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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, 2004
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. X
-----
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, 2004 (assuming solely for the purposes of this calculation that all
directors and executive officers of the registrant are "affiliates"):
$55,221,516
Number of shares of Common Stock outstanding at February 11, 2005: 4,003,156
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 19, 2005
TOWER FINANCIAL CORPORATION
Fort Wayne, Indiana
Annual Report to Securities and Exchange Commission
December 31, 2004
PART I
ITEM 1. BUSINESS.
GENERAL
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,
and a financial holding company under the Federal Bank Holding Company Act of
1956, as amended. The Bank is an Indiana chartered bank with depository accounts
insured by the Federal Deposit Insurance Corporation ("FDIC") and is a member of
the Federal Reserve System.
The Bank provides a range of commercial and consumer banking services from six
locations in market area comprised of the metropolitan area of Fort Wayne,
Indiana. Those services reflect the Bank's strategy of focusing on 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.
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
The bank has four branch locations and one mortgage loan production office.
During 2004, the Bank opened its fourth branch on the south side of Fort Wayne,
in Waynedale and its mortgage loan production office in Angola, Indiana.
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 loans.
These loans are both secured and unsecured and are made available for general
operating purposes, including acquisition of fixed assets including real estate,
equipment and machinery, lines of credit collateralized by inventory and
accounts receivable. Typically, the Bank's customers' financing requirements
range from $100,000 to $2.0 million. Approximately 39.6% 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. Commercial loans may also be further secured by junior
liens on real estate. 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 78.5% of the Bank's total
loan portfolio at December 31, 2004.
Mortgage Banking. The Bank provides both fixed and variable rate, long-term
residential mortgage loans to its customers. 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 or broker the majority
of long-term, fixed rate and
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variable rate loans in the secondary market. In late 2003, the Bank made a
decision to no longer sell residential mortgage loans on the secondary market.
Loans are either retained in the Bank's loan portfolio or direct brokered. The
Bank does not retain servicing rights with respect to any of the residential
mortgage loans that it brokers or sells. During 2004, the Bank originated $9.1
million of residential mortgage loans, of which all were retained, and none were
sold in the secondary market. The Bank brokered $22.8 million of residential
mortgage loans during 2004. The following table reflects residential real estate
mortgage loans originated, sold and retained or brokered for the periods
indicated.
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
($ in thousands) 2004 2003 2002
- ---------------- ------- ------- -------
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
Real estate mortgage loan sales -- 19,312 31,183
------- ------- -------
Real estate mortgage loans held for sale at
end of period $ -- $ -- $ 3,356
======= ======= =======
Real estate mortgage loans originated and retained $ 9,053 $25,376 $10,996
Real estate mortgages brokered 22,783 49,977 46,005
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 to make 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 in its loan portfolio.
Investment Management and Trust Services. The Bank's investment management and
trust services (IM&T) department offers a wide range of traditional personal
trust services to customers in its market area. The Bank's trust services
include estate planning and money management. The Bank's IM&T products and
services include traditional revocable trusts, irrevocable trusts, charitable
trusts, estate administration, guardianship administration, IRA administration,
personal and institutional investment management, and custodial services. The
Bank believes that by offering IM&T services through personalized client
service, an experienced professional staff, and a tailored approach to
investments that it can enhance and leverage client relationships. The Bank
believes that its approach to investment management and trust services has
contributed to growth in assets under management to $354 million at December 31,
2004. More importantly, the Bank believes that this approach should allow for
continued growth in assets under management and IM&T revenues.
The following table reflects assets under management and revenue of the Bank's
IM&T department for the periods indicated.
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
($ in thousands) 2004 2003 2002
- ---------------- -------- -------- --------
Assets under management $353,995 $312,327 $235,439
Number of accounts 512 428 364
Average account size $ 691 $ 730 $ 647
Trust revenue $ 1,670 $ 1,402 $ 1,085
Tower Investment Services: In July of 2004, the Bank began offering securities
and insurance brokerage services under the private label name of Tower
Investment Services, through PrimeVest Financial Services, Inc., and ING
company. Tower Investment Services offers the Bank's clients comprehensive
brokerage capabilities. PrimeVest is a self-clearing broker dealer that works
exclusively with banks and
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financial institutions. Tower Investment Services had $18.7 million in assets
under management at December 31, 2004.
Deposit Generation. The Bank generates deposits primarily through offering a
broad array of deposit products to individuals, businesses, associations,
financial institutions, and government entities in its primary market area. The
Bank generally seeks a comprehensive banking relationship from its lending
customers, which has contributed to its internal deposit growth. This often
includes encouraging new customers to consider both business and personal
checking accounts and other deposit services. The Bank's deposit services
include checking, savings, and money market accounts, certificates of deposit,
direct deposit services, and telephone and Internet banking. The Bank also
generates certificates of deposit through national, out-of-market sources
developed during 2002, 2003, and 2004. These deposits include brokered deposits,
which the Bank began accepting during 2003. These out-of-market deposits are
generated by direct negotiation with out-of-market banks and credit unions and
through negotiated transactions with brokers. The Bank also offers a courier
service for the deposit convenience of its business customers as well as
wholesale lockbox and other business deposit and cash management services. At
December 31, 2004, approximately 77.0% of the Bank's deposits were generated
in-market, while 23.0% were out-of-market deposits. Deposits at December 31,
2004, 2003 and 2002 are summarized as follows:
2004 2003 2002
---------------- ---------------- ----------------
($ in thousands) BALANCE % BALANCE % BALANCE %
- ---------------- -------- ----- -------- ----- -------- -----
Noninterest-bearing demand $ 57,800 15.0% $ 62,638 17.3% $ 42,966 13.8%
Interest-bearing checking 27,787 7.2% 23,544 6.5% 21,582 7.0%
Money market 74,018 19.2% 98,250 27.1% 99,105 31.9%
Savings 12,936 3.3% 10,576 2.9% 8,343 2.7%
Time, under $100,000 69,220 17.9% 63,029 17.4% 54,803 17.6%
Time, $100,000 and over 144,619 37.4% 104,840 28.9% 83,785 27.0%
-------- ----- -------- ----- -------- -----
TOTAL DEPOSITS $386,380 100.0% $362,877 100.0% $310,584 100.0%
======== ===== ======== ===== ======== =====
LENDING PRACTICES
The Bank makes loans to individuals and businesses located within its market
area. The Bank's loan portfolio at December 31, 2004 consisted of commercial and
commercial real estate loans (78.5%), residential mortgage loans (11.3%) and
personal loans (10.2%). The Bank's legal lending limit under applicable federal
banking regulations is approximately $7.6 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 the Bank's 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
39.6% 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.
