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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 2002 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to
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Commission file number 0-49771
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Merchants Bancorp, Inc.
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(Exact name of registrant as specified in its Charter.)
Ohio 31-1467303
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(State or other jurisdiction of incorporation or organization) (IRS) Employer Identification No.)
100 North High Street, Hillsboro, Ohio 45133
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(Address of principal executive offices) (ZIP Code)
(937) 393-1993
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title Of Each Class Name of Each Exchange On Which Registered
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Securities registered pursuant to Section 12(g) of the Act:
Common Shares
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(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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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. [X]
1
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes No X
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State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter. $62,433,000
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Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 3,000,000 common shares
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DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the part
of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) any annual report to security holders; (2) any proxy or
information statement; and (3) any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980).
Portions of the Company's Proxy Statement to shareholders in connection with the
2003 annual meeting of shareholders are incorporated by reference into Part III
of this Report on Form 10-K.
2
PART I
ITEM 1. BUSINESS
General
Merchants Bancorp, Inc. (the "Company") was incorporated under the laws
of the State of Ohio on March 29, 1996 at the direction of the Board of
Directors of the Merchants National Bank (the "Bank") for the purpose of
becoming a bank holding company by acquiring all of the outstanding shares of
the Bank. In December, 1996 the Company became the sole shareholder of the Bank.
The principal office of the Company is located at 100 North High Street,
Hillsboro, Ohio 45133. Hillsboro, situated in south central Ohio, is centrally
located between the cities of Columbus, Cincinnati and Dayton, and is the county
seat of Highland County. Highland County has a population of approximately
41,000. The company, through its banking affiliate, also conducts business in
the neighboring counties of Madison and Fayette, which have populations of
approximately 40,000 and 28,000 respectively.
This tri-county area is primarily agricultural. Madison County is one
of Ohio's principal producers of corn and soybeans, and Fayette County is a
significant horsebreeding area. However, manufacturing also provides a
significant source of employment in the area, accounting for approximately 30%
of all jobs in the three counties. Area manufacturers produce a wide array of
products, including textiles, electrical components and automotive parts. Some
of the area's principal manufacturers include the Hobart Corp., Johnson
Controls, Inc., the Showa Aluminum Corp., Yamashita Rubber and Calmas, Inc. The
Bank has operated in Hillsboro, Ohio as a national banking association since its
charter was granted on December 26, 1879.
The Company, through its banking affiliate, offers a broad range of
banking services to the commercial, industrial and consumer market segments
which it serves. The primary business of the Bank consists of accepting deposits
through various consumer and commercial deposit products, and using such
deposits to fund various loan products. The Bank's primary loan products (and
the general terms for each) are as follows: (1) loans secured by residential
real estate, including loans for the purchase of one to four family residences
which are secured by 1st and 2nd mortgages (15 to 30 year terms with fixed and
adjustable rate options) and home equity loans (10 year maturities tied to prime
rate); (2) consumer loans, including new and used automobile loans (up to 60
months), loans for the purchase of mobile homes (10 to 15 year terms) and debt
consolidation loans (exact terms depending upon available collateral); (3)
agricultural loans, including loans for the purchase of real estate used in
connection with agricultural purposes (15 to 30 year terms), operating loans (1
year terms) and loans for the purchase of equipment (5 to 7 year terms); and (4)
commercial loans, including loans for the purchase of real estate used in
connection with office or retail activities (15 to 20 year terms), loans for the
purchase of equipment (7 to 10 year terms) and loans for the purchase of
inventory (1 year terms).
The primary risks inherent in any type of lending include interest rate
risk and credit risk associated with the credit quality of individual borrowers.
For further information regarding interest rate risk, see the section captioned
"Market Risk Management" under "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Credit risk is generally offset
both through the use of security and mortgage interests, and through the
implementation of designated loan approval processes. Senior mortgages in real
estate provide the greatest protection in the event of borrower default, while
junior mortgages and security interests in depreciating assets provide somewhat
less protection. Loans not secured by real or personal property present the
greatest risk of loss upon default. All loans, whether secured or unsecured, are
approved in accordance with a loan policy adopted by the Company's Board of
Directors. While loan officers do have authority to make credit decisions
outside of the parameters of the Board's loan policy, such loan officers must
satisfy designated documentation
3
requirements when doing so. Credit risk is further mitigated both by restricting
the types of loans and by establishing maximum amounts which can be approved by
individual loan officers. Loans made beyond these individual limitations must be
affirmatively approved by a committee comprised of loan officers. The Bank also
engages in certain government guarantee programs, which help to reduce the risk
inherent in certain types of loans.
All of the Bank's deposit and lending services are available at its
four full service offices. The remaining three offices of the Bank are engaged
primarily in deposit-related services. The Company has no foreign operations,
assets or investments.
The Bank is a national banking association organized under the laws of
the United States. The Bank is regulated by the Office of the Comptroller of the
Currency ("OCC"), and its deposits are insured by the Federal Deposit Insurance
Company ("FDIC") to the extent permitted by law and, as a subsidiary of the
Company, is regulated by the Board of Governors of the Federal Reserve. As of
December 31, 2002, the Company and its subsidiary had consolidated total assets
of approximately $319 million, consolidated total deposits of approximately $263
million and consolidated total shareholders' equity of approximately $33.5
million.
Employees
As of December 31, 2002, the Bank had 84 full-time and 9 part-time
employees. The Bank provides a number of benefits for its full-time employees,
including health and life insurance, pension, profit sharing and 401(k) plans,
workers' compensation, social security, paid vacations, and certain bank
services.
Competition
The Bank's market consists of the following Ohio Counties: Fayette;
Highland; and Madison. The commercial banking business in this market is very
competitive. The Company and the Bank are in competition with other commercial
banks operating in the primary market area. Some competitors of the Company and
the Bank are substantially larger than the Bank. In addition to local bank
competition, the Bank competes with larger commercial banks headquartered in
metropolitan areas, savings banks, savings and loan associations, credit unions,
finance companies and other financial institutions for loans and deposits.
Pursuant to Deposit Market Share statistical information compiled by
the Federal Deposit Insurance Corporation, there are approximately twenty (20)
financial institutions operating in the Bank's market. As of June 30, 2002 (the
most recent date for which the compiled statistical information is available)
the Bank possessed the second largest market share with $247 million in total
deposits, representing a market share of approximately 17.9%. Three other
depositary institutions also possess over 10% of the market share in the Bank's
market.
The principal methods of competition within the financial services
industry include improving customer service through the quality and range of
services provided, improving efficiencies, and pricing services competitively.
The Bank views its primary competitive advantages as being the provider of
outstanding customer service and maintaining strong relationships with its core
customer base. Rarely does the Bank offer the highest rates on deposit accounts
or the lowest rates on loans. Fees and service charges are priced to meet the
competition. The Bank believes that its distinguishing characteristics are
knowing its customers, offering quality customer service and timely loan
decisions and closings. By focusing on these key attributes, the Bank has built
a loyal customer base, which also serves as its greatest source of new business
by way of customer referrals.
4
SUPERVISION AND REGULATION
General
Merchants Bancorp, Inc. is a corporation organized under the laws of
the State of Ohio. The business in which the Company and its subsidiary are
engaged is subject to extensive supervision, regulation and examination by
various bank regulatory authorities. The supervision, regulation and examination
to which the Company and its subsidiary are subject are intended primarily for
the protection of depositors and the deposit insurance funds that insure the
deposits of banks, rather than for the protection of shareholders.
Several of the more significant regulatory provisions applicable to
banks and bank holding companies to which the Company and its subsidiary are
subject are discussed below, along with certain regulatory matters concerning
the Company and its subsidiary. To the extent that the following information
describes statutory or regulatory provisions, it is qualified in its entirety by
reference to the particular statutory provisions. Any change in applicable law
or regulation may have a material effect on the business and prospects of the
Company and its subsidiary.
Regulatory Agencies
The Company, upon approval from the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board"), became a bank holding company on
December 31, 1996, and continues to be subject to regulation under the Bank
Holding Company Act of 1956 and to inspection, examination and supervision by
the Federal Reserve Board.
The Bank is a national banking association chartered under the laws of
the United States of America. It is subject to regulation and examination
primarily by the Office of the Comptroller of the Currency (the "OCC") and
secondarily by the Federal Reserve Board and the FDIC.
Holding Company Activities
As a bank holding company incorporated and doing business within the
State of Ohio, the Company is subject to regulation and supervision under the
Bank Holding Act of 1956, as amended (the "Act"). The Company is required to
file with the Federal Reserve Board on a quarterly basis information pursuant to
the Act. The Federal Reserve Board may conduct examinations or inspections of
the Company and its subsidiary.
The Company is required to obtain prior approval from the Federal
Reserve Board for the acquisition of more than five percent of the voting shares
or substantially all of the assets of any bank or bank holding company. In
addition, the Company is generally prohibited by the Act from acquiring direct
or indirect ownership or control of more than five percent of the voting shares
of any company which is not a bank or bank holding company and from engaging
directly or indirectly in activities other than those of banking, managing or
controlling banks or furnishing services to its subsidiaries. The Company may,
however, subject to the prior approval of the Federal Reserve Board, engage in,
or acquire shares of companies engaged in activities which are deemed by the
Federal Reserve Board by order or by regulation to be so closely related to
banking or managing and controlling a bank as to be a proper activity.
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted
into law. The GLB Act made sweeping changes with respect to the permissible
financial services which various
5
types of financial institutions may now provide. The Glass-Steagall Act, which
had generally prevented banks from affiliation with securities and insurance
firms, was repealed. Pursuant to the GLB Act, bank holding companies may elect
to become a "financial holding company," provided that all of the depository
institution subsidiaries of the bank holding company are "well capitalized" and
"well managed" under applicable regulatory standards.
Under the GLB Act, a bank holding company that has elected to become a
financial holding company may affiliate with securities firms and insurance
companies and engage in other activities that are financial in nature.
Activities that are "financial in nature" include securities underwriting,
dealing and market-making, sponsoring mutual funds and investment companies,
insurance underwriting and agency, merchant banking, and activities that the
Federal Reserve Board has determined to be closely related to banking. No
Federal Reserve Board approval is required for the Company to acquire a company,
other than a bank holding company, bank or savings association, engaged in
activities that are financial in nature or incidental to activities that are
financial in nature, as determined by the Federal Reserve Board. Prior Federal
Reserve Board approval is required before the Company may acquire the beneficial
ownership or control of more than 5% of the voting shares, or substantially all
of the assets, of a bank holding company, bank or savings association. If any
subsidiary bank of the Company ceases to be "well capitalized" or "well managed"
under applicable regulatory standards, the Federal Reserve Board may, among
other actions, order the Company to divest the subsidiary bank. Alternatively,
the Company may elect to conform its activities to those permissible for a bank
holding company that is not also a financial holding company. If any subsidiary
bank of the Company receives a rating under the Community Reinvestment Act of
1977 of less than satisfactory, the Company will be prohibited from engaging in
new activities or acquiring companies other than bank holding companies, banks
or savings associations. The Company has not elected to become a financial
holding company and has no current intention of making such an election.
Affiliate Transactions
Various governmental requirements, including Sections 23A and 23B of
the Federal Reserve Act, limit borrowings by holding companies and non-bank
subsidiaries from affiliated insured depository institutions, and also limit
various other transactions between holding companies and their non-bank
subsidiaries, on the one hand, and their affiliated insured depository
institutions on the other. Section 23A of the Federal Reserve Act also generally
requires that an insured depository institution's loan to its non-bank
affiliates be secured, and Section 23B of the Federal Reserve Act generally
requires that an insured depository institution's transactions with its non-bank
affiliates be on arms-length terms.
Interstate Banking and Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act
("Riegle-Neal"), subject to certain concentration limits and other requirements,
bank holding companies such as the Company are permitted to acquire banks and
bank holding companies located in any state. Any bank that is a subsidiary of a
bank holding company is permitted to receive deposits, renew time deposits,
close loans, service loans and receive loan payments as an agent for any other
bank subsidiary of that bank holding company. Banks are permitted to acquire
branch offices outside their home states by merging with out-of-state banks,
purchasing branches in other states and establishing de novo branch offices in
other states, The ability of banks to acquire branch offices is contingent,
however, on the host state having adopted legislation "opting in" to those
provisions of Riegle-Neal. In addition, the ability of a bank to merge with a
bank located in another state is contingent on the host state not having adopted
legislation "opting out" of that provision of Riegle-Neal. The Company could
from time to time use Riegle-Neal to acquire banks in additional states.
6
Control Acquisitions
The Change in Bank Control Act prohibits a person or group of persons
from acquiring "control" of a bank holding company, unless the Federal Reserve
Board has been notified and has not objected to the transaction. Under the
rebuttable presumption established by the Federal Reserve Board, the acquisition
of 10% or more of a class of voting stock of a bank holding company with a class
of securities registered under Section 12 of the Exchange Act, such as the
Company, would, under the circumstances set forth in the presumption, constitute
acquisition of control of the bank holding company. In addition, a company is
required to obtain the approval of the Federal Reserve Board under the Bank
Holding Company Act before acquiring 25% (5% in the case of an acquiror that is
a bank holding company) or more of any class of outstanding voting stock of a
bank holding company, or otherwise obtaining control or a "controlling
influence" over that bank holding company.
Liability for Banking Subsidiaries
Under the current Federal Reserve Board policy, a bank holding company
is expected to act as a source of financial and managerial strength to each of
its subsidiary banks and to maintain resources adequate to support each
subsidiary bank. This support may be required at times when the bank holding
company may not have the resources to provide it. In the event of a bank holding
company's bankruptcy, any commitment by the bank holding company to a U.S.
federal bank regulatory agency to maintain the capital of a subsidiary bank
would be assumed by the bankruptcy trustee and entitled to priority of payment.
Any depository institution insured by the FDIC can be held liable for any loss
incurred, or reasonably expected to be incurred, by the FDIC in connection with
(1) the "default" of a commonly controlled FDIC-insured depository institution;
or (2) any assistance provided by the FDIC to both a commonly controlled
FDIC-insured depository institution "in danger of default." The Company's
subsidiary bank is an FDIC-insured depository institution. If a default occurred
with respect to the Bank, any capital loans to the Bank from its parent holding
company would be subordinate in right of payment to payment of the Bank's
depositors and certain of its other obligations.
Regulatory Capital Requirements
The Company is required by the various regulatory authorities to
maintain certain capital levels. Bank holding companies are required to maintain
minimum levels of capital in accordance with Federal Reserve capital adequacy
guidelines. If capital falls below minimum guideline levels, a bank holding
company, among other things, may be denied approval to acquire or establish
additional banks or non-bank businesses. The required capital levels and the
Company's capital position at December 31, 2002 are summarized in the table
included in Note 13 to the consolidated financial statements.
