) Financial Statements
The following information appearing in the Registrant's Annual Report to
Stockholders for the year ended December 31, 1998, is incorporated by reference
in this Annual Report on Form 10-K as Exhibit 13.
Annual Report Section Pages in Annual Report
Selected Financial Data 7, 11
Management's Discussion and Analysis
of Financial Condition and Results
of Operations 6 - 19
Report of Independent Auditor 20
Consolidated Balance Sheets 21
Consolidated Statements of Income 23
Consolidated Statements of Cash Flows 24
Consolidated Statement of
Stockholders' Equity 22
Notes to Consolidated Financial
Statements 25 - 44
(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted as the required
information is inapplicable or has been included in the Notes to Consolidated
Financial Statements.
27
(a) (3) Exhibits
Regulation S-K
Exhibit Number Document
3.1 Articles of Incorporation *
3.2 Bylaws *
4.0 Common Stock Certificate *
10.1 Employment Agreement with Michael L. Douglas
10.2 Stock Option Plan **
10.3 1995 Stock Option adopted by NCF Financial Corporation
13.0 Form of Annual Report to Security Holders
21.0 Subsidiaries of Registrant
27.0 Financial Data Schedule
* Incorporated herein by reference to Registration Statement on Form S-1
dated December 9, 1994, Registration No. 33-87228.
** Incorporated herein by reference to the Definitive Proxy Statement filed
March 25, 1998.
(b) Reports on Form 8-K: No Reports on 8-K were filed during the quarter
ended December 31, 1998.
28
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.
COMMUNITY BANK SHARES OF INDIANA, INC.
Date: March 23, 1999 By: \s\ Michael L. Douglas
----------------------
MICHAEL DOUGLAS
President, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: \s\ C. Thomas Young By: \s\ Timothy T. Shea
-------------------- -------------------
C. THOMAS YOUNG, TIMOTHY T. SHEA,
Chairman of the Board Vice Chairman of the Board
of Directors of Directors
Date: March 23,1999 Date: March 23, 1999
By: \s\ Robert J. Koetter, Sr. By: \s\ Steven Stemler
ROBERT J. KOETTER, SR., STEVEN STEMLER,
Director Director
Date: March 23,1999 Date: March 23,1999
By: \s\ Gary L. Libs By: \s\ Dale L. Orem
GARY L. LIBS, DALE L. OREM,
Director Director
Date: March 23,1999 Date: March 23,1999
By: \s\ James W. Robinson By: \s\ James Stutsman
JAMES W. ROBINSON, JAMES M. STUTSMAN,
Director Senior Vice President
and Chief Financial Officer
Date: March 23, 1999 Date: March 23, 1999
By: \s\ Gordon L. Huncilman By: \s\ M. Diane Murphy
GORDON L. HUNCILMAN, M. DIANE MURPHY,
Director Senior Vice President and
Corporate Secretary
Date: March 23, 1999 Date: March 23, 1999
By: \s\ Kerry M. Stemler By: \s\ Stanley L. Krol
KERRY M. STEMLER, STANLEY L. KROL,
Director Chief of Operations
Date: March 23,1999 Date: March 23, 1999
By: \s\ Robert E. Yates
ROBERT E. YATES,
Director
Date: March 23,1999
29