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
3
(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 sell or broker the majority of long-term, fixed rate and variable rate loans
in the secondary market. 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 sells or 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 to make home
improvements and personal investments. The majority of the Bank's personal loans
are home equity loans or home equity lines of credit 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 help to 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 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. 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.
4
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 certificate of deposit accounts to select national
and brokered markets at rates competitive with the national market as well as
those in the greater Fort Wayne metropolitan area. 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 the greater Fort Wayne metropolitan area, as
well as certificate of deposit accounts nationally through deposit brokers and 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 and Internet banking to its customers. 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 and a $20,000 investment in an economic development venture capital
limited partnership focusing on businesses located in Northeast Indiana, both of
which were 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 "Department"). 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.
FUNDING SOURCES
During 2002, 2003 and 2004, the Company contributed $7,000,000, $0 and
$5,000,000, 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 uses alternative funding sources as
5
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 and the Bank 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 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 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.
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.
6
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
affected 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.
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.
7
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% or
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, 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.
8
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.
USA Patriot Act of 2001. On October 6, 2001, the "Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism (USA Patriot) Act of 2001" was enacted. The statute increased the
power of the United States Government to obtain access to information and to
investigate a full array of criminal activities. In the area of money laundering
activities, the statute added terrorism, terrorism support, and foreign
corruption to the definition of money laundering offenses and increased the
civil and criminal penalties for money laundering; applied certain anti-money
laundering measures to United States bank accounts used by foreign persons;
prohibited financial institutions from establishing, maintaining, administering
or managing a correspondent account with a foreign shell bank; provided for
certain forfeitures of funds deposited in United States interbank accounts by
foreign banks; provided the Secretary of the Treasury with regulatory authority
to ensure that certain types of bank accounts are not used to hide the identity
of customers transferring funds and to impose additional reporting requirements
with respect to money laundering activities; and included other measures. On
October 28, 2002, the Department of Treasury issued a final rule concerning
compliance by covered United States financial institutions with the new
statutory anti-money laundering requirement regarding correspondent accounts
established or maintained for foreign banking institutions, including the
requirement that financial institutions take reasonable steps to ensure that
correspondent accounts provided to foreign banks are not being used to
indirectly provide banking services to foreign shell banks. The Company believes
that compliance with the new requirements will not have a material adverse
impact on its operations or financial condition.
Sarbanes-Oxley Act of 2002. The passage of the Sarbanes-Oxley Act of 2002 and
subsequent actions of the Securities and Exchange Commission and stock exchanges
have had a significant impact on the Company's corporate governance and related
matters. In June 2003, the Securities and Exchange Commission adopted final
rules under Section 404 of the Sarbanes-Oxley Act of 2002. Commencing with its
2005 Annual Report on Form 10-K, the Company will be required to include a
report of management on the Company's internal control over financial reporting.
The internal control report must include a statement of management's
responsibility for establishing and maintaining adequate control over financial
reporting as of year-end; of the framework used by management to evaluate the
effectiveness of the Company's internal control over financial reporting; and
that the Company's independent accounting firm has issued an attestation report
on management's assessment of the Company's internal control over financial
reporting, which report is also required to be filed as part of the Annual
Report.
COMPETITION
All phases of the business of the Bank are highly competitive. The Bank competes
with numerous financial institutions, including other commercial banks in the
greater Fort Wayne metropolitan area. 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.
9
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, 2004, the Company had 132 employees, including 115 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.
STATISTICAL DISCLOSURE
The statistical disclosure concerning the Company and the Bank, on a
consolidated basis, included in response to Item 7 of this report is hereby
incorporated by reference herein.
AVAILABLE INFORMATION
The Company's Internet website address is www.towerbank.net. The Company's
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act are available or may be accessed free of
charge through the TOFC Investor Relations section of the Company's Internet
website as soon as reasonably practicable after it electronically files such
material with, or furnishes it to, the SEC. The Company's Internet website and
the information contained therein or connected thereto are not intended to be
incorporated into this Annual Report on Form 10-K.
The following corporate governance documents are also available through the TOFC
Investor Relations section of the Company's Internet website or may be obtained
in print form by written request addressed to Secretary, Tower Financial
Corporation, 116 East Berry Street, Fort Wayne, Indiana 46802: Code of Business
Conduct and Ethics (the "Code"), Audit Committee Charter, Compensation Committee
Charter, and Nominating and Corporate Governance Committee Charter. The Company
intends to post any amendments to the foregoing documents on its website and
will report any waivers of the Code for directors and executive officers on a
Current Report on Form 8-K.
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 the same renewal option as prior to the extension. In March 2004 the
Company signed 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 also contains 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. The Bank leases
450 square feet of office space in Angola, Indiana for use as a mortgage loan
production office. The office space is leased on a month-to-month basis.
10
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, RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES.