FDICIA
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
and the regulations promulgated under FDICIA, among other things, established
five capital categories for insured depository institutions-well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized-and requires U.S. federal bank regulatory agencies
to implement systems for "prompt corrective action" for insured depository
institutions that do not meet minimum capital requirements based on these
categories. Unless a bank is well capitalized, it is subject to restrictions on
its ability to offer brokered deposits and on certain other aspects of its
operations. An undercapitalized bank must develop a capital restoration plan and
its parent bank holding company must guarantee the bank's compliance with the
plan up to the lesser of 5% of the bank's or thrift's assets at the time it
became undercapitalized and the amount needed to comply with the plan. As of
December 31,
7
2002, the Company's banking subsidiary was well capitalized pursuant to these
prompt corrective action guidelines.
Dividend Restrictions
The ability of the Company to obtain funds for the payment of dividends
and for other cash requirements will be largely dependent on the amount of
dividends which may be declared by its banking subsidiary. Various U.S. federal
statutory provisions limit the amount of dividends the Company's banking
subsidiaries can pay to the Company without regulatory approval. Dividend
payments by national banks are limited to the lesser of (1) the level of
undivided profits; (2) the amount in excess of which the bank ceases to be at
least adequately capitalized; and (3) absent regulatory approval, an amount not
in excess of net income for the current year combined with retained net income
for the preceding two years.
In addition, U.S. federal bank regulatory authorities have authority to
prohibit the Company's banking subsidiary from engaging in an unsafe or unsound
practice in conducting their business. The payment of dividends, depending upon
the financial condition of the bank in question, could be deemed to constitute
an unsafe or unsound practice. The ability of the Company's banking subsidiary
to pay dividends in the future is currently, and could be further, influenced by
bank regulatory policies and capital guidelines.
Deposit Insurance Assessments
The deposits of the Company's banking subsidiary are insured up to
regulatory limits by the FDIC, and, accordingly, are subject to deposit
insurance assessments to maintain the Bank Insurance Fund (the "BIF") and/or the
Savings Association Insurance Fund (the "SAIF") administered by the FDIC.
Depositor Preference Statute
In the "liquidation or other resolution" of an institution by any
receiver, U.S. federal legislation provides that deposits and certain claims for
administrative expenses and employee compensation against the insured depository
institution would be afforded a priority over general unsecured claims against
that institution, including federal funds and letters of credit.
Government Monetary Policy
The earnings of the Company are affected primarily by general economic
conditions, and to a lesser extent by the fiscal and monetary policies of the
federal government and its agencies, particularly the Federal Reserve. Its
policies influence, to some degree, the volume of bank loans and deposits, and
interest rates charged and paid thereon, and thus have an effect on the earnings
of the Company's subsidiary Bank.
Additional Regulation
The Bank is also subject to federal regulation as to such matters as
required reserves, limitation as to the nature and amount of its loans and
investments, regulatory approval of any merger or consolidation, issuance or
retirement of their own securities, limitations upon the payment of dividends
and other aspects of banking operations. In addition, the activities and
operations of the Bank are subject to a number of additional detailed, complex
and sometimes overlapping laws and regulations. These include state usury and
consumer credit laws, state laws relating to fiduciaries, the Federal
Truth-in-Lending Act and
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Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the
Fair Credit Reporting Act, the Truth in Savings Act, the Community Reinvestment
Act, anti-redlining legislation and antitrust laws.
Future Legislation
Changes to the laws and regulations, both at the federal level and in
the states where the Company and its subsidiary do business, can affect the
operating environment of the Company and its subsidiary in substantial and
unpredictable ways. The Company cannot accurately predict whether those changes
in laws and regulations will occur, and, if those changes occur, the ultimate
effect they would have upon the financial condition or results of operations of
the Company or its subsidiary.
ITEM 2. PROPERTIES.
The Bank owns the real property used in its business as follows:
Main Office: Greenfield Main
100 N. High Street 117 S. Washington Street
Hillsboro, Ohio 45133 Greenfield, Ohio 45123
Hillsboro Branch Greenfield Branch
1478 N. High Street 102 Jefferson Street
Hillsboro, Ohio 45133 Greenfield, Ohio 45123
Hillsboro Uptown Branch Washington Court House Branch
145 W. Beech Street 128 S. North Street
Hillsboro, Ohio 45133 Washington Court House, Ohio 43160
London Branch
279 LaFayette Street
London, Ohio 43140
All such properties are suitable for carrying on the general business
of commercial banking. No such properties are subject to any material
encumbrance.
ITEM 3. LEGAL PROCEEDINGS.
Currently, there are no legal proceedings of a material nature pending
to which either the Company or the Bank is a party, or to which any of their
property is the subject. Additionally, management of the Company is not aware of
the contemplation of any proceedings the institution of which would have a
material adverse impact upon the financial condition of the Company or the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There was no matter submitted during the fourth quarter of the fiscal
year covered by this report to a vote of the Company's security holders.
9
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.
a. Market Information
There is no established public trading market for the Company's common
stock and the shares of the Company are not listed on any exchange. Sale price
information provided below on a quarterly basis for the two most recent fiscal
years is based on information reported to the Company by individual buyers and
sellers of the Company's stock, based on actual transactions of which
information was obtained at the time of transfer. Not all sales transaction
information during these periods was obtained.
2002
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First Quarter Second Quarter Third Quarter Fourth Quarter
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High Low High Low High Low High Low
$28.00 $26.50 $28.06 $20.00 $25.00 $21.00 $26.00 $20.00
2001
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First Quarter(1) Second Quarter Third Quarter Fourth Quarter
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High Low High Low High Low High Low
$27.00 $25.00 $30.00 $26.66 $30.00 $26.00 $31.00 $26.00
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(1) Adjusted to reflect a 3 for 1 stock split effective March 5, 2001.
The Company currently has 3,000,000 shares of common stock outstanding.
All of such shares are eligible for sale in the open market without restriction
or registration under the Securities Act of 1933, as amended (the "Securities
Act"), except for shares held by "affiliates" of the Company. Shares held by
affiliates are subject to the resale limitations of Rule 144, as promulgated
under the Securities Act. For purposes of Rule 144, "affiliates" are deemed to
be all Directors, Executive Officers and ten percent beneficial owners of the
Company. As of December 31, 2002, affiliates of the Company had beneficial
ownership of an aggregate of 502,669 shares of the Company's common stock. The
Company has one shareholder with beneficial ownership of more than ten percent
of its outstanding shares, and such individual is also a Director of the
Company.
Rule 144 subjects affiliates to certain restrictions in connection with
the resale of Company securities that do not apply to individuals currently
holding outstanding shares of Company stock. Commencing ninety days after the
effective date of this Registration Statement, affiliates of the Company may
sell within any three-month period a number of shares that does not exceed the
greater of one percent of the number of then outstanding shares of Company
common stock, or the average weekly trading volume of the common stock in the
over-the-counter market during the four calendar weeks preceding filing by the
selling affiliate of the requisite notice of sale with the SEC on Form 144.
Sales under Rule 144 are also subject to certain requirements as to the manner
of sale, notice to the Securities and Exchange Commission, and the availability
of current public information about the Company.
The Company has no outstanding options or warrants to purchase shares
of its common stock or securities convertible into shares of common stock.
b. Holders
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The number of holders of record of the Company's common stock at
December 31, 2002 was 743.
c. Dividends
Dividends are generally declared by the Board of Directors of the
Company semiannually (June 30 and December 31, respectively). Dividends per
share declared by the Company on its common stock during the years of 2002 and
2001 are as follows:
2002 2001
Month
June $0.28 $0.24
December $0.32 $0.28
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TOTALS $0.60 $0.52
===== =====
The Company currently expects that comparable semiannual cash dividends
will continue to be paid in the future. For information on regulatory
restrictions to the Board's ability to declare and pay dividends, please refer
to the following: (1) Supervision and Regulation -- Dividend Restrictions and
(2) Note 13 to the Company's Consolidated Financial Statements, Regulatory
Matters.
The Company's Quarterly Financial Data for 2002 and 2001 follows:
Three months ended
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(in thousands, except per share data) March 31 June 30 Sept 30 Dec 31
- ---------------------------------------------------------------------------------------------------------------------
2002
Net interest income $2,926 $3,296 $ 3,483 $ 3,267
Provision for loan losses 84 145 138 69
Noninterest income 352 379 400 378
Noninterest expense 1,735 1,797 1,887 1,691
Net income $ 995 $1,178 $ 1,255 $ 1,344
Per common share:
Basic and diluted earnings per share $ 0.33 $ 0.39 $ 0.42 $ 0.45
Dividends declared $ -- $ 0.28 $ -- $ 0.32
Selected ratios:
Return on average assets, annualized 1.31% 1.57% 1.63% 1.69%
Return on average common equity, annualized 13.00% 14.97% 15.76% 16.22%
Net interest margin, annualized 4.40% 4.71% 4.83% 4.52%
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2001
Net interest income $ 2,889 $ 2,967 $ 3,004 $ 2,778
Provision for loan losses 49 67 52 9
Noninterest income 313 347 388 424
Noninterest expense
1,661 1,563 1,661 1,691
Net income
$ 1,027 $ 1,153 $ 1,142 $ 1,083
Per common share:
Basic and diluted earnings per share $ 0.34 $ 0.38 $ 0.38 $ 0.37
Dividends declared $ -- $ 0.24 $ -- $ 0.28
Selected ratios:
Return on average assets, annualized 1.48% 1.63% 1.57% 1.45%
Return on average common equity, annualized 15.07% 16.14% 15.73% 14.35%
Net interest margin, annualized 4.44% 4.51% 4.55% 4.24%
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth certain information derived from the
consolidated financial information of the Company for each of the years as of
December 31 (in thousands, except per share data).
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SELECTED FINANCIAL DATA
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2002 2001 2000 1999 1998
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Interest and loan fee income $ 20,866 $ 22,431 $ 21,603 $ 18,427 $ 16,926
Interest expense 7,894 10,793 10,395 8,088 7,529
Net interest income 12,972 11,638 11,208 10,339 9,397
Provision for loan losses 436 177 177 130 315
Net interest income after provision for loan losses 12,536 11,461 11,031 10,209 9,082
Noninterest income 1,509 1,472 1,269 1,094 1,019
Noninterest expense 7,110 6,576 6,131 5,762 5,023
Income before income taxes 6,935 6,357 6,169 5,541 5,078
Income taxes 2,163 1,952 1,964 1,765 1,574
Net income 4,772 4,405 4,205 3,776 3,504
YEAR-END BALANCES
Assets $318,799 $304,896 $278,734 $246,923 $227,170
Securities 40,012 38,221 37,753 40,661 38,157
Loans, net 246,164 221,767 220,460 184,963 166,252
Deposits 262,716 262,608 236,046 216,857 193,098
Short Term Borrowings 3,365 1,424 1,887 1,172 2,771
Federal Home Loan Bank advances 17,470 8,993 7,000 4,000 8,000
Shareholders' equity 33,508 30,232 27,114 23,579 21,926
AVERAGE BALANCES
Assets $308,488 $288,236 $265,957 $238,980 $227,000
Securities 45,511 37,245 40,639 38,789 39,827
Loans 237,788 227,150 210,325 176,738 157,838
Deposits 253,869 246,919 231,047 205,329 180,748
Short-term borrowings 3,158 1,996 2,150 1,986 4,048
Federal Home Loan Bank advances 17,649 8,285 6,403 7,879 11,507
Shareholders' equity 32,384 29,357 25,523 23,148 21,215
SELECTED FINANCIAL RATIOS
Net interest margin (tax equivalent) 4.63% 4.37% 4.55% 4.66% 4.70%
Return on average assets 1.55% 1.53% 1.58% 1.58% 1.54%
Return on average equity 14.74% 15.00% 16.48% 16.31% 16.52%
Average equity to average assets 10.50% 10.19% 9.60% 9.69% 9.35%
Dividend payout ratio 37.72% 35.41% 32.10% 33.10% 61.35%
Ratio of nonperforming loans to total loans 0.19% 0.17% 0.14% 0.13% 0.04%
Ratio of loan loss allowance to total loans 0.85% 0.88% 0.86% 1.02% 1.14%
Ratio of loan loss allowance to nonperforming loans 442% 512% 599% 781% 3185%
Basic earnings per share(1) $ 1.59 $ 1.47 $ 1.40 $ 1.26 $ 1.17
Diluted earnings per share(1) $ 1.59 $ 1.47 $ 1.40 $ 1.26 $ 1.17
Dividends declared per share(1) $ 0.60 $ 0.52 $ 0.45 $ 0.42 $ 0.72
Efficiency ratio(2) 49.10% 50.16% 49.13% 50.41% 48.22%
- --------------------------------------------------------------------------------
(1) Per share amounts have been retroactively restated to reflect the 3 for 1
stock split in 2001.
(2) Computed by dividing noninterest expense by the sum of net interest income
and noninterest income.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis comparing 2002 to prior years
should be read in conjunction with the audited consolidated financial statements
at December 31, 2002 and 2001 and for the three years ended December 31, 2002.
In addition to the historical information contained herein with respect to the
Company, the following discussion contains forward-looking statements that
involve risks and uncertainties. Economic circumstances, the Company's operation
and the Company's actual results could differ significantly from those discussed
in the forward-looking statements. Forward-looking statements are typically
identified by words or phrases such as "believe," "expect," "anticipate,"
"intend," "estimate," "may increase," "may fluctuate," and similar expressions
or future or conditional verbs such as "will," "should," "would" and "could."
These forward-looking statements involve risks and uncertainties including, but
not limited to, economic conditions, portfolio growth, the credit performance of
the portfolios, including bankruptcies, and seasonal factors; changes in general
economic conditions including the performance of financial markets, the prices
of crops, prevailing inflation and interest rates, and losses on lending
activities; results of various investment activities; the effects of
competitors' pricing policies, of changes in laws and regulations on competition
and of demographic changes on target market populations' savings and financial
planning needs; industry changes in information technology systems on which we
are dependent; and the resolution of legal proceedings and related matters. In
addition, the policies and regulations of the various regulatory authorities
could affect the Company's results. These statements are representative only on
the date hereof, and the Company undertakes no obligation to update any
forward-looking statements made.
Critical Accounting Policies
Management believes that the determination of the allowance for loan
losses represents a critical accounting policy. The Company maintains an
allowance for loan losses to absorb probable loan losses inherent in the
portfolio. The allowance for loan losses is maintained at a level management
considers to be adequate to absorb probable loan losses inherent in the
portfolio, based on evaluations of the collectibility and historical loss
experience of loans. Credit losses are charged and recoveries are credited to
the allowance. Provisions for loan losses are based on management's review of
the historical loan loss experience and such factors which, in management's
judgment, deserve consideration under existing economic conditions in estimating
probable credit losses. The allowance is based on ongoing assessments of the
probable estimated losses inherent in the loan portfolio. The Company's
methodology for assessing the appropriate allowance level consists of several
key elements, as described below.
