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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission file number 000-25287
TOWER FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
INDIANA 35-2051170
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
116 EAST BERRY STREET, FORT WAYNE, INDIANA 46802
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (260) 427-7000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
WITHOUT PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Aggregate market value of the voting and non-voting common stock held by
nonaffiliates of the registrant based on the last sale price for such stock at
June 30, 2003 (assuming solely for the purposes of this calculation that all
directors and executive officers of the registrant are "affiliates"):
$45,262,544
Number of shares of Common Stock outstanding at February 13, 2004: 3,943,644
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document have been incorporated by reference into this
Annual Report on Form 10-K.
PART OF 10-K INTO WHICH
IDENTITY OF DOCUMENT DOCUMENT IS INCORPORATED
Definitive Proxy Statement for the Part III
Annual Meeting of Shareholders
To be held April 20, 2004
TOWER FINANCIAL CORPORATION
Fort Wayne, Indiana
Annual Report to Securities and Exchange Commission
December 31, 2003
PART I
ITEM 1. BUSINESS.
GENERAL DEVELOPMENT OF BUSINESS
Tower Financial Corporation (the "Company") was incorporated as an Indiana
corporation on July 8, 1998. The Company owns all of the issued and outstanding
stock of Tower Bank & Trust Company (the "Bank") and is a bank holding company
under the Federal Bank Holding Company Act of 1956, as amended. In February,
2001, the Federal Reserve Bank of Chicago approved the Company's election to
become a financial holding company under the Gramm-Leach Bliley Act. The
financial holding company designation permits the Company to engage in certain
financial activities, such as selling and underwriting insurance, securities
brokerage and merchant banking. At this time, the Company does not engage in
such activities and has no current plans to pursue them. The Bank is an Indiana
chartered bank with depository accounts insured by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank is a member of the Federal Reserve System. The
Bank commenced business on February 19, 1999. Prior to the opening of the Bank,
the Company's principal activities related to the organization of the Bank and
the conducting of its initial public offering, or IPO. The Company received
total proceeds of $23.5 million (net of offering expenses and underwriters'
discounts) from the IPO, of which $15.0 million was used to initially capitalize
the Bank.
The Bank provides a range of commercial and consumer banking services primarily
in Allen County, Indiana, including Fort Wayne and its suburbs. Those services
reflect the Bank's strategy of serving small- to medium-sized businesses and
individual customers. The Bank's lending strategy is focused on commercial loans
and, to a lesser extent, on consumer and residential mortgage loans. The Bank
offers a broad array of deposit products, including checking, savings, and money
market accounts, certificates of deposit and direct deposit services. The Bank
also provides personal trust services through its Investment Management & Trust
Services.
The Bank's main office is located at 116 East Berry Street in downtown Fort
Wayne, Indiana, and serves as the Company's corporate headquarters.
EXPANSION
In May 2000, the Bank opened its first branch office located in the northwest
section of Fort Wayne, Indiana. In January 2001, the Bank opened a second branch
office located in the southwest section of Fort Wayne and, in September 2002,
the Bank opened its third branch office in the northeast section of Fort Wayne.
The Bank opened its fourth branch in January 2004 on the south side of Fort
Wayne, in Waynedale.
The Bank closed its mortgage loan production office in Huntington, Indiana in
October 2003, consolidating that operation into the Bank's main office in
downtown Fort Wayne.
PRIMARY LINES OF BUSINESS
Commercial Lending .The Bank's lending activities focus primarily on providing
small- and medium-sized businesses in its market area with commercial business
loans. These loans are both secured and unsecured and are made available for
general operating purposes, acquisition of fixed assets including real estate,
equipment and
1
machinery, lines of credit collateralized by inventory and accounts receivable,
as well as any other purposes considered appropriate by executive management.
Typically, the Bank's customers' financing requirements range from $100,000 to
$2.0 million. Approximately 33.6% of the Bank's commercial loans are commercial
real estate loans secured by a first lien on the commercial real estate. The
majority of commercial loans that are not mortgage loans are secured by a lien
on equipment, inventory and/or other assets of the commercial borrower. The
Bank's commercial loans have both fixed and floating interest rates and
typically have maturities of 1 to 5 years. Commercial and commercial real estate
loans comprised approximately 79.2% of the Bank's total loan portfolio at
December 31, 2003.
Mortgage Banking. The Bank originates both fixed and variable rate, long-term
residential mortgage loans and sells a majority of them in the secondary market.
The Bank's general policy, which is subject to review by management as a result
of changing market and economic conditions and other factors, is to retain a
portion of fixed rate balloon maturity mortgage loans in its loan portfolio and
to sell the majority of long-term, fixed rate and variable rate loans in the
secondary market. Generally, the loans sold into the secondary mortgage market
make funds available for reuse in mortgage or other lending activities. The Bank
also brokers real estate mortgage loans in the secondary market. The Bank does
not retain servicing rights with respect to any of the residential mortgage
loans that it brokers or sells. During 2003, the Bank originated $41.3 million
of residential mortgage loans, of which $25.3 million were retained, and $16.0
million were sold in the secondary market. The Bank also brokered $50.0 million
of residential mortgage loans during 2003. The following table reflects
residential real estate mortgage loans originated, sold and retained or brokered
for the periods indicated.
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
($ in thousands) 2003 2002 2001
- ---------------- ------- ------- -------
Real estate mortgage loans held for sale at
beginning of period $ 3,356 $ 4,293 $
Real estate mortgage loans originated for sale 15,956 30,246 16,850
Real estate mortgage loan sales 19,312 31,183 12,557
------- ------- -------
Real estate mortgage loans held for sale at
end of period $ $ 3,356 $ 4,293
======= ======= =======
Real estate mortgage loans originated and retained $25,376 $10,996 $17,791
Real estate mortgages brokered 49,977 46,005 26,868
Personal Loans and Lines of Credit. The Bank makes personal loans and lines of
credit available to consumers for various purposes, such as the purchase of
automobiles, boats and other recreational vehicles, and the making of home
improvements and personal investments. The majority of the Bank's personal loans
are home equity loans and secured by a second lien on real estate. The Bank
retains all of such loans.
Investment Management and Trust Services. The Bank's investment management and
trust services department offers a range of personal trust services to customers
in its market area. The Bank's trust services include estate planning and money
management. The Bank believes offering a range of trust products and services is
an excellent way to leverage its customer relationships, which should allow for
continued growth in investment management and trust department revenues. Trust
personnel are experienced and provide personalized customer service. The Bank
believes these factors have contributed to its growth from no trust assets under
management in October 1999 to approximately $312.3 million of trust assets under
management at December 31, 2003. At December 31, 2003, approximately 60.8% of
the Bank's assets under management were invested in equities, 27.0% were
invested in fixed income products and 12.2% were invested in cash and other
products.
The following table reflects assets under management and revenue of the Bank's
investment management and trust services department for the periods indicated.
2
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
($ in thousands) 2003 2002 2001
- ---------------- -------- -------- --------
Assets under management $312,327 $235,439 $223,710
Number of accounts 428 364 268
Average account size $ 730 $ 647 $ 835
Trust revenue $ 1,402 $ 1,085 $ 798
Deposit Generation. The Bank generates deposits primarily through offering a
broad array of deposit products to individuals, businesses, associations,
financial institutions, and government entities in Allen County and surrounding
counties. The Bank generally seeks a comprehensive banking relationship from its
lending customers, which has contributed to its internal deposit growth. This
often includes encouraging new customers to consider both business and personal
checking accounts and other deposit services. The Bank's deposit services
include checking, savings, and money market accounts, certificates of deposit,
direct deposit services, and telephone and Internet banking. The Bank also
generates certificate of deposits through national, out-of-market sources
developed during 2002 and 2003. These deposits include brokered deposits, which
the Bank began accepting during 2003. These out-of-market deposits are generated
by direct negotiation with out-of-market banks and credit unions, posting CD
rates on a national bulletin board via the Internet to a member customer base
and through negotiated transactions with brokers. The Bank also offers a courier
service for the deposit convenience of its business customers as well as
wholesale lockbox and other business deposit services. At December 31, 2003,
approximately 80.4% of the Bank's deposits were generated in-market, while 19.6%
were out-of-market deposits. Deposits at December 31, 2003, 2002 and 2001 are
summarized as follows:
2003 2002 2001
------------------- ------------------ ------------------
($ in thousands) BALANCE % BALANCE % BALANCE %
- ---------------- --------- ------ -------- ------ -------- ------
Noninterest-bearing demand $ 62,638 17.3% $ 42,966 13.8% $ 28,383 11.1%
Interest-bearing checking 23,544 6.5% 21,582 7.0% 14,909 5.8%
Money market 98,250 27.1% 99,105 31.9% 112,580 44.0%
Savings 10,576 2.9% 8,343 2.7% 4,521 1.8%
Time, under $100,000 63,029 17.4% 54,803 17.6% 30,076 11.7%
Time, $100,000 and over 104,840 28.9% 83,785 27.0% 65,684 25.6%
-------- ----- -------- ----- -------- -----
TOTAL DEPOSITS $362,877 100.0% $310,584 100.0% $256,153 100.0%
======== ===== ======== ===== ======== =====
LENDING PRACTICES
The Bank makes loans to individuals and businesses located within its market
area. The Bank's loan portfolio at December 31, 2003 consisted of commercial and
commercial real estate loans (79.2%), residential mortgage loans (10.8%) and
personal loans (10.0%). The Bank's legal lending limit under applicable federal
banking regulations is approximately $6.3 million, based on the legal lending
limit of 15% of total risk based capital of the Bank.
Commercial Loans. Commercial loans are made primarily to small- and medium-sized
businesses within our market area. These loans may be secured or unsecured and
are made available for general operating purposes, acquisition of fixed assets
including real estate, equipment and machinery, financing of inventory and
accounts receivable, as well as any other purposes considered appropriate by
management. The Bank generally looks to a borrower's business operations as the
principal source of repayment, but also receives, when appropriate, mortgages on
real estate, security interests in inventory, accounts receivable and other
personal property and/or personal guarantees. Approximately 33.6% of the Bank's
commercial loans are commercial real estate loans secured by a first lien on the
commercial real estate. In addition, commercial loans that are not mortgage
loans are typically secured by a lien on equipment, inventory and/or other
assets of the commercial borrower.
3
Commercial real estate lending involves more risk than residential lending
because loan balances are greater and repayment is dependent upon the borrower's
operations. The Bank endeavors to reduce the risk associated with these
transactions by generally limiting its exposure to owner-operated properties of
customers with an established profitable history. In many cases, the Bank may
further reduce this risk by (i) limiting the amount of credit to any one
borrower to an amount less than the Bank's legal lending limit and (ii) avoiding
certain types of commercial real estate financing.
Residential Mortgage Loans. The Bank originates residential mortgage loans which
are generally long-term, with either fixed or variable interest rates. The
Bank's general policy, which is subject to review by management as a result of
changing market and economic conditions and other factors, is to retain a
portion of fixed rate balloon maturity mortgage loans in its loan portfolio and
to broker the majority of long-term, fixed rate and variable rate loans in the
secondary market. The Bank also offers home equity loans. Residential real
estate loans are secured by a first lien on the real estate. The Bank does not
retain servicing rights with respect to any of the residential mortgage loans
that it brokers.
Personal Loans and Lines of Credit. The Bank makes personal loans and lines of
credit available to consumers for various purposes, such as the purchase of
automobiles, boats and other recreational vehicles, and the making of home
improvements and personal investments. The majority of the Bank's personal loans
are home equity loans secured by a second lien on real estate. The Bank retains
all of such loans.
Consumer loans generally have shorter terms and higher interest rates than
residential mortgage loans and, except for home equity lines of credit, usually
involve more credit risk than mortgage loans because of the type and nature of
the collateral. Consumer lending collections are dependent on a borrower's
continuing financial stability and are thus likely to be adversely affected by
job loss, illness and personal bankruptcy. In many cases, repossessed collateral
for a defaulted consumer loan will not provide an adequate source of repayment
of the outstanding loan balance because of depreciation of the underlying
collateral. The Bank has a policy of careful loan underwriting, with a strong
emphasis on the amount of the down payment, credit quality, employment
stability, and monthly income. These loans are generally repaid on a monthly
repayment schedule with the payment amount tied to the borrower's periodic
income. The Bank believes that the generally higher yields earned on consumer
loans will help compensate for the increased credit risk associated with such
loans and that consumer loans are important to its efforts to serve the credit
needs of its customer base.
Loan Policies. Although the Bank takes a progressive and competitive approach to
lending, it stresses high quality in its loans. Because of the Bank's local
nature, management believes that quality control is achieved while still
providing prompt and personal service. The Bank is subject to written loan
policies that contain general lending guidelines and are subject to periodic
review and revision by the Bank's Loan and Investment Committee and its Board of
Directors. These policies relate to loan administration, documentation, approval
and reporting requirements for various types of loans.
The Bank's loan policies include procedures for oversight and monitoring of the
Bank's lending practices and loan portfolio. The Bank seeks to make sound loans,
while recognizing that lending money involves a degree of business risk. The
Bank's loan policies are designed to assist in managing the business risk
involved in making loans. These policies provide a general framework for the
Bank's loan operations, while recognizing that not all loan activities and
procedures can be anticipated. The Bank's loan policies instruct lending
personnel to use care and prudent decision-making and to seek the guidance of
the President or Chief Executive Officer of the Bank where appropriate.
The Bank's loan policies provide guidelines for loan-to-value ratios that limit
the size of certain types of loans to a maximum percentage of the value of the
collateral securing the loans, which percentage varies by the type of
collateral. The Federal Deposit Insurance Corporation Improvement Act of 1991
establishes regulatory and supervisory loan-to-value limits. The Bank's internal
loan-to-value limitations follow those limits and, in certain cases, are more
restrictive than those required by the regulators.
The Bank's loan policies also establish an "in-house" limit on the aggregate
amount of loans to any one borrower. This limit is a guideline that currently
does not exceed $4.0 million. This internal limit is subject to review and
revision by the Board of Directors from time to time.
4
In addition, the Bank's loan policies provide guidelines for (i) personal
guarantees, (ii) loans to employees, executive officers and directors, (iii)
problem loan identification, (iv) maintenance of an allowance for loan losses
and (v) other matters relating to the Bank's lending practices.
Loan Review Policies. To ensure that lending practices adhere to loan policies
and guidelines, and to ensure that loans are risk rated correctly, the Bank
established a Loan Review Department. The primary activities of the Loan Review
Department include (i) conducting reviews of specific loans, (ii) assessing the
adequacy of loan ratings assigned by lending personnel, (iii) monitoring
portfolio concentrations and (iv) monitoring loans subject to Regulation O. To
complete these activities, the Bank employs several management tools, primarily
a loan grading system, a loan review memorandum and a formalized watch list.
DEPOSITS AND OTHER SERVICES
Deposits. The Bank offers a broad range of deposit services, including checking,
savings, and money market accounts, certificates of deposit and direct deposit
services. Transaction accounts and certificates of deposit are tailored to the
Bank's primary market area at rates competitive with those offered in Allen
County. The Bank also offers certificates of deposit accounts to select national
and brokered markets at rates competitive with the national market as well as
those in Allen County. All depositors are insured by the FDIC up to the maximum
amount permitted by law. The Bank solicits deposit accounts from individuals,
businesses, associations, financial institutions and government entities in and
around Allen County, as well as certificates of deposit accounts nationally
through a rate-posting system.
Other Services. The Bank offers a courier service for the deposit convenience of
its business customers. The Bank also offers investment management and trust
services and telephone banking to its customers. In addition, during early 2001
the Bank also began providing computer banking through the Internet. The Bank
has established relationships with correspondent banks and other independent
financial institutions to provide other services requested by its customers,
including loan participations where the requested loan amounts exceed the Bank's
policies or legal lending limits.
INVESTMENTS
The principal investment of the Company is its ownership of all of the common
stock of the Bank. Funds retained by the Company from time to time may be
invested in various debt instruments, including but not limited to obligations
guaranteed by the United States, general obligations of a state or political
subdivision thereof, bankers' acceptance of deposit of United States commercial
banks, or commercial paper of United States issuers rated in the highest
category by a nationally recognized statistical rating organization. Although
the Company is permitted to make limited portfolio investments in equity
securities and to make equity investments in subsidiary corporations engaged in
certain non-banking activities (which may include real estate-related activities
such as mortgage banking, community development, real estate appraisals,
arranging equity financing for commercial real estate, and owning or operating
real estate used substantially by the Bank or acquired for future use), the
Company has no present plans to make any such equity investments except for a
$100,000 investment in a statewide economic development venture capital limited
partnership which was recorded in other assets.
The Bank may invest its funds in a wide variety of debt instruments and may
participate in the federal funds market with other depository institutions.
Subject to certain exceptions, the Bank is prohibited from investing in equity
securities. Real estate acquired by the Bank in satisfaction of, or foreclosure
upon, loans may be held by the Bank for no longer than 10 years after the date
of acquisition without the written consent of the Indiana Department of
Financial Institutions. The Bank is also permitted to invest an aggregate amount
not in excess of 50% of the "sound capital" of the Bank in such real estate and
buildings as are necessary for the convenient transaction of its business. The
Bank's Board of Directors may alter the Bank's investment policy without
shareholders' approval.
5
FUNDING SOURCES
The Bank funded its operations in 1999 from its initial capitalization with
proceeds of the Company's initial public offering. During 2001, 2002 and 2003,
the Company contributed $6,750,000 $7,000,000 and $0, respectively, to the Bank
as capital to support the balance sheet growth. On an ongoing basis, the Bank
funds its operations primarily with local deposits. Secondarily, the Bank also
uses alternative funding sources as needed, including advances from the Federal
Home Loan Bank, out-of-market deposits (including national market CDs and
brokered CDs) and other forms of wholesale financing.
EFFECT OF GOVERNMENT MONETARY POLICIES
The earnings of the Company are affected by domestic economic conditions and the
monetary and fiscal policies of the United States government, its agencies and
the Federal Reserve Board. The Federal Reserve Board's monetary policies have
had, and will continue to have, an important impact on the operating results of
commercial banks through its power to implement national monetary policy in
order to, among other things, curb inflation and avoid a recession. The
instruments of monetary policy employed by the Federal Reserve Board include
open market operations in United States government securities, changes in the
discount rate on member bank borrowing and changes in reserve requirements
against deposits held by all federally insured banks. In view of changing
conditions in the national economy and in the money markets, as well as the
effect of actions by monetary fiscal authorities including the Federal Reserve
Board, no prediction can be made as to possible future changes in interest
rates, deposit levels, loan demand or the business and earnings of the Bank.
REGULATION AND SUPERVISION
General. Financial institutions and their holding companies are extensively
regulated under federal and state law. Consequently, the growth and earnings
performance of the Company and the Bank can be affected not only by management
decisions and general economic conditions, but also by the statutes administered
by, and the regulations and policies of, various governmental regulatory
authorities. Those authorities include but are not limited to the Federal
Reserve Board, the FDIC, the Indiana Department of Financial Institutions (the
"Department"), the Internal Revenue Service and the state taxing authorities.
The effect of such statutes, regulations and policies can be significant and
cannot be predicted with any high degree of certainty. Federal and state laws
and regulations generally applicable to the Company and the Bank regulate among
other things:
- the scope of permitted businesses,
- investments,
- reserves against deposits,
- capital levels relative to operations,
- lending activities and practices,
- the nature and amount of collateral for loans,
- the establishment of branches,
- mergers and consolidations, and
- dividends.
The system of supervision and regulation applicable to the Company and the Bank
establishes a comprehensive framework for their respective operations and is
intended primarily for the protection of the FDIC's deposit insurance funds, the
depositors of the Bank and the public, rather than shareholders of the Bank or
the Company. Any change in government regulation may have a material adverse
effect on the business of the Company and the Bank.
The Company. As a bank holding company, the Company is subject to regulation by
the Federal Reserve Board under the Federal Bank Holding Company Act of 1956, as
amended (the "BHCA"). Under the BHCA, the Company is subject to examination by
the Federal Reserve Board and is required to file reports of its operations and
such additional information as the Federal Reserve Board may require. Under
Federal Reserve Board policy, the Company is expected to act as a source of
financial strength to the Bank and to commit resources to support the Bank in
circumstances where the Company might not do so absent such policy.
6
Any loans by a bank holding company to a subsidiary bank are subordinate in
right of payment to deposits and to certain other indebtedness of such
subsidiary bank. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
With certain limited exceptions, the BHCA prohibits bank holding companies from
acquiring direct or indirect ownership or control of voting shares or assets of
any company other than a bank, unless the company involved is engaged in one or
more activities which the Federal Reserve Board has determined to be so closely
related to banking or managing or controlling banks as to be incidental to these
operations. Under current Federal Reserve Board regulations, such permissible
non-bank activities include such things as mortgage banking, equipment leasing,
securities brokerage, and consumer and commercial finance company operations. As
a result of recent amendments to the BHCA, many of these acquisitions may be
effected by bank holding companies that satisfy certain statutory criteria
concerning management, capitalization, and regulatory compliance, if written
notice is given to the Federal Reserve within 10 business days after the
transaction. In other cases, prior written notice to the Federal Reserve Board
will be required.