MARKET INFORMATION
The Company's common stock is traded on the Nasdaq National Market System under
the symbol "TOFC." As of February 11, 2005, there were 645 shareholders of
record and approximately 2,109 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 2004 and 2003.
HIGH/LOW STOCK PRICE
2004 2003
----------------- -----------------
HIGH LOW HIGH LOW
------- ------- ------- -------
1st Quarter $15.980 $14.400 $14.100 $12.611
2nd Quarter $14.900 $13.110 $14.250 $12.950
3rd Quarter $14.250 $12.500 $14.350 $12.630
4th Quarter $15.000 $12.930 $15.150 $12.800
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 dividends is also subject to its profitability, financial condition,
11
capital expenditures and other cash flow requirements. In addition, under the
terms of the debentures issued in connection with the issuance of the 9% trust
preferred securities due 2031 issued by the Company's statutory trust
subsidiary, 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.
The information required by this Item concerning equity compensation plans is
incorporated by reference to Item 12 of this report.
ITEM 6. SELECTED FINANCIAL DATA.
12
CONSOLIDATED SUMMARY OF OPERATIONS AND SELECTED STATISTICAL DATA
Years ended December 31,
----------------------------------------------------
($ in thousands, except share data) 2004 2003 2002 2001 2000
- ----------------------------------- -------- -------- -------- -------- --------
RESULTS OF OPERATIONS:
Interest income $ 20,965 $ 17,826 $ 16,494 $ 15,931 $ 12,769
Interest expense 6,649 6,061 6,444 8,102 7,047
Net interest income 14,316 11,765 10,050 7,829 5,722
Provision for loan losses 2,360 2,185 1,765 1,120 1,355
Noninterest income 4,274 3,642 2,954 1,785 1,028
Noninterest expense 12,400 10,353 8,416 6,638 4,909
Income before income taxes 3,830 2,869 2,823 1,856 486
Income taxes expense (benefit) 1,351 1,069 1,107 736 (588)
Net income 2,479 1,800 1,716 1,120 1,074
PER SHARE DATA:
Net income: basic $ 0.63 $ 0.46 $ 0.57 $ 0.44 $ 0.42
Net income: diluted 0.61 0.45 0.56 0.44 0.42
Book value at end of period 10.99 10.38 9.97 9.29 8.85
Dividends declared n/a n/a n/a n/a n/a
BALANCE SHEET DATA:
Total assets $481,117 $436,469 $377,311 $291,874 $212,413
Total securities available for sale 35,025 24,325 11,171 2,384 9,957
Loans held for sale -- -- 5,770 4,293 --
Total loans 400,510 376,839 321,340 232,346 155,880
Allowance for loan losses 5,608 5,259 4,746 3,480 2,364
Total deposits 386,380 362,877 310,584 256,153 188,296
FHLB advances 45,000 27,000 21,500 6,500 --
Junior subordinated debt 3,608 3,608 3,608 3,608 --
Stockholders' equity 44,013 40,909 39,175 23,505 22,395
PERFORMANCE RATIOS:
Return on average assets 0.54% 0.45% 0.53% 0.47% 0.68%
Return on average stockholders' equity 5.89% 4.53% 5.90% 4.88% 5.04%
Net interest margin 3.31% 3.04% 3.17% 3.33% 3.70%
Efficiency ratio 66.70% 67.20% 64.72% 69.04% 72.73%
ASSET QUALITY RATIOS:
Nonperforming loans to total loans 0.56% 0.51% 0.22% 0.35% 0.00%
Nonperforming assets to total assets 0.56% 0.45% 0.19% 0.28% 0.00%
Net charge-offs to average loans 0.52% 0.47% 0.18% 0.00% 0.00%
Allowance for loan losses to total loans 1.40% 1.40% 1.48% 1.50% 1.52%
LIQUIDITY AND CAPITAL RATIOS:
Loan to deposit ratio 103.66% 103.85% 103.46% 90.71% 82.78%
Total stockholders' equity to total assets 9.15% 9.37% 10.38% 8.05% 10.54%
Total risk-based capital 12.29% 12.66% 13.86% 12.12% 14.24%
Tier 1 leverage risk-based capital 11.08% 11.44% 12.61% 10.87% 12.99%
Tier 1 leverage capital 9.87% 10.26% 11.75% 10.02% 11.21%
n/a - not applicable
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION. ($ in thousands except for share data)
INTRODUCTION
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, 2004 and 2003 and for the years ended December 31, 2004, 2003 and
2002. 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 limited 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.
14
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 any loan charged off.
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 two components: identified specific allocations and a percentage allocation
based on loss history for different loan groups.
To determine the allocated component of the allowance, the Company combines
estimated 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.
15
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 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 significant growth during 2004. Total assets of the
Company were $481,117 at December 31, 2004 compared to $ 436,469 at December 31,
2003, an increase of $44,648 or 10.2%. 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. 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 2004. Loans were $400,510 at December 31, 2004
compared to $376,839 at December 31, 2003, an increase of $23,671, or 6.3%. The
loan portfolio, which equaled 86.3% and 90.5% of earning assets at December 31,
2004 and 2003, respectively, was primarily comprised of commercial and
commercial real estate loans at both dates. At December 31, 2004, commercial and
commercial real estate loans were approximately 78.5% of the loan portfolio and
represented loans to business interests generally located within the Bank's
market area. Approximately 47.4% of the loan portfolio at December 31, 2004
consisted of general commercial and industrial loans primarily secured by
inventory, receivables and equipment, while 31.2% 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 $124,625, or 31.1% of total loans,
and building, development and general contracting at $63,777, or 15.9% of total
loans. The concentration and growth in commercial credits is in keeping with the
Bank's strategy of focusing a substantial amount of efforts on commercial
banking. Business banking is an area of expertise for the Bank's management and
lending team. Residential mortgage and home equity lending, while only 18.4% of
loans at December 31, 2004, also experienced significant growth. Consumer loans,
only 3.1% of total loans at December 31, 2004, reflected a slight increase
during 2004 from 2003 levels. Management believes that loan growth should
continue as the Bank expands its distribution network during 2005; however, the
Company's main strategy for growth and profitability is expected to come largely
from the commercial loan sector. The following table presents loans outstanding
as of December 31, 2004, 2003, 2002, 2001 and 2000.