Larger commercial loans that exhibit probable or observed credit
weaknesses are subject to individual review. Where appropriate, reserves are
allocated to individual loans based on management's estimate of the borrower's
ability to repay the loan given the availability of collateral, other sources of
cash flow and available legal options. Included in the review of individual
loans are those that are impaired as provided in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan," as amended. Any specific reserves for impaired loans are measured based
on the fair value of the underlying collateral. The Company evaluates the
collectibility of both principal and interest when assessing the need for a
specific reserve. Historical loss rates are applied to other commercial loans
not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage
loans, are not individually reviewed for impairment by management. Reserves are
established for each pool of loans based on the expected net charge-offs. Loss
rates are based on the average five-year net charge-off history by loan
category.
14
Historical loss rates for commercial and consumer loans may be adjusted
for significant factors that, in management's judgment, reflect the impact of
any current conditions on loss recognition. Factors which management considers
in the analysis include the effects of the local economy, trends in the nature
and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans),
changes in the internal lending policies and credit standards, collection
practices, and examination results from bank regulatory agencies and the
Company's internal credit review function.
An unallocated reserve is maintained to recognize the imprecision in
estimating and measuring loss when evaluating reserves for individual loans or
pools of loans.
Specific reserves on individual loans and historical loss rates are
reviewed throughout the year and adjusted as necessary based on changing
borrower and/or collateral conditions and actual collection and charge-off
experience.
The Company has not substantively changed any aspect of its overall
approach in the determination of the allowance for loan losses since January 1,
2002. There have been no material changes in assumptions or estimation
techniques as compared to prior years that impacted the determination of the
current year allowance.
Based on the procedures discussed above, management believes the
allowance for loan losses was adequate to absorb estimated loan losses
associated with the loan portfolio at December 31, 2002. See further information
regarding the allowance for loan losses in Notes 1 and 4 of the Notes to the
consolidated financial statements.
I. RESULTS OF OPERATIONS
Overview
Net income for 2002 was $4.8 million, an increase of 8.3% from 2001 net
income of $4.4 million, which was an increase of 4.8% over 2000 net income of
$4.2 million. Net income per share was $1.59 in 2002, compared to $1.47 in 2001,
and $1.40 in 2000. The increase between years is primarily due to increases in
net interest income year over year and increased service charges and fees
received from deposit accounts. Net interest income before the provision for
loan losses increased to $13.0 million in 2002, from $11.6 million in 2001 and
$11.2 million in 2000, representing an increase of 11.5% and 3.6% in 2002 and
2001, respectively. The provision for loan losses was $436,000, $177,000, and
$177,000 in 2002, 2001 and 2000, respectively. Noninterest income was $1.5
million in 2002 and 2001, which was an increase of 15.4% from $1.3 million in
2000. Noninterest expense increased 8.1%, to $7.1 million for 2002, from $6.6
million in 2001, which was an increase of 8.2% from $6.1 million in 2000.
Selected Statistical Information
The following tables set forth certain statistical information relating
to the Company and its subsidiary on a consolidated basis and should be read
together with the consolidated financial statements of the Company.
CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND
YIELDS/RATES
The following table presents the daily average balance of each category of
interest-earning assets and interest-bearing liabilities, and the interest
earned or paid on such amounts (dollars in thousands).
15
CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND
YIELDS/RATES (IN THOUSANDS)
---------------------------------------------------------------------------------------------
2002 2001 2000
---------------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
----------------------------- ------------------------------ ----------------------------
Interest-earning assets:
Loans (1)(2)(3) $ 237,788 $ 18,520 7.79% $ 227,150 $ 20,033 8.82% $ 210,325 $ 18,930 9.00%
Securities available for sale (3) 43,420 2,648 6.10% 35,264 2,348 6.66% 38,788 2,717 7.00%
FHLB and FRB stock 2,091 98 4.69% 1,981 132 6.66% 1,851 135 7.29%
Interest-bearing deposits 1,553 27 1.74% 628 5 0.80% 15 1 0.50%
Federal funds sold 6,748 92 1.36% 7,697 203 2.64% 1,678 99 5.90%
----------------------------- ------------------------------ ----------------------------
Total interest-earning assets 291,600 21,385 7.33% 272,720 22,721 8.33% 252,657 21,882 8.66%
----------------------------- ------------------------------ ----------------------------
Noninterest-earning assets 18,950 17,483 15,231
Less: Allowance for loan losses (2,062) (1,967) (1,931)
---------- ---------- ----------
Total assets $ 308,488 $ 288,236 $ 265,957
========== ========== ==========
Interest-bearing liabilities:
Interest-bearing demand deposits $ 68,787 $ 1,379 2.00% $ 57,938 $ 1,636 2.82% $ 52,602 $ 1,541 2.93%
Savings deposits 20,759 348 1.68% 17,090 377 2.21% 16,288 391 2.40%
Time deposits > $100 27,798 1,004 3.61% 31,690 1,689 5.33% 30,752 1,709 5.56%
Other time deposits 107,565 4,169 3.88% 114,803 6,529 5.69% 106,412 6,277 5.90%
Securities sold under repo agreemt. 2,088 91 4.36% 1,494 85 5.69% 1,279 70 5.47%
Federal funds purchased 1,070 21 1.96% 502 31 6.18% 871 59 6.77%
Federal Home Loan Bank advances 17,649 882 5.00% 8,285 446 5.38% 6,403 348 5.43%
----------------------------- ------------------------------ ----------------------------
Total interest-bearing liabilities 245,716 7,894 3.21% 231,802 10,793 4.66% 214,607 10,395 4.84%
----------------------------- ------------------------------ ----------------------------
Noninterest-bearing liabilities:
Demand deposits 28,960 25,398 24,993
Other liabilities 1,428 1,679 834
Shareholders' equity 32,384 29,357 25,523
---------- ---------- ----------
Total liabilities and shareholders'
equity $ 308,488 $ 288,236 $ 265,957
========== ========== ==========
Net interest income $ 13,491 $ 11,928 $ 11,487
========== ========== ==========
Net interest spread (4) 4.12% 3.67% 3.82%
========= ========== ========
Net interest margin (5) 4.63% 4.37% 4.55%
========= ========== ========
(1) Nonaccrual loans are included in loan totals and do not have a significant
impact on the information presented. Interest on nonaccrual loans is
recorded when received.
(2) Interest includes fees on loans of $675, $590, and $483, in 2002, 2001,and
2000, respectively.
(3) Tax-exempt income on loans and securities is reported on a fully taxable
equivalent basis using a 34% rate.
(4) Net interest spread represents the difference between the average yield on
interest-earning assets and the average rate on interest-bearing
liabilities.
(5) Net interest margin represents the net interest income as a percentage of
average interest earning assets.
16
NET INTEREST DIFFERENTIAL
The following table illustrates the summary of the changes in interest
earned and interest paid resulting from changes in volume and rates for the
major components of interest-earning assets and interest-bearing liabilities on
a fully taxable equivalent basis for the periods indicated (dollars in
thousands).
Change Change Total Change Due Change Total
Due to Due to Changes to Due to Changes
Volume Rate 2002/2001 Volume Rate 2001/2000
---------------------------------------------------------------------------------------------
INTEREST INCOME ATTRIBUTABLE TO:
Loans $938 $(2,451) $(1,513) $1,514 (411) $1,103
Securities available for sale 543 (243) 300 (247) (122) (369)
FHLB and FRB Stock 7 (41) (34) 9 (12) (3)
Interest-bearing deposits 7 15 22 41 (37) 4
Federal funds sold (25) (86) (111) 351 (247) 104
---------------------------------------------------------------------------------------------
Total interest income 1,470 (2,806) (1,336) 1,668 (829) 839
INTEREST EXPENSE ATTRIBUTABLE TO:
Demand deposits 306 (563) (257) 156 (61) 95
Savings deposits 81 (110) (29) 19 (33) (14)
Time deposits (624) (2,421) 543 (311) 232
(3,045)
Securities sold under repo agreement 34 (28) 6 12 3 15
Federal funds purchased 35 (45) (10) (3) (28)
(25)
Federal Home Loan Bank advances 511 (75) 436 102 (4) 98
Total interest expense 343 (3,242) (2,899) 807 (409) 398
---------------------------------------------------------------------------------------------
Net interest income $ 1,127 $ 436 $ 1,563 $ 861 $ (420) $ 441
=============================================================================================
Results of Operations
The Company reported net income of $4.8 million, $4.4 million, and
$4.2 million for the years ended 2002, 2001, and 2000, respectively. During the
same periods, basic and diluted earnings per share were $1.59, $1.47, and $1.40,
respectively.
Net interest income increased to $13.0 million in 2002 from $11.6
million in 2001 and $11.2 million in 2000. Noninterest income remained at $1.5
million in 2002 and 2001, an increase from $1.3 million in 2000, while
noninterest expense was $7.1 million, $6.6 million, and $6.1 million for the
respective years.
Return on average assets was 1.55%, 1.53%, and 1.58%, in 2002, 2001,
and 2000, respectively. Return on average equity was 14.74%, 15.00%, and 16.48%,
for the respective years.
Net Interest Income
Net interest income increased to $13.0 million in 2002 from $11.6 million in
2001 and $11.2 million in 2000, representing an increase of 11.5% and 3.6% in
2002 and 2001, respectively. The Company's tax equivalent yield on average
interest-earning assets decreased to 7.33% in 2002 from 8.33% in 2001, which was
lower than the 8.66% yield in 2000. The decrease in yield is primarily a result
of the Bank's declining Prime Rate and decreasing yields on the investment
portfolio during the year.
17
Because a large portion of commercial loans are tied to the Prime Rate, the
unusual decline in interest rates negatively impacted our yield. The interest
and fees on loans decreased 7.6% during 2002. The decrease in interest and fees
was primarily due to the low interest rate environment.
The Company's average interest-earning assets increased approximately
$19.0 million (6.9%) in 2002 and $20.0 (7.9%) million in 2001. The lower growth
rate in 2002 as compared to 2001 is primarily due to the lower interest rate
environment and many customers opting for fixed rate residential real estate
loans, which are generally sold to independent parties shortly after
origination. In addition, the Company experienced an increase in its securities
portfolio due to an increase in funds caused by the increase in deposits.
The previously mentioned decline in interest rates also impacted the
Company's interest expense. Falling interest rates caused interest expense to
decrease 26.9% to $7.9 million in 2002 as compared to $10.8 million in 2001
while the average interest-bearing liabilities increased $13.9 million, or 6%,
during 2002 as compared to $17.2 in 2001. The cost of funds decreased to 3.21%
in 2002 from 4.66% in 2001. The average balance of certificates of deposit
decreased $11.1 million, or 7.6%, in 2002. The fluctuation in cost of funds and
certificate of deposit growth between each year can be largely attributed to the
changing interest rate environment.
The Company's tax equivalent net interest margin was 4.63% in 2002,
4.37% in 2001 and 4.55% in 2000. The increase in net interest margin in 2002 was
primarily due to the large decline in the Bank's cost of funds. The decline in
2001 from 2000 was primarily attributable to increased cost of funds due to
local competition.
The Company's securities portfolio experienced an increase in average
balances and a decrease in yield during 2002. The average balance of the
portfolio increased $8.2 million (23.1%) as compared to 2001, and the tax
equivalent yield decreased to 6.10% in 2002 from 6.66% in 2001. The decrease in
yield is primarily due to receiving prepayments on higher yielding securities
and the adjustable rate securities repricing downward. The Company's
reinvestment rate was lower in 2002 than in 2001.
For further information, see the table titled "Consolidated Average
Balance Sheets and Taxable Equivalent Income/Expense and Yields/Rates" in the
Selected Statistical Information.
Provision for Loan Losses
The provision for loan losses was $436,000 in 2002, $177,000 in 2001
and $177,000 in 2000. The increase in the provision in 2002 was due to
management's current assessment of the loan portfolio characteristics during the
year. Net charge-offs in 2002 were $290,000 compared to $128,000 in 2001 and
$171,000 in 2000. The ratio of the allowance for loan losses as a percentage of
total loans at December 31 was 0.85% in 2002, 0.88% in 2001, and .86% in 2000.
For further information about the provision and management's methodology for
estimating the allowance for loan losses, see "Allowance for Loan Losses" and
"Critical Accounting Policies" within Management's Discussion and Analysis.
18
Noninterest Income
Total noninterest income was $1.5 million in 2002, $1.5 million in
2001, and $1.3 million in 2000, representing a nominal increase in 2002 and
15.4% in 2001. As a percentage of average assets, noninterest income was 0.49%,
0.51%, and 0.48%, in 2002, 2001, and 2000, respectively. Service charges and
fees have increased over the last three years due to increased charges and
growth in the number of accounts.
Noninterest Expense
Total noninterest expense was $7.1 million in 2002, $6.6 million in
2001, and $6.1 million in 2000, representing an increase of 8.1% in 2002 and
7.3% in 2001. As a percentage of average assets, noninterest expense was 2.30%,
2.28%, and 2.31% in 2002, 2001, and 2000, respectively.
Salaries and benefits expense comprises the largest component of
noninterest expense, with totals of $3.5 million in 2002, $3.3 million in 2001,
and $3.3 million in 2000. As a percentage of assets, salaries and benefits
expense was 1.14%, 1.16%, and 1.23% in 2002, 2001, and 2000, respectively. The
average number of full-time equivalent employees was 88 in 2002, 86 in 2001, and
85 in 2000.
Included in salaries and benefits expense was net pension costs of
approximately $145,000 in 2002 and $110,000 in 2001, which are based upon
specific actuarial assumptions, including a long-term rate of return of 7.50%.
Management believes the rate of return is a reasonable assumption of projected
equity and bond indices long-term return projections as well as actual long-term
historical plan returns realized. Management will continue to evaluate the
actuarial assumptions, including the expected rate of return, annually, and will
adjust the assumptions as necessary.
The Company based its determination of pension expense on a
market-related valuation of assets. Investment gains or losses are computed as
the difference between the expected return calculated using the market-related
value of assets and the actual return based on the market-related value of
assets. The future value of assets will be impacted as previously deferred gains
or losses are recognized.
The discount rate that the Company utilizes for determining future
pension obligations decreased to 6.50% in 2002 from 7.50% in 2001, based on
management's evaluation of current yields on long-term yields on highly-rated
bonds.
Lowering the expected long-term rate of return on plan assets or the
discount rate by .25% would not have had a significant impact on pension expense
in 2002.
II. FINANCIAL CONDITION
Assets
The Company's total assets increased to $318.8 million in 2002 from
$304.9 million in 2001, representing an increase of 4.6%. Average total assets
increased to $308.4 million in 2002 from $288.2 million in 2001, an increase of
7.0%. Average interest-earning assets increased to $291.6 in 2002 from $272.7
million in 2001, and remained at approximately 95% of total average assets.
Securities available for sale
The Company reported securities available for sale (at fair value) of $40.0
million and $38.2 million at 2002 and 2001, respectively, and average securities
available for sale of $43.4 million in 2002
19
and $35.2 million in 2001. As a percentage of average assets, average securities
were 14.07% in 2002, 12.2% in 2001 and 14.6% in 2000. As of December 31, 2002
and 2001, the Company did not classify any securities as trading or held to
maturity. It is the general practice of management to hold securities until they
are called or matured. But, by classifying securities in the available for sale
category, management has the flexibility to sell the securities should the need
arise. The available for sale portion of the portfolio includes mortgage-backed
securities, U.S. Treasuries and municipals with an average life of 4 years, and
average repricing term of 4 years, and an average tax-equivalent yield of 6.10%
for the year ended December 31, 2002. Total available for sale securities
consisted of the following: U.S. Treasuries and Agencies -- 9%; fixed-rate
mortgage-backed securities and CMO's -- 40%; and fixed-rate tax-exempt municipal
securities -- 51%.