The Federal Reserve Board uses capital adequacy guidelines in its examination
and regulation of bank holding companies. If capital falls below minimum
guidelines, a bank holding company may, among other things, be denied approval
to acquire or establish banks or non-bank businesses. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Capital Sources."
The Gramm-Leach-Bliley Act ("Gramm-Leach") was signed into law on November 12,
1999 and authorizes bank holding companies that meet specified conditions to
elect to become "financial holding companies" and thereby engage in a broader
array of financial activities than previously permitted. Such activities include
selling and underwriting insurance (including annuities), underwriting and
dealing in securities, and merchant banking. Gramm-Leach also authorizes banks
to engage through "financial subsidiaries" in certain of the activities
permitted for financial holding companies. The Company is registered as a
financial holding company; however, the Company has no current plans to pursue
any of the expanded activities available to financial holding companies under
Gramm-Leach.
Gramm-Leach contains provisions intended to safeguard consumer financial
information in the hands of financial service providers by, among other things,
requiring these entities to disclose their privacy policies to their customers
and allowing customers to "opt out" of having their financial service providers
disclose their confidential financial information to non-affiliated third
parties, subject to certain exceptions. Final regulations implementing the new
financial privacy regulations became effective during 2001. Similar to most
other consumer-oriented laws, the regulations contain some specific prohibitions
and require timely disclosure of certain information. The Company believes it is
in compliance with these requirements.
The Bank. The Bank is an Indiana banking corporation and a member of the Federal
Reserve System. As a state-chartered member bank, the Bank is subject to the
examination, supervision, reporting and enforcement jurisdiction of the
Department, as the chartering authority for Indiana banks, and the Federal
Reserve Board as the primary federal bank regulatory agency for state-chartered
member banks. The Bank's deposit accounts are insured by the Bank Insurance Fund
("BIF") of the FDIC, which also has jurisdiction over BIF-insured banks. These
agencies, and federal and state law, extensively regulate various aspects of the
banking business including, among other things:
- permissible types and amounts of loans,
- investments and other activities,
- capital adequacy,
- branching,
- interest rates on loans and on deposits,
- the maintenance of noninterest bearing reserves on deposit, and
- the safety and soundness of banking practices.
7
Federal law and regulations, including provisions added by the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA") and regulations
promulgated thereunder, establish supervisory standards applicable to the
lending activities of the Bank, including internal controls, credit
underwriting, loan documentation, and loan-to-value ratios for loans secured by
real property.
The Bank is subject to certain federal and state statutory and regulatory
restrictions on any extension of credit to the Company or its subsidiaries, on
investments in the stock or other securities of the Company or its subsidiaries,
and on the acceptance of the stock or other securities of the Company or its
subsidiaries as collateral for loans to any person. Limitations and reporting
requirements are also placed on extensions of credit by the Bank to its
directors and officers, to directors and officers of the Company and its
subsidiaries, to principal shareholders of the Company, and to "related
interests" of such persons. In addition, such legislation and regulations may
affect the terms upon which any person becoming a director or officer of the
Company or one of its subsidiaries or a principal shareholder of the Company may
obtain credit from banks with which the Company maintains a correspondent
relationship. Also, in certain circumstances, an Indiana banking corporation may
be required by order of the Department to increase its capital or reduce the
amount of its deposits.
The federal banking agencies have published guidelines implementing the FDICIA
requirement that the federal banking agencies establish operational and
managerial standards to promote the safety and soundness of federally insured
depository institutions. The guidelines establish standards for internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. In general, the guidelines prescribe the goals to be achieved
in each area, and each institution is responsible for establishing its own
procedures to achieve those goals. If an institution fails to comply with any of
the standards set forth in the guidelines, the institution's primary federal
bank regulator may require the institution to submit a plan for achieving and
maintaining compliance. The preamble to the guidelines states that the agencies
expect to require a compliance plan from an institution whose failure to meet
one or more of the standards is of such severity that it could threaten the safe
and sound operation of the institution. Failure to submit an acceptable
compliance plan, or failure to adhere to a compliance plan that has been
accepted by the appropriate regulator, would constitute grounds for further
enforcement action.
Insurance of Deposit Accounts. Under FDICIA, as an FDIC-insured institution, the
Bank is required to pay deposit insurance premiums based on the risk it poses to
BIF. The FDIC also has authority to raise or lower assessment rates on insured
deposits to achieve the statutorily required reserve ratios in insurance funds
and to impose special additional assessments. Each depository institution is
assigned to one of three capital groups: "well capitalized," "adequately
capitalized" or "undercapitalized." An institution is considered well
capitalized if it has a total risk-based capital ratio of 10% or greater, has a
Tier 1 risk-based capital ratio of 6% of greater, has a leverage ratio of 5% of
greater and is not subject to any order or written directive to meet and
maintain a specific capital level. An "adequately capitalized" institution has a
total risk-based capital ratio of 8% or greater, has a Tier 1 risk-based capital
ratio of 4% or greater, has a leverage ratio of 4% or greater and does not meet
the definition of a well capitalized bank. An institution is considered
"undercapitalized" if it does not meet the definition of "well capitalized" or
"adequately capitalized." Within each capital group, institutions are assigned
to one of three supervisory subgroups: "A" (institutions with few minor
weaknesses), "B" (institutions that demonstrate weaknesses which, if not
corrected, could result in significant deterioration of the institution and
increased risk of loss to the insurance funds), and "C" (institutions that pose
a substantial probability of loss to the insurance funds unless effective
corrective action is taken). There are nine combinations of capital groups and
supervisory subgroups to which varying assessment rates may apply. A bank's
assessment rate depends on the capital category and supervisory category to
which it is assigned.
Consumer and Other Laws. The Bank's business includes making a variety of types
of loans to individuals. In making these loans, the Bank is subject to state
usury and regulatory laws and to various federal statutes, such as the Equal
Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act,
the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act,
and the regulations promulgated thereunder, which prohibit discrimination,
specify disclosures to be made to borrowers regarding credit and settlement
costs and regulate the mortgage loan servicing activities of the Bank, including
the maintenance and operation of escrow accounts and the transfer of mortgage
loan servicing. The Riegle Act imposed new escrow requirements on depository and
non-depository mortgage lenders and services under the National Flood Insurance
Program. In receiving deposits, the Bank is subject to extensive regulation
under state and federal law and regulations,
8
including the Truth in Savings Act, the Expedited Funds Availability Act, the
Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit
Insurance Act. Violation of these laws could result in the imposition of
significant damages and fines upon the Bank, its directors and officers.
Under the Community Reinvestment Act (the "CRA") and the implementing
regulations, the Bank has a continuing and affirmative obligation to help meet
the credit needs of its local community, including low- and moderate-income
neighborhoods, consistent with the safe and sound operation of the institution.
The CRA requires the board of directors of financial institutions, such as the
Bank, to adopt a CRA statement for each assessment area that, among other
things, describes its efforts to help meet community credit needs and the
specific types of credit that the institution is willing to extend. The Bank's
service area is designated as all of Allen County, Indiana. The Bank's offices
are located in Allen County. The Bank's Board of Directors is required to review
the appropriateness of this delineation at least annually. The CRA also requires
that all financial institutions publicly disclose their CRA ratings. The Bank
received a "satisfactory" rating on its most recent CRA performance evaluation.
COMPETITION
All phases of the business of the Bank are highly competitive. The Bank competes
with numerous financial institutions, including other commercial banks in Allen
County, Indiana and the City of Fort Wayne. The Bank, along with other
commercial banks, competes with respect to its lending activities and competes
in attracting demand deposits. The Bank faces competition from thrift
institutions, credit unions and other banks as well as finance companies,
insurance companies, mortgage companies, securities brokerage firms, money
market funds, trust companies and other providers of financial services. Most of
the Bank's competitors have been in business a number of years, have established
customer bases, are larger and have larger lending limits than the Bank. The
Bank competes for loans principally through its ability to communicate
effectively with its customers and understand and meet their needs. The Bank
offers personal attention, professional service, off-site ATM capability and
competitive interest rates. Management believes that its personal service
philosophy enhances the Bank's ability to compete favorably in attracting
individuals and small- to medium-sized businesses.
EMPLOYEES
As of December 31, 2003, the Company had 120 employees, including 104 full-time
employees. None of the Company's employees is covered by a collective bargaining
agreement. Management believes that its relationship with the Company's
employees is good.
ITEM 2. PROPERTIES.
The Company is leasing the first and second floors of the Lincoln Tower, a
landmark building located at 116 East Berry Street in downtown Fort Wayne,
Indiana, for use as its headquarters and the Bank's main office. The
headquarters facility consists of drive-up banking windows and approximately
33,400 square feet of usable office space. The lease had an initial term of 10
years, with one renewal option for an additional 10 years. During 2001, the
original lease term was extended to 15 years with an expiration date of December
2013 and has the same renewal option as prior to the extension. It is
anticipated that in early 2004 the Company will sign an additional amendment to
the lease to occupy an additional 8,336 square feet of space on the first floor
at rates similar to the original lease. The amendment is also expected to
contain a right of first refusal to buy the entire building in the event the
landlord wishes to divest the property.
The Bank leases a bank branch office location in the northwest section of Fort
Wayne at 1545 W. Dupont Road. The branch office occupies 2,600 square feet of
space and has two drive-up lanes. The lease has an initial term of five years,
expires May 2005 and has two consecutive five-year renewal options. The Bank
also leases a bank branch office location in the southwest section of Fort Wayne
at 10373 Illinois Road. The branch office occupies 2,400 square feet and has two
drive-up lanes. The lease has an initial term of 10 years, expires January 2011
and has two consecutive five-year renewal options. The Bank leases a branch
office located in the south side of Fort Wayne in the Waynedale area. The branch
occupies 2,600 square feet of space and has two drive-up lanes. The lease has an
initial term of 10 years expiring December 31, 2013, with an option to extend
the lease for two additional consecutive five-year periods each.
9
The Bank owns a bank branch on 1.4 acres of land in northeast Fort Wayne at 4303
Lahmeyer Road. This branch office contains 3,000 square feet of space and has
two drive-up lanes.
ITEM 3. LEGAL PROCEEDINGS.
The Bank may be involved from time to time in various routine legal proceedings
incidental to its business. Neither the Company nor the Bank is engaged in any
legal proceeding that is expected to have a material adverse effect on the
results of operations or financial position of the Company or the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET PRICES
The Company's common stock is traded on the Nasdaq National Market System under
the symbol "TOFC." As of February 13, 2004, there were 687 shareholders of
record and approximately 2,139 beneficial owners of the common stock.
The following table also presents the high and low sales prices for the common
stock on the Nasdaq National Market System by quarter for 2003 and 2002.
HIGH / LOW STOCK PRICE
2003 2002
----------------- -----------------
HIGH LOW HIGH LOW
------- ------- ------- -------
1st Quarter $14.100 $12.611 $15.550 $11.800
2nd Quarter $14.250 $12.950 $15.250 $11.500
3rd Quarter $14.350 $12.630 $12.250 $10.250
4th Quarter $15.150 $12.800 $12.820 $11.600
DIVIDENDS
The Company does not pay cash dividends on its common stock, and the Company
does not anticipate paying any cash dividends on its common stock in the
foreseeable future. The declaration and payment of future dividends will be at
the discretion of the Company's board of directors and must comply with
applicable law. Future dividend payments will depend upon the Company's
financial condition, results of operations, future liquidity needs, potential
acquisitions, regulatory and capital requirements and other factors deemed
relevant by its board of directors.
In addition, the Company is a holding company and substantially all of its
assets are held by the Bank. The Company's ability to pay dividends to its
shareholders, if it determines in the future to do so, will depend primarily on
the Bank's ability to pay dividends to the Company. Dividend payments and
extensions of credit to the Company from the Bank are subject to legal and
regulatory limitations, generally based on capital levels and profits, imposed
by law and regulatory agencies with authority over the Bank. The ability of the
Bank to pay
10
dividends is also subject to its profitability, financial condition, capital
expenditures and other cash flow requirements. In addition, under the terms of
the debentures issued in connection with the issuance of its 9% trust preferred
securities due 2031, the Company would be precluded from paying dividends on its
common stock (other than dividends in the form of additional shares of common
stock) if it was in default under the debentures, if it exercised its right to
defer payments of interest on the debentures, or if certain related defaults
occurred.
SALES OF UNREGISTERED SECURITIES
On November 16, 2001, the Company's wholly-owned special purpose trust
subsidiary, Tower Capital Trust 1 ("TCT1"), issued $3,500,000 aggregate
principal amount of Trust Preferred Securities in a private placement offering.
Concurrently therewith, TCT1 loaned the proceeds of that offering to the
Company, and in exchange therefore the Company issued to TCT1 its 9%
Subordinated Debentures due 2031, with similar terms as the Trust Preferred
Securities. The issuance by the Company of the Subordinated Debentures and the
issuance by TCT1 of the Trust Preferred Securities were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereof.
USE OF PROCEEDS
On August 29, 2002, the Company completed a rights offering and limited public
offering of its common stock. The Company previously disclosed the use of
proceeds from those offerings in its Quarterly Report on Form 10-QSB for the
period ended September 30, 2002. Subsequent to that report, the Company incurred
additional expenses in connection with those offerings. As a result, the Company
is updating its previously reported disclosure. Total gross proceeds from the
offerings were $14,998,744; of which $609,017 was applied to marketing agents'
fees and $733,165 was used to pay expenses of the offerings. Of the resulting
$13,656,562 in net proceeds of the offerings to the Company, $7,000,000 was
contributed to the Bank as additional capital for future growth and the
remaining $6,656,562 of net proceeds was retained by the Company for general
operating uses and continues to be deposited with the Bank.
11
ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED SUMMARY OF OPERATIONS AND SELECTED STATISTICAL DATA
Years ended December 31,
-----------------------------------------------------------
($ in thousands, except share data) 2003 2002 2001 2000 1999
- ----------------------------------- -------- -------- -------- --------- ---------
RESULTS OF OPERATIONS:
Interest income $ 17,826 $ 16,494 $ 15,931 $ 12,769 $ 3,682
Interest expense 6,061 6,444 8,102 7,047 1,394
Net interest income 11,765 10,050 7,829 5,722 2,288
Provision for loan losses 2,185 1,765 1,120 1,355 1,010
Noninterest income 3,642 2,954 1,785 1,028 288
Noninterest expense 10,353 8,416 6,638 4,909 3,241
Income (loss) before income taxes 2,869 2,823 1,856 486 (1,675)
Income taxes expense (benefit) 1,069 1,107 736 (588)
Net income (loss) 1,800 1,716 1,120 1,074 (1,675)
PER SHARE DATA:
Net income (loss): basic $ 0.46 $ 0.57 $ 0.44 $ 0.42 $ (0.71)
Net income (loss): diluted 0.45 0.56 0.44 0.42 (0.71)
Book value at end of period 10.38 9.97 9.29 8.85 8.43
Dividends declared n/a n/a n/a n/a n/a
BALANCE SHEET DATA:
Total assets $436,469 $377,311 $291,874 $ 212,413 $ 103,647
Total securities available for sale 24,325 11,171 2,384 9,957 5,246
Loans held for sale 5,770 4,293
Total loans 376,839 321,340 232,346 155,880 67,315
Allowance for loan losses 5,259 4,746 3,480 2,364 1,010
Total deposits 362,877 310,584 256,153 188,296 81,733
FHLB advances 27,000 21,500 6,500
Junior subordinated debt 3,608 3,608 3,608
Stockholders' equity 40,909 39,175 23,505 22,395 21,320
PERFORMANCE RATIOS:
Return on average assets 0.45% 0.53% 0.47% 0.68% (2.96)%
Return on average stockholders' equity 4.53% 5.90% 4.88% 5.04% (8.25)%
Net interest margin 3.04% 3.17% 3.33% 3.70% 4.20%
Efficiency ratio 67.20% 64.72% 69.04% 72.73% 125.82%
ASSET QUALITY RATIOS:
Nonperforming loans to total loans 0.51% 0.22% 0.35% 0.00% 0.00%
Nonperforming assets to total assets 0.45% 0.19% 0.28% 0.00% 0.00%
Net charge-offs to average loans 0.47% 0.18% 0.00% 0.00% 0.00%
Allowance for loan losses to total loans 1.40% 1.48% 1.50% 1.52% 1.50%
LIQUIDITY AND CAPITAL RATIOS:
Loan to deposit ratio 103.85% 103.46% 90.71% 82.78% 82.36%
Total stockholders' equity to total assets 9.37% 10.38% 8.05% 10.54% 20.57%
Total risk-based capital 12.66% 13.86% 12.12% 14.24% 25.96%
Tier 1 leverage risk-based capital 11.44% 12.61% 10.87% 12.99% 24.79%
Tier 1 leverage capital 10.26% 11.75% 10.02% 11.21% 24.75%
n/a - not applicable
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION. ($ in thousands except for share data)
INTRODUCTION
The Company was formed as a bank holding company for the Bank. The Company was
in a development stage until the Bank commenced operations on February 19, 1999.
Prior to the opening of the Bank, the Company's principal activities related to
the organization of the Bank and the conducting of the Company's initial public
offering ("IPO"). Total proceeds to the Company from the IPO were $23,470 (net
of offering expenses and underwriters' discounts), of which $15,000 was used to
initially capitalize the Bank.
As a result of continued growth, on August 29, 2002, the Company completed a
rights offering and a limited public offering of its common stock during which
1,395,232 shares were sold. Total proceeds from the offering were $13,657 (net
of offering and marketing expenses) of which $7,000 was initially used to
provide additional capitalization to the Bank for future growth.
The following discussion presents management's discussion and analysis of the
consolidated financial condition and results of operations of the Company as of
December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and
2001. This discussion should be read in conjunction with the Company's audited
consolidated financial statements and the related notes appearing elsewhere in
this report.
FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements." All statements regarding the
Company's expected financial position, business and strategies are
forward-looking statements and the Company intends for them to be covered by the
safe harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995. The words "anticipates," "believes,"
"estimates," "seeks," "expects," "plans," "intends," and similar expressions, as
they relate to the Company, the Bank or its management, are intended to identify
forward-looking statements. Although the Company believes that the expectations
reflected in these forward-looking statements are reasonable and have based
these expectations on its beliefs as well as assumptions it has made, these
expectations may prove to be incorrect. Important factors that could cause
actual results to differ materially from the Company's expectations include,
without limitation, the following:
- the Company's status as a start-up company with only five years of
operating history;
- the effect of extensive banking regulation on the Bank's ability
to grow and compete;
- the effect of changes in federal economic and monetary policies on
the Bank's ability to attract deposits, make loans and achieve
satisfactory interest spreads;
- the competitive disadvantage resulting from the Company's status
as a highly regulated, start-up company;
- the Company's dependence on key management personnel;
- the increased risk of losses due to loan defaults caused by the
Bank's commercial loan concentration;
- the Company's dependence on a favorable local economy in the
Bank's primary service area;
- the Bank's dependence on net interest spread for profitability;
- the Bank's ability to implement developments in technology to be
competitive;
- failure of a significant number of borrowers to repay their loans;
- general changes in economic conditions, including interest rates
and real estate values; and
- restrictions imposed on the Company by regulators or regulations
of the banking industry.
Readers are also directed to other risks and uncertainties discussed in other
documents filed by the Company with the Securities and Exchange Commission. The
Company undertakes no obligation to update or revise any forward-looking
information, whether as a result of new information, future developments or
otherwise.
13
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the Company's financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
the Company to make estimates and judgments that affect the reported amount of
assets and liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities at the date of its financial statements.
Actual results may differ from these estimates under different assumptions or
conditions. Certain policies inherently have a greater reliance on the use of
estimates, and as such have a greater possibility of producing results that
could be materially different than originally reported. Critical accounting
policies are defined as those that are reflective of significant judgments and
uncertainties, and potentially result in materially different results under
different assumptions and conditions. Management believes that its critical
accounting policies are limited to those described below. For a detailed
discussion on the application of these and other accounting policies, see Note 1
- -- Summary of Significant Accounting Policies to the audited consolidated
financial statements included in this report.
Allowance for Loan Losses. The Company's allowance for loan losses represents
management's estimate of probable incurred losses inherent in the loan portfolio
at the balance sheet date. Additions to the allowance may result from recording
provision for loan losses and recoveries, while charge offs are deducted from
the allowance. Allocation of the allowance is made for analytical purposes only,
and the entire allowance is available to absorb probable and estimated credit
losses inherent in the loan portfolio.