LOANS OUTSTANDING
DECEMBER 31,
----------------------------------------------------
($ in thousands) 2004 2003 2002 2001 2000
- ---------------- -------- -------- -------- -------- --------
Commercial $189,717 $198,063 $185,250 $133,675 $ 95,834
Commercial real estate 124,722 100,309 76,546 49,964 33,581
Residential real estate 45,081 40,648 26,097 16,740 6,978
Home equity 28,430 25,944 20,043 16,043 6,994
Consumer 12,239 11,594 13,290 15,717 12,386
-------- -------- -------- -------- --------
Total loans 400,189 376,558 321,226 232,139 155,773
Net deferred loan costs 322 280 114 207 107
Allowance for loan losses (5,608) (5,259) (4,746) (3,480) (2,364)
-------- -------- -------- -------- --------
NET LOANS $394,903 $371,579 $316,594 $228,866 $153,516
======== ======== ======== ======== ========
The following table presents the maturity of total loans outstanding as of
December 31, 2004, according to scheduled repayments of principal and also based
upon repricing opportunities.
16
MATURITIES OF LOANS OUTSTANDING
WITHIN 1 - 5 OVER
($ in thousands) 1 YEAR YEARS 5 YEARS TOTALS
- ---------------- ------- -------- -------- --------
LOANS - CONTRACTUAL MATURITY DATES:
Commercial $27,443 $ 98,329 $ 63,945 $189,717
Commercial real estate 31,525 67,935 25,262 124,722
Residential real estate 9,204 3,988 31,889 45,081
Home equity 4,698 22,924 808 28,430
Consumer 6,442 5,745 52 12,239
------- -------- -------- --------
Total loans $79,312 $198,921 $121,956 $400,189
======= ======== ======== ========
LOAN REPRICING OPPORTUNITIES:
Fixed rate $18,166 $ 51,786 $ 52,325 $122,277
Variable rate 61,146 147,135 69,631 277,912
------- -------- -------- --------
Total loans $79,312 $198,921 $121,956 $400,189
======= ======== ======== ========
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, 2004, there were
$12,597 of potential problem loans outstanding classified on the watchlist.
Nonperforming loans at December 31, 2004 were $2,257, including $1,580 of loans
placed on nonaccrual status and categorized as impaired and $677 of loans past
due 90 days and still accruing which are not categorized as impaired. Total
impaired loans are $5,095, which includes all nonaccrual loans plus commercial
loans impaired of $3,515 that are still accruing but restructured. Gross
interest for 2004 for nonaccrual loans would have been $147. Interest actually
received on nonaccrual loans was $43 resulting in lost interest to date of $104.
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.
During 2004, the Bank experienced $2,011 in net charged-off loans compared to
$1,671 of net charge-offs in 2003 and $500 in 2002. The 2004 ratio of net
charge-offs to total average loans was 0.52%. Of the loans charged off during
2004, $1,000 was attributable to one commercial credit. Of the loans charged off
during 2003, $600 was attributable to the unauthorized mortgage activity loss
and $563 was attributable to one commercial credit, which was identified during
the year and restructured at year-end.
In each quarter, the allowance for loan losses is adjusted by management to the
amount management believes is necessary to maintain the allowance at adequate
levels. Management allocates specific portions of the allowance for loan losses
to specifically identified problem loans. Management's evaluation of the
allowance is further based on consideration of actual loss experience, the
present and prospective financial condition of borrowers, industry
concentrations within the portfolio and general
17
economic conditions. Management believes that the present allowance is adequate,
based on the broad range of considerations listed above, and further, based upon
peer industry data of comparable banks.
The following table illustrates the breakdown of the allowance for loan losses
by loan type.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
($ 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 %
2004 OF TOTAL 2003 OF TOTAL 2002 OF TOTAL 2001 OF TOTAL 2000 OF TOTAL
LOAN TYPE ALLOC. LOANS ALLOC. LOANS ALLOC. LOANS ALLOC. LOANS ALLOC. LOANS
- --------- ------- -------- ------- -------- ------- -------- ------- -------- ------- --------
Commercial $5,124 47.4% $4,011 52.6% $4,033 57.7% $2,140 57.6% $ 821 61.5%
Commercial real estate 137 31.1% 751 26.6% 199 23.8% 405 21.5% 230 21.6%
Residential real estate 51 11.3% 190 10.8% 90 8.1% 42 7.2% 18 4.5%
Home equity 33 7.1% 85 6.9% 125 6.3% 80 6.9% 35 4.5%
Consumer 156 3.1% 111 3.1% 269 4.1% 236 6.8% 186 7.9%
Unallocated 107 n/a 111 n/a 30 n/a 577 n/a 1,074 n/a
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total allowance
for loan losses $5,608 100.0% $5,259 100.0% $4,746 100.0% $3,480 100.0% $2,364 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
See Note 3 to the Consolidated Financial Statements for detail of activity in
allowance for loan losses
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. The Company experienced
$2,057 of charge-offs and $46 of recoveries during 2004. The Company experienced
$1,705 of charge-offs and $34 of recoveries during 2003. Prior to 2003, the
Company only experienced an aggregate amount of $505 in loan charge-offs during
its first four years of operations.