INVESTMENT PORTFOLIO
The amortized cost and fair values of securities available for sale as
of December 31, 2002 and 2001 are presented in Note 2 to the
consolidated financial statements. The amortized cost of securities as
of December 31, 2002, 2001, and 2000, is presented below (dollars in
thousands):
-------------------------------------------
2002 2001 2000
-------------------------------------------
Securities available for sale:
U.S. Treasury & agency obligations $ 3,556 $ 2,515 $ 3,494
Obligations of states and political subdivisions 19,476 8,588 9,298
Mortgage-backed securities 15,564 26,320 24,588
-------------------------------------------
Total securities available for sale $38,596 $37,423 $37,380
Federal Home Loan Bank stock 2,028 1,937 1,812
Federal Reserve Bank stock 120 120 120
-------------------------------------------
Total securities $40,744 $39,480 $39,312
===========================================
INVESTMENT PORTFOLIO MATURITIES
The maturity distribution and weighted average interest rates of
securities available for sale as of December 31, 2002, are as follows (dollars
in thousands):
Less Total
than 1 1 to 5 5 to 10 Over 10 Amortized Fair
Year Years Years Years Cost Value
----------------------------------------------------------------------------------------------------
Wtd Wtd Wtd Wtd Wtd
Ave Ave Ave Ave Ave
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount
----------------------------------------------------------------------------------------------------
Securities available for sale:
U.S. Treasury and agency
obligations $ 1,001 1.62% $ 2,055 1.78% $ -- --% $ 500 5.79% 3,556 2.30% $ 3,606
Obligations of states and
political sub 1,291 5.20% 5,596 8.23 12,589 8.55% $ -- --% 19,476 7.71% 20,276
Mortgage-backed securities 8,027 5.01% 7,537 5.98 -- -- --% 15,564 5.46% 16,130
----------------------------------------------------------------------------------------------------
Total securities available for
sale $10,319 $15,188 $12,589 $ 500 $38,596 $40,012
====================================================================================================
20
The calculations of the weighted average interest rates for each
maturity category are based on yield weighted by the respective costs of the
securities. The weighted average rates on states and political subdivisions are
computed on a taxable equivalent basis using a 34% tax rate. For purposes of the
above presentation, maturities of U.S. Treasury and agency obligations and
obligations of states and political subdivisions are based on average life or
earliest call date; mortgage-backed securities are based on estimated
maturities.
Excluding those holdings of U.S. Treasury securities and other agencies
of the U.S. Government, the Company did not hold any securities of any one
issuer that exceeded 10% of the shareholders' equity of the Company at December
31, 2002.
Loans
The Company reported total loans of $248.2 million and $223.7 million
at 2002 and 2001, respectively. As a percentage of average assets, average loans
were 77.1% in 2002, and 78.8% in 2001.
The table below shows the Company's loans outstanding at period-end by
type of loan. The portfolio composition has remained relatively consistent
during the three years ended December 31, 2002. Commercial and industrial loans
totaled $25.8 million in 2002, representing an increase from $24.1 million in
2001, and $22.9 million in 2000. The increase was primarily a result of
increased origination of working capital and equipment loans. Residential real
estate loans increased $2.5 million to $99.7 million in 2002 from $97.1 million
in 2001 due to the increased demand by the Company's customers for home equity
loans.
For interest rate risk management purposes commencing in 2000, the
Company started selling the majority of fixed-rate residential real estate loans
originated, while holding the adjustable-rate loans in the portfolio. The
Company recognizes a gain on sale of loans based on the premium received from
the sale of loans to an independent party. The Company did not have any loans
held for sale at December 31, 2002 and 2001. At December 31, 2002, the Company
serviced approximately $2.3 million of mortgage loans previously sold, for the
benefit of others. The servicing asset and the related servicing fees generated
from serviced loans are not material to the Company's financial statements.
The Company has experienced an increase in commercial lending, both
real estate and industrial, because of the movement of the Company into new
markets. The Company focused its commercial lending on small- to medium-sized
companies in its market area, most of which are companies with long established
track records. The Company expects to continue to grow in the real estate and
commercial portfolios. At December 31, 2002, the Company serviced approximately
$3.8 million of commercial loans previously sold, for the benefit of others.
The Company will also continue to focus on agriculture lending and
continue to use the Farm Service Agency (FSA) Guarantee Program which will
guarantee up to 90% of the loan to qualified borrowers and therefore limits the
Company's loss exposure while servicing the agricultural industry.
Installment loans as a percentage of total loans outstanding has
remained relatively consistent between 2002, 2001, and 2000.
21
LOAN PORTFOLIO
The following table displays the loan portfolio composition at December
31 for each respective year (dollars in thousands).
% of % of % of % of % of
2002 Total 2001 Total 2000 Total 1999 Total 1998 Total
----------------------------------------------------------------------------------------------------------
Commercial and industrial $ 25,759 10.4% $ 24,126 10.8% $ 22,918 10.3% $ 19,479 10.4% $ 13,363 7.9%
Commercial real estate 53,104 21.4% 41,917 18.7% 39,247 17.7% 33,784 18.1% 29,040 17.3%
Agricultural 41,106 16.5% 34,313 15.3% 34,316 15.5% 30,511 16.3% 31,049 18.5%
Residential real estate 99,728 40.2% 97,115 43.4% 99,242 44.6% 81,677 43.7% 75,045 44.6%
Installment 27,122 10.9% 24,995 11.2% 24,681 11.1% 20,813 11.2% 19,440 11.6%
Other 1,493 0.6% 1,267 0.6% 1,857 0.8% 499 0.3% 226 0.1%
----------------------------------------------------------------------------------------------------------
Total loans $248,312 100.0% $223,733 100.0% $222,261 100.0% $186,763 100.0% $168,163 100.0%
Less:
Net deferred loan (42) (6) 110 105 53
origination fees/costs
Allowance for loan losses (2,106) (1,960) (1,911) (1,905) (1,911)
----------------------------------------------------------------------------------------------------------
Net loans $246,164 $221,767 $220,460 $184,963 $166,305
==========================================================================================================
The following tables show the Company's loan maturities and composition of fixed
and adjustable rate loans at December 31, 2002 (in thousands).
Less than 1 Year 1 - 5 Years Over 5 Years Total
----------------------------------------------------------------------------------
Commercial real estate $ 8,837 $ 5,802 $ 38,465 $ 53,104
Commercial and industrial 12,899 7,519 5,361 25,779
Agricultural 12,298 7,760 21,048 41,106
Residential real estate 6,416 5,111 88,083 99,610
Installment 2,081 21,762 3,335 27,178
Other 891 516 86 1,493
----------------------------------------------------------------------------------
Total $ 43,422 $ 48,470 $156,378 $248,270
==================================================================================
Predetermined Floating or
Rates Adjustable Rates Total
-----------------------------------------------------
Commercial and industrial $10,582 $15,197 $25,779
Commercial real estate 12,827 40.277 53,104
Agricultural 11,820 29,286 41,106
Residential real estate 13,371 86,239 99,610
Installment 26,755 423 27,178
Other 999 494 1,493
-----------------------------------------------------
Total $76,354 $171,916 $248,270
=====================================================
Allowance for Loan Losses
Federal regulations and generally accepted accounting principles
require that the Company establish prudent allowances for loan losses. The
Company maintains an allowance for loan losses to absorb probable loan losses
inherent in the portfolio, based on evaluations of the collectibility and
historical loss experience of loans. Loan losses are charged and recoveries are
credited to the allowance.
22
Provisions for loan losses are based on management's review of the historical
loan loss experience and such factors which, in management's judgment, deserve
consideration under existing economic conditions in estimating probable loan
losses. The allowance is based on ongoing assessments of the probable estimated
losses inherent in the loan portfolio. The Company's methodology for assessing
the appropriate allowance level consists of several key elements, described
below.
Larger commercial loans that exhibit probable or observed credit
weaknesses are subject to individual review. Where appropriate, reserves are
allocated to individual loans based on management's estimate of the borrower's
ability to repay the loan given the availability of collateral, other sources of
cash flow and available legal options. Included in the review of individual
loans are those that are impaired as provided in Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan," as amended. Any specific reserves for impaired loans are measured based
on the fair value of the underlying collateral. The Company evaluates the
collectibility of both principal and interest when assessing the need for a
specific reserve. Historical loss rates are applied to other commercial loans
not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential
mortgage loans, are not individually reviewed by management. Reserves are
established for each pool of loans based on the expected net charge-offs. Loss
rates are based on the average five-year net charge-off history by loan
category.
Historical loss rates for commercial and consumer loans may be
adjusted for significant factors that, in management's judgment, reflect the
impact of any current conditions on loss recognition. Factors which management
considers in the analysis include the effects of the local economy, trends in
the nature and volume of loans (delinquencies, charge-offs, nonaccrual and
problem loans), changes in the internal lending policies and credit standards,
collection practices, and examination results from bank regulatory agencies and
the Company's internal credit review function.
Specific reserves on individual loans and historical loss rates are
reviewed throughout the year and adjusted as necessary based on changing
borrower and/or collateral conditions and actual collection and charge-off
experience.
A portion of the allowance is not allocated to any particular loan
type and is maintained in recognition of the inherent inability to precisely
determine the loss potential in any particular loan or pool of loans. Among the
factors used by management in determining the unallocated portion of the
allowance are current economic conditions, trends in the Company's loan
portfolio delinquency, losses and recoveries, level of underperforming and
nonperforming loans, and concentrations of loans in any one industry.
The Company has not substantively changed any aspect of its overall
approach in the determination of the allowance for loan losses during 2002.
There have been no material changes in assumptions or estimation techniques as
compared to prior years that impacted the determination of the current year
allowance.
Real estate acquired, or deemed acquired, by the Company as a result of
foreclosure proceedings is classified as other real estate owned ("OREO") until
it is sold. Interest accrual, if any, ceases no later than the date of
acquisition of the real estate, and all costs incurred from such date in
maintaining the property are expensed. OREO is recorded by the Company at the
lower of cost or fair value less estimated costs of disposal, and any write-down
resulting there from is charged to the allowance for loan losses. When the
foreclosed property is sold, the difference between proceeds received on OREO
and the recorded value is recognized in current earnings.
23
As discussed above, the allowance is maintained at a level necessary to
absorb probable losses in the portfolio. Management's determination of the
adequacy of the reserve is based on reviews of specific loans, loan loss
experience, general economic conditions and other pertinent factors. If, as a
result of charge-offs or increases in risk characteristics of the loan
portfolio, the reserve is below the level considered by management to be
adequate to absorb probable loan losses, the provision for loan losses is
increased.
The allowance for loan losses was 0.85% of total loans as of December
31, 2002, a decrease from 0.88% at the end of 2001. As a percentage of total
loans, the allowance has declined from the 1.14% level in 1998, primarily as a
result of credit quality and declining net charge-offs. In 2002, the Company
experienced net charge-offs of $290,000, or 0.12% of average loans, compared to
net charge-offs of $128,000 (0.06%) in 2001 and $171,000 (0.08%) in 2000. The
Company recorded a provision for loan losses of $436,000, $177,000 and $177,000
in 2002, 2001, and 2000, respectively. As a percentage of the provision for loan
losses, net charge-offs were 66.5%, 72.3%, and 96.6% in 2002, 2001, and 2000,
respectively.
The amount of nonaccrual loans increased to $476,000 in 2002 from
$383,000 in 2001. As a percentage of total loans, nonaccrual loans represented
..19% in 2002 and .17% in 2001. The Company would have reported additional
interest income of approximately $79,000, $49,000 and $30,000 in 2002, 2001 and
2000, respectively, if nonaccrual loans had been accruing interest. Interest
income from nonaccrual loans of approximately $2,000 has been included in net
income in each of the years ended 2002, 2001 and 1999. Nonaccrual loans at
December 31, 2002 consisted of 17 relationships. Nonaccrual loans are expected
to be resolved through payments or through liquidation of collateral in the
normal course of business. Management estimates losses from these nonaccrual
loans to be approximately $64,000, which has been included in the allowance for
loan losses.
The category of accruing loans which are past due 90 days or more
decreased at December 31, 2002 to $1,133,000 as compared to $1,649,000 at
December 31, 2001. As a percentage of total loans, loans past due 90 days and
still accruing interest represented 0.46% in 2002 and 0.74% in 2001. Management
has analyzed these credits as to the borrower's current circumstances, value of
the security pledged and the likely ultimate disposition of these loans. In
management's opinion, appropriate specific reserves have been allocated to
absorb any probable loss and these accounts are expected to be resolved through
payments or liquidation of collateral in the normal course of business. The
$1,133,000 of delinquent loans is represented by 40 accounts as follows:
o 13 residential real estate accounts with outstanding balances of $613,000
of which $33,000 has been included as a specific reserve in the allowance
for loan losses;
o 5 commercial loan accounts with outstanding balances of $242,000 of which
$41,000 has been specifically reserved;
o 21 consumer installment loans with outstanding balances of $128,000 of
which $31,000 has been specifically reserved;
o 1 dealer floor plan agreement with outstanding balance of $150,000 with
$18,000 specifically reserved.
As a percentage of the allowance for loan losses, total nonaccrual loans and
loans past due 90 days or more were 76.4% in 2002 and 103.7% in 2001.
24
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses for the years ended December
31 are as follows (in thousands).
2002 2001 2000 1999 1998
---------------------------------------------------------------------
Balance, beginning of period $ 1,960 $ 1,911 $ 1,905 $ 1,911 $ 1,731
Loans charged-off:
Commercial and industrial 44 34 42 31 31
Commercial real estate 0 -- -- -- --
Agricultural 67 -- -- -- --
Residential real estate 91 9 -- 5 --
Installment 154 139 161 123 168
------------------------------------------------------------------------
Total charge-offs 356 182 203 159 199
Recoveries of loans previously charged-off:
Commercial and industrial 22 3 5 1 --
Commercial real estate 0 -- -- -- --
Agricultural 0 -- -- -- --
Residential real estate 0 5 -- -- --
Installment 44 46 27 22 64
---------------------------------------------------------------------
Total recoveries 66 54 32 23 64
Net charge-offs 290 128 171 136 135
Provision for loan losses 436 177 177 130 315
---------------------------------------------------------------------
Balance, end of period $ 2,106 $ 1,960 $ 1,911 $ 1,905 $ 1,911
=====================================================================
Allowance to loans, end of year 0.85% 0.88% 0.86% 1.02% 1.14%
Ratio of net charge-offs to average loans 0.12% 0.06% 0.08% 0.08% 0.09%
outstanding
Loan balance, end of year $248,270 $223,727 $222,371 $186,868 $168,216
Total average loans $237,788 $227,150 $210,325 $176,738 $157,838
25
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The following table indicates the portion of the loan loss reserve
management has allocated to each loan type at December 31 (in thousands).