The Company has an established process for determining the adequacy of the
allowance for loan losses that relies on various procedures and pieces of
information to arrive at a range of probable outcomes. No single statistic or
measurement, in itself, determines the adequacy of the allowance. The allowance
has three components: identified specific allocation, a percentage allocation
based on loss history for different loan groups, and unallocated.
To determine the allocated component of the allowance, the Company combines
estimates allowances required for specifically identified loans that are
analyzed individually and loans that are analyzed on a group basis. First,
management allocates specific portions of the allowance for loan losses based on
identifiable problem loans. Problem loans are identified through a loan risk
rating system and monitored through watchlist reporting. Specific allocations of
allowance for loan losses are determined for each identified credit based on
delinquency rates, collateral and other risk factors identified for that credit.
Second, management's evaluation of the allowance for different loan groups is
based on consideration of actual loss experience, the present and prospective
financial condition of borrowers, industry concentrations within the loan
portfolio and general economic conditions, and absent the ability of some of
those factors, based upon peer industry data of comparable banks. Lastly, the
unallocated component of the allowance is maintained to supplement the allocated
component and to recognize the imprecision of estimating and measuring loss when
evaluating loss allocations for individual loans or pools of loans. The
allocated and the unallocated components represent the total allowance for loan
losses that would adequately cover losses inherent in the loan portfolio.
The determination of the level of allowance and, correspondingly, the provision
for loan losses, rests upon estimates and assumptions, including past loan loss
experience, the nature and volume of the portfolio, information about specific
borrower situations and estimated collateral values, economic conditions and
other factors. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan is confirmed. A loan is impaired when
full payment under the loan terms is not expected. Impairment is evaluated in
the aggregate for smaller-balance loans of a similar nature such as residential
mortgage and consumer loans, and on an individual loan basis for other loans.
Commercial loans and mortgage loans secured by other properties are evaluated
individually for impairment. When analysis of a borrower's operating results and
financial condition indicates that underlying cash flows of the borrower's
business are not adequate to meet its debt service requirements, the loan is
evaluated for impairment. If a loan is impaired, a portion of the allowance is
allocated so that the loan is reported, net, at the present value of estimated
future cash flows using the loan's existing interest rate or at the fair value
of collateral if repayment is expected solely from the collateral.
There are many factors affecting the allowance for loan losses; some are
quantitative while others require qualitative judgment. Although management
believes its process for determining the allowance adequately
14
considers all of the potential factors that could potentially result in credit
losses, the process includes subjective elements and may be susceptible to
significant change. To the extent actual outcomes differ from management
estimates, additional provision for loan losses could be required that could
adversely affect earnings or financial position in future periods.
FINANCIAL CONDITION
The Company experienced its fifth year of significant growth during 2003. Total
assets of the Company were $436,469 at December 31, 2003 compared to $ 377,311
at December 31, 2002, an increase of $59,158 or 15.7%. The significant increase
in assets was mainly attributable to growth in the loan portfolio and was funded
by a significant growth in deposits and FHLB advances. Asset growth has been
substantial during each year since the Bank began operations. The significant
growth during previous years was also a result of deposit growth at the Bank. As
the Bank enters its sixth year of operation, management anticipates that, in the
near-term, assets will increase at a rate similar to the Bank's historical
trends as management continues to market its institution, products and banking
expertise, deliver a high level of customer service and develop its branch
network.
Earning Assets. The Company's loan portfolio experienced another year of
significant growth during 2003. Loans were $376,839 at December 31, 2003
compared to $321,340 at December 31, 2002, an increase of $55,499, or 17.3%. The
loan portfolio, which equaled 90.5% and 88.0% of earning assets at December 31,
2003 and 2002, respectively, was primarily comprised of commercial and
commercial real estate loans at both dates. At December 31, 2003, commercial and
commercial real estate loans were approximately 79.2% of the loan portfolio and
represented loans to business interests generally located within the Bank's
market area. Approximately 52.6% of the loan portfolio at December 31, 2003
consisted of general commercial and industrial loans primarily secured by
inventory, receivables and equipment, while 26.6% of the loan portfolio
consisted of commercial loans primarily secured by real estate. The largest
concentrations of credit within the commercial category are represented by
owner-occupied and investment real estate at $58,200, or 15.4% of total loans,
and building, development and general contracting at $41,600, or 11.0% of total
loans. The concentration and growth in commercial credits is in keeping with the
Bank's strategy of focusing a substantial amount of efforts on commercial
banking. Business banking is an area of expertise for the Bank's management and
lending team. Residential mortgage and home equity lending, while only 17.7% of
loans at December 31, 2003, also experienced significant growth. Consumer loans,
only 3.1% of total loans at December 31, 2003, reflected a decline during 2003
from 2002 levels. Management believes that loan growth should continue as the
Bank expands its distribution network during 2004; however, the Company's main
strategy for growth and profitability is expected to come largely from the
commercial loan sector. The following table presents loans outstanding as of
December 31, 2003, 2002, 2001, 2000 and 1999.
LOANS OUTSTANDING
DECEMBER 31,
-------------------------------------------------------------
($ in thousands) 2003 2002 2001 2000 1999
- ---------------- --------- --------- --------- --------- ---------
Commercial $ 198,063 $ 185,250 $ 133,675 $ 95,834 $ 41,577
Commercial real estate 100,309 76,546 49,964 33,581 11,698
Residential real estate 40,648 26,097 16,740 6,978 5,918
Home equity 25,944 20,043 16,043 6,994 2,551
Consumer 11,594 13,290 15,717 12,386 5,571
--------- --------- --------- --------- ---------
Total loans 376,558 321,226 232,139 155,773 67,315
Deferred loan costs 280 114 207 107
Allowance for loan losses (5,259) (4,746) (3,480) (2,364) (1,010)
--------- --------- --------- --------- ---------
NET LOANS $ 371,579 $ 316,594 $ 228,866 $ 153,516 $ 66,305
========= ========= ========= ========= =========
The following table presents the maturity of total loans outstanding as of
December 31, 2003, according to scheduled repayments of principal and also based
upon repricing opportunities.
15
MATURITIES OF LOANS OUTSTANDING
WITHIN 1 - 5 OVER
($ in thousands) 1 YEAR YEARS 5 YEARS TOTALS
- ---------------- -------- -------- -------- --------
LOANS - CONTRACTUAL MATURITY DATES:
Commercial $ 52,734 $ 89,678 $ 55,651 $198,063
Commercial real estate 11,368 74,397 14,544 100,309
Residential real estate 1,833 9,319 29,496 40,648
Home equity 15,882 9,495 567 25,944
Consumer 6,883 4,692 19 11,594
-------- -------- -------- --------
Total loans $ 88,700 $187,581 $100,277 $376,558
======== ======== ======== ========
LOAN REPRICING OPPORTUNITIES:
Fixed rate $ 36,249 $ 56,065 $ 33,770 $126,084
Variable rate 250,474 250,474
-------- -------- -------- --------
Total loans $286,723 $ 56,065 $ 33,770 $376,558
======== ======== ======== ========
The Bank's credit policies establish guidelines to manage credit risk and asset
quality. These guidelines include loan review and early identification of
problem loans to provide effective loan portfolio administration. The credit
policies and procedures are meant to minimize the risk and uncertainties
inherent in lending. In following these policies and procedures, the Bank must
rely on estimates, appraisals and evaluation of loans and the possibility that
changes could occur because of changing economic conditions. Identified problem
loans, which exhibit characteristics (financial or otherwise) that could cause
the loans to become nonperforming or require restructuring in the future, are
included on an internal "watchlist." Senior management reviews this list
regularly and adjusts for changing conditions. At December 31, 2003, there were
$8,342 of potential problem loans outstanding classified on the watchlist.
Nonperforming loans at December 31, 2003 were $1,905, including $1,615 of loans
placed on nonaccrual status and categorized as impaired and $290 of loans past
due 90 days and still accruing which are not categorized as impaired. Total
impaired loans are $2,156, which includes all nonaccrual loans plus commercial
loans impaired of $541 that are still accruing but restructured. Gross interest
for 2003 for nonaccrual loans would have been $102. Interest actually received
on nonaccrual loans was $14 resulting in lost interest to date of $88.
Nonperforming loans at December 31, 2002 were $719, including $632 of loans
placed on nonaccrual status and categorized as impaired and $87 of loans past
due 90 days and still accruing which are not categorized as impaired. Gross
interest for 2002 for nonaccrual loans would have been $61. At December 31, 2001
there were $816 in nonperforming loans consisting of $469 in nonaccrual and $347
in loans accruing but more than 90 days past due. There were no nonaccrual or
impaired loans or any loans past due 90 days or more at December 31, 2000 or
1999. There were no foreign loans outstanding at the end of each of the last
five years.
During 2003, the Bank experienced $1,671 in net charged-off loans compared to
$500 of net charge-offs in 2002 and $4 in 2001. There were no charge-offs during
2000 or 1999. While the 2003 level of net charge-offs represents a significant
increase over prior years, the 2003 results partially represent a normal aging
of the loan portfolio and reflect the general effects of the sluggish economy on
businesses. The 2003 ratio of net charge-offs to total average loans was 0.47%.
Of the loans charged off during 2003, $600 was attributable to the unauthorized
mortgage activity loss and $563 was attributable to one commercial credit, which
was identified during the year and restructured at year end.
In each quarter, the allowance for loan losses is adjusted by management to the
amount management believes is necessary to maintain the allowance at adequate
levels. Management will allocate specific portions of the allowance for loan
losses based on specifically identifiable problem loans. Management's evaluation
of the allowance is further based on consideration of actual loss experience,
the present and prospective financial condition of borrowers, industry
concentrations within the portfolio and general economic conditions. Management
believes that the present allowance is adequate, based on the broad range of
considerations listed above, and absent some of those factors, based upon peer
industry data of comparable banks.
16
The following table illustrates the breakdown of the allowance for loan losses
by loan type.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
($ in thousands)
LOAN LOAN LOAN LOAN LOAN
TYPE TYPE TYPE TYPE TYPE
DEC 31, AS A % DEC 31, AS A % DEC 31, AS A % DEC 31, AS A % DEC 31, AS A %
2003 OF TOTAL 2002 OF TOTAL 2001 OF TOTAL 2000 OF TOTAL 1999 OF TOTAL
LOAN TYPE ALLOC. LOANS ALLOC. LOANS ALLOC. LOANS ALLOC. LOANS ALLOC. LOANS
- --------- ------- -------- ------- -------- ------- -------- ------ -------- ------- --------
Commercial $ 4,011 52.6% $ 4,033 57.7% $ 2,140 57.6% $ 821 61.5% $ 334 61.7%
Commercial real estate 751 26.6% 199 23.8% 405 21.5% 230 21.6% 69 17.4%
Residential real estate 190 10.8% 90 8.1% 42 7.2% 18 4.5% 15 8.8%
Home equity 85 6.9% 125 6.3% 80 6.9% 35 4.5% 12 3.8%
Consumer 111 3.1% 269 4.1% 236 6.8% 186 7.9% 84 8.3%
Unallocated 111 n/a 30 n/a 577 n/a 1,074 n/a 496 n/a
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total allowance
for loan losses $ 5,259 100.0% $ 4,746 100.0% $ 3,480 100.0% $ 2,364 100.0% $ 1,010 100.0%
======= ===== ======= ===== ======= ===== ======= ===== ======= =====
The primary risk element considered by management with respect to each
installment and residential real estate loan is lack of timely payment.
Management has a reporting system that monitors past due loans and has adopted
policies to pursue its creditor's rights in order to preserve the Bank's
position. The primary risk elements with respect to commercial loans are the
financial condition of the borrower, the sufficiency of collateral, and lack of
timely payment. Management has a policy of requesting and reviewing periodic
financial statements from its commercial loan customers, and periodically
reviews the sufficiency of collateral and its value.
Although management considers the allowance for loan losses to be adequate to
absorb losses that are incurred, there can be no assurance that charge-offs in
future periods will not exceed the allowance. Additionally, banking regulators
can require an increase to the allowance for loan losses if they deem necessary
to satisfy regulatory safety and soundness concerns. Additional provisions for
the allowance are expected during 2004 as a result of anticipated increases in
the total loan portfolio. The Company experienced $1,705 of charge-offs and $34
of recoveries during 2003. The Company experienced $504 of charge-offs and $4 of
recoveries during 2002. Prior to 2002, the Company only experienced an aggregate
amount of $5 in loan charge-offs during its first three years of operations.
TOTAL SECURITIES PORTFOLIO
DECEMBER 31,
---------------------------------------------------
2003 2002 2001
($ in thousands) CARRYING VALUE CARRYING VALUE CARRYING VALUE
- ---------------- -------------- -------------- --------------
U.S. Government agency debt obligations $ 9,052 $ 6,215 $ 1,982
Obligations of states and political subdivisions 7,854 1,943 402
Mortgage-backed securities 7,419 3,013
------- ------- -------
TOTAL SECURITIES $24,325 $11,171 $ 2,384
======= ======= =======
Securities available for sale at fair value reflected an increase during 2003,
and totaled $24,325 at December 31, 2003 compared to $11,171 at December 31,
2002. The Company maintains a modest securities portfolio to provide for
secondary liquidity and for interest rate risk management. During 2001 and 2000,
the portfolio was used mainly for liquidity as these assets were held in
short-term discount notes. During 2003, the Company again expanded the size of
and the length of maturity of the portfolio as it began to develop a more
diversified portfolio. The portfolio will continue to include some short-term
liquid holdings from time to time as loan demand remains strong and more
liquidity is needed. Since the inception of the Company, all securities have
been designated as "available for sale" as defined in Statement of Financial
Accounting Standards ("SFAS") No.115 Accounting for Certain Investments in Debt
and Equity Securities. Securities designated as available for sale are stated at
fair
17
value, with the unrealized gains and losses, net of income tax, reported as a
separate component of stockholders' equity. A net unrealized gain on this
portfolio was recorded at December 31, 2003 in the amount of $42 compared to a
net unrealized gain in the amount of $372 at December 2002, and a net unrealized
loss of $16 at December 31, 2001. There were no interest-bearing deposits with
other banks at December 31, 2003 or December 31, 2002 compared to $2,806 in
interest-bearing deposits with other banks at December 31, 2001. The table above
presents the total securities portfolio as of December 31, 2003, 2002 and 2001.
During the first quarter of 2003, the Company sold $3,175 of available for sale
agency securities and recorded a $191 gain from the sale.
Federal funds sold, consisting of excess funds sold overnight to correspondent
banks, and short-term investments and interest-bearing deposits, consisting of
certificates of deposit with maturities less than 90 days and interest-bearing
accounts at correspondent banks, are used to manage daily liquidity needs and
interest rate sensitivity. Together, these short-term assets, which recorded a
decline of $11,807 during 2003, were $15,133 and $26,940 at December 31, 2003
and 2002, respectively. At December 31, 2003 and 2002, these short-term assets
were approximately 3.6% and 7.3% of earning assets, respectively. The decline in
short-term assets during 2003 was reflected mainly as an increase in securities
available for sale as the Company modestly extended asset maturity. The balance
of short-term assets and the balance as a percent of earning assets are expected
to fluctuate as the Company's balance sheet experiences continued growth.
SOURCE OF FUNDS
The Bank's major source of funds is from core deposits of local businesses,
governmental and municipal public fund entities, and consumers within the market
area. The Bank also generates certificates of deposits through national
out-of-market sources (outside Allen and surrounding counties) developed during
2002 and 2003. The Bank began taking deposits when it commenced operations in
February 1999 and has experienced significant growth each year. The
out-of-market deposits are generated by direct negotiation with out-of-market
banks and credit unions, posting on a national bulletin board via the Internet
to a member customer base, and through negotiated transaction with brokers.
Total deposits were $362,877 at December 31, 2003 and $310,584 at December 31,
2002, an increase of $52,293, or 16.8%.
Noninterest-bearing deposits grew significantly during 2003 and were $62,638 at
December 31, 2003, a 45.8% increase over $42,966 at December 31, 2002. At
December 31, 2003, noninterest-bearing deposits were approximately 17.3% of
total deposits, an increase from the 2002 level of 13.8 %. Noninterest-bearing
deposits at December 31, 2003 were comprised of $56,392 in business checking
accounts, $1,852 in public funds and $4,394 in consumer accounts.
Interest-bearing deposits also grew significantly during 2003 and were $300,239
at December 31, 2003, a 12.2% increase over $267,618 at December 31, 2002.
Interest-bearing deposits at December 31, 2003 were comprised of approximately
32.7% in money market accounts, 11.4% in interest-bearing checking and savings
accounts, and 55.9% in certificates of deposit. The December 31, 2003
percentages reflect a modest change in the deposit mix from 2002, when the
percentages were 37.0%, 11.2%, and 51.8%, respectively. In 2003, all deposit
categories reflected balance increases over 2002 levels with the exception of
money market accounts. The most significant increase from 2002 was in both
categories of certificates of deposit. CDs under $100 grew by $8,225 from 2002
year-end levels and CDs $100 and over increased by $21,055. The balance of money
market accounts at December 31, 2003 was $98,250 compared to $99,105 at December
31, 2002, a decrease of $855. While total interest-bearing deposits increased
$32,621 from 2002, mainly a result of new accounts established in the business
and consumer sectors, the shift in interest-bearing deposits from money markets
to CDs was reflective of the low interest rate environment as customers from all
segments sought better returns. The total of interest-bearing deposits at
December 31, 2003 reflected $124,868 in business accounts, $121,260 in consumer
accounts and $54,111 in public fund accounts compared to $101,523, $107,483 and
$58,612, respectively, at December 31, 2002. As of December 31, 2003, the
Company had $104,840 in certificates of deposit of $100 or more, of which
$64,724 mature within three months; $8,555 mature over three months through six
months; $21,306 mature over six months through twelve months; and $ 10,255
mature over twelve months.
Short-term borrowings at December 31, 2003 were $1,060, unchanged from December
31, 2002, and were entirely comprised of overnight federal funds purchased from
one correspondent bank. In addition to federal funds purchased, the Company also
had borrowings in the amount of $27,000 in Federal Home Loan Bank ("FHLB")
18
callable and bullet advances at December 31, 2003 compared to $21,500 at
December 31, 2002. The increase of $5,500 in FHLB borrowings from the 2002
levels was a result of the Company's efforts to diversify its funding base and
desire to lock in funding costs. The FHLB bullet advances mature in various
years from March 2004 to December 2005. There was $6,500 in FHLB callable
advances outstanding at December 31, 2003. The callable advances mature in 2011,
and each contains a quarterly call feature.
The Company had $3,608 aggregate principal amount in junior subordinated
debenture outstanding at December 31, 2003 and 2002 as a result of the Company,
through its subsidiary, TCT1, closing a private placement offering of $3,500 in
Trust Preferred Securities on November 16, 2001. The proceeds of the offering
were loaned to the Company in exchange for junior subordinated debentures with
similar terms to the Trust Preferred Securities. These securities are considered
Tier I capital (with certain limitations applicable) under current regulatory
guidelines.
The junior subordinated debentures are subject to mandatory redemption, in whole
or in part, upon repayment of the Trust Preferred Securities at maturity or
their earlier redemption at the par amount. The maturity date of the Trust
Preferred Securities is November 15, 2031. Subject to the Company having
received prior approval of the Federal Reserve Bank, if then required, the Trust
Preferred Securities are redeemable prior to the maturity date beginning
November 15, 2006 and each year thereafter at the option of the Company.
Stockholders' equity was $40,909 at December 31, 2003 and $39,175 at December
31, 2002. The increase of $1,734 was mainly attributable to 2003 net income of
$1,800 and $132 from the net exercise of stock options. The only other item
affecting stockholders' equity was a $(198) change in net unrealized
appreciation on securities available for sale, net of tax. The Company issued
1,395,232 shares of common stock in conjunction with its rights offering and
limited public offering during 2002, providing net proceeds of $13,657 after
deducting marketing agent fees and offering expenses. At the completion of the
IPO during 1999, the Company had issued 2,530,000 shares of common stock. The
net proceeds from the sale of the stock in the IPO was $23,470 after deducting
offering expenses and underwriters' discounts and was recorded as common stock
and paid-in-capital. No additional shares were issued during 2000 or 2001. At
December 31, 2003, the Company had a balance of $3,561 in retained earnings
while at December 31, 2002 the balance was $1,761, an increase of $1,800 from
2002 due to net income generated during 2003. See "Results of Operations."
RESULTS OF OPERATIONS
Summary. The Company reported net income of $1,800, or $.45 per diluted share,
for the year ended December 31, 2003. This reflects an increase in net income
from the $1,716 in 2002 and net income of $1,120 posted during 2001, however net
income per diluted share reflects a decrease from the $.56 reported in 2002 and
a $.01 increase from the $.44 posted in 2001. Per share earnings were diluted
compared to prior years as a result of a 30.5% increase in average outstanding
shares. The increase in shares was mainly from the rights offering and limited
public offering completed August 2002.