TOTAL SECURITIES PORTFOLIO
DECEMBER 31,
------------------------------------------------
2004 2003 2002
NET NET NET
($ in thousands) CARRYING VALUE CARRYING VALUE CARRYING VALUE
- ---------------- -------------- -------------- --------------
U.S. Government agency debt obligations $14,926 $ 9,052 $ 6,215
Obligations of states and political subdivisions 12,797 7,854 1,943
Mortgage-backed securites 7,302 7,419 3,013
------- ------- -------
TOTAL SECURITIES $35,025 $24,325 $11,171
======= ======= =======
Securities available for sale at fair value increased during 2004, and totaled
$35,025 at December 31, 2004 compared to $24,325 at December 31, 2003 and
$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 2004, the Company again expanded the size and length of
maturity of the portfolio as it continued 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
18
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 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, 2004 in the amount of $34 compared to a net unrealized gain in the
amount of $42 at December 2003, and a net unrealized gain of $372 at December
31, 2002. There were no interest-bearing deposits with other banks at December
31, 2004, 2003, or 2002. The table above presents the total securities portfolio
as of December 31, 2004, 2003 and 2002. During 2004, the Company sold $10,212 of
available for sale agency securities and recorded a $154 gain from the sales.
During 2003, the Company sold $3,175 of available for sale agency securities and
recorded a $191 gain from the sales.
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 an
increase of $10,181 during 2004, were $25,314 and $15,133 at December 31, 2004
and 2003, respectively. At December 31, 2004 and 2003, these short-term assets
were approximately 5.5% and 3.6% of earning assets, respectively. The increase
in short term assets during 2004 was primarily due to a large increase in
Federal funds sold.
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 deposit through national
out-of-market sources (outside Allen and surrounding counties) developed during
2003 and 2004. The out-of-market deposits are generated by direct negotiation
with out-of-market banks and credit unions, and through negotiated transaction
with brokers. Total deposits were $386,380 at December 31, 2004 and $362,877 at
December 31, 2003, an increase of $23,503, or 6.5%.
Noninterest-bearing deposits totaled $57,800 at December 31, 2004, a 7.7%
decrease from $62,638 at December 31, 2003. At December 31, 2004,
noninterest-bearing deposits were approximately 15% of total deposits, a
decrease from the 2003 level of 17.3%. Noninterest-bearing deposits at December
31, 2004 were comprised of $52,635 in business checking accounts, $1,287 in
public funds and $3,878 in consumer accounts.
Interest-bearing deposits grew during 2004 and were $328,580 at December 31,
2004, a 9.4% increase over $300,239 at December 31, 2003. Interest-bearing
deposits at December 31, 2004 were comprised of approximately 22.5% in money
market accounts, 12.4% in interest-bearing checking and savings accounts, and
65.1% in certificates of deposit. The December 31, 2004 percentages reflect a
modest change in the deposit mix from 2003, when the percentages were 32.7%,
11.4%, and 55.9%, respectively. In 2004, all deposit categories reflected
balance increases over 2003 levels with the exception of noninterest-bearing
deposits and money market accounts. The most significant increase from 2003 was
in of certificates of deposit over $100. CDs under $100 grew by $6,192 from 2003
year-end levels and CDs $100 and over increased by $39,779. The balance of money
market accounts at December 31, 2004 was $74,018 compared to $98,250 at December
31, 2003, a decrease of $24,232. While total interest-bearing deposits increased
$28,341 from 2003, 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, 2004 reflected $158,158 in business accounts, $133,724 in consumer
accounts and $36,698 in public fund accounts compared to $124,868, $121,260 and
$54,111, respectively, at December 31, 2003. As of December 31, 2004, the
Company had $144,619 in certificates of deposit of $100 or more, of which
$44,911 mature within three months; $57,851 mature over three months through
twelve months; and $41,857 mature over twelve months.
Short-term borrowings at December 31, 2004 were $200, a significant decrease
from $1,060 at December 31, 2003, 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 $45,000 in
Federal Home Loan Bank ("FHLB") callable and bullet advances at December 31,
19
2004 compared to $27,000 at December 31, 2003. The increase of $18,000 in FHLB
borrowings from the 2003 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 June 2006. There were $6,500
in FHLB callable advances outstanding at December 31, 2004. 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, 2004 and 2003, the Company's statutory
trust subsidiary, TCT1, sold a private placement offering of $3,500 in Trust
Preferred Securities on November 16, 2001. The proceeds 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 $44,013 at December 31, 2004 and $40,909 at December
31, 2003. The increase of $3,104 was mainly attributable to 2004 net income of
$2,479 and $630 from the net exercise of stock options. The only other item
affecting stockholders' equity was a $(5) 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. No additional shares were issued
during 2000 or 2001. At December 31, 2004, the Company had a balance of $6,040
in retained earnings while at December 31, 2003 the balance was $3,561, an
increase of $2,479 from 2003 due to net income generated during 2004. See
"Results of Operations."
RESULTS OF OPERATIONS
Summary. The Company reported net income of $2,479, or $.61 per diluted share,
for the year ended December 31, 2004. This reflects an increase in net income
from $1,800 in 2003 and net income of $1,716 posted during 2002. Net income per
diluted share reflects a $0.16 increase from the $.45 reported in 2003 and a
$.05 increase from the $.56 posted in 2002. Per share earnings in 2002 reflect a
significantly lower number of average shares outstanding. In August 2002 a
rights offering and limited public offering were completed, which increased the
average number of outstanding shares by 31.8% from 2002 to 2004 and 30.5% from
2002 to 2003.