2002 2001 2000 1999 1998
------------------------------------------------------------------------
Commercial and industrial $371 $315 $271 $197 $235
Commercial real estate 276 648 603 743 544
Agricultural 676 274 255 295 261
Residential real estate 402 334 311 383 280
Installment 284 283 248 254 552
Other - 10 16 5 20
Unallocated 97 96 207 28 19
------------------------------------------------------------------------
Balance, end of year $2,106 $1,960 $1,911 $1,905 $1,911
========================================================================
NONPERFORMING ASSETS
The following table represents the total of nonaccrual loans and loans
90 days past due and accruing interest at December 31 (in thousands).
2002 2001 2000 1999 1998
------------------------------------------------------------------------
Loans accounted for on nonaccrual basis $ 476 $ 383 $319 $244 $ 60
Accruing loans which are past due 90 days 1,133 1,649 668 442 521
or more
Restructured loans -- -- -- -- --
------------------------------------------------------------------------
Total $1,609 $2,032 $987 $686 $581
========================================================================
Deposits
Deposits have traditionally been the primary source of the Company's
funds for use in lending and other investment activities. In addition to
deposits, the Company derives funds from interest payments and principal
repayments on loans and income on earning assets. Loan payments are a relatively
stable source of funds, while deposit inflows and outflows fluctuate more in
response to general interest rates and money market conditions.
Deposits are attracted principally from within the Company's market
area through the offering of numerous deposit instruments, including checking
accounts, regular passbook savings accounts, NOW accounts, money market deposit
accounts, term certificate accounts and individual retirement accounts ("IRAs").
Interest rates paid, maturity terms, service fees and withdrawal penalties for
the various types of accounts are established periodically by the Company's
management based on the Company's liquidity requirements, growth goals and
market trends.
The table below presents a summary of period end deposit balances. The
composition of deposit categories has remained relatively consistent as a
percentage of total deposits throughout the three-year period ended December 31,
2002. As a percentage of total deposits, interest-bearing demand accounts have
increased slightly to 24% in 2002 from 22% in 2001, while certificates of
deposits (less than
26
$100,000) have decreased to 40% in 2002 from 44% in 2001. This shift was caused
by the lower rate environment in 2002 and a slightly less aggressive marketing
strategy. Savings accounts continue to remain consistent in each year as a
percentage of deposits, and money market accounts have increased to 6% in 2002
from 3% in 2001 and 2000. Certificates of deposit $100,000 and over are
primarily short-term public funds. Balances of such large certificates fluctuate
depending on the Company's pricing strategy and funding needs at any particular
time and were comparable as a percentage of total deposits in 2002 and 2001.
Interest rates, maturity terms, service fees, and withdrawal penalties
for the various types of accounts are established periodically by management
based on the Company's liquidity requirements, growth goals and market trends.
The amount of deposits currently from outside the Company's market area is not
significant.
DEPOSIT COMPOSITION
The following table indicates the total deposits by type at December 31
(dollars in thousands):
2002 Percent 2001 Percent 2000 Percent
of of of
Amount Total Amount Total Amount Total
- ------------------------------------------------------------------------------------------------------------------
Noninterest-bearing demand deposits $ 30,195 11% $ 31,220 12% $ 26,065 11%
Interest-bearing demand deposits 63,755 24% 59,012 22% 46,207 20%
Money market deposits 16,150 6% 8,618 3% 7,505 3%
Savings 21,852 9% 18,350 7% 15,871 7%
Time deposits greater than $100 27,296 10% 30,618 12% 29,367 12%
Other time deposits 103,468 40% 114,790 44% 111,031 47%
------------------------------------------------------------------------
Total $262,716 $262,608 100% $236,046 100%
========================================================================
The following table indicates the average amount of and the average
rate paid on deposit categories which exceeded 10% of average total deposits at
December 31 (in thousands):
2002 2001 2000
Amount Rate Amount Rate Amount Rate
---------------------------------------------------------------------------------------
Noninterest-bearing demand deposits $ 28,960 $ 25,398 -- $ 24,993 --
Interest-bearing demand deposits 68,787 2.00% 57,938 2.82% 52,602 2.93%
including money market deposits
Time deposits greater than $100 27,798 3.61% 31,690 5.33% 30,752 5.56%
Other time deposits 107,565 3.88% 114,803 5.69% 106,412 5.90%
---------------------------------------------------------------------------------------
$233,110 $229,829 $214,759
=======================================================================================
27
MATURITIES OF TIME DEPOSITS GREATER THAN $100,000
The following table indicates the amount of the Company's time deposits
greater than $100,000 by time remaining until maturity as of December 31,
2002(dollars in thousands):
Three months or less $ 4,972
Over three through 6 months 5,945
Over six through 12 months 8,972
Over 12 through 60 months 7,407
Over 60 months --
-----------
Total $27,296
===========
Other Borrowings
Periodically, the Company will borrow long term money from the Federal
Home Loan Bank (FHLB) as a way to provide funding for loan demand. At December
31, 2002, the Company had outstanding, $17.5 million of total borrowings from
the FHLB with a weighted average cost of 5.0%. Borrowings of $7 million consist
of three fixed-rate notes with maturities in 2008 and 2010. At the option of the
FHLB, these notes can be converted at certain dates to instruments that adjust
quarterly at the three-month LIBOR rate. The note amount and nearest optional
conversion dates at December 31, 2002, are $3 million in March 2003; $1 million
in April 2003; and $3 million in March 2003 if the three month LIBOR reaches 8%.
The Company borrowed a $500,000 amortizing note to match against a loan to earn
a 2.55% spread. Additionally, the Company utilized a borrowing of $10 million,
due in 2012, with a rate that can adjust quarterly if the three-month LIBOR
reaches 7.75%. With the funds, the Company purchased $10 million in securities
classified as available for sale with an average yield of 5% and call features
ranging from 2011 to 2013, resulting in a net spread of 2.7%. on the borrowing.
Capital
The declaration and payment of dividends by the Company are subject to
the discretion of the Board of Directors and to the earnings and financial
condition of the Company and applicable laws and regulations. The dividend
payout ratio was increased to 37.7% in 2002 from 35.4% in 2001. At December 31,
2002 consolidated Tier 1 risk based capital was 13.9%, and total risk-based
capital was 14.7%. The minimum Tier 1 and total risk-based capital ratios
required by the Board of Governors of the Federal Reserve are 4% and 8%,
respectively.
Liquidity
Effective liquidity management ensures that the cash flow requirements
of depositors and borrowers, as well as company cash needs, are met. The Company
manages liquidity on both the asset and liability sides of the balance sheet.
Community bank liquidity management currently involves the challenge of
attracting deposits while maintaining positive loan growth at a reasonable
interest rate spread. The loan to deposit ratio at December 31, 2002, was 94.5%,
compared to 85.2% in 2001. Loans to total assets were 77.9% at the end of 2002,
compared to 73.4% in 2001. The securities portfolio is available for sale and
consists of securities that are readily marketable. Approximately 44% of the
available for sale portfolio is pledged to secure public deposits, short-term
and long-term borrowings and for other purposes as required by law. The balance
of the available for sale securities could be sold if
28
necessary for liquidity purposes. Also, a stable deposit base, consisting of 90%
core deposits, makes the Company less susceptible to large fluctuations in
funding needs. The Company also has both short- and long-term borrowings
capacity available through FHLB with unused available credit of approximately
$25.4 million as of December 31, 2002 The Company has the ability to obtain
deposits in the brokered certificate of deposit market to help provide liquidity
to fund loan growth, if necessary. Generally, the Company uses short-term
borrowings to fund overnight and short-term funding needs in the Company's
balance sheet. Longer-term borrowings have been primarily used to fund
mortgage-loan originations. This has occurred when FHLB longer-term rates are a
more economical source of funding than traditional deposit gathering activities.
Additionally, the Company occasionally uses FHLB borrowings to fund larger
commercial loans.
Impact of Inflation, Changing Prices and Local Economic Conditions
The majority of the Company's assets and liabilities are monetary in
nature. Therefore, the Company differs greatly from most commercial and
industrial companies that have significant investments in non-monetary assets,
such as fixed assets and inventories. However, inflation does have an important
impact on the growth of assets in the banking industry and on the resulting need
to increase equity capital at higher than normal rates in order to maintain an
appropriate equity to assets ratio. Inflation also affects other expenses, which
tend to rise during periods of general inflation.
Management believes the most significant impact on financial and
operating results is the Company's ability to react to changes in interest
rates. Management seeks to maintain an essentially balanced position between
interest sensitive assets and liabilities in order to protect against the
effects of wide interest rate fluctuations.
The Company's success is dependent on the general economic conditions
of the communities we serve. Unlike larger banks that are more geographically
diversified, we provide financial and banking services primarily in south
central Ohio. The economies of our markets are dependent to a significant extent
on the agricultural industry. The economic conditions in these areas have a
significant impact on loan demand, the ability of borrowers to repay these
loans, and the value of the collateral securing these loans. A significant
decline in general economic conditions, and in particular the agricultural
industry, could affect these local economic conditions and could negatively
impact the financial results of our banking operations. Factors influencing
general conditions include inflation, recession, unemployment, and other factors
beyond our control.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
III. MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from adverse changes in the
fair value of financial instruments due to variations in interest rates,
exchange rates, equity price risk and commodity prices. The Company does not
maintain a trading account for any class of financial instrument, and is not
currently subject to currency exchange rate risk, equity price risk or commodity
price risk. The Company's market risk is composed primarily of interest rate
risk.
The major source of the Company's interest rate risk is the difference
in the maturity and repricing characteristics between the Company's core banking
assets and liabilities -- loans and deposits. This difference, or mismatch,
poses a risk to net interest income. Most significantly, the Company's core
banking assets and liabilities are mismatched with respect to repricing
frequency, maturity and/or index.
29
Most of the Company's commercial loans, for example, reprice rapidly in response
to changes in short-term interest. In contrast, many of the Company's consumer
deposits reprice slowly, if at all, in response to changes in market interest
rates.
The Company's Senior Management is responsible for reviewing the
interest rate sensitivity position of the Company and establishing policies to
monitor and limit exposure to interest rate risk. The guidelines established by
senior management are approved by the Company's Board of Directors. The primary
goal of the asset/liability management function is to maximize net interest
income within the interest rate risk limits set by approved guidelines.
Techniques used include both interest rate gap management and simulation
modeling that measures the effect of rate changes on net interest income and
market value of equity under different rate scenarios. The interest rate gap
analysis schedule quantifies the asset/liability static sensitivity as of
December 31, 2002. As shown, the Company was asset-sensitive through 3 months,
liability-sensitive 3 through 12 months, and asset-sensitive within the one- to
five-year period. The cumulative gap as a percent of total assets through one
year at the end of 2002 was 7.94%. The balances of transaction type NOW and MMDA
accounts are scheduled to run off over their expected lives. Although the entire
balance of these deposits is subject to repricing or withdrawal in a relatively
short period of time, they have demonstrated over time to be a stable base of
retail core deposits for the company. Also, their sensitivity to changes in
interest rates is significantly less than some other deposits, such as
certificates of deposits.
30
INTEREST RATE GAP ANALYSIS
The following table displays the Company's interest rate gap analysis
at December 31, 2002 (in thousands):
---------------------------------------------------------------------------------------------
3-6 6-12
Total 0-3 Months Months Months 1-5 Years 5+ Years
---------------------------------------------------------------------------------------------
Loans $248,270 $ 72,133 $ 12,473 $ 24,946 $117,127 $ 21,591
Securities 40,012 6,948 1,842 3,684 15,182 12,356
Short-term funds 8,350 8,350 -- -- -- --
---------------------------------------------------------------------------------------------
Total earning assets 296,632 87,431 14,315 28,630 132,309 33,947
---------------------------------------------------------------------------------------------
Interest-bearing deposits 101,757 1,796 1,796 3,593 28,742 65,830
Time deposits 130,764 25,896 25,545 43,077 36,234 12
Short-term borrowings 3,365 2,010 1,355 -- -- --
Long-term debt 17,470 -- -- -- -- 17,470
---------------------------------------------------------------------------------------------
Total interest-bearing liabilities 253,356 29,702 28,696 46,670 64,976 83,312
---------------------------------------------------------------------------------------------
Period gap $ 43,276 $ 57,729 $(14,381) $(18,040) $ 67,333 $(49,365)
Cumulative gap -- $ 57,729 $ 43,348 $ 25,308 $ 92,641 $ 43,276
Gap as a percentage of assets -- 18.11% 13.60% 7.94% 29.06% 13.57%
In the Company's simulation models, each asset and liability balance is
projected over a time horizon. Net interest income is then projected based on
expected cash flows and projected interest rates under a stable rate scenario
and analyzed. The results of this analysis are factored into decisions made
concerning pricing strategies for loan and deposits, balance sheet mix,
securities portfolio strategies, liquidity and capital adequacy.
Simulation models are also performed under an instantaneous parallel
200 basis point increase or decrease in interest rates. The model includes
assumptions as to repricing and expected prepayments, anticipated calls, and
expected decay rates of transaction accounts under the different rate scenarios.
The results of these simulations include changes in both net interest income and
market value of equity.
The Company's rate shock simulation models provide results in extreme
interest rate environments and results are used accordingly. Reacting to changes
in economic conditions, interest rates and market forces, the Company has been
able to alter the mix of short and long-term loans and investments, and increase
or decrease the emphasis on fixed and variable rate products in response to
changing market conditions. By managing the interest rate sensitivity of its
asset composition in this manner, the Company has been able to maintain a fairly
stable flow of net interest income.
Complicating management's efforts to control non-trading exposure to
interest rate risk is the fundamental uncertainty of the maturity, repricing,
and/or runoff characteristics of some of the Company's core banking assets and
liabilities. This uncertainty often reflects options embedded in these financial
instruments. The most important embedded options are contained in consumer
deposits and loans.
For example, many of the Company's interest bearing retail deposit
products (e.g., interest checking, savings and money market deposits) have no
contractual maturity. Customers have the right to withdraw funds from these
deposit accounts freely. Deposit balances may therefore run off unexpectedly due
to changes in competitive or market conditions. To forestall such runoff, rates
on interest bearing
31
deposits may have to be increased more (or reduced less) than expected. Such
repricing may not be highly correlated with the repricing of prime rate-based or
U.S. Treasury-based loans. Finally, balances that leave the banking franchise
may have to be replaced with other more expensive retail or wholesale deposits.
Given the uncertainties surrounding deposit runoff and repricing, the interest
rate sensitivity of core bank liabilities cannot be determined precisely.
The following table indicates the Company's interest rate-sensitive
instruments and their repricing year and current average yield/(cost) for the
periods ended December 31 (in thousands).