The 2003 results reflected a 4.9% growth in net income compared to 2002 despite
recording approximately $1,060 of pretax expenses for loan losses and
administrative costs during 2003 from previously disclosed unauthorized mortgage
activity. The improvement in net income over 2002 was mainly the result of
substantial revenue growth. Net interest income in 2003 was $11,765 compared to
$10,050 in 2002, an increase of $1,715 due mainly from an increase in loans
outstanding. Noninterest income in 2003 was $3,642 compared to $2,954 in 2002,
an increase of $688 from further development of the trust business and other fee
income-based products including mortgage broker fees as well as $191 from gains
on the sale of securities. Offsetting the improvements in revenue during 2003
was a $420 increase from 2002 in the provision for loan losses and a $1,937
increase in noninterest expenses related mainly to infrastructure growth costs
for compensation, occupancy and equipment. Approximately one-fourth of the
noninterest expense increase over 2002 was related to costs associated with
unauthorized mortgage activity.
Loan loss provisions are made in the period loans are recorded and are immediate
reductions to earnings. Loan loss provisions are expected to continue to reduce
earnings (as was the case during 2003 and prior years),
19
although more moderately, if the anticipated rate of loan growth slows relative
to the size of the Bank's loan portfolio.
Although continued asset growth is anticipated, resulting in increased loan loss
provisions, management believes the overall earnings performance of the Company
will improve. The asset growth of the Company is expected to result in an
increased level of net interest income, which, coupled with noninterest income,
is expected to exceed the growth and level of noninterest expense and provision
for loan losses. The following table shows some of the key equity performance
ratios for the years ended December 31, 2003, 2002 and 2001.
PERFORMANCE RATIOS
2003 2002 2001
---- ---- ----
Return on average total assets 0.45% 0.53% 0.47%
Return on average equity 4.53 5.90 4.88
Average equity to average assets 9.87 8.91 9.53
Net Interest Income. Net interest income, the difference between revenue
generated from earning assets and the interest cost of funding those assets, is
the Company's primary source of earnings. Interest income and interest expense
for the year ended December 31, 2003 were $17,826 and $6,061, respectively,
netting $11,765 in net interest income. Interest income and interest expense for
the year ended December 31, 2002 were $16,494 and $6,444, respectively,
resulting in $10,050 in net interest income. Interest income and interest
expense for the year ended December 31, 2001 totaled $15,931 and $8,102,
respectively, providing for net interest income of $7,829. The substantial
increase of $1,715 in net interest income in 2003 from 2002 and the increase
over net interest income from 2001 were primarily attributable to an increase in
the loans outstanding.
The net yield on average earning assets during 2003 was 3.04% compared to 3.17%
for 2002 and 3.33% for 2001. The decline in margin during 2003, 2002 and 2001
was attributable each year to net interest spread compression caused by the
decline in general interest rates and its effects on the Company's mostly
variable rate mix of loans. Management anticipates that margins will improve due
to the Company's current asset-sensitive balance sheet, assuming interest rates
increase.
The level of net interest income is primarily a function of asset size, as the
weighted-average interest rate received on earning assets is greater than the
weighted average interest cost of funding sources; however, factors such as
types of assets and liabilities, interest rate risk, liquidity, and customer
behavior also impact net interest income as well as the net yield.
The following table reflects the average balance, interest earned or paid, and
yields or costs of the Company's assets, liabilities and stockholders' equity
during 2003, 2002 and 2001.
20
AVERAGE BALANCE, INTEREST AND YIELD / COST ANALYSIS
2003 2002 2001
---------------------------- ---------------------------- -----------------------------
INTEREST INTEREST INTEREST
AVERAGE EARNED YIELD AVERAGE EARNED YIELD AVERAGE EARNED YIELD
($ in thousands) BALANCE OR PAID OR COST BALANCE OR PAID OR COST BALANCE OR PAID OR COST
- ---------------- --------- -------- ------- --------- -------- ------- --------- -------- --------
ASSETS
Short-term investments and
interest-earning deposits $ 5,659 $ 62 1.10% $ 6,042 $ 138 2.29% $ 6,916 $ 324 4.68%
Federal funds sold 13,795 129 0.94% 16,535 266 1.61% 31,490 1,270 4.03%
Securities - taxable 10,906 377 3.46% 8,035 362 4.50% 8,054 420 5.22%
Securities - tax exempt (1) 2,967 168 5.66% 1,464 84 5.73% 270 23 8.75%
Loans held for sale 777 42 5.48% 2,246 80 3.56% 922 61 6.62%
Loans 354,817 17,099 4.82% 283,899 15,593 5.49% 187,678 13,840 7.37%
--------- -------- --------- -------- --------- --------
Total interest-earning assets 388,921 17,877 4.60% 318,221 16,523 5.19% 235,330 15,938 6.77%
Allowance for loan losses (5,362) (4,094) (2,845)
Cash and due from banks 10,219 7,258 4,884
Other assets 9,027 4,697 3,141
--------- --------- ---------
Total assets $ 402,805 $ 326,082 $ 240,510
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing checking $ 17,550 $ 78 0.44% $ 13,707 $ 130 0.95% $ 9,134 $ 135 1.48%
Savings 10,015 47 0.47% 6,452 91 1.41% 3,028 73 2.42%
Money market 109,575 1,253 1.14% 107,540 1,877 1.75% 92,558 3,470 3.75%
Certificates of deposit 156,186 3,806 2.44% 115,283 3,562 3.09% 83,627 4,240 5.07%
Short-term borrowings 1,257 13 1.03% 1,383 22 1.59% 828 28 3.31%
FHLB advances 19,579 536 2.74% 14,634 445 3.04% 3,141 117 3.71%
Junior Subordinated Debt 3,608 327 9.06% 3,608 318 8.80% 441 39 9.00%
--------- -------- --------- -------- --------- --------
Total interest-bearing liabilities 317,770 6,060 1.91% 262,607 6,445 2.46% 192,757 8,102 4.20%
Noninterest-bearing checking 44,133 33,386 23,560
Other liabilities 1,129 1,025 1,264
Stockholders' equity 39,773 29,064 22,929
--------- --------- ---------
Total liabilities and
stockholders' equity $ 402,805 $ 326,082 $ 240,510
========= ========= =========
NET INTEREST INCOME $ 11,817 $ 10,078 $ 7,836
======== ======== ========
RATE SPREAD 2.69% 2.73% 2.57%
NET INTEREST INCOME AS A PERCENT
OF AVERAGE EARNING ASSETS 3.04% 3.17% 3.33%
(1) Computed on a tax equivalent basis for tax equivalent securities using a
34% statutory tax rate.
The following table shows the changes in interest income, interest expense, and
net interest income due to variances in rate and volume of average earning
assets and interest-bearing liabilities. The change in interest not solely due
to changes in rate or volume has been allocated in proportion to the absolute
dollar amounts of the change in each.
21
CHANGES IN NET INTEREST INCOME DUE
TO RATE AND VOLUME
2003 OVER 2002
------------------------------
($ in thousands) RATE VOLUME TOTAL
- ---------------- -------- -------- --------
INCREASE (DECREASE) IN INTEREST INCOME:
Short-term investments and interest-
earning deposits $ (68) $ (8) $ (76)
Federal funds sold (98) (39) (137)
Securities - taxable (96) 111 15
Securities - tax exempt (1) 85 84
Loans available for sale 30 (68) (38)
Loans (2,069) 3,575 1,506
------- ------- -------
Net change in interest income (2,302) 3,656 1,354
INCREASE (DECREASE) IN INTEREST EXPENSE:
Interest-bearing checking (81) 29 (52)
Savings (79) 35 (44)
Money market (659) 35 (624)
Certificates of deposit (852) 1,096 244
Short-term borrowings (6) (2) (8)
FHLB advances (49) 139 90
Trust preferred securities 9 - 9
------- ------- -------
Net change in interest expense (1,717) 1,332 (385)
------- ------- -------
NET CHANGE IN INTEREST INCOME AND
INTEREST EXPENSE $ (585) $ 2,324 $ 1,739
======= ======= =======
2002 OVER 2001
------------------------------
($ in thousands) RATE VOLUME TOTAL
- ---------------- -------- -------- --------
INCREASE (DECREASE) IN INTEREST INCOME:
Short-term investments and interest-
earning deposits $ (148) $ (37) $ (185)
Federal funds sold (561) (443) (1,004)
Securities - taxable (58) (1) (59)
Securities - tax exempt (11) 71 60
Loans available for sale (38) 57 19
Loans (4,133) 5,887 1,754
------- ------- -------
Net change in interest income (4,949) 5,534 585
INCREASE (DECREASE) IN INTEREST EXPENSE:
Interest-bearing checking (59) 53 (6)
Savings (40) 58 18
Money market (2,084) 492 (1,592)
Certificates of deposit (1,975) 1,296 (679)
Short-term borrowings (18) 13 (5)
FHLB advances (25) 353 328
Trust preferred securities 1 278 279
------- ------- -------
Net change in interest expense (4,200) 2,543 (1,657)
------- ------- -------
NET CHANGE IN INTEREST INCOME AND
INTEREST EXPENSE $ (749) $ 2,991 $ 2,242
======= ======= =======
Interest income is primarily generated from the loan portfolio. Average loans
comprised 91%, 89% and 80% of average earning assets during 2003, 2002 and 2001,
respectively. During 2003, the loan portfolio had an average yield of 4.82%, and
earned $17,099, or 96% of total interest income, an increase of $1,506 from
2002. The improvement in net interest income was mainly due to the increase in
average loans while the impact from the
22
decrease in the prime lending rate during 2003 reflected negatively on net
interest income and offset some of the improvement. During 2002, the loan
portfolio had an average yield of 5.49% and earned $15,593, or 94% of total
interest income while the loan portfolio had an average yield of 7.37% and
earned $13,840, or 87% of total interest income during 2001.
The total securities portfolio and total short-term investments equaled 4% and
5%, respectively, of average earning assets during 2003. With an average
tax-equivalent yield of 3.93%, total securities contributed $545, or 3% of total
interest income in 2003, while total short-term investments had a combined
average yield of 0.98% and earned $191, or 1% of total interest income, in 2003.
During 2002, the total securities portfolio and total short-term investments
equaled 3% and 7%, respectively, of average earning assets. With an average
yield of 4.70%, securities contributed $446, or 3% of total interest income in
2002, while total short-term investments had a combined average yield of 1.79%
and earned 2% of total interest income in 2002. During 2001, the total
securities portfolio and total short-term investments equaled 4% and 16%,
respectively, of average earning assets. With an average yield of 5.32%,
securities contributed $443, or 3% of total interest income in 2001, while total
short-term investments had a combined average yield of 4.15% and earned 10% of
total interest income in 2001.
Interest expense is primarily generated from money market deposits and
certificates of deposit, which equaled 34% and 49%, respectively, of average
earning assets during 2003; 41% and 44%, respectively of average earning assets
during 2002; and 48% and 43%, respectively, of average earning assets during
2001. The percentage change within the money market category reflects the
decrease in this type of funding during 2003 and 2002, reductions mainly from
business and municipal funds as these depositors sought greater yields. CD
balances grew during 2003 as a percent of earning assets reflective of growth
from brokered and national market sources. Total borrowings were 8% and 7% of
average earning assets during 2003 and 2002, up from the 2% level in 2001.
Money market balances had an average rate of 1.14% and cost $1,253, or 21% of
total interest expense, in 2003 compared to an average rate of 1.75% and cost
$1,877, or 29% of total interest expense, in 2002. Certificates of deposit had
an average rate of 2.44% and cost $3,806, or 63% of total interest expense, in
2003 compared to an average rate of 3.09% and cost $3,562, or 55% of total
interest expense, in 2002. Interest expense on savings and interest-bearing
checking totaled 2% of total interest expense during 2003, down slightly from 3%
in 2002. The Company paid $876 of interest expense on borrowings, or 14% of
total interest expense, during 2003 and paid $785 of interest expense on
borrowings, or 12% of total interest expense, during 2002. The increase in
borrowing cost during 2003 compared to 2002 is reflective of the higher levels
of FHLB advances.
During 2001, money market accounts had an average rate of 3.75% and cost $3,470
or 43% of total interest expense, while certificates of deposit had an average
rate of 5.07% and cost $4,240, or 52% of total interest expense. Savings
deposits and interest-bearing checking accounts totaled 6% of average earning
assets during 2001 with an average rate of 1.71%, or 3% of total interest
expense in 2001. Total borrowings had an average rate of 4.17% during 2001.
Provision for Loan Losses. With significant loan growth in all reported years,
the provision for loan losses was $2,185 for 2003, $1,765 for 2002 and $1,120
for 2001. This reflects a $420, or 23.8%, increase from 2003 to 2002. The
allowance for loan losses as a percentage of total loans outstanding was 1.40%,
1.48% and 1.50% at December 31, 2003, 2002, and 2001, respectively. The Company
maintains the allowance for loan losses at a level management feels is adequate
to absorb losses incurred in the loan portfolio. The evaluation is based upon
the Company's and the banking industry's historical loan loss experience, known
and inherent risks contained in the loan portfolio, composition and growth of
the loan portfolio, current and projected economic conditions and other factors.
Although the Bank experienced loan losses during 2003, it does not yet have
enough history of loss activity to only use its own loss experience to establish
the allowance for loan losses, therefore, in addition to considering the
Company's loss history, management has established the provision and allowance
for loan losses in consideration of the loss experience of peer financial
institutions with similar heavy concentrations in commercial lending and in
consideration of general trends in the economy.
The Company had $1,905 of nonperforming loans at December 31, 2003, an increase
of $1,186 from the $719 of nonperforming loans at December 31, 2002. The Company
reported $1,671 of net charge-offs, or .47% of average loans during 2003
compared to $500 in net charge offs or .18% of average loans during 2002. While
the charge-
23
off results for 2003 reported increases over the 2002 level, $600 of the charge
offs was related to the unauthorized mortgage activity previously disclosed.
Noninterest Income. Noninterest income recorded substantial growth during 2003
as all major categories reflected improved performance. Total noninterest income
was $3,642 for the year ended December 31, 2003 compared to $2,954 and $1,785
for the years ended December 31, 2002 and 2001, respectively. Fees from trust
services grew 29.2% resulting from an increasing base of accounts and assets
under management and was $1,402 for 2003 compared to $1,085 for 2002 and $798 in
2001. In addition to trust income, the mortgage origination unit improved its
results during 2003, attributable to a lower interest rates and the refinancing
business; however with industry trends, the mortgage originations moderated
during the fourth quarter. Mortgage broker fees were $813 during 2003, an
increase of $31 or 4.0% from $782 for 2002. Mortgage broker fees were $490 for
2001. Other improvements during 2003 included a $218 or 52.3% increase in
deposit service charges, and a $207 or 52.6% increase in other fee income.
Service charge income increased due to an overall expanded account base, a
higher level of fees generated on business accounts and increased activity from
NSF/OD charges. Other fee income increased mainly as a result of income
generated from bank-owned life insurance (BOLI). In addition to the above, 2003
noninterest income results included $191 in gains on the sale of securities
available for sale compared to gains on the sale of securities and loans
totaling $276,526 during 2002. There were no gains or losses on the sale of
assets during 2001.
Noninterest Expense. Noninterest expense totaled $10,353 for the year ended
December 31, 2003 compared to $8,416 and $6,638 for the years ended December 31,
2002 and 2001, respectively, an increase of $1,937 or 23.0% over 2002. The
increase in expenses is mainly attributable to the infrastructure growth of the
Company. This is evidenced by salary and benefit costs, which increased $911, or
19.8%, and occupancy and equipment costs which increased $193, or 18.5%, over
their respective 2002 levels. Salary and benefits costs were $5,516 or 53.3% of
total expenses for 2003, while occupancy and equipment costs were $1,237 or
12.0% of total expenses. Loan and professional costs increased during 2003 from
prior year levels by $386 or 81.9% as the Company mainly incurred administrative
costs related to the unauthorized mortgage issue and nonrecurring upfront
consulting costs for future loan and fee origination. Other various expense
categories increased during 2003, such as marketing, data processing, office
supplies and postage, and courier services, but to a lesser dollar amount than
those mentioned above. Other expense was $1,172 for 2003, $1,086 for 2002 and
a$434 for 2001, which reflected an $86, or 7.9%, increase in 2003 and, $652 or
150.2% increase in 2002, as compared to the prior year. Other expense for both
2003 and 2002 included losses recorded for the unauthorized mortgage activity in
the amount of $365 and $428, respectively.
During 2002, salaries and benefits costs were $4,604, while occupancy and
equipment expenses totaled $1,044. Additional large overhead expenses in 2002
included costs for loan and professional fees and services, which amounted to
$471, and marketing expenses were $263. Significant noninterest expenses during
2001 were $3,892 for salary and benefit costs, $825 for occupancy and equipment
costs, and $525 for loan and professional costs.
Monitoring and controlling overhead expenses while providing high quality
service to customers is of the utmost importance to the Company. The efficiency
ratio, computed by dividing noninterest expense by net interest income plus
noninterest income, was 67.2% in 2003 compared to 64.7% in 2002 and 69.0% in
2001. The overall level of efficiency ratio continues to be high, but reflects
expected infrastructure costs associated with growth. As anticipated, this
improvement in efficiency ratio is dependent upon the growth in earning assets
along with the development of fee-based products and the resulting increases in
revenue. Management expects that as additional asset growth and operating
efficiencies are realized, the Company will earn more on the larger base of
earning assets while operating costs will increase at a lesser rate, resulting
in an improved efficiency ratio.
Income Taxes Expense. During 2003, 2002 and 2001, the Company recorded $1,069,
$1,108 and $736 respectively, in income taxes expense. The effective tax rate
recorded for 2003 was 37.3% as compared to 39.2% for 2002 and 39.7% for 2001.
The effective tax rate decreased from the prior years as the Company grew its
tax-exempt security portfolio in 2002 and 2003 and purchased bank-owned life
insurance (BOLI) during 2003.
24
CAPITAL SOURCES
Stockholders' equity is a noninterest-bearing source of funds, which provides
support for asset growth. Stockholders' equity was $40,909 and $39,175 at
December 31, 2003 and 2002, respectively. Affecting the increase in
stockholders' equity during 2003 was net income of $1,800 and $132 from the net
exercise of stock options. Significant additions to stockholders' equity during
2002 and 2001 were from net income amounting to $1,716 and $1,120, respectively.
During 2002 the Company completed a rights offering and limited public offering
of its common stock, which increased capital net of costs by $13,657.
The Company and the Bank are subject to regulatory capital requirements
administered by federal banking agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. As a condition to regulatory approvals for
the formation of the Bank, the Company was required to have capitalization
sufficient to provide a ratio of Tier 1 capital to total assets of not less than
eight percent (8%) and Tier 1 capital to average assets in excess of nine
percent (9%), during the first three years of operation. These restrictions
expired in February 2002. Currently, and going forward, both the Company and the
Bank are now subject to the same capitalization requirements as other financial
holding companies and banks. Since the Bank began operations, both the Company
and the Bank have been categorized as "Well Capitalized," the highest
classification contained within the banking regulations. The capital ratios of
the Company and the Bank as of December 31, 2003 and 2002 are disclosed in Note
15 of the Notes to Consolidated Financial Statements.
The ability of the Company to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. No cash or stock dividends were paid in 2003, 2002 or 2001. The
Company expects that its future earnings and those of the Bank, if any, would be
retained to finance future growth and operations. The Company does not
anticipate paying any cash dividends on the common stock in the foreseeable
future.
DECEMBER 31
-----------------
LIQUIDITY AND CAPITAL RATIOS 2003 2002
- ---------------------------- ------- -------
Loan to deposit ratio 103.85% 103.46%
Loan to funding ratio 95.51% 95.42%
Total risk-based capital 12.66% 13.86%
Tier 1 risk-based capital 11.44% 12.61%
Tier 1 leverage capital 10.26% 11.75%
LIQUIDITY
Liquidity is measured by the Company's ability to raise funds through deposits,
borrowed funds, capital or cash flow from the repayment of loans and investment
securities. These funds are used to meet depositor withdrawals, maintain reserve
requirements, fund loans and operate the Company. Liquidity is primarily
achieved through the growth of deposits and liquid assets such as securities
available for sale, matured securities, and federal funds sold. Asset and
liability management is the process of managing the balance sheet to achieve a
mix of earning assets and liabilities that maximize profitability, while
providing adequate liquidity.