The 2004 results reflected a 38.3% growth in net income compared to 2003. The
improvement in net income over 2004 was mainly the result of substantial revenue
growth due to loan volume growth along with increases in interest rates during
the last six months of the year. Net interest income in 2004 was $14,316
compared to $11,765 in 2003, an increase of $2,551 due mainly from an increase
in loans outstanding and the increase in interest rates. Noninterest income in
2004 was $4,274 compared to $3,642 in 2003, an increase of $632. The increase
was due primarily to a $285 increase in trust fees and an $860 insurance
settlement on the previously disclosed unauthorized mortgage activity. This was
offset by a reduction of $486 in loan broker fees due to a reduction in volume
from 2003. Offsetting the improvements in revenue during 2004 was a $175
increase from 2003 in the provision for loan losses and a $2,046 increase in
noninterest expenses related mainly to infrastructure growth costs for
compensation, occupancy and equipment. Additionally, loan and professional
expenses increased during 2004 due to administrative expenses relating to the
unauthorized mortgage activity and other matters.
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.
20
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, 2004 were $20,965 and $6,649, respectively,
netting $14,316 in net interest income. Interest income and interest expense for
the year ended December 31, 2003 were $17,826 and $6,061, respectively,
resulting in $11,765 in net interest income. Interest income and interest
expense for the year ended December 31, 2002 totaled $16,494 and $6,444,
respectively, providing for net interest income of $10,050. The substantial
increase of $2,551 in net interest income in 2004 from 2003 and the increase
over net interest income from 2002 were primarily attributable to an increase in
the loans outstanding in both years, as well as an increase in the prime lending
rate during 2004.
The net yield on average earning assets during 2004 was 3.31% compared to 3.04%
for 2003 and 3.17% for 2002. The increase in margin during 2004 was attributable
to net interest spread expansion caused by the increase in general interest
rates and its effects on the Company's mostly variable rate mix of loans.
Management anticipates that margins will continue to improve due to the
Company's current asset-sensitive balance sheet, assuming interest rates
increase.
The level of net interest income is primarily a function of asset size, as the
weighted-average interest rate received on earning assets is greater than the
weighted average interest cost of funding sources; however, factors such as
types of assets and liabilities, interest rate risk, liquidity, and customer
behavior also impact net interest income as well as the net yield.
The following table reflects the average balance, interest earned or paid, and
yields or costs of the Company's assets, liabilities and stockholders' equity
during 2004, 2003 and 2002.
21
AVERAGE BALANCE, INTEREST AND YIELD/COST ANALYSIS
2004 2003 2002
--------------------------- --------------------------- ---------------------------
INTEREST INTEREST INTEREST
AVERAGE EARNED YIELD AVERAGE EARNED YIELD AVERAGE EARNED YIELD
($ 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 $ 4,998 $ 65 1.30% $ 5,659 $ 62 1.10% $ 6,042 $ 138 2.29%
Federal funds sold 10,418 112 1.08% 13,795 129 0.94% 16,535 266 1.61%
Securities - taxable 26,342 1,093 4.15% 10,906 377 3.46% 8,035 362 4.50%
Securities - tax exempt (1) 11,452 742 6.48% 2,967 168 5.66% 1,464 84 5.73%
Loans held for sale -- 777 42 5.48% 2,246 80 3.56%
Loans 386,587 19,205 4.97% 354,817 17,099 4.82% 283,899 15,593 5.49%
-------- ------- -------- ------- -------- -------
Total interest-earning assets 439,797 21,217 4.82% 388,921 17,877 4.60% 318,221 16,523 5.19%
Allowance for loan losses (5,272) (5,362) (4,094)
Cash and due from banks 12,908 10,219 7,258
Other assets 10,127 9,027 4,697
-------- -------- --------
Total assets $457,560 $402,805 $326,082
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing checking $ 23,316 $ 86 0.37% $ 17,550 $ 78 0.44% $ 13,707 $ 130 0.95%
Savings 11,448 36 0.31% 10,015 47 0.47% 6,452 91 1.41%
Money market 93,504 965 1.03% 109,575 1,253 1.14% 107,540 1,877 1.75%
Certificates of deposit 200,528 4,520 2.25% 156,186 3,806 2.44% 115,283 3,562 3.09%
Short-term borrowings 656 9 1.37% 1,257 13 1.03% 1,383 22 1.59%
FHLB advances 26,680 708 2.65% 19,579 536 2.74% 14,634 445 3.04%
Junior Subordinated Debt 3,608 325 9.01% 3,608 327 9.06% 3,608 318 8.80%
-------- ------- -------- ------- -------- -------
Total interest-bearing liabilities 359,740 6,649 1.85% 317,770 6,060 1.91% 262,607 6,445 2.46%
Noninterest-bearing checking 53,987 44,133 33,386
Other liabilities 1,756 1,129 1,025
Stockholders' equity 42,077 39,773 29,064
-------- -------- --------
Total liabilities and
stockholders' equity $457,560 $402,805 $326,082
======== ======== ========
NET INTEREST INCOME $14,568 $11,817 $10,078
======= ======= =======
RATE SPREAD 2.97% 2.69% 2.73%
NET INTEREST INCOME AS A PERCENT OF
AVERAGE EARNING ASSETS 3.31% 3.04% 3.17%
(1) Computed on a tax equivalent basis for tax equivalent securities using a
34% statutory tax rate.
The following table shows the changes in interest income, interest expense, and
net interest income due to variances in rate and volume of average earning
assets and interest-bearing liabilities. The change in interest not solely due
to changes in rate or volume has been allocated in proportion to the absolute
dollar amounts of the change in each.