---------------------------------------------------------------------------------------------
Later
2003 2004 2005 2006 2007 Years Total Fair Value
---------------------------------------------------------------------------------------------
Fixed rate loans 32,417 12,350 8,652 6,293 3,369 13,273 76,354 75,059
Average interest rate 7.42% 8.13% 7.98% 7.66% 7.78% 7.64%
Adjustable rate loans 82,627 32,684 31,506 11,101 11,478 2,520 171,916 171,916
Average interest rate 5.9% 7.36% 7.23% 7.68% 7.27% 8.31%
Securities(1) 12,470 10,587 1,842 1,687 1,070 13,087 40,743 42,159
Average interest rate 4.45% 5.10% 5.23% 5.55% 5.72% 5.16%
Interest-bearing time deposits 94,520 19,550 16,451 231 -- 12 130,764 131,558
Average interest rate 2.84% 3.80% 3.81% 3.43% 0.00% 4.72%
Interest-bearing demand deposits 101,757 -- -- -- -- -- 101,757 101,757
Average interest rate 1.41% -- -- -- -- --
Short-term borrowings 3,365 -- -- -- -- -- 3,365 3,365
Average interest rate 3.94% -- -- -- -- --
Long-term debt -- -- -- -- -- 17,470 17,470 21,932
Average interest rate -- -- -- -- -- 5.00%
(1) For the purpose of this table, securities include FHLB Stock and FRB Stock
32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Registrant's Financial Statements are attached hereto as an exhibit.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is set forth in the Company's
definitive Proxy Statement for the 2003 Annual Meeting of Shareholders to be
held April 22, 2003 under the sections captioned "ELECTION OF DIRECTORS AND
VOTING PROCEDURES," "EXECUTIVE COMPENSATION AND RELATED ITEMS" and "SECTION
16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE," and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is set forth in the Company's
definitive Proxy Statement for the 2003 Annual Meeting of Shareholders to be
held April 22, 2003 under the section captioned "EXECUTIVE COMPENSATION AND
RELATED ITEMS," and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required by this item is set forth in the Company's
definitive Proxy Statement for the 2003 Annual Meeting of Shareholders to be
held April 22, 2003 under the section captioned "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT," and is incorporated herein by reference.
The Company currently has no securities authorized for issuance under
equity compensation plans which would require the disclosures mandated by
Section 201(d) of Regulation S-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is set forth in the Company's
definitive Proxy Statement for the 2003 Annual Meeting of Shareholders to be
held April 22, 2003 under the section captioned "CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS," and is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to
33
the Company (including its consolidated subsidiaries) required to be included in
the Company's periodic SEC filings.
There were no significant changes made in the Company's internal
controls or in other factors that could significantly affect these internal
controls subsequent to the date of the evaluation performed by the Company's
Chief Executive Officer and Chief Financial Officer.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
A. Annual Financial Statements
Independent Auditors' Report
Consolidated Balance Sheets,
December 31, 2002 and 2001
Consolidated Statements of Income,
Years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Changes in Shareholders' Equity
Years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows,
Years ended December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements,
December 31, 2002, 2001 and 2000
B. Exhibits
(3) (I) Articles of Incorporation, filed as Exhibit (3)(I) to
the Form 10 filed with the SEC on April 30, 2002 and
incorporated herein by reference.
(II) Code of Regulations, filed as Exhibit (3)(II) to the
Form 10 filed with the SEC on April 30, 2002 and
incorporated herein by reference.
(10) Material Contracts:
10.1 The Merchants National Bank Defined Benefit
Retirement Plan, filed as Exhibit 10.1 to the Form
10 filed with the SEC on April 30, 2002 and
incorporated herein by reference.
10.2 The Merchants National Bank Profit Sharing and 401(k)
Savings Retirement Plan and Trust, filed as Exhibit
10.2 to the Form 10 filed with the SEC on April 30,
2002 and incorporated herein by reference.
o Defined Contribution Prototype Plan; and
o Non-Standardized 401(k) Savings Plan and Trust
Prototype Plan Adoption Agreement
10.3 The Merchants National Bank Profit Sharing Bonus
Plan, filed as Exhibit 10.3 to the Form 10 filed with
the SEC on April 30, 2002 and incorporated herein by
reference.
10.4 The Merchants National Bank of Hillsboro, Ohio
Executive Investment Plan, filed as Exhibit 10.4 to
the Form 10 filed with the SEC on April 30, 2002 and
incorporated herein by reference.
34
10.5 The Merchants National Bank Directors' Deferred
Compensation Plan, filed as Exhibit 10.5 to the Form
10 filed with the SEC on April 30, 2002 and
incorporated herein by reference.
(21) Subsidiaries of the Registrant, filed as Exhibit (21) to the
Form 10 filed with the SEC on April 30, 2002 and incorporated
herein by reference.
(99.1) Certification of the Chief Executive and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act or 1934, the registrant has duly caused this registration statement
to be signed on its behalf by the undersigned, thereunto duly authorized.
Merchants Bancorp, Inc.
-----------------------------------
(Registrant)
Date March 28, 2003 By /s/ Paul W. Pence, Jr.
------------------------ -----------------------------------
Paul W. Pence, Jr., President
Pursuant to the requirements of the Securities Exchange Act 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.
Date March 28, 2003 By /s/ Paul W. Pence, Jr.
------------------------------- --------------------------------------------
Paul W. Pence, Jr.
Principal Executive, Financial & Accounting
Officer and Director
Date March 28, 2003 By /s/ Donald Fender, Jr.
------------------------------- --------------------------------------------
Donald Fender, Jr., Director
Date March 28, 2003 By /s/ Richard S. Carr
------------------------------- --------------------------------------------
Richard S. Carr, Director
Date March 28, 2003 By /s/ James R. Vanzant
------------------------------- --------------------------------------------
James R. Vanzant, Director
Date March 28, 2003 By /s/ Robert Hammond
------------------------------- --------------------------------------------
Robert Hammond, Director
Date March 28, 2003 By /s/ William Butler
------------------------------- --------------------------------------------
William Butler, Director
Date March 28, 2003 By /s/ Charles A. Davis
------------------------------- --------------------------------------------
Charles A. Davis, Director
Date March 28, 2003 By /s/ Jack Walker
------------------------------- --------------------------------------------
Jack Walker, Director
36
CERTIFICATIONS
I, Paul W. Pence, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Merchants
Bancorp, 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 we 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 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 or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date or our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date March 28, 2003
------------------------------------------------------------------
By /s/ Paul W. Pence, Jr.
------------------------------------------------------------------
Paul W. Pence, Jr., Principal Executive Officer and Principal
Financial Officer
37
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Merchants Bancorp, Inc.
Hillsboro, Ohio
We have audited the accompanying consolidated balance sheets of Merchants
Bancorp, Inc. and subsidiary (the "Corporation") as of December 31, 2002 and
2001, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2002. These financial statements are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Corporation as of December 31,
2002 and 2001, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
January 17, 2003
Cincinnati, Ohio
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 and 2001 (IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
ASSETS 2002 2001
CASH AND CASH EQUIVALENTS:
Cash and due from banks $ 13,852 $ 13,570
Interest-bearing deposits in banks 4,618
Federal funds sold 8,350 16,600
--------- ---------
Total cash and cash equivalents 22,202 34,788
--------- ---------
SECURITIES AVAILABLE FOR SALE
(amortized cost of $38,596 and $37,423, respectively) 40,012 38,221
--------- ---------
LOANS 248,270 223,727
Less allowance for loan losses (2,106) (1,960)
--------- ---------
Net loans 246,164 221,767
--------- ---------
OTHER ASSETS:
Bank premises and equipment, net 4,349 4,343
Accrued interest receivable 3,088 2,957
Deferred income taxes 111 137
Other 2,873 2,683
--------- ---------
Total other assets 10,421 10,120
--------- ---------
TOTAL $ 318,799 $ 304,896
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest bearing $ 30,195 $ 31,220
Interest bearing 232,521 231,388
--------- ---------
Total deposits 262,716 262,608
--------- ---------
Repurchase agreements 3,365 1,424
FHLB borrowings 17,470 8,993
Other liabilities 1,740 1,639
--------- ---------
Total liabilities 285,291 274,664
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock - no par value; 4,500,000 shares authorized
and 3,000,000 shares issued and outstanding 2,000 2,000
Surplus 2,000 2,000
Retained earnings 28,682 25,710
Accumulated other comprehensive income 826 522
--------- ---------
Total shareholders' equity 33,508 30,232
--------- ---------
TOTAL $ 318,799 $ 304,896
========= =========
See notes to consolidated financial statements.
- 2 -
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS EXCEPT PER
SHARE DATA)
- --------------------------------------------------------------------------------
2002 2001 2000
INTEREST INCOME:
Interest and fees on loans $ 18,478 $ 20,001 $ 18,922
Interest and dividends on securities:
Taxable 1,340 1,721 2,057
Exempt from income taxes 929 501 524
Interest on federal funds sold and other short-term investments 119 208 100
-------- -------- --------
Total interest income 20,866 22,431 21,603
-------- -------- --------
INTEREST EXPENSE:
Interest on deposits 6,900 10,231 9,918
Interest on repurchase agreements and federal funds purchased 112 116 129
Interest on FHLB borrowings 882 446 348
-------- -------- --------
Total interest expense 7,894 10,793 10,395
-------- -------- --------
NET INTEREST INCOME 12,972 11,638 11,208
PROVISION FOR LOAN LOSSES (436) (177) (177)
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 12,536 11,461 11,031
-------- -------- --------
NONINTEREST INCOME:
Service charges and fees 1,224 1,124 983
Securities gains, net - - 1
Other 285 348 285
-------- -------- --------
Total noninterest income 1,509 1,472 1,269
-------- -------- --------
NONINTEREST EXPENSE:
Salaries and employee benefits 3,505 3,334 3,283
Occupancy 1,121 1,083 908
Legal and professional services 576 323 226
Franchise tax 323 281 235
Data processing 282 253 209
Advertising 230 211 231
Other 1,073 1,091 1,039
-------- -------- --------
Total noninterest expense 7,110 6,576 6,131
-------- -------- --------
INCOME BEFORE INCOME TAXES 6,935 6,357 6,169
INCOME TAXES (2,163) (1,952) (1,964)
-------- -------- --------
NET INCOME $ 4,772 $ 4,405 $ 4,205
======== ======== ========
BASIC AND DILUTED EARNINGS PER SHARE $ 1.59 $ 1.47 $ 1.40
======== ======== ========
See notes to consolidated financial statements.
- 3 -
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS EXCEPT PER
SHARE DATA)
- --------------------------------------------------------------------------------
ACCUMULATED
OTHER
COMMON RETAINED COMPREHENSIVE
STOCK SURPLUS EARNINGS INCOME (LOSS) TOTAL
BALANCE, DECEMBER 31, 1999 $2,000 $2,000 $20,010 $(432) $23,578
-------
COMPREHENSIVE INCOME:
Net income 4,205 4,205
Net change in unrealized gains on available for sale
securities, net of income taxes of $350 681 681
-------
Total comprehensive income 4,886
-------
CASH DIVIDENDS DECLARED ($0.45 PER SHARE) (1,350) (1,350)
------ ------ ------- ---- -------
BALANCE, DECEMBER 31, 2000 2,000 2,000 22,865 249 27,114
COMPREHENSIVE INCOME:
Net income 4,405 4,405
Net change in unrealized gains on available for sale
securities, net of income taxes of $143 273 273
-------
Total comprehensive income 4,678
-------
CASH DIVIDENDS DECLARED ($0.52 PER SHARE) (1,560) (1,560)
------ ------ ------- ---- -------
BALANCE, DECEMBER 31, 2001 2,000 2,000 25,710 522 30,232
COMPREHENSIVE INCOME:
Net income 4,772 4,772
Minimum pension liability adjustment, net of income taxes of $58 (108) (108)
Net change in unrealized gains on available for sale
securities, net of income taxes of $206 412 412
-------
Total comprehensive income 5,076
-------
CASH DIVIDENDS DECLARED ($0.60 PER SHARE) (1,800) (1,800)
------ ------ ------- ---- -------
BALANCE, DECEMBER 31, 2002 $2,000 $2,000 $28,682 $826 $33,508
====== ====== ======= ==== =======
See notes to consolidated financial statements.
- 4 -
MERCHANTS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS)
- --------------------------------------------------------------------------------
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,772 $ 4,405 $ 4,205
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 890 633 486
Provision for loan losses 436 177 177
Gain on sale of mortgage loans (134) (178) (21)
Proceeds from sale of mortgage loans 8,755 16,007 1,665
Mortgage loans originated for sale (8,621) (15,829) (1,644)
Deferred federal income taxes (129) (7) 48
Changes in assets and liabilities:
Accrued interest receivable (131) (56) (427)
Other assets (99) 34 (209)
Accrued interest, taxes and other liabilities (58) (248) 571
-------- -------- --------
Net cash provided by operating activities 5,681 4,938 4,851
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales and maturities of securities available for sale 16,259 9,638 5,595
Purchases of securities available for sale (17,663) (9,690) (3,461)
Purchases of FHLB stock (91) (125) (127)
Net increase in loans (24,833) (1,484) (35,674)
Capital expenditures (665) (544) (712)
-------- -------- --------
Net cash used in investing activities (26,993) (2,205) (34,379)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 108 26,562 19,190
Net (decrease) increase in repurchase agreements 1,941 (463) 715
Proceeds from FHLB borrowings 10,000 1,993 3,000
Payments on FHLB borrowings (1,523)
Net federal funds purchased (4,800) 4,800
Dividends paid (1,800) (1,560) (1,350)
-------- -------- --------
Net cash provided by financing activities 8,726 21,732 26,355
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (12,586) 24,465 (3,173)
CASH AND CASH EQUIVALENTS:
Beginning of year 34,788 10,323 13,496
-------- -------- --------
End of year $ 22,202 $ 34,788 $ 10,323
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for federal income taxes $ 2,351 $ 1,781 $ 2,010
======== ======== ========
Cash paid during the year for interest $ 7,738 $ 10,916 $ 10,237
======== ======== ========
See notes to consolidated financial statements.
- 5 -
MERCHANTS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
The accounting and reporting policies of Merchants Bancorp, Inc. (the
"Corporation") conform with accounting principles generally accepted in
the United States of America and with general practices within the
banking industry. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
The significant estimates used by management include the allowance for
loan losses, fair value of financial instruments, and pension
obligations.
DESCRIPTION OF BUSINESS--The Corporation is a bank holding company
whose subsidiary, the Merchants National Bank (the "Bank"), provides a
full range of banking services. Substantially all assets, liabilities,
revenues, and expenses are related to banking operations, including
lending, investing of funds, and obtaining of deposits and other
financing. All of the Corporation's business offices and majority of
its business activities are located in the Ohio Counties of Fayette,
Highland, and Madison. The Corporation manages its business as one
operating segment and reportable unit--community banking.
The following is a summary of the Corporation's significant accounting
policies:
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements
include the accounts of Merchants Bancorp, Inc. and its wholly-owned
subsidiary, the Merchants National Bank. All significant intercompany
balances and transactions have been eliminated in consolidation.