The Company's liquidity strategy is to fund growth with deposits (from both
in-market and out-of-market sources), FHLB borrowings and to maintain an
adequate level of short-term and medium-term investments to meet typical daily
loan and deposit activity needs. Deposit growth was substantial during 2003 and
2002. The Company mainly generated deposits from in-market sources; however, it
expanded its funding base during 2002 to include national, non-brokered
certificates of deposit, borrowings from the FHLB and trust preferred
securities. During 2003 the Company further expanded its funding base to include
brokered deposits. At December 31, 2003, the balance of non-brokered national
market CDs, brokered CDs, and FHLB borrowings were $45,970, $25,208 and $27,000
respectively, as compared to $26,913, $0 and $21,500, respectively, at December
31, 2002. At December 31, 2003 and 2002, total deposits were $362,877 and
$310,584, respectively, and the loan-to-deposit ratio was 103.8% and 103.5%,
respectively. The Company expects to continue to experience loan growth. Funding
for the loan growth will continue to come from in-market sources through the
marketing of products and the development
25
of branch locations. The Company will also continue to develop wholesale and
out-of-market deposits and borrowing capacities and use them to augment its
interest rate sensitivity strategy and liquidity capabilities and to diversify
the funding base of the Bank.
The Company has the ability to borrow money on a daily basis through
correspondent banks (federal funds purchased), and at December 31, 2003 had
$1,060 outstanding, unchanged from the December 31, 2002 balance. Additional
capacity to borrow overnight in the form of unused lines of commitment from
correspondent banks totaled $27,000 and $21,115 at December 31, 2003 and 2002,
respectively. This type of funding is viewed by the Company as only a secondary
and temporary source of funds.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF-BALANCE SHEET RISK
In addition to normal loan funding and deposit flow, the Company also needs to
maintain liquidity to meet the demands of certain unfunded loan commitments and
standby and commercial letters of credit. The Bank maintains off-balance-sheet
financial instruments in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. Loan commitments to extend credit
are agreements to lend to a customer at any time, as the customer's needs vary,
as long as there is no violation of any condition established in the contract.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. We monitor fluctuations in loan balances and commitment
levels and include such data in our overall liquidity management.
These instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized, if any, in the balance sheet. The Bank's maximum
exposure to loan loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and standby letters of
credit is represented by the face amount of these instruments. Commitments to
extend credit are recorded when they are funded and standby letters of credit
are recorded at fair value.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments. Collateral, such as
accounts receivable, securities, inventory, property and equipment is generally
required based on management's credit assessment of the borrower.
Fair value of the Bank's off-balance-sheet instruments (commitments to extend
credit and standby letters of credit) is based on rates currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing. At December 31, 2003, the
rates on existing off-balance-sheet instruments were equivalent to current
market rates, considering the underlying credit standing of the counterparties.
The Company and the Bank occupy their respective headquarters, offices and other
facilities under long-term operating leases and, in addition, are parties to
long-term contracts for data processing and operating systems.
Under the terms of certain employment contracts, upon the occurrence of certain
events resulting in the severance of certain executive officers' employment with
the Company, payments may be required to be made in excess of amounts that have
been accrued.
The following tables represent the Company's contractual obligations and
commitments at December 31, 2003.
26
CONTRACTUAL OBLIGATIONS
at December 31, 2003
PAYMENTS DUE BY PERIOD
------------------------------------------------------
LESS THAN 1-3 4-5 AFTER 5
($ in thousands) 1 YEAR YEARS YEARS YEARS TOTAL
- ---------------- --------- ------- ------- ------- -------
Federal Home Loan Bank advances $ 13,000 $ 7,500 $ $ 6,500 $27,000
Junior subordinated debt 3,608 3,608
Operating leases 549 1,140 1,215 2,896 5,800
Other 95 15 110
--------- ------- ------- ------- -------
Total contractual cash obligations $ 13,644 $ 8,655 $ 1,215 $13,004 $36,518
========= ======= ======= ======= =======
COMMITMENTS
at December 31, 2003
AMOUNT OF COMMITMENT EXPIRATIONS PER PERIOD
------------------------------------------------------
LESS THAN 1-3 4-5 AFTER 5
($ in thousands) 1 YEAR YEARS YEARS YEARS TOTAL
- ---------------- --------- ------- ------- ------- -------
Lines of credit / loan commitments $ 28,296 $ 8,183 $ 6,866 $39,404 $82,749
Standby letters of credit 1,400 647 300 2,347
--------- ------- ------- ------- -------
Total commercial commitments $ 29,696 $ 8,830 $ 7,166 $39,404 $85,096
========= ======= ======= ======= =======
RELATED PARTY TRANSACTIONS
Certain directors and executive officers of the Company, including their
immediate families and companies in which they are principal owners, are loan
customers of the Bank. At December 31, 2003 and 2002, the Bank had $23,260 and
$20,992, respectively, in loan commitments to directors and executive officers,
of which $17,617 and $16,609 were funded at the respective period-ends. These
loans have been made in the Bank's ordinary course of business with similar
terms to the Bank's similarly situated customers.
During 2003 and 2002, the Company and the Bank engaged in transactions with
entities controlled by their respective directors or their affiliates. The Bank
leases its headquarters facility from Tippmann Properties, Inc., agent for John
V. Tippmann, Sr., a director. The original lease was a 10-year lease commencing
on January 1, 1999. During 2001, the original lease term was extended to 15
years with provisions for one renewal term of 10 years at then prevailing market
rates. The total amount paid to Tippmann Properties by the Company and the Bank
for rent and maintenance was $416, $348 and $252 during 2003, 2002 and 2001,
respectively. The lease is accounted for as an operating lease. Refer to the
table above for a summary of future lease payment commitments under this and
other leases.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK ANALYSIS
The Company's primary market risk exposure is interest rate risk and, to a
lesser extent, liquidity risk. All of the Company's transactions are denominated
in U.S. dollars with no specific foreign exchange exposure. The Company has no
agricultural-related loan assets and therefore has no significant exposure to
changes in commodity prices. Any impact that changes in foreign exchange rates
and commodity prices would have on interest rates is assumed to be
insignificant.
Interest rate risk is the exposure of the Company's financial condition to
adverse movements in interest rates. The Company derives its income primarily
from the excess of interest collected on its interest-earning assets over the
interest paid on its interest-bearing liabilities. The rates of interest the
Company earns on its assets and owes on its liabilities generally are
established contractually for a period of time. Since market interest rates
change over time, the Company is exposed to lower profitability if it cannot
adapt to interest rate changes. Accepting interest rate risk can be an important
source of profitability and stockholder value; however, excessive levels of
interest rate risk could pose a significant threat to the Company's earnings and
capital base. Accordingly, effective risk
27
management that maintains interest rate risk at prudent levels is essential to
the Company's safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. The Company's interest rate risk management process seeks to
ensure that appropriate policies, procedures, management information and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk, the Company assesses the existing and potential future
effects of changes in interest rates on its financial condition, including
capital adequacy, earnings, liquidity and overall asset quality.
There are two interest rate risk measurement techniques which may be used by the
Company. The first, which is commonly referred to as GAP analysis, measures the
difference between the dollar amount of interest-sensitive assets and
liabilities that will be refinanced or repriced during a given time period. A
significant repricing gap could result in a negative impact to the Company's net
interest margin during periods of changing market interest rates.
The following table depicts the Company's GAP position as of December 31, 2003:
RATE SENSITIVITY ANALYSIS
WITHIN THREE TO ONE TO AFTER
THREE TWELVE FIVE FIVE
($ in thousands) MONTHS MONTHS YEARS YEARS TOTAL
- ---------------- ---------- ---------- --------- --------- ----------
ASSETS
Federal funds sold, short-term
investments and interest-
earning deposits $ 15,133 $ $ $ $ 15,133
Securities available for sale 2,160 3,619 5,281 13,265 24,325
FHLBI and FRB stock 2,333 2,333
Fixed rate loans 4,326 31,923 56,065 33,770 126,084
Variable rate loans 250,474 250,474
Allowance for loan losses (5,259)
Other assets 23,379
---------- ---------- --------- --------- ----------
Total assets $ 272,093 $ 35,542 $ 61,346 $ 49,368 $ 436,469
---------- ---------- --------- --------- ----------
LIABILITIES
Interest-bearing checking $ 23,543 $ $ $ $ 23,543
Savings accounts 10,576 10,576
Money market accounts 98,250 98,250
Time deposits < $100,000 17,423 28,166 17,439 63,028
Time deposits $100,000 and over 64,724 29,861 10,255 104,840
Short-term borrowings 1,060 1,060
FHLB advances 7,000 6,000 7,500 6,500 27,000
Junior subordinated debt 3,608 3,608
Noninterest-bearing checking 62,638
Other liabilities 1,017
---------- ---------- --------- --------- ----------
Total liabilities 222,576 64,027 35,194 10,108 395,560
STOCKHOLDERS' EQUITY 40,909
---------- ---------- --------- --------- ----------
Total sources of funds $ 222,576 $ 64,027 $ 35,194 $ 10,108 $ 436,469
---------- ---------- --------- --------- ----------
Net asset (liability) GAP $ 49,517 $ (28,485) $ 26,152 $ 39,260 $
---------- ---------- --------- --------- ----------
CUMULATIVE GAP $ 49,517 $ 21,032 $ 47,184 $ 86,444 $
---------- ---------- --------- --------- ----------
PERCENT OF CUMULATIVE GAP TO TOTAL ASSETS 11.3% 4.8% 10.8% 19.8% %
A second interest rate risk measurement used is commonly referred to as net
interest income simulation analysis. A simulation model assesses the direction
and magnitude of variations in net interest income resulting from potential
changes in market interest rates. Key assumptions in the model include
prepayment speeds on various
28
loan and investment assets; cash flows and maturities of interest-sensitive
assets and liabilities; and changes in market conditions impacting loan and
deposit volume and pricing. These assumptions are inherently uncertain, subject
to fluctuation and revision in a dynamic environment; therefore, a model cannot
precisely estimate net interest income or exactly predict the impact of higher
or lower interest rates on net interest income. Actual results will differ from
simulated results due to timing, magnitude, and frequency of interest rate
changes and changes in market conditions and the Company's strategies, among
other factors.
As growth has dictated, the Company began utilizing simulation analysis as a
tool for measuring the effects of interest rate risk on the income statement at
the end of 2003.
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of other variables, including the growth,
composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; economic and competitive conditions; potential
changes in lending, investing, and deposit gathering strategies; client
preferences; and other factors.
The following table provides information about the Company's financial
instruments used for purposes other than trading that are rate sensitive to
changes in interest rates as of December 31, 2003. It does not provide when
these items may actually reprice. For loans receivable, securities, and
liabilities with contractual maturities, the table presents principal cash flows
and related weighted-average interest rates by contractual maturities as well as
the Company's historical experience of the impact of interest rate fluctuations
on the prepayment of loans and mortgage backed securities. For core deposits
(demand deposits, interest-bearing checking, savings, and money market deposits)
that have no contractual maturity, the table presents principal cash flows and,
as applicable related weighted-average interest rates based upon the Company's
historical experience, and management's judgment as applicable, concerning their
most likely withdrawal behaviors. The current historical interest rates for core
deposits have been assumed to apply for future periods in this table as the
actual interest rates that will need to be paid to maintain these deposits are
not currently known. Weighted average variable rates are based upon contractual
rates existing at the report date. There is only the 2003 table because this is
the first year it is required.
29
PRINCIPAL AMOUNT MATURING IN:
----------------------------------------------------------------------------------------------
FAIR VALUE
($ in thousands) 2004 2005 2006 2007 2008 THEREAFTER TOTAL 12/31/2003
- ---------------- --------- --------- -------- --------- --------- ----------- ---------- ----------
Rate sensitive assets:
Fixed interest rate loans $ 36,249 $ 14,370 $11,833 $ 12,546 $ 17,316 $ 33,770 $ 126,084 $ 126,176
Average interest rate 5.05% 6.11% 6.36% 6.50% 5.80% 5.56% 5.68%
Variable interest rate loans 78,474 36,059 28,649 38,449 17,699 51,144 250,474 250,474
Average interest rate 4.28% 4.16% 4.20% 4.16% 4.28% 4.36% 4.25%
Fixed interest rate securities 5,779 3,820 448 866 148 13,264 24,325 24,325
Average interest rate 3.70% 3.91% 3.93% 4.32% 4.38% 4.43% 4.16%
Other interest bearing assets 15,133 15,133 15,133
Average interest rate 1.70% 1.70%
Rate sensitive liabilities:
Interest bearing checking 23,544 23,544 23,544
Average interest rate 0.34% 0.34%
Savings accounts 10,576 10,576 10,576
Average interest rate 0.28% 0.28%
Money market accounts 98,250 98,250 98,250
Average interest rate 0.96% 0.96%
Time deposits 140,175 18,403 1,795 5,888 1,608 167,869 168,379
Average interest rate 1.91% 2.85% 3.56% 4.47% 3.86% 2.14%
Fixed interest rate
borrowings 11,000 7,500 10,108 28,608 29,363
Average interest rate 2.10% 4.09% 6.62% 4.21%
Variable interest rate
borrowings 3,060 3,060 3,060
Average interest rate 1.07% 1.07%
30
ITEM 8. FINANCIAL STATEMENTS
Tower Financial Corporation
CONSOLIDATED BALANCE SHEETS
At December 31, 2003 and 2002
2003 2002
------------- -------------
ASSETS
Cash and due from banks $ 12,708,817 $ 9,228,782
Short-term investments and interest-earning deposits 4,017,755 13,598,037
Federal funds sold 11,115,643 13,341,860
------------- -------------
Total cash and cash equivalents 27,842,215 36,168,679
Securities available for sale, at fair value 24,324,935 11,170,570
FHLB and FRB stock 2,332,500 2,057,500
Loans held for sale - 5,769,700
Loans 376,838,578 321,339,946
Allowance for loan losses (5,259,273) (4,745,672)
------------- -------------
Net loans 371,579,305 316,594,274
Premises and equipment, net 2,932,580 2,625,602
Accrued interest receivable 1,289,370 1,092,806
Other assets 6,168,085 1,831,785
------------- -------------
Total assets $ 436,468,990 $ 377,310,916
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing $ 62,638,230 $ 42,966,347
Interest-bearing 300,238,538 267,617,640
------------- -------------
Total deposits 362,876,768 310,583,987
Short-term borrowings 1,060,000 1,060,000
Federal Home Loan Bank (FHLB) advances 27,000,000 21,500,000
Junior subordinated debt 3,608,000 3,608,000
Accrued interest payable 278,964 272,303
Other liabilities 736,609 1,111,763
------------- -------------
Total liabilities 395,560,341 338,136,053
STOCKHOLDERS' EQUITY
Preferred stock, no par value, 4,000,000 shares authorized;
no shares issued and outstanding
Common stock and paid-in-capital, no par value, 6,000,000
shares authorized; 3,942,519 and 3,931,184 shares issued and
outstanding at December 31, 2003 and December 31, 2002,
respectively 37,322,694 37,190,692
Retained earnings 3,560,844 1,760,778
Accumulated other comprehensive income, net of tax
of $16,741 in 2003 and $148,928 in 2002 25,111 223,393
------------- -------------
Total stockholders' equity 40,908,649 39,174,863
------------- -------------
Total liabilities and stockholders' equity $ 436,468,990 $ 377,310,916
============= =============
The following notes are an integral part of the financial statements.
31
Tower Financial Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
----------- ----------- -----------
INTEREST INCOME:
Loans, including fees $17,141,325 $15,673,401 $13,901,202
Securities - taxable 376,849 361,612 420,478
Securities - tax exempt 116,362 54,994 15,891
Other interest income 191,152 404,391 1,593,454
----------- ----------- -----------
Total interest income 17,825,688 16,494,398 15,931,025
INTEREST EXPENSE:
Deposits 5,184,506 5,659,440 7,918,267
Short-term borrowings 36,495 21,963 27,375
FHLB advances 512,475 445,396 116,524
Junior subordinated debt 327,060 317,633 39,375
----------- ----------- -----------
Total interest expense 6,060,536 6,444,432 8,101,541
----------- ----------- -----------
Net interest income 11,765,152 10,049,966 7,829,484
PROVISION FOR LOAN LOSSES 2,185,000 1,765,000 1,120,000
----------- ----------- -----------
Net interest income after provision
for loan losses 9,580,152 8,284,966 6,709,484
NONINTEREST INCOME:
Trust fees 1,402,012 1,085,023 798,464
Service charges 635,917 417,471 249,051
Loan broker fees 813,051 781,909 489,944
Net gain on sale of loans 96,175
Net gain on sale of securities 190,766 180,351
Other fees 600,211 393,426 247,903
----------- ----------- -----------
Total noninterest income 3,641,957 2,954,355 1,785,362
NONINTEREST EXPENSE:
Salaries and benefits 5,515,892 4,604,488 3,892,043
Occupancy and equipment 1,237,281 1,044,155 825,325
Marketing 352,223 262,857 200,451
Data processing 356,092 282,737 219,842
Loan and professional costs 856,320 470,723 525,244
Office supplies and postage 274,576 230,032 199,922
Courier services 281,460 243,711 187,935
Business development 307,082 190,999 153,547
Other expense 1,172,067 1,086,490 434,182
----------- ----------- -----------
Total noninterest expense 10,352,993 8,416,192 6,638,491
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 2,869,116 2,823,129 1,856,355
Income taxes expense 1,069,050 1,107,500 736,400
----------- ----------- -----------
NET INCOME $ 1,800,066 $ 1,715,629 $ 1,119,955
=========== =========== ===========
BASIC EARNINGS PER COMMON SHARE $ 0.46 $ 0.57 $ 0.44
DILUTED EARNINGS PER COMMON SHARE $ 0.45 $ 0.56 $ 0.44
Average common shares outstanding 3,933,339 3,008,145 2,530,000
Average common shares and dilutive
potential common shares outstanding 4,007,036 3,069,648 2,531,818
The following notes are an integral part of the financial statements.
32
Tower Financial Corporation
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
----------- ----------- -----------
Net income $ 1,800,066 $ 1,715,629 $ 1,119,955
Other comprehensive income (loss):
Change in net unrealized appreciation
(depreciation) on securities available for
sale, net of reclassification adjustments
and tax of $(132,187) in 2003, $155,328
in 2002 and $(6,747) in 2001 (198,282) 232,973 (10,109)
----------- ----------- -----------
COMPREHENSIVE INCOME $ 1,601,784 $ 1,948,602 $ 1,109,846
=========== =========== ===========
The following notes are an integral part of the financial statements.
33
Tower Financial Corporation
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the years ended December 31, 2003, 2002 and 2001
COMMON RETAINED ACCUMULATED
STOCK AND EARNINGS OTHER
PAID-IN (ACCUMULATED COMPREHENSIVE
CAPITAL DEFICIT) INCOME (LOSS) TOTAL
------------- ------------ ------------- ------------
BALANCE, JANUARY 1, 2001 $ 23,469,770 $ (1,074,806) $ 529 $ 22,395,493
Net income for 2001 1,119,955 1,119,955
Change in net unrealized appreciation
(depreciation) on securities available
for sale, net of tax of $(6,747) (10,109) (10,109)
------------- ------------ ------------ ------------
BALANCE, DECEMBER 31, 2001 23,469,770 45,149 (9,580) 23,505,339
Net income for 2002 1,715,629 1,715,629
Issuance of 1,395,232 shares of common
stock, net of underwriters' fee and
offering costs 13,656,562 13,656,562
Issuance of 5,952 shares of common
stock for stock options exercised 59,520 59,520
Tax benefit on non-qualified stock options 4,840 4,840
Change in net unrealized appreciation
(depreciation) on securities available
for sale, net of tax of $155,328 232,973 232,973
------------- ------------ ------------ ------------
BALANCE, DECEMBER 31, 2002 37,190,692 1,760,778 223,393 39,174,863
Net income for 2003 1,800,066 1,800,066
Issuance of 11,335 shares of common
stock for stock options exercised 116,369 116,369
Tax benefit on non-qualified stock options 15,633 15,633
Change in net unrealized appreciation
(depreciation) on securities available
for sale, net of tax of $(132,187) (198,282) (198,282)
------------- ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 $ 37,322,694 $ 3,560,844 $ 25,111 $ 40,908,649
============= ============ ============ ============
The following notes are an integral part of the financial statements.