22
CHANGES IN NET INTEREST INCOME DUE
TO RATE AND VOLUME
2004 OVER 2003
------------------------
($ in thousands) RATE VOLUME TOTAL
- ---------------- ------ ------ ------
INCREASE (DECREASE) IN INTEREST INCOME:
Short-term investments and interest-
earning deposits $ 11 $ (8) $ 3
Federal funds sold 18 (35) (17)
Securities - taxable 89 627 716
Securities - tax exempt 28 546 574
Loans available for sale -- (44) (44)
Loans 540 1,566 2,106
------ ------ ------
Net change in interest income 686 2,652 3,338
INCREASE (DECREASE) IN INTEREST EXPENSE:
Interest-bearing checking (15) 23 8
Savings (18) 7 (11)
Money market (115) (173) (288)
Certificates of deposit (302) 1,016 714
Short-term borrowings 3 (7) (4)
FHLB advances (17) 189 172
Trust preferred securities (2) -- (2)
------ ------ ------
Net change in interest expense (466) 1,055 589
------ ------ ------
NET CHANGE IN INTEREST INCOME AND
INTEREST EXPENSE $1,152 $1,597 $2,749
====== ====== ======
2003 OVER 2002
-------------------------
($ 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
======= ====== ======
Interest income is primarily generated from the loan portfolio. Average loans
comprised 88%, 91% and 89% of average earning assets during 2004, 2003 and 2002,
respectively. During 2004, the loan portfolio had an average yield of 4.97%, and
earned $19,205, or 91% of total interest income, an increase of $2,106 from
2003. The improvement in net interest income was mainly due to the increase in
average loans along with the impact from the increase in the prime lending rate
during 2004. During 2003, the loan
23
portfolio had an average yield of 4.82% and earned $17,099, or 96% of total
interest income while the loan portfolio had an average yield of 5.49% and
earned $15,593, or 94% of total interest income during 2002.
The total securities portfolio and total short-term investments equaled 9% and
3%, respectively, of average earning assets during 2004. With an average
tax-equivalent yield of 4.86%, total securities contributed $1,835, or 8% of
total interest income in 2004, while total short-term investments had a combined
average yield of 1.15% and earned $177, or 1% of total interest income, in 2004.
During 2003, the total securities portfolio and total short-term investments
equaled 4% and 5%, respectively, of average earning assets. With an average
yield of 3.93%, 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 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.
Interest expense is primarily generated from money market deposits and
certificates of deposit, which equaled 26% and 56%, respectively, of average
interest-bearing liabilities during 2004; 34% and 49%, respectively of average
interest-bearing liabilities during 2003; and 41% and 44%, respectively, of
average interest-bearing liabilities during 2002. The percentage change within
the money market category reflects the decrease in this type of funding during
2004, 2003, and 2002, with reductions mainly from business and municipal funds
as these depositors sought greater yields. CD balances grew during 2004 and 2003
as a percent of earning assets reflective of growth from brokered and national
market sources. Total borrowings were 7% of average earning assets during 2004,
up from the 6% level in 2003 and 2002.
Money market balances had an average rate of 1.03% and cost $965, or 15% of
total interest expense, in 2004 compared to an average rate of 1.14% and cost
$1,253, or 21% of total interest expense, in 2003. Certificates of deposit had
an average rate of 2.25% and cost $4,520, or 68% of total interest expense, in
2004 compared to an average rate of 2.44% and cost $3,806, or 63% of total
interest expense, in 2003. Interest expense on savings and interest-bearing
checking totaled 1% of total interest expense during 2004, down slightly from 2%
in 2003. The Company paid $1,042 of interest expense on borrowings, or 16% of
total interest expense, during 2003 and paid $876 of interest expense on
borrowings, or 14% of total interest expense, during 2003. The increase in
borrowing cost during 2004 compared to 2003 is reflective of the higher levels
of FHLB advances.
During 2002, money market accounts had an average rate of 1.75% and cost $1,877
or 29% of total interest expense, while certificates of deposit had an average
rate of 3.09% and cost $3,562, or 55% of total interest expense. Savings
deposits and interest-bearing checking accounts totaled 8% of average
interest-bearing liabilities during 2002 with an average rate of 1.10%, or 3% of
total interest expense in 2002. Total borrowings had an average rate of 4.00%
during 2002.
Provision for Loan Losses. Driven by net charge-offs and continued significant
loan growth, the provision for loan losses was $2,360 for 2004, $2,185 for 2003
and $1,765 for 2002. This reflects a $175, or 8.0%, increase from 2004 to 2003.
The allowance for loan losses as a percentage of total loans outstanding was
1.40%, 1.40% and 1.48% at December 31, 2004, 2003, and 2002, 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. Given the lack of seasoning of the Bank's
portfolio in addition to considering the Company's loss history, management has
established the provision and allowance for loan losses in part based on the
loss experience of peer financial institutions with similar heavy concentrations
in commercial lending and in part based on general trends in the economy.
The Company had $1,580 of nonperforming loans at December 31, 2004, a decrease
of $325 from the $1,905 of nonperforming loans at December 31, 2003. The Company
reported $2,011 of net charge-offs,
24
or .52% of average loans during 2003 compared to $1,671 in net charge offs or
..47% of average loans during 2003.
Noninterest Income. Noninterest income recorded substantial growth during 2004
as all major categories reflected improved performance. Total noninterest income
was $4,274 for the year ended December 31, 2004 compared to $3,642 and $2,954
for the years ended December 31, 2003 and 2002, respectively. Fees from trust
services grew 20.3% resulting from an increasing base of accounts and assets
under management and was $1,687 for 2004 compared to $1,402 for 2003 and $1,085
in 2002. Mortgage broker fees were $327 during 2004, a decrease of $486 or 59.8%
from $813 for 2003. Mortgage broker fees were $782 for 2002. The decrease was
attributable to a rising interest rate environment, as well as a decline in the
number of applicants due to the high volume in previous years. Deposit service
charges remained relatively flat in 2004, showing a decrease of $16 or 2.6% from
2003. Deposit service charges increased $218 or 52.3% between 2003 and 2002.
Service charge income increased in 2003 due to an overall expanded account base,
a higher level of fees generated on business accounts and increased activity
from NSF/OD charges. In November 2004, the Bank received a reimbursement from
its insurance carrier against losses recorded for the unauthorized mortgage
issue detected in 2002. The reimbursement received was for $860, however the
Bank incurred expenses and losses against this claim of $241, $1,055, and $428
in 2004, 2003, and 2002 respectively. Other fee income increased mainly as a
result of income generated from bank-owned life insurance (BOLI). In addition to
the above, 2004 noninterest income results included $154 in gains on the sale of
securities available for sale compared to gains on the sale of securities and
loans totaling $191 during 2003 and $276 in 2002.