CASH AND DUE FROM BANKS--The Corporation was required to maintain funds
with the Federal Reserve Bank in accordance with regulatory reserve
requirements of approximately $4,114,000 and $3,482,000 at December 31,
2002 and 2001, respectively.
INVESTMENT SECURITIES-- Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," requires securities to be classified as held to
maturity, available for sale or trading. Only those securities
classified as held to maturity, which the Corporation intends and has
the ability to hold until maturity, are reported at amortized cost.
Available for sale and trading securities are reported at fair value
with unrealized gains and losses included in shareholders' equity or
income, respectively. All of the Corporation's investment securities
are classified as available for sale at December 31, 2002 and 2001.
Amortization of premiums and accretion of discounts are recorded as
interest income using methods which approximate a level yield over the
period to maturity. Gains and losses realized on sales of securities
are computed using the adjusted cost of the specific securities sold.
LOANS--Loans are reported at the carrying value of unpaid principal
reduced by unearned interest, net deferred loan origination fees and an
allowance for loan losses. Loan origination costs and fees on certain
loans are deferred and the net amount is amortized as an adjustment of
the related loan's yield over the estimated life of the loan.
- 6 -
Income is recorded on the effective yield basis. Interest accrual is
discontinued when management believes, after considering economic and
business conditions and collection efforts, that the borrower's
financial condition is such that collection of interest is doubtful.
Any loan greater than 90 days past due must be well secured and in the
process of collection to continue accruing interest. Cash payments
received on nonaccrual loans generally are applied against principal,
and interest income is only recorded once principal recovery is
reasonably assured. Loans are not reclassified as accruing until
principal and interest payments are brought current and future payments
appear reasonably certain.
A loan is considered impaired when it is probable the Corporation will
be unable to collect all contractual principal and interest payments
due in accordance with the terms of the loan agreement. Impaired loans
are measured based on the loan's observable market price or the
estimated fair value of the collateral if the loan is collateral
dependent. The amount of impairment, if any, and any subsequent changes
are included in the allowance for loan losses.
The allowance for loan losses is established through a provision for
loan losses charged to operating expense. Loan losses are charged
against the allowance when management believes the loans are
uncollectible. Subsequent recoveries, if any, are credited to the
allowance.
The Corporation maintains an allowance for loan losses to absorb
probable loan losses inherent in the portfolio. The allowance for loan
losses is maintained at a level management considers to be adequate to
absorb probable loan losses inherent in the portfolio, based on
evaluations of the collectibility and historical loss experience of
loans. The allowance is based on ongoing assessments of the probable
estimated losses inherent in the loan portfolio. The Corporation's
methodology for assessing the appropriate allowance level consists of
several key elements, as described below.
Larger commercial loans that exhibit probable or observed credit
weaknesses are subject to individual review. Where appropriate,
reserves are allocated to individual loans based on management's
estimate of the borrower's ability to repay the loan given the
availability of collateral, other sources of cash flow and available
legal options. Included in the review of individual loans are those
that are impaired as provided in Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan."
As mentioned above, specific reserves for impaired loans are measured
based on the fair value of the underlying collateral. The Corporation
evaluates the collectibility of both principal and interest when
assessing the need for a specific reserve. Historical loss rates are
applied to other commercial loans not subject to specific reserve
allocations.
Homogenous loans, such as consumer installment and residential mortgage
loans, are not individually reviewed by management. Reserves are
established for each pool of loans based on the expected net
charge-offs. Loss rates are based on the average five-year net
charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted
for significant factors that, in management's judgment, reflect the
impact of any current conditions on loss recognition. Factors which
management considers in the analysis include the effects of the local
economy, trends in the nature and volume of loans (delinquencies,
charge-offs, nonaccrual and problem loans), changes in the internal
lending policies and credit standards, collection practices, and
examination results from bank regulatory agencies and the Corporation's
internal credit review function.
- 7 -
A portion of the allowance is not allocated to any particular loan type
and is maintained in recognition of the inherent inability to precisely
determine the loss potential in any particular loan or pool of loans.
Among the factors used by management in determining the unallocated
portion of the allowance are current economic conditions, trends in the
Corporation's loan portfolio delinquency, losses and recoveries, level
of underperforming and nonperforming loans, and concentrations of loans
in any one industry.
The Corporation has not substantively changed any aspect of its overall
approach in the determination of the allowance for loan losses. There
have been no material changes in assumptions or estimation techniques
as compared to prior years that impacted the determination of the
current year allowance.
BANK PREMISES AND EQUIPMENT--Bank premises and equipment are stated at
cost, less accumulated depreciation computed using the straight-line
method over their estimated useful lives, which range from five to
twenty-five years.
NONMARKETABLE SECURITIES--The Corporation's investments in the Federal
Home Loan Bank and Federal Reserve Bank are carried at cost and
included in other assets. The Corporation owned Federal Home Loan Bank
and Federal Reserve Bank stock totaling $2,147,700 and $2,057,000 as of
December 31, 2002 and 2001, respectively.
OTHER REAL ESTATE OWNED--Real estate assets acquired through
foreclosure are recorded at the lower of the recorded loan balance or
fair value. Other real estate owned at December 31, 2002 and 2001 was
$141,000 and $42,000, respectively, and is included in other assets.
REVENUE RECOGNITION--Interest income on loans is based on the principal
balance outstanding, with the exception of interest on certain
installment loans which is computed using the sum-of-the-digits method
(which approximates the interest yield method) over the lives of the
loans
INCOME TAXES--Deferred income taxes represent the net tax effects of
temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for
federal income tax purposes.
EARNINGS PER SHARE--Basic earnings per share is computed using the
weighted average number of shares of common stock outstanding during
the year. For the years ending 2002, 2001, and 2000, the Corporation
had three million shares issued and outstanding, restated in prior
years for the 3-for-1 stock split in 2001. There were no common stock
equivalents outstanding during the respective periods.
STATEMENTS OF CASH FLOWS--Cash and cash equivalents is defined to
include cash on-hand, noninterest and interest-bearing amounts due from
other banks and federal funds sold. Generally, federal funds are sold
for one day periods. The Corporation reports cash flow on a net basis
for customer loan transactions and deposit transactions.
NEW ACCOUNTING PRONOUNCEMENTS--ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS - In August 2001, the Financial
Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standard (SFAS) No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which was required to be adopted January
1, 2002. SFAS No. 144 supercedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of, and APB Opinion No. 30, Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, and combines the two accounting
models into a single model based on the framework established in SFAS
No. 121. Effects
- 8 -
of adopting SFAS No. 144 on January 1, 2002 have had no material impact
on the Corporation's earnings and financial position.
RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS - In April 2002, the FASB
issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections, which is
required to be adopted January 1, 2003. SFAS No. 145 rescinds SFAS No.
4, Reporting Gains and Losses from Extinguishment of Debt, and an
amendment of that Statement, SFAS No. 64, Extinguishments of Debt Made
to Satisfy Sinking-Fund Requirements. Under SFAS No. 4, all gains and
losses from extinguishment of debt were required to be aggregated and,
if material, classified as an extraordinary item, net of related income
tax effect. This Statement eliminates Statement 4 and, thus, the
exception to applying APB Opinion No. 30 to all gains and losses
related to extinguishments of debt (other than extinguishments of debt
to satisfy sinking-fund requirements--the exception to application of
Statement 4 noted in SFAS No. 64). As a result, gains and losses from
extinguishment of debt should be classified as extraordinary items only
if they meet the criteria in APB Opinion No. 30. Applying the
provisions of Opinion 30 will distinguish transactions that are part of
an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification as an
extraordinary item. SFAS No. 145 also rescinds SFAS No. 44, Accounting
for Intangible Assets of Motor Carriers. SFAS No. 145 amends SFAS No.
13, Accounting for Leases, to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. SFAS No. 145 also
amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their
applicability under changed conditions. Management has determined that
the adoption of this Statement will have no material effect on the
Corporation's financial position, results of operations, or cash flows.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES - In
June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which is required to be
adopted January 1, 2003. SFAS No. 146 requires recording costs
associated with exit or disposal activities at their fair values when a
liability has been incurred. Under previous guidance, certain exit
costs were accrued upon management's commitment to an exit plan, which
is generally before an actual liability has been incurred. Management
has determined that the adoption of this Statement will have no
material effect on the Corporation's financial position, results of
operations, or cash flows.
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS - SFAS No. 147,
Acquisitions of Certain Financial Institutions, was issued in October
2002. This statement clarifies that, if certain criteria are met, an
acquisition of a less-than-whole financial institution (such as a
branch acquisition) should be accounted for as a business combination.
SFAS No. 147 states that, in such instances, the excess of the fair
value of liabilities assumed over the value of tangible and
identifiable intangible assets acquired represents goodwill. Prior to
SFAS No. 147, such excesses were classified as an unidentifiable
intangible asset subject to continuing amortization under SFAS No. 142.
As a result of SFAS No. 147, entities are required to reclassify and
restate both the goodwill asset and amortization expense as of the date
SFAS No. 142 was adopted. In addition, SFAS No. 147 amends SFAS No. 144
to include in its scope long-term customer-relationship intangible
assets of financial institutions such as depositor- and
borrower-relationship intangible assets. As a result, those intangible
assets are subject to the same undiscounted cash flow recoverability
test and impairment loss recognition and measurement provisions that
SFAS No. 144 requires for other long-lived assets that are held and
used by a company. SFAS No. 147 is effective October 1, 2002 and is not
expected to have a material impact on the Corporation's financial
statements.
ACCOUNTING FOR STOCK-BASED COMPENSATION--TRANSITION AND DISCLOSURE - In
December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and
- 9 -
Disclosure. This statement amends SFAS No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, this statement amends
the disclosure requirements of SFAS No. 123 to require disclosures in
both annual and interim financial statements regarding the method of
accounting for stock-based employee compensation and the effect of the
method used on reported results. The Corporation does not have any
outstanding stock options or stock option plans at December 31, 2002
and 2001.
GUARANTOR'S ACCOUNTING FOR GUARANTEES--In December 2002, the FASB
issued Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. Interpretation No. 45 requires that at the time
a company issues a guarantee, the company must recognize an initial
liability for the fair value, or market value, of the obligations it
assumes under that guarantee. This interpretation is applicable on a
prospective basis to guarantees issued or modified after December 31,
2002. While the Corporation has various guarantees included in
contracts in the normal course of business, primarily in the form of
indemnities, these guarantees would only result in immaterial increases
in future costs, but do not represent significant commitments or
contingent liabilities of the indebtedness of others.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES--In January 2003, the FASB
issued Interpretation No. 46, Consolidation of Variable Interest
Entities. Interpretation No. 46 requires companies with a variable
interest in a variable interest entity to apply this guidance to that
entity after June 15, 2003 for existing interests and immediately for
new interests. The Corporation does not have any variable interest
entities. Management has determined that adoption will not have a
material impact on the Corporation's financial statements.
RECLASSIFICATIONS--The Corporation has reclassified certain prior year
amounts to conform to the 2002 presentation.
2. SECURITIES
The following tables provide information related to securities
available for sale as of December 31, (in thousands):
2002
----------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
United States Government and agency
obligations $ 3,556 $ 50 $ $ 3,606
Obligations of states and political subdivisions 19,476 824 (24) 20,276
Mortgage-backed securities 15,564 569 (3) 16,130
------- ------- ------- -------
Total $38,596 $ 1,443 $ (27) $40,012
======= ======= ======= =======
2001
----------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
United States Government and agency
obligations $ 2,515 $ 44 $ (1) $ 2,558
Obligations of states and political subdivisions 8,588 420 (12) 8,996
Mortgage-backed securities 26,320 380 (33) 26,667
------- ------- ------- -------
Total $37,423 $ 844 $ (46) $38,221
======= ======= ======= =======
- 10 -
The book value and approximate fair value of securities at December 31,
2002 by contractual maturity, are shown below (in thousands). Actual
maturities may differ from contractual maturities when there exists a
right to call or prepay obligations.
AMORTIZED FAIR
COST VALUE
Less than 1 year $ 1,352 $ 1,365
1 to 5 years 5,070 5,270
6 to 10 years 443 456
Over 10 years 16,167 16,791
Mortgage-backed securities 15,564 16,130
------- -------
Total $38,596 $40,012
======= =======
Management reviews the securities portfolio on a quarterly basis to
determine whether any securities have been impaired. As of December 31,
2002 and 2001, the securities portfolio did not include any securities
with other-than-temporary impairments.
The Corporation did not sell any securities in 2002 or 2001. The
Corporation recognized gross gains of $2,000 and gross losses of $1,000
from the sale of securities in 2000.
At December 31, 2002 and 2001, securities with amortized cost of
approximately $17,197,000 and $21,136,000, respectively, were pledged
to secure public deposits and for other purposes as required or
permitted by law.
3. LOANS
Loans at December 31, 2002 and 2001 were as follows (in thousands):
2002 2001
Commercial real estate $ 53,104 $ 41,917
Commercial and industrial 25,779 24,088
Agricultural 41,106 34,313
Residential real estate 99,610 97,182
Installment 27,178 24,960
Other 1,493 1,267
-------- --------
Total 248,270 223,727
Less allowance for loan losses (2,106) (1,960)
-------- -------
$246,164 $221,767
======== ========
At December 31, 2002 and 2001, the recorded investment in loans
considered to be impaired was approximately $4,031,000 and $4,133,000,
of which $476,000 and $383,000 were on a nonaccrual basis,
respectively. Specific reserves for credit losses allocated to these
loans were $664,000 and $235,000 at December 31, 2002 and 2001,
respectively. The average investment in impaired loans for 2002, 2001,
and 2000 was $2,132,000, $2,625,000, and $2,094,000, respectively.
Interest income recognized from cash payments on impaired loans was
$11,000, $133,000, and $122,000 for 2002, 2001, and 2000, respectively.
Total loans serviced by the Bank for the benefit of others at December
31, 2002 and 2001 were approximately $6,103,000 and $3,217,000,
respectively.
- 11 -
4. ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows (in
thousands):
2002 2001 2000
Balance, January 1 $ 1,960 $ 1,911 $ 1,905
Provision for loan losses 436 177 177
Loans charged-off (356) (182) (203)
Recoveries of loans previously charged-off 66 54 32
------- ------- -------
Balance, December 31 $ 2,106 $ 1,960 $ 1,911
======= ======= =======
5. BANK PREMISES AND EQUIPMENT
Bank premises and equipment at December 31, 2002 and 2001 consisted of
the following (in thousands):
2002 2001
Land $ 735 $ 735
Buildings and improvements 4,266 3,923
Furniture and equipment 4,580 4,258
------- -------
Total 9,581 8,916
Less accumulated depreciation (5,232) (4,573)
------- -------
bank premises and equipment, net $ 4,349 $ 4,343
======= =======
Depreciation expense was $659,000, $633,000, and $486,000 for the years
ended December 31, 2002, 2001, and 2000, respectively.