34
Tower Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2003, 2002 and 2001
2003 2002 2001
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,800,066 $ 1,715,629 $ 1,119,955
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization 602,589 405,672 324,916
Provision for loan losses 2,185,000 1,765,000 1,120,000
Earnings on life insurance (127,384)
Net gain on sale of loans (96,175)
Net gain on sale of securities (190,766) (180,351)
Net loss on sale of premises and equipment 2,778
FHLB stock dividend (41,500)
Change in accrued interest receivable (196,564) (138,001) 97,771
Change in other assets (1,076,729) (668,356) (467,806)
Change in accrued interest payable 6,661 (16,629) (176,940)
Change in other liabilities (375,154) 352,791 33,753
Origination of loans held for sale (15,956,100) (32,660,100) (16,849,805)
Proceeds from sales of loans held for sale 21,725,800 31,183,750 12,556,455
------------- ------------- -------------
Net cash from operating activities 8,358,697 1,663,230 (2,241,701)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in loans (72,891,522) (113,770,421) (90,975,485)
Net change in interest-earning deposits 2,806,000 (306,000)
Purchase of securities available for sale (AFS) (21,755,180) (14,493,462) (29,444,026)
Purchase of FHLB and FRB stock (233,500) (960,000) (428,050)
Purchase of life insurance (3,000,000)
Proceeds from maturities of securities AFS 5,193,600 3,087,096 37,000,000
Proceeds from sale of securities AFS 3,174,780 3,176,070
Proceeds from sale of participation loans 15,721,491 24,277,313 14,505,255
Purchase of equipment and leasehold expenditures (819,613) (1,445,028) (644,641)
------------- ------------- -------------
Net cash from investing activities (74,609,944) (97,322,432) (70,292,947)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits 52,292,781 54,430,920 67,856,943
Net change in short-term borrowings 530,000
Gross proceeds from issuance of common stock
from exercise of stock options and tax benefits 132,002 64,360
Gross proceeds from issuance of common stock
from stock offering 14,998,744
Payment of underwriters' fee and offering costs (1,342,182)
Proceeds from FHLB advances 16,500,000 20,000,000 6,500,000
Repayment of FHLB advances (11,000,000) (5,000,000)
Proceeds from issuance of junior
subordinated debt 3,608,000
------------- ------------- -------------
Net cash from financing activities 57,924,783 83,151,842 78,494,943
------------- ------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (8,326,464) (12,507,360) 5,960,295
Cash and cash equivalents, beginning of period 36,168,679 48,676,039 42,715,744
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 27,842,215 $ 36,168,679 $ 48,676,039
============= ============= =============
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 6,053,875 $ 6,461,061 $ 8,278,481
Income taxes 1,896,076 1,725,480 1,010,474
The following notes are an integral part of the financial statements.
35
Tower Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS, INDUSTRY SEGMENTS, AND CONCENTRATIONS OF CREDIT
RISK: Tower Financial Corporation (the "Company") was incorporated on
July 8, 1998. The Company's wholly owned banking subsidiary, Tower Bank
& Trust Company (the "Bank"), opened on February 19, 1999 after
receiving federal and state bank regulatory approvals to commence its
banking operations. Until February 19, 1999, the Company was in the
development stage and its activities were limited to the organization
of the Bank as well as the completion of its initial public stock
offering. The Company's wholly-owned special purpose trust subsidiary,
Tower Capital Trust 1 ("TCT1"), was incorporated on November 1, 2001
for the single purpose of issuing trust preferred securities.
On August 29, 2002, the Company completed a rights offering and a
limited public offering of its common stock during which 1,395,232
shares were sold at $10.75 per share. Of the shares sold, 694,199
shares were sold to existing shareholders through the rights offering
and 701,033 shares were sold to new investors through the limited
public offering. Total gross proceeds from the offerings were
$14,998,744 with marketing agent's fees and offering expenses of
$1,342,182. The Company used $7.0 million of the net proceeds from the
offerings to provide additional capitalization to Tower Bank & Trust
Company for future growth.
While the Company's management monitors the revenue streams of the
various Company products and services, operations are managed and
financial performance is evaluated on a company-wide basis.
Accordingly, all of the Company's financial services operations are
considered by management to be aggregated in one reportable segment.
The Company accepts deposits and grants commercial, real estate, and
installment loans to customers primarily in northeastern Indiana.
Substantially all loans are secured by specific items of collateral
including business assets, consumer assets, and real estate. Commercial
loans are expected to be repaid from cash flow from operations of
businesses. Real estate loans are secured by both residential and
commercial real estate. At December 31, 2003, commercial and commercial
real estate loans totaled approximately 79.2% of total loans,
residential real estate loans totaled approximately 10.8% and home
equity and consumer loans totaled approximately 10.0%. Categories by
industry of commercial loans at December 31, 2003 exceeding 30% of
year-end stockholders' equity are as follows: real estate (including
owner-occupied and investment) - $58.2 million, or 15.4% of total
loans; wholesale and retail trade - $48.1 million, or 12.8% of total
loans; building, development and general contracting - $41.6 million,
or 11.0% of total loans; health care and social assistance - $27.3
million, or 7.3% of total loans; manufacturing - $16.6 million, or 4.3%
of total loans; and professional, scientific and technical services -
$13.5 million, or 3.6% of total loans. Other financial instruments that
potentially represent concentrations of credit risk include deposit
accounts in other financial institutions and federal funds sold. The
Company also provides trust services to customers.
PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial
statements include the accounts of the Company and the Bank. As further
discussed in Note 8, a trust that had previously been consolidated with
the Company is now reported separately. All significant intercompany
balances and transactions have been eliminated in consolidation.
USE OF ESTIMATES: To prepare financial statements in conformity with
accounting principles generally accepted in the United States of
America, management makes estimates and assumptions based on available
information. These estimates and assumptions affect the amounts
reported in the financial statements and the disclosures provided;
future results could differ. The allowance for loan losses, impaired
loan disclosures, and the fair values of securities and other financial
instruments are particularly subject to change.
CASH FLOW REPORTING: Cash and cash equivalents include cash on hand,
demand deposits with other financial institutions, short-term
investments and federal funds sold. Cash flows are reported net for
36
customer loan and deposit transactions, interest-earning deposits and
short-term borrowings with maturities of 90 days or less.
SECURITIES: Securities available for sale consist of those securities
which might be sold prior to maturity due to changes in interest rates,
prepayment risks, yield, availability of alternative investments,
liquidity needs and other factors. Securities classified as available
for sale are reported at their fair value and the related unrealized
holding gain or loss is reported as other comprehensive income (loss)
and stockholders' equity, net of tax, until realized. Other securities,
such as Federal Reserve Bank stock and Federal Home Loan Bank stock,
are carried at cost. Premiums and discounts on securities are
recognized as interest income using the interest method over the
estimated life of the security. Gains and losses on the sale of
securities available for sale are determined based upon amortized cost
of the specific security sold. Securities are written down to fair
value when a decline in fair value is not temporary.
LOANS: Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at the
principal balance outstanding, net of unearned interest, deferred loan
fees and costs and an allowance for loan losses. Loans held for sale
are reported at the lower of cost or market, on an aggregate basis.
Interest income is reported on the interest method and includes
amortization of net deferred loan fees and costs over the loan term.
Interest income is not reported when full loan repayment is in doubt,
typically when the loan is impaired or payments are past due over 90
days (180 days for residential mortgages). In all cases, loans are
placed on nonaccrual or charged-off at an earlier date if collection of
principal or interest is considered doubtful. Payments received on such
loans are reported as principal reductions.
All interest accrued but not received for loans placed on nonaccrual
are reversed against income. Interest received on such loans is
accounted for on the cash-basis or cost recovery method, until
qualifying for return to accrual. Loans are returned to accrual status
when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured.
ALLOWANCE FOR LOAN LOSSES: The Company's allowance for loan losses
represents management's estimate of probable losses inherent in the
loan portfolio at the balance sheet date. Additions to the allowance
may result from recording provision for loan losses and recoveries,
while charge offs are deducted from the allowance. Allocation of the
allowance is made for analytical purposes only, and the entire
allowance is available to absorb probable and estimated credit losses
inherent in the loan portfolio.
The Company has an established process for determining the adequacy of
the allowance for loan losses that relies on various procedures and
pieces of information to arrive at a range of probable outcomes. First,
management allocates specific portions of the allowance for loan losses
based on identifiable problem loans. Problem loans are identified
through a loan risk rating system and monitored through watchlist
reporting. Specific reserves are determined for each identified credit
based on delinquency rates, collateral and other risk factors
identified for that credit. Second, management's evaluation of the
allowance for different loan groups is based on consideration of actual
loss experience, the present and prospective financial condition of
borrowers, industry concentrations within the loan portfolio and
general economic conditions, and absent the ability of some of those
factors, based upon peer industry data of comparable banks. Lastly, the
unallocated component of the allowance is maintained to supplement the
allocated component and to recognize the imprecision of estimating and
measuring loss when evaluating loss allocations for individual loans or
pools of loans.
The determination of the level of allowance and, correspondingly, the
provision for loan losses, rests upon estimates and assumptions,
including past loan loss experience, the nature and volume of the
portfolio, information about specific borrower situations and estimated
collateral values, economic conditions and other factors. Loan losses
are charged against the allowance when management believes the
uncollectibility of a loan is confirmed.
A loan is impaired when full payment under the loan terms is not
expected. Large groups of smaller balance homogeneous loans, such as
consumer and residential real estate loans, are collectively evaluated
for impairment, and accordingly, they are not identified for impairment
disclosures. Commercial
37
loans and mortgage loans secured by other properties are evaluated
individually for impairment. When analysis of a borrower's operating
results and financial condition indicates that underlying cash flows of
the borrower's business are not adequate to meet its debt service
requirements, the loan is evaluated for impairment. If a loan is
impaired, a portion of the allowance is allocated so that the loan is
reported, net, at the present value of estimated future cash flows
using the loan's existing interest rate or at the fair value of
collateral if repayment is expected solely from the collateral.
FORECLOSED ASSETS: Assets acquired through or instead of loan
foreclosure are initially recorded at fair value when acquired,
establishing a new cost basis. If fair value declines, a valuation
allowance is recorded through expense. Costs after acquisition are
expensed.
PREMISES AND EQUIPMENT: Land is carried at cost. Premises and equipment
are stated at cost less accumulated depreciation. Depreciation is
computed using both the straight-line method and accelerated methods
over the estimated useful lives of the buildings, leasehold
improvements, furniture and equipment, ranging from three years to 39
years. Maintenance, repairs, and minor alterations are charged to
current operations as expenditures occur and major improvements are
capitalized. These assets are reviewed for impairment when events
indicate the carrying amount may not be recoverable.
BANK OWNED LIFE INSURANCE: The Bank has purchased life insurance
policies for on certain executives. Bank owned life insurance is
recorded at its cash surrender value, or the amount that can be
realized. Bank owned life insurance totaled $3,127,384 and $0, at
December 31, 2003 and 2002 and is included in other assets in the
consolidated balance sheets.
BENEFIT PLANS: Bonus and 401(k) plan expense is the amount contributed
determined by formula. Deferred compensation plan expense and
supplemental employee retirement plan expense is allocated over years
of service.
STOCK COMPENSATION: Employee compensation expense under stock options
is reported using the intrinsic value method. No stock-based
compensation cost is reflected in the net income, as all options had an
exercise price equal to or greater than the market price of the
underlying common stock at date of grant. The following table
illustrates the effect on net income and earnings per share if expense
was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation.
38
2003 2002 2001
----------- ----------- -----------
Net income as reported $ 1,800,066 $ 1,715,629 $ 1,119,955
Deduct: Stock-based compensation expense
determined under fair value-based method (146,607) (126,673) (201,381)
----------- ----------- -----------
Pro forma net income $ 1,653,459 $ 1,588,956 $ 918,574
Basic earnings per share as reported $ 0.46 $ 0.57 $ 0.44
Pro forma basic earnings per share 0.42 0.53 0.36
Diluted earnings per share as reported 0.45 0.56 0.44
Pro forma diluted earnings per share 0.41 0.52 0.36
The pro forma effects are computed using option pricing models, using the
following weighted average assumptions as of grant date.
2003 2002 2001
------- ------- -------
Risk-free interest rate 3.20% 4.81% 4.83%
Expected option life 6 years 8 years 8 years
Expected stock price volatility 25.74% 25.78% 30.85%
Dividend yield None None None
INCOME TAXES: Income taxes expense is the sum of current year income
tax due or refundable and the change in deferred tax assets and
liabilities. Deferred tax assets and liabilities are the expected
future tax consequences of temporary differences between the carrying
amounts and tax bases of assets and liabilities computed using enacted
tax rates. A valuation allowance, if needed, reduces deferred tax
assets to the amount expected to be realized.
DERIVATIVES: All derivative instruments are recorded at their fair
values. If derivative instruments are designated as hedges of fair
values, both the change in fair value of the hedge and the hedged item
are included in current earnings. Fair value adjustments related to
cash flow hedges are recorded in other comprehensive income and
reclassified to earnings when the hedged transaction is reflected in
earnings. Ineffective portions of hedges are reflected in earnings as
they occur. There were no derivatives or hedge activity during the
years 2003 or 2002.
OFF BALANCE SHEET FINANCIAL INSTRUMENTS: Financial instruments include
off-balance sheet credit instruments, such as commitments to make loans
and standby letters of credit, issued to meet customer financial needs.
The face amount for these items represents the exposure to loss, before
considering customer collateral or ability to repay. Such financial
instruments are recorded when they are funded.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial
instruments are estimated using relevant market information and other
assumptions. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments
and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of
existing on- and off-balance-sheet financial instruments do not include
the value of anticipated future business or the value of assets and
liabilities not considered financial instruments.
DIVIDEND RESTRICTION: Banking regulations require maintaining certain
capital levels and may limit the dividends paid by the Bank to the
Company or by the Company to its shareholders. The Company does not
anticipate paying any cash dividends on its common stock in the
foreseeable future.
39
EARNINGS PER COMMON SHARE: Basic earnings per common share is net
income divided by the weighted average number of common shares
outstanding during the period. Diluted earnings per common share
includes the dilutive impact of any additional potential common shares
issuable under stock options.
COMPREHENSIVE INCOME: Comprehensive income consists of net income and
other comprehensive income (loss). Other comprehensive income (loss)
includes the net change in net unrealized appreciation (depreciation)
on securities available for sale, net of reclassification adjustments
and tax, which is also recognized as a separate component of
stockholders' equity.
LOSS CONTINGENCIES: Loss contingencies, including claims and legal
actions arising in the ordinary course of business, are recorded as
liabilities when the likelihood of loss is probable and an amount or
range of loss can be reasonably estimated. Management does not believe
there now are such matters that will have a material effect on the
consolidated financial statements.
RESTRICTIONS ON CASH: Cash on hand or on deposit with the Federal
Reserve Bank of $4.0 million and $1.8 million was required to meet
regulatory reserve and clearing requirements at December 31, 2003 and
2002, respectively. These balances do not earn interest.
ADOPTION OF NEW ACCOUNTING STANDARDS: During 2003, the Company adopted
FASB Statement 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities, FASB Statement 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equities, FASB Statement 132, (revised 2003), Employers' Disclosure
about Pensions and Other Postretirement Benefits, FASB Interpretation
45, Guarantors' Accounting and Disclosure Requirements for Guarantees,
and FASB Interpretation 46, Consolidation of Variable Interest Entries.
Adoption of the new standards did not materially affect the Company.
EFFECT OF NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS:
There are no newly issued but not yet effective Accounting Standards,
that would materially effect the Company's financial position or
results of operations.
RECLASSIFICATIONS: Certain items from the prior period financial
statements were reclassified to conform to the current presentation.
40
Note 2 - SECURITIES AVAILABLE FOR SALE
The fair value of securities available for sale at December 31, 2002 were
as follows: 2003
2003
----------------------------------------------------
CARRYING GROSS UNREALIZED GROSS UNREALIZED
VALUE GAINS LOSSES
------------ ---------------- ----------------
U.S. Government agency debt obligations $ 9,052,024 $ 49,645 $ (30,815)
Obligations of states and political
subdivisions 7,853,724 56,408 $ (31,452)
Mortgage-backed securities 7,419,187 12,270 (14,204)
------------ ---------- -----------
TOTAL INVESTMENT SECURITIES $ 24,324,935 $ 118,323 $ (76,471)
============ ========== ===========
2002
----------------------------------------------------
CARRYING GROSS UNREALIZED GROSS UNREALIZED
VALUE GAINS LOSSES
------------ ---------------- ----------------
U.S. Government agency debt obligations $ 6,214,830 $ 208,897 $
Obligations of states and political
subdivisions 1,942,595 73,222
Mortgage-backed securities 3,013,145 90,202
------------ ----------- ------------
TOTAL INVESTMENT SECURITIES $ 11,170,570 $ 372,321 $
============ =========== ============
The fair values of debt securities available for sale at December 31, 2003, by
contractual maturity are shown below. Securities not due at a single date,
primarily mortgage-backed securities, are shown separately. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without penalties.
41
Note 2 - SECURITIES AVAILABLE FOR SALE (CONTINUED)
WEIGHTED
AVERAGE CARRYING
YIELD (1) VALUE
--------- -----------
AGENCIES:
Due in one year or less % $
Due after one to five years 3.49% 5,013,815
Due after five years 3.13% 4,038,209
---- -----------
Total Agencies 3.33% $ 9,052,024
---- -----------
MORTGAGE-BACKED SECURITIES:
Mortgage-backed securities 3.87% $ 7,419,187
---- -----------
OBLIGATIONS OF STATE AND POLITICAL SUBDIVISIONS:
Due in one year or less 5.17% $ 632,935
Due after one to five years 5.70% 1,175,579
Due after five years 6.48% 6,045,210
---- -----------
Total Obligations of state and political subdivisions 6.26% $ 7,853,724
---- -----------
(1) Computed on a tax-equivalent basis for tax-exempt securities using a 34%
statutory tax rate
Proceeds from the sale of securities available for sale during 2003 totaled
$3,174,780. Gross gains and losses realized were $190,766 and $0. Proceeds from
the sale of securities available for sale during 2002 totaled $3,176,070. Gross
gains and losses realized were $180,351 and $0. There were no sales of
securities during 2001.
Securities with an amortized cost of $12,450,015 and $3,100,000 were pledged to
secure borrowings from the FHLB at December 31, 2003 and 2002, respectively. At
December 31, 2003, there were no holdings of any one issue, other than the U.S.
Government and its agencies and corporations, in an amount greater than 10% of
stockholders' equity.
Securities with unrealized losses at year end 2003 not recognized in income
are as follows:
CONTINUING UNREALIZED CONTINUING UNREALIZED
LOSSES FOR LOSSES FOR
LESS THAN 12 MONTHS MORE THAN 12 MONTHS TOTAL
-------------------------------------------------------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
----------- ---------- -------- ---------- ----------- ----------
U.S. Government agency debt obligations $ 3,017,775 $ (30,815) $ $ $ 3,017,775 $ (30,815)
Obligations of states and political
subdivisions 2,323,975 (31,452) 2,323,975 (31,452)
Mortgage-backed securities 2,706,318 (14,204) 2,706,318 (14,204)
----------- --------- -------- ---------- ----------- ---------
Total temporarily impaired $ 8,048,068 $ (76,471) $ $ $ 8,048,068 $ (76,471)
=========== ========= ======== ========== =========== =========
Unrealized losses on U. S. government agencies, state and municipality bonds
have not been recognized into income because the issuers' bonds are of high
credit quality, management has the intent and ability to hold for the
foreseeable future, and the decline in fair value is largely due to increased
market interest rates. The fair value is expected to recover as the bonds
approach their maturity and/or as market rates decline.
42
Note 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans at December 31, 2003 and 2002 were as follows:
2003 2002
---------------------- -----------------------
BALANCE % BALANCE %
------------- ------ ------------- ------
Commercial $ 198,063,494 52.6% $ 185,249,123 57.7%
Commercial real estate 100,309,154 26.6% 76,546,922 23.8%
Residential real estate 40,648,402 10.8% 26,097,307 8.1%
Home equity 25,943,402 6.9% 20,042,459 6.3%
Consumer 11,593,808 3.1% 13,290,091 4.1%
------------- ----- ------------- -----
Total loans 376,558,260 100.0% 321,225,902 100.0%
Net deferred loan costs 280,318 114,044
Allowance for loan losses (5,259,273) (4,745,672)
------------- -------------
NET LOANS $ 371,579,305 $ 316,594,274
============= =============
Activity in the allowance for loan losses during 2003, 2002, 2001, 2000 and 1999
was as follows:
2003 2002 2001 2000 1999
------------ ----------- ------------ ----------- -----------
Beginning balance, January 1 $ 4,745,672 $ 3,480,205 $ 2,364,509 $ 1,009,509 $
Provision charged to operating
expense 2,185,000 1,765,000 1,120,000 1,355,000 1,010,000
Charge-offs:
Commercial (940,306) (479,375) (4,304)
Commercial real estate (54,442) (579)
Residential real estate (489,326)
Home equity (97,600) (22,284)
Consumer (123,379) (1,834) (491)
------------ ----------- ------------ ----------- -----------
Total Charge-offs (1,705,053) (504,072) (4,304) (491)
------------ ----------- ------------ ----------- -----------
Recoveries:
Commercial 2,417
Commercial real estate 579 472
Residential real estate 11,000
Home equity 866 4,067
Consumer 18,792
------------ ----------- ------------ ----------- -----------
Total Recoveries 33,654 4,539
------------ ----------- ------------ ----------- -----------
Total Net Charge-offs (1,671,399) (499,533) (4,304) (491)
------------ ----------- ------------ ----------- -----------
ENDING BALANCE, DECEMBER 31 $ 5,259,273 $ 4,745,672 $ 3,480,205 $ 2,364,509 $ 1,009,509
============ =========== ============ =========== ===========
43
Note 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
Impaired loans were as follows:
at December 31,
------------------------------------
2003 2002 2001
----------- --------- ---------
Year-end loans with no allocated allowance
for loan losses $ 154,499 $ $
Year-end loans with allocated allowance
for loan losses 2,001,005 632,137 468,863
----------- --------- ---------
TOTAL IMPAIRED LOANS $ 2,155,504 $ 632,137 $ 468,863
=========== ========= =========
Amount of the allowance for loan losses allocated $ 807,000 $ 181,100 $ 234,432
Average of impaired loans during the year $ 1,732,787 $ 727,286 $ 720,754
Information regarding interest income recognized during impairment and
cash-basis interest is not considered significant to this presentation.