6. DEPOSITS
Major classifications of deposits are categorized as follows (in
thousands):
2002 2001
Noninterest-bearing deposits $ 30,195 $ 31,220
Savings and interest checking 101,757 85,980
Certificates of deposits > $100,000 27,296 30,618
Other time deposits 103,468 114,790
-------- --------
Total $262,716 $262,608
======== ========
- 12 -
Maturities of certificates of deposit for each of the next five years
are as follows (in thousands):
AMOUNT
2003 $ 94,520
2004 19,550
2005 16,451
2006 231
2007 12
--------
Total $130,764
========
7. FHLB BORROWINGS
All stock in the Federal Home Loan Bank ("FHLB") with a carrying value
of $2,027,000 and first mortgage residential loans with an unpaid
principal balance of $43,837,000, which equals at least 135% of the
amount borrowed, are pledged as collateral on FHLB borrowings.
Maturities and interest rates at December 31, 2002 are as follows (in
thousands):
INTEREST
MATURITY RATE AMOUNT
April 10, 2008 5.39 % $ 1,000
September 25, 2008 4.78 % 3,000
March 15, 2010 6.26 % 3,000
September 1, 2011 5.23 % 470
January 9, 2012 4.64 % 10,000
-------
Total $17,470
=======
The interest rate on the advances maturing on April 10, 2008, September
25, 2008, and March 15, 2010 are fixed for three years. On a quarterly
basis, the FHLB may convert, at its option, the fixed rate to one that
varies with the three month LIBOR. This advance may be prepaid at
anytime, subject to the terms of the agreement.
In addition to the FHLB borrowings, the Corporation has an outstanding
standby letter of credit available with the FHLB totaling $15,000,000
at December 31, 2002 and 2001.
8. FEDERAL INCOME TAXES
Federal income taxes consisted of the following (in thousands):
2002 2001 2000
Currently payable $ 2,292 $ 1,959 $ 1,916
Deferred provision (benefit) (129) (7) 48
------- ------- -------
Total $ 2,163 $ 1,952 $ 1,964
======= ======= =======
-13-
A reconciliation of the Corporation's statutory income tax rate to the
effective rate at December 31 follows:
2002 2001 2000
Statutory tax rate 34.0 % 34.0 % 34.0 %
Decrease from tax-exempt interest (4.1)% (2.3)% (2.5)%
Other, net 1.3 % (1.0)% 0.3 %
------ ------ ------
Effective tax rate 31.2 % 30.7 % 31.8 %
====== ====== ======
Deferred income taxes are provided for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases (primarily the allowance for loan losses and unrealized
gains/losses on securities available for sale).
The tax effects of significant items comprising the Corporation's
deferred tax assets (liabilities) at December 31, are as follows (in
thousands):
2002 2001
Unrealized gains on securities
available for sale $(482) $(271)
Allowance for loan losses 624 574
Other, net (31) (166)
----- -----
Net deferred tax asset $ 111 $ 137
===== =====
9. EMPLOYEE BENEFIT PLANS
The Corporation provides defined pension benefits to substantially all
eligible employees. Benefits are based on years of service and earnings
in the highest five consecutive calendar years preceding retirement or
a monthly amount if employed less than five years. The Plan is funded
in accordance with the minimum funding requirements of the Employee
Retirement Income Security Act of 1974.
The details of net periodic pension cost included in personnel expense
in the accompanying consolidated statements of income for the years
ended December 31, 2002, 2001 and 2000 are as follows (in thousands):
- 14 -
2002 2001 2000
Economic assumptions:
Discount rate 6.50 % 7.50 % 7.50 %
Return on assets 7.50 % 7.50 % 7.50 %
Salary increases 4.00 % 4.00 % 4.00 %
Service cost $ 111 $ 107 $ 96
Interest cost on projected benefit obligation 100 105 93
Expected return on plan assets (73) (98) (95)
Net amortization and deferral 7 (4) (4)
----- ----- -----
Net periodic pension cost $ 145 $ 110 $ 90
===== ===== =====
A summary of the Plan's funded status at December 31 is as follows (in
thousands):
2002 2001
Projected benefit obligation at beginning of year $ 1,306 $ 1,429
Service cost 111 107
Interest cost 100 105
Actuarial (gain)/loss 367 (24)
Benefits paid during year (1) (311)
------- -------
Projected benefit obligation at end of year 1,883 1,306
------- -------
Fair value of plan assets at beginning of year 1,004 1,323
Actual return on assets (185) (145)
Employer contributions 168 137
Benefits paid (1) (311)
------- -------
Fair value of plan assets at end of year 986 1,004
------- -------
Funded status - underfunded 897 302
Unrecognized transition obligation 15 17
Unrecognized prior service cost 16 17
Minimum pension liability 162
Unrecognized net gain (loss) (908) (292)
------- -------
Accrued pension cost $ 182 $ 44
======= =======
The above accrued pension cost is included in "Accrued interest, taxes
and other liabilities" in the accompanying consolidated balance sheets.
Unrecognized prior service cost and net gain (loss) is amortized over
the average future service lives of plan participants (18 years).
For the Corporation's defined benefit plan, with an accumulated benefit
obligation exceeding assets, the total projected benefit obligation,
accumulated benefit obligation and fair value of plan assets were
approximately $1,883,000, $1,169,000, and $986,000, respectively as of
December 31, 2002, and $1,306,000, $757,000, and $1,004,000,
respectively as of December 31, 2001. At
- 15 -
December 31, 2002, an additional minimum pension liability was recorded
as a reduction to shareholders' equity in an amount of $108,000, net of
$58,000 of tax benefit.
The Corporation has entered into supplemental deferred compensation
agreements with certain executives of the Corporation under an
Executive Investment Plan. Total expense related to this plan was
approximately $25,000, $16,000, and $37,000 in 2002, 2001, and 2000,
respectively. As of December 31, 2002 and 2001, the amounts payable
under this plan were approximately $188,000 and $179,000, respectively.
The Corporation has a defined contribution 401(k) plan covering
substantially all eligible employees. The Corporation made
contributions of $36,000, $32,000 and $30,000 for 2002, 2001 and 2000,
respectively.
10. COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, the Corporation has outstanding
various financial instruments with off-balance sheet risk, such as
commitments to extend credit and commercial and standby letters of
credit. At December 31, 2002 and 2001, the Corporation had
approximately $21,864,000 and $17,400,000, respectively, of commitments
to extend credit. Commercial and standby letters of credit with
customers were $80,000 and $159,000 at December 31, 2002 and 2001,
respectively.
Commitments to extend credit are agreements to lend. Commercial and
standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. The
Corporation's exposure to credit loss in the event of nonperformance by
the other party is represented by the contractual amount. No material
losses or liquidity demands are anticipated as a result of these
commitments.
The Corporation evaluates each customer's creditworthiness on a
case-by-case basis in accordance with the Corporation's credit
policies. The amount of collateral obtained, if deemed necessary by the
Corporation upon extension of credit, is based upon management's credit
evaluation of the customer. Collateral held varies, but may include
business assets of commercial borrowers as well as personal property
and real estate of individual borrowers or guarantors.
The Corporation grants agribusiness, commercial, residential and
installment loans to customers in the surrounding areas of its offices
in Hillsboro, Greenfield, London, and Washington Court House, Ohio.
Although the Bank has a diversified loan portfolio, the borrower's
ability to honor their commitments is dependent upon the regional
economy. As of December 31, 2002 and 2001, the Corporation had
outstanding approximately $41,106,000 and $34,105,000, respectively, in
loans for agriculture purposes, or secured by agricultural properties.
11. RELATED PARTY TRANSACTIONS
At December 31, 2002 and 2001, certain directors, executive officers
and/or companies in which these individuals had a ten percent or more
beneficial ownership were indebted to the Corporation in the aggregate
amounts of approximately $1,282,000 and $1,540,000, respectively. A
rollforward of the related party activity follows (in thousands):
- 16 -
] 2002 2001
Balance, January 1, $ 1,540 $ 1,642
Originations 222 1,044
Payments (480) (1,146)
------- -------
Balance, December 31, $ 1,282 $ 1,540
======= =======
12. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments is as follows (in
thousands):
DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------- ----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
Cash and cash equivalents $ 22,202 $ 22,202 $ 34,788 $ 34,788
Securities available for sale 40,012 40,012 38,221 38,221
Federal Reserve Bank and
FHLB Stock 2,147 2,147 2,057 2,057
Loans, net 246,164 246,975 221,767 223,339
Deposits:
Demand deposits 30,195 30,195 31,220 31,220
Savings deposits 101,757 101,757 85,980 85,980
Certificates and other time deposits 130,764 131,558 145,408 147,308
FHLB borrowings 17,470 21,932 8,993 8,993
Repurchase agreements 3,365 3,365 1,424 1,424
The estimated fair value amounts are determined by the Corporation,
using available market information and appropriate valuation
methodologies. However, considerable judgment is required in
interpreting market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Corporation could realize in a current
market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated
fair value amounts.
CASH AND CASH EQUIVALENTS, FEDERAL RESERVE BANK AND FHLB STOCK--The
carrying amounts of these items are a reasonable estimate of their fair
value.
SECURITIES AVAILABLE FOR SALE--Fair values are based on quoted market
prices and dealer quotes.
LOANS RECEIVABLE--The fair value of loans receivable is estimated by
discounting future cash flows at market rates for loans of similar
terms and maturities, taking into consideration repricing
characteristics and prepayment risk.
DEPOSITS--The fair value of demand deposits and savings deposits is the
amount payable on demand at the reporting date. The fair value of
fixed-rate certificates of deposits is estimated by discounting the
future cash flows using rates offered on the reporting date for
deposits of similar remaining maturities.
- 17 -
FHLB BORROWINGS-- The fair value of FHLB borrowings is estimated by
discounting the future cash flows using rates offered on the
reporting date for borrowings of similar remaining maturities.
REPURCHASE AGREEMENTS--The carrying amounts of these items are a
reasonable estimate of their fair value.
COMMITMENTS--The estimated fair value of commitments to originate
fixed-rate loans is determined based on the fees currently charged to
enter into similar agreements and the difference between current levels
of interest rates and the committed rates. Based on the analysis, the
estimated fair value of such commitments is a reasonable estimate of
the loan commitments at par.
The fair value estimates presented herein are based on information
available to management as of December 31, 2002 and 2001. Although
management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements
since that date, and therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
13. REGULATORY MATTERS
The Corporation is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken,
could have a direct material effect on the Corporations' financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Corporation must meet
specific capital guidelines that involve quantitative measures of the
Corporation's assets, liabilities, and certain off-balance sheet items
as calculated under regulatory accounting practices. The Corporation's
capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Corporation to maintain minimum amounts and ratios
(set forth in the table below, in thousands) of total and Tier I
capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as
defined). Management believes, as of December 31, 2002, that the
Corporation meets all capital adequacy requirements to which it is
subject.
As of December 31, 2002, the most recent notification from the Office
of the Comptroller of the Currency categorized the Corporation as well
capitalized under the regulatory framework for prompt corrective
action. To be categorized as adequately capitalized the Corporation
must maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed
the institutions' categories.
- 18 -
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(000'S) (000'S) (000'S)
As of December 31, 2002:
Total risk-based capital
(to risk-weighted assets)
Consolidated $34,791 14.7% $18,885 8% N/A
Bank $28,815 12.4% $18,591 8% $23,239 10%
Tier 1 risk-based capital
(to risk-weighted assets)
Consolidated $32,682 13.9% $ 9,442 4% N/A
Bank $18,706 8.1% $ 9,296 4% $13,943 6%
Tier 1 leverage capital
(to adjusted total assets)
Consolidated $32,682 10.3% $12,704 4% N/A
Bank $18,706 6.0% $12,447 4% $15,559 5%
As of December 31, 2001:
Total risk-based capital
(to risk-weighted assets)
Consolidated $31,666 14.9% $16,992 8% N/A
Bank $25,858 12.5% $16,499 8% $20,624 10%
Tier 1 risk-based capital
(to risk-weighted assets)
Consolidated $29,706 14.0% $ 8,496 4% N/A
Bank $23,898 11.6% $ 8,250 4% $12,375 6%
Tier 1 leverage capital
(to adjusted total assets)
Consolidated $29,706 9.9% $11,975 4% N/A
Bank $23,898 8.2% $11,729 4% $14,662 5%
DIVIDEND RESTRICTIONS--National banking laws restrict the maximum
amount of dividends that a bank may pay in any calendar year. Dividends
are limited to the Bank's retained profits (as defined by the
Comptroller of the Currency) for that year and the two preceding years.
The amount of retained earnings available for cash dividends payable by
the Bank to the Corporation was approximately $8,267,000 and $7,765,000
as of December 31, 2002 and 2001, respectively.
- 19 -
14. PARENT COMPANY FINANCIAL STATEMENTS
Condensed Balance Sheets (in thousands):
2002 2001
ASSETS
Due from banks $ 288 $ 949
Securities available for sale 3,996 4,516
Loans, net 2,166 652
Subordinated note receivable from subsidiary 8,000
Other assets 53 55
Investment in subsidiary 19,449 24,398
------- -------
TOTAL $33,952 $30,570
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Other liabilities $ 444 $ 338
------- -------
Total liabilities 444 338
------- -------
SHAREHOLDERS' EQUITY 33,508 30,232
------- -------
TOTAL $33,952 $30,570
======= =======
Condensed Statements of Income for the year ended December 31 (in
thousands):
2002 2001 2000
INCOME:
Dividends from subsidiary bank $1,800 $1,560 $1,350
Other income 265 314 309
------ ------ ------
Total income 2,065 1,874 1,659
------ ------ ------
EXPENSES:
Other expenses 19 28 6
------ ------ ------
INCOME BEFORE INCOME TAXES 2,046 1,846 1,653
------ ------ ------
Income tax expense 78 89 91
------ ------ ------
Income before equity in undistributed
income of bank subsidiary 1,968 1,757 1,562
------ ------ ------
Equity in undistributed income of bank subsidiary 2,804 2,648 2,643
------ ------ ------
NET INCOME $4,772 $4,405 $4,205
====== ====== ======
- 20 -
Condensed Statements of Cash Flows for the year ended December 31 (in
thousands):
2002 2001 2000
Cash flows from operating activities:
Net income $ 4,772 $ 4,405 $ 4,205
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of subsidiary (2,804) (2,648) (2,643)
Change in other assets and liabilities, net 108 112 171
------- ------- -------
Net cash provided by operating activities 2,076 1,869 1,733
------- ------- -------
Cash flows from investing activities:
Chance in securities, net 577 53 512
Change in loans, net (1,514) 87 (739)
------- ------- -------
Net cash (used in) provided by investing activities (937) 140 (227)
------- ------- -------
Cash flows from financing activities:
Dividends paid (1,800) (1,560) (1,350)
------- ------- -------
Net cash used in financing activities (1,800) (1,560) (1,350)
------- ------- -------
Net (decrease) increase in cash and cash equivalents (661) 449 156
Cash and cash equivalents at beginning of year 949 500 344
------- ------- -------
Cash and cash equivalents at end of year $ 288 $ 949 $ 500
======= ======= =======
******
- 21 -
10-K EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
EX-99.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002