Nonperforming assets were as follows:
at December 31,
---------------------------------------------------
2003 2002 2001 2000 1999
----------- --------- --------- ---- ----
Loans past due over 90 days
still accruing $ 290,375 $ 87,304 $ 347,233 $ $
Nonaccrual loans 1,614,447 632,137 468,863
----------- --------- --------- ---- ----
Total nonperforming loans $ 1,904,822 $ 719,441 $ 816,096 $ $
----------- --------- --------- ---- ----
Other real estate owned 80,000
----------- --------- --------- ---- ----
TOTAL NONPERFORMING ASSETS $ 1,984,822 $ 719,441 $ 816,096 $ $
=========== ========= ========= ==== ====
Nonperforming loans and impaired loans are defined differently. Some
loans may be included in both categories, whereas other loans may only be
included in one category. There was one troubled debt restructuring at
December 31, 2003 for $253,131, included in impaired loans. There were no
troubled debt restructurings at December 31, 2002, or 2001. There was one
other real estate owned property at December 31, 2003 for $80,000. There
was no other real estate owned property at year end in prior years.
44
Note 4 - PREMISES AND EQUIPMENT, NET
Premises and equipment and December 31, 2003 and 2002 were as follows:
2003 2002
------------- ------------
Land $ 350,179 $ 350,179
Buildings 200,442 200,442
Leasehold improvements 749,707 760,997
Furniture and equipment 3,096,747 2,374,248
------------- ------------
Subtotal 4,397,075 3,685,866
Accumulated depreciation (1,464,495) (1,060,264)
------------- ------------
PREMISES AND EQUIPMENT, NET $ 2,932,580 $ 2,625,602
============= ============
Information regarding lease commitments and commitments to purchase
fixed assets is provided in Note 12.
Note 5 - DEPOSITS
Deposits at December 31, 2003 and 2002 are summarized as follows:
2003 2002
---------------------- -----------------------
BALANCE % BALANCE %
------------- ------ ------------- ------
Noninterest-bearing demand $ 62,638,230 17.3% $ 42,966,347 13.8%
Interest-bearing checking 23,543,523 6.5% 21,582,021 7.0%
Money market 98,250,351 27.1% 99,104,831 31.9%
Savings 10,575,908 2.9% 8,342,455 2.7%
Time, under $100,000 63,028,461 17.4% 54,803,014 17.6%
Time, $100,000 and over 104,840,295 28.8% 83,785,319 27.0%
------------- ----- ------------- -----
TOTAL DEPOSITS $ 362,876,768 100.0% $ 310,583,987 100.0%
============= ===== ============= =====
The following table shows the maturity distribution for certificates of
deposit at December 31, 2003.
UNDER $100,000
$100,000 AND OVER TOTAL
------------ ------------- -------------
2004 $ 45,589,565 $ 94,585,760 $ 140,175,325
2005 10,686,031 7,716,487 18,402,518
2006 1,364,930 429,987 1,794,917
2007 4,087,403 1,800,314 5,887,717
2008 1,300,532 307,747 1,608,279
------------ ------------- -------------
TOTAL $ 63,028,461 $ 104,840,295 $ 167,868,756
============ ============= =============
Deposits accepted from brokers totaled $25.2 million and $0 at December 31, 2003
and 2002, respectively.
45
Note 6 - SHORT-TERM BORROWINGS
Information relating to short-term borrowings, comprised of federal
funds purchased at December 31, 2003 and 2002 is summarized below:
2003 2002
----------- -----------
Outstanding balance at year-end $ 1,060,000 $ 1,060,000
Interest rate at year-end 0.69% 0.94%
Average balance during the year $ 1,257,260 $ 1,383,000
Average interest rate during the year 1.03% 1.59%
Maximum month-end balance during the year $ 1,060,000 $ 1,060,000
At December 31, 2003 and 2002, the Bank had $27,000,000 and
$21,115,000, respectively, in lines of credit available from
correspondent banks to purchase federal funds.
Note 7 - FEDERAL HOME LOAN BANK ADVANCES
At December 31, 2003 and 2002, advances from the Federal Home Loan Bank
("FHLB") were:
2003 2002
------------ ------------
4.09% callable advance, quarterly call option beginning
March 22, 2002, principal due at maturity March 22, 2011 $ 2,500,000 $ 2,500,000
2.99% callable advance, quarterly call option beginning
March 12, 2002, principal due at maturity September 12, 2011 4,000,000 4,000,000
1.31% variable rate advance, principal due at maturity June 28, 2004 2,000,000
2.35% bullet advance, principal due at maturity March 17, 2003 2,500,000
2.55% bullet advance, principal due at maturity June 18, 2003 3,500,000
1.71% bullet advance, principal due at maturity September 12, 2003 5,000,000
1.40% bullet advance, principal due at maturity March 10, 2004 5,000,000
1.36% bullet advance, principal due at maturity June 18, 2004 3,500,000
2.07% bullet advance, principal due at maturity June 29, 2005 3,000,000
2.37% bullet advance, principal due at maturity December 29, 2005 3,000,000
3.42% bullet advance, principal due at maturity June 18, 2004 2,500,000 2,500,000
4.03% bullet advance, principal due at maturity June 20, 2005 1,500,000 1,500,000
------------ ------------
TOTAL FEDERAL HOME LOAN BANK ADVANCES $ 27,000,000 $ 21,500,000
============ ============
Of the total FHLB borrowings at December 31, 2003 and 2002, two
advances totaling $6,500,000 had callable options on a quarterly basis.
The call options for each of these advances, which initiated during
March of 2002, can be executed on a quarterly basis with at least four
days notice. These advances have not been called to-date by the FHLB as
current interest rates deem the advances more favorable to hold. It is
anticipated that the FHLB will call these advances at the appropriate
time if and when interest rates rise.
46
At December 31, 2003 scheduled principal reductions on these FHLB
advances were as follows:
YEAR ADVANCES
- ---------- ------------
2004 $ 13,000,000
2005 7,500,000
2006
2007
2008
Thereafter 6,500,000
------------
TOTAL $ 27,000,000
============
At December 31, 2003, in addition to FHLB stock, the Company pledged
securities with the FHLB totaling $12.7 million. In addition, as of
December 31, 2003, the Company pledged loans totaling approximately
$106.8 million under a blanket collateral agreement to secure advances
outstanding. Also, the Company had unpledged interest-bearing deposits
with the FHLB at December 31, 2003 totaling $4.0 million.
Note 8 - JUNIOR SUBORDINATED DEBENTURES AND TRUST PREFERRED SECURITIES
On November 16, 2001, TCT1 closed a private placement offering of 3,500
of 9.00% fixed rate Trust Preferred Securities with a par value of
$1,000. The proceeds of the offering and the initial equity investment
were loaned to the Company in exchange for junior subordinated
debentures of $3,608,000 with similar terms to the Trust Preferred
Securities. The sole assets of TCT1 are the junior subordinated
debentures of the Company and payments there under as well as certain
unamortized issuance costs. The junior subordinated debentures are
subject to mandatory redemption, in whole or in part, upon repayment of
the Trust Preferred Securities at maturity or their earlier redemption
at the par amount. The maturity date of the Trust Preferred Securities
is November 15, 2031. Subject to the Company having received prior
approval of the Federal Reserve Bank, if then required, the Trust
Preferred Securities are redeemable prior to the maturity date
beginning November 15, 2006 and each year thereafter at the option of
the Company. The Company has the option to defer interest payments on
the Trust Preferred Securities from time to time for a period not to
exceed 40 consecutive quarterly periods.
Prior to 2003, the trust was consolidated in the Company's financial
statements, with the Trust Preferred Securities issued by the trust
reported in liabilities as Trust Preferred Securities and the
subordinated debentures eliminated in consolidation. Under new
accounting guidance, FASB Interpretation No. 46, as revised in December
2003, the trust is no longer consolidated with the Company.
Accordingly, the Company does not report the securities issued by the
trust as liabilities, and instead reports as liabilities the
subordinated debentures issued by the Company and held by the trust, as
these are no longer eliminated in consolidation. Amounts previously
reported as Trust Preferred Securities in liabilities have been
recaptioned "junior subordinated debt" and continue to be presented in
liabilities on the balance sheet. The effect of no longer consolidating
the trust does not significantly change the amounts reported as the
Company's assets, liabilities, equity, or interest expense.
47
Note 9 - INCOME TAXES
The consolidated provision for income taxes for the following years
ended December 31 are as follows:
2003 2002 2001
----------- ----------- -----------
Federal - current $ 596,296 $ 1,270,967 $ 871,666
- deferred 231,874 (348,598) (269,975)
State - current 177,355 301,062 214,670
- deferred 63,525 (115,931) (79,961)
----------- ----------- -----------
TOTAL INCOME TAXES EXPENSE $ 1,069,050 $ 1,107,500 $ 736,400
=========== =========== ===========
The effective tax rate differs from the statutory tax rate applicable
to corporations as a result of permanent and other differences between
accounting and taxable income as shown below:
2003 2002 2001
---- ---- ----
Statutory tax rate 34.0% 34.0% 34.0%
State tax, net of federal income tax effect 5.5% 4.3% 5.6%
Tax exempt interest (1.4)% (0.7)% (0.3)%
Earnings on life insurance (1.5)%
Other 0.7% 1.6% 0.4%
---- ---- ----
EFFECTIVE TAX RATE 37.3% 39.2% 39.7%
==== ==== ====
The net deferred tax asset included the following amounts of deferred
tax assets and liabilities at December 31, 2003 and 2002:
2003 2002
----------- -----------
DEFERRED TAX ASSETS:
Provision for loan losses $ 1,761,583 $ 1,782,976
Start-up / pre-opening expenses 4,930 64,583
Accrued expenses
Deferred compensation 39,843 39,060
Net unrealized depreciation on securities
available for sale
Other 63,653 20,988
----------- -----------
Total deferred tax assets 1,870,009 1,907,607
----------- -----------
DEFERRED TAX LIABILITIES:
Depreciation (263,865) (137,581)
Prepaid expenses (67,395)
Net deferred loan costs (108,679) (44,557)
Net unrealized appreciation on securities
available for sale (20,666) (148,928)
----------- -----------
Total deferred tax liabilities (460,605) (331,066)
----------- -----------
Net deferred tax asset before asset valuation 1,409,404 1,576,541
Valuation allowance for deferred tax assets
----------- -----------
NET DEFERRED TAX ASSET $ 1,409,404 $ 1,576,541
=========== ===========
48
Note 10 - STOCK OPTION PLANS
Options to buy stock are granted to directors, officers and employees
under the 1998 and 2001 Stock Option and Incentive Plans (the "Plans"),
which together provide for issuance of up to 435,000 shares of common
stock of the Company. The exercise price of stock options granted under
the Plans may not be less than the market price at the date of grant.
The maximum option term is ten years. Option vesting occurs over
various periods of time ranging from immediate to four years. A summary
of options granted pursuant to the Plans is as follows:
2003 2002 2001
------------------- -------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- -------- --------
Beginning balance, January 1 374,438 $ 10.35 337,400 $ 9.96 307,650 $ 9.94
Granted 44,250 13.37 44,000 13.32 36,780 10.06
Exercised (11,335) 10.27 (5,952) 10.00
Forfeited (7,000) 11.03 (1,010) 10.19 (7,030) 9.26
--------- --------- --------
ENDING BALANCE, DECEMBER 31 400,353 10.68 374,438 10.35 337,400 9.96
========= ========= ========
Options exercisable at year-end 306,901 10.06 287,388 9.97 229,748 9.98
Weighted average fair value of
options granted during year $ 4.32 $ 5.73 $ 4.72
Options outstanding at December 31, 2003 were as follows:
OUTSTANDING EXERCISABLE
------------------------------------- -----------------
WEIGHTED
AVERAGE
WEIGHTED YEARS OF WEIGHTED
RANGE OF AVERAGE REMAINING AVERAGE
EXERCISE # OF EXERCISE CONTRACTUAL # OF EXERCISE
PRICES OPTIONS PRICE LIFE OPTIONS PRICE
- --------------- ------- -------- ----------- ------- --------
$7.00 - $7.99 500 $ 7.63 6.97 375 $ 7.63
$8.00 - $8.99 3,250 8.32 6.88 2,063 8.31
$9.00 - $9.99 24,880 9.09 6.18 21,440 9.07
$10.00 - $10.99 288,723 10.05 5.30 273,273 10.03
$12.00 - $12.99 750 12.14 8.74
$13.00 - $13.99 82,250 13.45 8.69 9,750 13.55
------- -------
TOTALS 400,353 10.68 6.07 306,901 10.06
======= =======
Note 11 - RELATED PARTY TRANSACTIONS
Certain directors and executive officers of the Company, including
their immediate families and companies in which they are principal
owners, are loan customers of the Bank. At December 31, 2003 and 2002,
the Bank had $23,260,123 and $20,991,948, respectively in loan
commitments to directors and executive officers, of which $17,617,429
and $16,608,693 were funded at the respective year-ends, as reflected
in the following table.
49
LOANS TO DIRECTORS AND EXECUTIVE OFFICERS
2003 2002
------------- -------------
Beginning balance, January 1 $ 16,608,693 $ 12,508,112
New loans 10,418,320 14,596,638
Repayments (8,112,787) (10,614,197)
Other Changes (1,296,797) 118,140
------------- -------------
ENDING BALANCE, DECEMBER 31 $ 17,617,429 $ 16,608,693
============= =============
Other changes include adjustments for loans applicable to one reporting
period that are excludable from the other reporting period.
During 2003, 2002 and 2001, the Company and the Bank engaged in
transactions with entities controlled by their respective directors or
their affiliates. The Bank leases its headquarters facility from
Tippmann Properties, Inc. agent for John V. Tippmann, Sr. The original
lease was a 10-year lease commencing on January 1, 1999. During 2001,
the original lease term was extended to 15 years with provisions for
one renewal term of 10 years at then prevailing market rates. The total
amount paid to Tippmann Properties by the Company and the Bank for rent
and maintenance was $415,824, $348,130 and $251,866 during 2003, 2002
and 2001, respectively. The lease is accounted for as an operating
lease. Refer to Note 12 for a summary of future lease payment
commitments under this and other leases.
Note 12 - COMMITMENTS AND OFF-BALANCE-SHEET RISK
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT: The Bank
maintains off-balance-sheet investments in the normal course of
business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of
credit. Loan commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established
in the contract. Standby letters of credit are conditional commitments
issued by the Bank to guarantee the performance of a customer to a
third party. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash
requirements.
The instruments involve, to varying degrees, elements of credit risk in
excess of the amount recognized, if any, in the balance sheet. The
Bank's maximum exposure to loan loss in the event of nonperformance by
the other party to the financial instruments for commitments to extend
credit and standby letters of credit is represented by the face amount
of these instruments. Commitments to extend credit are recorded when
they are funded and stand by letters of credit are carried at fair
value.
The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.
Collateral, such as accounts receivable, securities, inventory,
property and equipment, is generally obtained based on management's
credit assessment of the borrower.
Fair value of the Bank's off-balance-sheet instruments (commitments to
extend credit and standby letters of credit) is based on rates
currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements and the counterparties' credit
standing. At December 31, 2003 and 2002, the rates on existing
off-balance-sheet instruments were equivalent to current market rates,
considering the underlying credit standing of the counterparties.
The Bank's maximum exposure to credit losses for loan commitments and
standby letters of credit outstanding at December 31, 2003 and 2002 was
as follows:
2003 2002
------------- ------------
Commitments to extend credit $ 82,749,343 $ 69,719,185
Standby letters of credit 2,347,361 1,959,004
------------- ------------
TOTAL $ 85,096,704 $ 71,678,189
============= ============
50
Management does not anticipate any significant losses as a result of
these commitments.
LEASE AND OTHER CONTRACTED COMMITMENTS: The Company and the Bank occupy
their respective headquarters, offices and other facilities under
long-term operating leases and, in addition, are parties to long-term
contracts for data processing and operating systems. The future minimum
annual commitments under all operating leases as of December 31, 2003
are as follows:
YEAR LEASE COMMITMENTS
- ---------- -----------------
2004 $ 644,251
2005 590,019
2006 564,887
2007 607,455
2008 607,455
Thereafter 2,895,872
-----------
TOTAL $ 5,909,939
===========
The lease expense paid for operating leases for the facilities leased
were $489,976, $417,316 and $306,532 for 2003, 2002 and 2001,
respectively.
EMPLOYMENT CONTRACTS: Under the terms of certain employment contracts,
upon the occurrence of certain events resulting in the severance of
certain executive officers' employment with the Company, payments may
be required to be made in excess of amounts that have been accrued.
OTHER: Other expense was $1,172,067 for 2003, $1,086,490 for 2002 and
$434,182 for 2001. Other expense for both 2003 and 2002 included losses
recorded for unauthorized mortgage activity in the amount of $365,000
and $428,500, respectively.
The Company during 2003 made a $100,000 investment in a statewide
economic development venture capital limited partnership, which was
recorded in other assets, $50,000 of this has been committed but not
yet funded.
Note 13 - BENEFIT PLANS
BONUS PLAN: The Company maintains a bonus plan covering substantially
all officers. Payments to be made under the bonus plan are determined
by a formula approved by the Board of Directors and are based on the
results of the operations of the Company and on individual performance.
As of December 31, 2003 and 2002, management had accrued a liability
for this plan of approximately $180,000 and $406,000, respectively,
which is included in other liabilities in the consolidated balance
sheets.
401(k) PLAN: The Company established a 401(k) plan effective March 1,
1999 covering substantially all of its employees. The plan allows
employees to contribute up to 15% of their compensation. The Company
may match a portion of the employees' contributions and provides
investment choices for the employees, including investment in common
stock of the Company. Matching contributions are vested equally over a
six-year period. Company matching contributions to the 401(k) plan are
determined annually by management and approved by the Board of
Directors. The Board of Directors approved annually an employer
contribution for the 2003, 2002 and 2001 plan year matching 50% of the
first 6% of the compensation contributed. This contribution was also
approved for 2004. The total contribution made by the Company during
2003, 2002 and 2001 was approximately $102,000, $83,000 and $58,000,
respectively.
DEFERRED COMPENSATION PLAN: Effective January 1, 2002, a deferred
compensation plan covers certain officers. Under the plan, the Company
pays each participant, or their beneficiary, the amount of compensation
deferred by the employee or contributed by the employer on a
discretionary basis, plus
51
interest, beginning with the individual's termination of service.
Payments are to be made either immediately or over a five-year period,
depending upon the amount to be paid. A liability is accrued for the
obligation under this plan and is reported in other liabilities in the
consolidated balance sheets. The expense incurred for the deferred
compensation plan in 2003, 2002 and 2001 was approximately $(1,000),
$22,000 and $10,000 respectively, resulting in a deferred compensation
liability of approximately $31,000 and $32,000 as of December 31, 2003
and 2002.
DEFERRED DIRECTORS' FEES PLAN: Effective January 1, 2002, a deferred
directors' fee plan covers all non-employee directors of the Company
for a period of 10 years. Under the plan, the Company pays each
participant, or their beneficiary, the amount of directors' fees
deferred plus interest, beginning with the director's termination of
service. Payments are to be made either immediately or over a five-year
period. A liability is accrued for the obligation under this plan and
is reported in other liabilities in the consolidated balance sheets.
The expense incurred for the deferred directors' fee plan for 2003 and
2002 was approximately $66,000 and $45,000 resulting in a deferred
compensation liability of approximately $103,000 and $45,000 as of
December 31, 2003 and 2002 respectively.
SUPPLEMENTAL EMPLOYMENT RETIREMENT PLAN: Effective January 1, 2002, a
supplemental employee retirement plan covers one officer. The Company
is recording an expense equal to the projected present value of the
payments due at retirement based on the projected remaining years of
service. The obligation under the plans was approximately $139,000 and
$67,000 at December 31, 2003 and 2002 respectively, and is included in
other liabilities in the consolidated balance sheet. The expense
attributable to the plan is included in salaries and other employee
benefits, was approximately $72,000 in 2003 and $67,000 in 2002.
Note 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following schedule reflects the carrying values and estimated fair
values of the Company's financial instruments at December 31, 2003 and
2002. Items which are not financial instruments are not shown.
2003 2002
--------------------------- ----------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
------------ ------------- ------------ --------------
FINANCIAL ASSETS:
Cash and cash equivalents $ 27,842,215 $ 27,842,215 $ 36,168,679 $ 36,168,679
Securities available for sale 24,324,935 24,324,935 11,170,570 11,170,570
FHLBI and FRB stock 2,332,500 2,332,500 2,057,500 2,057,500
Loans held for sale 5,769,700 5,769,700
Loans, net 371,579,305 371,671,000 316,594,274 317,387,388
Accrued interest receivable 1,289,370 1,289,370 1,092,806 1,092,806
FINANCIAL LIABILITIES:
Deposits (362,876,768) (363,387,000) (310,583,987) (311,856,599)
Short-term borrowings (1,060,000) (1,060,000) (1,060,000) (1,060,000)
FHLB advances (27,000,000) (27,333,000) (21,500,000) (21,598,574)
Junior subordinated debt (3,608,000) (4,030,000) (3,608,000) (3,851,639)
Accrued interest payable (278,964) (278,964) (272,303) (272,303)
Estimated fair value for securities available for sale is based on
quoted market values for the individual securities or for equivalent
securities. Estimated fair value for loans is based on the rates
charged at year-end for new loans with similar maturities, applied
until the loan is assumed to reprice or be paid and the allowance for
loan losses is considered to be a reasonable estimate of discount for
credit quality concerns. Estimated fair value for IRAs, CDs, short-term
borrowings, fixed rate advances from the FHLB and the junior
subordinated debt is based on the rates at year-end for new deposits or
borrowings, applied until
52
maturity. Estimated fair value for other financial instruments and
off-balance-sheet loan commitments is considered to approximate
carrying value.
Note 15 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
Banks and bank holding companies are subject to regulatory capital
requirements administered by federal banking agencies. Capital adequacy
guidelines and, additionally for banks, prompt corrective action
regulations involve quantitative measures of assets, liabilities and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators. Failure to meet various capital
requirements can initiate regulatory action that could have a direct
material effect on the financial statements.
Prompt corrective action regulations provide five classifications: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms
are not used to represent overall financial condition. If only
adequately capitalized, regulatory approval is required to accept
brokered deposits. If undercapitalized, capital distributions are
limited, as is asset growth and expansion, and capital restoration
plans are required.
Management believes, as of December 31, 2003 and 2002, that the Company
and the Bank had met all capital adequacy requirements to which they
are subject.
As of December 31, 2003, the most recent notification from the Federal
Reserve Bank of Chicago and the Indiana Department of Financial
Institutions categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as
well capitalized, the Bank must maintain minimum total risk-based, Tier
1 risk-based, and Tier 1 leverage ratios as set forth in the following
table. There have been no conditions or events since that notification
which management believes have changed the Bank's category.
Actual and required capital amounts and ratios are presented in the
schedule below as of December 31, 2003 and 2002:
TOTAL TIER 1 TIER 1
RISK-BASED RISK-BASED LEVERAGE
2003 CAPITAL CAPITAL CAPITAL
- --------------------------------------------- ------------ ------------ ------------
Minimum capital adequacy ratio 8.00% 4.00% 4.00%
Percent to be well capitalized 10.00% 6.00% 5.00%
Actual % - December 31, 2003
Company 12.66% 11.44% 10.26%
Bank 10.93% 9.68% 8.68%
AT DECEMBER 31, 2003:
Required capital for minimum capital adequacy
Company $ 31,050,002 $ 15,525,001 $ 17,307,508
Bank 31,076,093 15,538,046 17,324,490
Required capital to be well capitalized
Company 38,812,502 23,287,501 21,634,385
Bank 38,845,116 23,307,069 21,655,613
Actual capital
Company 49,132,134 44,383,538 44,383,538
Bank 42,466,652 37,606,029 37,606,029
53
TOTAL TIER 1 TIER 1
RISK-BASED RISK-BASED LEVERAGE
2002 CAPITAL CAPITAL CAPITAL
- --------------------------------------------- ------------ ------------ -----------
Minimum capital adequacy ratio 8.00% 4.00% 4.00%
Percent to be well capitalized 10.00% 6.00% 5.00%
Actual % - December 31, 2002
Company 13.86% 12.61% 11.75%
Bank 11.77% 10.52% 9.80%
AT DECEMBER 31, 2002:
Required capital for minimum capital adequacy
Company $27,021,401 $13,510,700 $14,455,435
Bank 27,046,139 13,523,070 14,468,766
Required capital to be well capitalized
Company 33,776,751 20,266,051 18,069,293
Bank 33,807,674 20,284,604 18,085,958
Actual capital
Company 46,680,028 42,451,470 42,451,470
Bank 39,687,168 35,454,793 35,454,793
Note 16 - EARNINGS PER SHARE
The following table reflects the calculation of basic and diluted
earnings per common share for the years ended December 31, 2003, 2002
and 2001. Options for 0 and 40,000 shares of common stock were not
included in the computation of diluted earnings per share for the
years 2003 and 2002, respectively, because they were not dilutive.
2003 2002 2001
---------- ---------- ----------
BASIC
Net income $1,800,066 $1,715,629 $1,119,955
---------- ---------- ----------
Weighted average common shares outstanding 3,933,339 3,008,145 2,530,000
---------- ---------- ----------
Basic earnings per common share $ 0.46 $ 0.57 $ 0.44
DILUTED
Net income $1,800,066 $1,715,629 $1,119,955
---------- ---------- ----------
Weighted average common shares outstanding 3,933,339 3,008,145 2,530,000
Add: dilutive effect of assumed stock option exercises 73,697 61,503 1,818
---------- ---------- ----------
Weighted average common shares and dilutive
potential common shares outstanding 4,007,036 3,069,648 2,531,818
---------- ---------- ----------
Diluted earnings per common share $ 0.45 $ 0.56 $ 0.44
54
Note 17 - PARENT COMPANY-ONLY CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company (the Company's) financial
statements as of December 31, 2003 and 2002 and for the years ended
December 31, 2003, 2002, 2001:
CONDENSED BALANCE SHEETS
2003 2002
----------- -----------
ASSETS
Cash and cash equivalents $ 7,212,620 $ 7,307,089
Investment in Tower Bank & Trust
Company 37,631,140 35,678,186
Investment in the Tower Capital Trust 1 173,397 108,000
Other assets 6,772 67,782
----------- -----------
Total assets $45,023,929 $43,161,057
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 507,280 $ 378,194
Junior subordinated debt 3,608,000 3,608,000
Stockholders' equity 40,908,649 39,174,863
----------- -----------
Total liabilities and stockholders' equity $45,023,929 $43,161,057
=========== ===========
CONDENSED STATEMENTS OF OPERATIONS
2003 2002 2001
----------- ----------- ------------
INCOME
Interest income $ $ $ 58,689
Dividend income from Tower
Capital Trust I 9,720 9,720
----------- ----------- -----------
Total income 9,720 9,720 58,689
EXPENSE
Interest expense 327,060 327,353 40,590
Professional fees 154,974 97,531 169,657
Other expense 108,776 32,659 7,985
----------- ----------- -----------
Total expense 590,810 457,543 218,232
LOSS BEFORE INCOME TAXES
BENEFIT AND EQUITY IN UNDISTRIBUTED
NET INCOME OF SUBSIDIARIES (581,090) (447,823) (159,543)
Income taxes benefit (229,920) (179,100) (63,600)
Equity in undistributed net
income of Tower Bank
& Trust Company 2,151,236 1,984,352 1,215,898
----------- ----------- -----------
NET INCOME $ 1,800,066 $ 1,715,629 $ 1,119,955
=========== =========== ===========
COMPREHENSIVE INCOME $ 1,601,784 $ 1,948,602 $ 1,109,846
=========== =========== ===========
55
CONDENSED STATEMENTS OF CASH FLOWS
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities
Net income $ 1,800,066 $ 1,715,629 $ 1,119,955
Adjustments to reconcile net income to net cash
from operating activities:
Equity in undistributed income of subsidiary (2,151,236) (1,984,352) (1,215,898)
Change in other assets (4,387) 1,993 (69,775)
Change in other liabilities 129,086 205,234 106,427
------------ ------------ ------------
Net cash from operating activities (226,471) (61,496) (59,291)
Cash flows from investing activities
Capital investment into Tower Bank & Trust Company (7,000,000) (6,750,000)
Capital investment into Tower Capital Trust 1 (108,000)
------------ ------------ ------------
Net cash from investing activities (7,000,000) (6,858,000)
Cash flows from financing activities
Gross proceeds from issuance of common stock
from exercise of stock options and tax benefit 132,002 64,360
Gross proceeds from issuance of common stock
from stock offering 14,998,744
Payment of underwriters' fee and offering costs (1,342,182)
Net proceeds from junior subordinated debt 3,608,000
------------ ------------ ------------
Net cash from financing activities 132,002 13,720,922 3,608,000
------------ ------------ ------------
Net change in cash and cash equivalents (94,469) 6,659,426 (3,309,291)
Cash and cash equivalents, beginning of period 7,307,089 647,663 3,956,954
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 7,212,620 $ 7,307,089 $ 647,663
============ ============ ============
56
Note 18 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as
follows.
2003 2002 2001
-------------------------------------------------
Unrealized holding gains and losses on
available-for-sales securities $ (139,703) $ 568,652 $ (16,856)
Less reclassification adjustments for gains
and losses later recognized in income (190,776) (180,351)
-------------------------------------------------
Net unrealized gains and losses (330,479) 388,301 (16,856)
Tax expense (benefit) (132,187) 155,328 (6,747)
-------------------------------------------------
Other comprehensive income (loss) $ (198,292) $ 232,973 $ (10,109)
=================================================
Note 19 - QUARTERLY FINANCIAL DATA (UNAUDITED)
INTEREST NET INTEREST NET EARNINGS PER SHARE
INCOME INCOME INCOME BASIC DILUTED
-----------------------------------------------------------------------------------
2003
First quarter $ 4,276,942 $ 2,717,402 $ 185,471 $ 0.05 $ 0.05
Second quarter 4,437,560 2,857,740 429,721 0.11 0.11
Third quarter 4,493,529 3,039,210 614,978 0.16 0.15
Fourth quarter 4,617,657 3,150,800 569,896 0.14 0.14
----------------------------------------------------------------------------------
Total $ 17,825,688 $ 11,765,152 $ 1,800,066 $ 0.46 $ 0.45
==================================================================================
2002
First quarter $ 3,738,560 $ 2,164,920 $ 320,793 $ 0.13 $ 0.12
Second quarter 4,046,883 2,490,740 354,640 0.14 0.14
Third quarter 4,320,491 2,627,554 428,259 0.14 0.14
Fourth quarter 4,388,464 2,766,752 611,937 0.16 0.16
----------------------------------------------------------------------------------
Total $ 16,494,398 $ 10,049,966 $ 1,715,629 $ 0.57 $ 0.56
==================================================================================
Net income and diluted earnings per share results for the first quarter
of 2003 were significantly lower than the same quarterly period in 2002
mainly as a result of pretax expenses of $720,000 recorded in the 2003
period for losses associated with discovery of unauthorized mortgage
activity. Additionally, earnings per share results during the first and
second quarters of 2003 were impacted by a 53% and 52% increase,
respectively, in the number of average diluted shares outstanding as a
result of the rights offering and limited public offering completed in
August of 2002.
57
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
Tower Financial Corporation
Fort Wayne, Indiana
We have audited the accompanying consolidated balance sheets of Tower Financial
Corporation as of December 31, 2003 and 2002 and the related consolidated
statements of operations, comprehensive income, changes in stockholders' equity,
and cash flows for the years ended December 31, 2003, 2002 and 2001. These
financial statements are the responsibility of the Company'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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tower Financial
Corporation as of December 31, 2003 and 2002 and the results of its operations
and its cash flows for the years ended December 31, 2003, 2002 and 2001 in
conformity with accounting principles generally accepted in the United States of
America.
Fort Wayne, Indiana /s/ Crowe Chizek and Company LLC
January 16, 2004
58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
We maintain a set of disclosure controls and procedures, which are designed to
ensure that information require to be disclosed by us in the reports filed by us
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. As of December 31, 2003, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chairman, President and Chief Executive Officer and our Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act.
Based on that evaluation, our Chairman, President and Chief Executive Officer
and our Chief Financial Officer concluded that our disclosure controls and
procedures are effective.
There was no change in our internal control over financial reporting during the
fourth quarter of our 2003 fiscal year that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item concerning the directors, and nominees for
director and executive officers of the Company and concerning disclosure of
delinquent filers is incorporated herein by reference to the Company's
definitive Proxy Statement for its 2004 Annual Meeting of Shareholders, to be
filed with the Commission pursuant to Regulation 14A within 120 days after the
end of the Company's last fiscal year.
The Company has adopted a Code of Business Conduct and Ethics (the "Code") that
applies to all of the Company's directors, officers and employees, including its
principal executive officer, principal financial officer, principal accounting
officer and controller. The Code is posted on the Company's website at
www.towerbank.net. The Company intends to disclose any amendments to the Code by
posting such amendments on its website. In addition, any waivers of the Code for
directors or executive officers of the Company will be disclosed in a report on
Form 8-K.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item concerning remuneration of the Company's
officers and directors and information concerning material transactions
involving such officers and directors is incorporated herein by reference to the
Company's definitive Proxy Statement for its 2004 Annual Meeting of Shareholders
which will be filed with the Commission pursuant to Regulation 14A within 120
days after the end of the Company's last fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER MATTERS.
The information required by this Item concerning the stock ownership of
management and five percent beneficial owners and the Company's common stock
that may be issued under existing equity compensation plans is
59
incorporated herein by reference to the Company's definitive Proxy Statement for
its 2004 Annual Meeting of Shareholders which will be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's last
fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item concerning certain relationships and
related transactions is incorporated herein by reference to the Company's
definitive Proxy Statement for its 2004 Annual Meeting of Shareholders which
will be filed with the Commission pursuant to Regulation 14A within 120 days
after the end of the Company's last fiscal year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item concerning principal accountant fees and
services is incorporated herein by reference to the Company's definitive Proxy
Statement for its 2004 Annual Meeting of Shareholders, to be filed with the
Commission pursuant to Regulation 14A within 120 days after the end of the
Company's last fiscal year.
PART IV
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
A list of exhibits required to be filed as part of this Annual Report is set
forth in the Index to Exhibits, which immediately precedes such exhibits and is
incorporated herein by reference.
(b) On October 31, 2003, we furnished a current report on Form 8-K dated
October 31, 2003 to report under Item 12 of the 8-K our results of
operations for the quarter ended September 30, 2003.
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
TOWER FINANCIAL CORPORATION
By: /s/ Donald F. Schenkel
---------------------------------
Date: March 5, 2004 Donald F. Schenkel
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of 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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Donald F. Schenkel Chairman of the Board, President, March 5, 2004
- ----------------------------------------- Chief Executive Officer and
Donald F. Schenkel Director (Principal Executive Officer)
/s/ Kevin J. Himmelhaver Executive Vice President, Chief March 5, 2004
- ----------------------------------------- Financial Officer and Secretary
Kevin J. Himmelhaver (Principal Financial Officer
and Principal Accounting Officer)
/s/ Keith E. Busse Director March 5, 2004
- -----------------------------------------
Keith E. Busse
/s/ Kathryn D. Callen Director March 5, 2004
- -----------------------------------------
Kathryn D. Callen
/s/ Peter T. Eshelman Director March 5, 2004
- -----------------------------------------
Peter T. Eshelman
/s/ Michael S. Gouloff Director March 5, 2004
- -----------------------------------------
Michael S. Gouloff
/s/ Jerome F. Henry, Jr. Director March 5, 2004
- -----------------------------------------
Jerome F. Henry, Jr.
/s/ R.V. Prasad Mantravadi, M.D. Director March 5, 2004
- -----------------------------------------
R.V. Prasad Mantravadi, M.D.
/s/ Michael J. Mirro, M.D. Director March 5, 2004
- -----------------------------------------
Michael J. Mirro, M.D.
/s/ Debra A. Niezer Director March 5, 2004
- -----------------------------------------
Debra A. Niezer
/s/ William G. Niezer Director March 5, 2004
- -----------------------------------------
William G. Niezer
61
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Joseph D. Ruffolo Director March 5, 2004
- -----------------------------------------
Joseph D. Ruffolo
/s/ Larry L. Smith Director March 5, 2004
- -----------------------------------------
Larry L. Smith
/s/ John V. Tippmann, Sr. Director March 5, 2004
- -----------------------------------------
John V. Tippmann, Sr.
/s/ Irene A. Walters Director March 5, 2004
- -----------------------------------------
Irene A. Walters
62
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3.1 (1) Restated Articles of Incorporation of the Registrant
3.2 (10) Amended By-Laws of the Registrant
10.1 (1) Lease Agreement dated October 6, 1998 between the
Registrant and Tippmann Properties, Inc.
10.3* (1) 1998 Stock Option and Incentive Plan
10.4* (2) Employment Agreement dated April 25, 2002 between the
Registrant and Gary D. Shearer
10.5* (2) Employment Agreement dated April 25, 2002 between the
Registrant and Kevin J. Himmelhaver
10.6* (2) Employment Agreement dated April 25, 2002 between the
Registrant and Curtis A. Brown
10.9 (3) Lease Agreement dated December 6, 1999 between
the Registrant and Chestnut Development
10.10 (4) Lease Agreement dated August 8, 2000 between the Registrant
and Rogers Markets Inc.
10.11 (5) Amendment to the Lease Agreement dated October 6, 1998
between the Registrant and Tippmann Properties, Inc.
10.12 (6) Agreement to purchase unimproved real estate dated August 14,
2001 between the Registrant and J - J Parent Corporation
10.13* (7) 2001 Stock Option and Incentive Plan
10.14* (8) Employment Agreement dated January 1, 2002 between the
Registrant and Donald F. Schenkel
10.18* (8) Supplemental Executive Retirement Plan dated January 1, 2002
10.19* (8) Deferred Compensation Plan dated January 1, 2002
10.20* (8) Deferred Compensation Plan for Non-Employee Directors dated
January 1, 2002
10.21* (9) 401(k) Plan of the Registrant
.
10.22 Lease Agreement dated April 7,2003 between Registrant and MER Group.
21 Subsidiaries of the Registrant
23 Consent of Independent Accountants
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a).
63
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a).
32.1 Certification of Chief Executive Officer pursuant to 18 USC Section 1350.
32.2 Certification of Chief Financial Officer pursuant to 18 USC Section 1350.
* The indicated exhibit is a management contract compensatory plan or
arrangement required to be filed by Item 601 of Regulation S-K.
(1) The copy of this exhibit filed as the same exhibit number to the
Company's Registration Statement on Form SB-2 (Registration No.
333-67235) is incorporated herein by reference.
(2) The copy of this exhibit filed as the same exhibit number to the
Company's Quarterly Report on Form 10-QSB for the three months ended
March 31, 2002 is incorporated herein by reference.
(3) The copy of this exhibit filed as the same exhibit number to the
Company's Annual Report on Form 10-KSB for the year ended December 31,
1999, is incorporated herein by reference.
(4) The copy of this exhibit filed as the same exhibit number to the
Company's Quarterly Report on Form 10-QSB for the three months ended
September 30, 2000, is incorporated herein by reference.
(5) The copy of this exhibit filed as the same exhibit number to the
Company's Quarterly Report on Form 10-QSB for the three months ended
June 30, 2001, is incorporated herein by reference.
(6) The copy of this exhibit filed as the same exhibit number to the
Company's Quarterly Report on Form 10-QSB for the three months ended
September 30, 2001, is incorporated herein by reference.
(7) The copy of this exhibit filed as Exhibit 4.3 to the Company's
Registration Statement on Form S-8 (Registration No. 333-64194) is
incorporated herein by reference.
(8) The copy of this exhibit filed as the same exhibit number to the
Company's Annual Report on Form 10-KSB for the year ended December 31,
2001 is incorporated herein by reference.
(9) The copy of this exhibit filed as Exhibit 4.3 to the Company's
Registration Statement on Form S-8 (Registration No. 333-64318) is
incorporated herein by reference.
(10) The copy of this exhibit filed as the same exhibit number to the
Company's Form 10-KSB for the year ended December 31, 2002 is
incorporated herein by reference.
64