Noninterest Expense. Noninterest expense totaled $12,399 for the year ended
December 31, 2004 compared to $10,353 and $8,416 for the years ended December
31, 2003 and 2002, respectively, an increase of $2,046 or 19.8% during 2004 over
2003. The increase in expenses is mainly attributable to the infrastructure
growth of the Company, including the addition of the fourth branch and mortgage
loan origination office. This is evidenced by salary and benefit costs, which
increased $1,351, or 24.5%, and occupancy and equipment costs which increased
$384, or 31.0%, over their respective 2003 levels. Salary and benefits costs
were $6,867 or 55.4% of total expenses for 2004, while occupancy and equipment
costs were $1,621 or 13.1% of total expenses. Loan and professional costs
increased during 2004 from prior year levels by $439 or 51.3%. The increase was
attributable to litigation costs related to the unauthorized mortgage issue
insurance settlement, increased accounting and auditing fees, nonrecurring
upfront consulting costs for future loan and fee origination processes, and
legal and accounting expenses related to exploring various strategic
alternatives considered by the Company. Other various expense categories
increased during 2004, 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 $830 for 2004, $1,172 for 2003 and a $1,086
for 2002, which reflected a $342, or 29.2% decrease in 2004 and, $86 or 7.9%
increase in 2003, 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 2003, salaries and benefits costs were $5,516, while occupancy and
equipment expenses totaled $1,237. Additional large overhead expenses in 2003
included costs for loan and professional fees and services, which amounted to
$856, and marketing expenses of $353. Significant noninterest expenses during
2002 were $4,604 for salary and benefit costs, $1,044 for occupancy and
equipment costs, and $471 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 66.7% in 2004 compared to 67.2% in 2003 and 64.7% in
2002. The overall level of efficiency ratio continues to be high, but reflects
expected infrastructure costs associated with growth as well as certain
non-recurring costs discussed above. As anticipated, improvement in the
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.
25
Income Taxes Expense. During 2004, 2003 and 2002, the Company recorded $1,351,
$1,069 and $1,108 respectively, in income taxes expense. The effective tax rate
recorded for 2004 was 35.3% as compared to 37.3% for 2003 and 39.2% for 2002.
The effective tax rate decreased from the prior years as the Company grew its
tax-exempt security portfolio in 2002, 2003 and 2004 and purchased bank-owned
life insurance (BOLI) during 2003.
CAPITAL SOURCES
Stockholders' equity is a noninterest-bearing source of funds, which provides
support for asset growth. Stockholders' equity was $44,013 and $40,909 at
December 31, 2004 and 2003, respectively. Affecting the increase in
stockholders' equity during 2004 was net income of $2,479 and $630 from the net
exercise of stock options. Stockholders' equity increased during 2003 primarily
from net income amounting to $1,800.
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.Currently, 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, 2004 and 2003 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 2004 or 2003. 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 2004 2003
- ---------------------------- ------ ------
Loan to deposit ratio 103.66% 103.85%
Loan to funding ratio 92.00% 95.51%
Total risk-based capital 12.29% 12.66%
Tier 1 risk-based capital 11.08% 11.44%
Tier 1 leverage capital 9.87% 10.26%
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 2004 and
2003. 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, 2004, the balance of non-brokered national
market CDs, brokered CDs, and FHLB borrowings were $25,491, $63,286 and $45,000
respectively, as compared to $45,970, $25,208 and $27,000, respectively, at
December 31, 2003. At December 31, 2004 and 2003,
26
total deposits were $386,380 and $362,877, respectively, and the loan-to-deposit
ratio was 103.7% and 103.8%, 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 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 had balances of $200 at
December 31, 2004 and $1,060 at December 31, 2003. Additional capacity to borrow
overnight in the form of unused lines of commitment from correspondent banks
totaled $45,000 and $27,000 at December 31, 2004 and 2003, 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.
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, 2004.
27
CONTRACTUAL OBLIGATIONS
at December 31, 2004
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 $28,500 $10,000 $ 6,500 $45,000
Junior subordinated debt 3,608 3,608
Operating leases 697 1,458 1,525 2,765 6,445
Other 0
------- ------- ------ ------- -------
Total contractual cash obligations $29,197 $11,458 $1,525 $12,873 $55,053
======= ======= ====== ======= =======
COMMITMENTS
at December 31, 2004
AMOUNT OF COMMITMENT EXPIRATIONS PER PERIOD
--------------------------------------------------
LESS THAN 1-3 4-5 AFTER 5
($ in thousands) 1 YEAR YEARS YEARS YEARS TOTAL
- ---------------- --------- ------- ------- ------- --------
Lines of credit / loan commitments $59,949 $15,958 $16,349 $11,898 $104,154
Standby letters of credit 2,415 144 300 2,859
------- ------- ------- ------- --------
Total commercial commitments $62,364 $16,102 $16,649 $11,898 $107,013
======= ======= ======= ======= ========
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, 2004 and 2003, the Bank had $21,831 and
$23,260, respectively, in loan commitments to directors and executive officers,
of which $16,363 and $17,617 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.
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. In March 2004, an amendment was executed to add 8,336 square feet
to the leased premises under the same terms as the original lease. The total
amount paid to Tippmann Properties by the Company and the Bank for rent and
maintenance was $484, $416 and $348 during 2004, 2003 and 2002, 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
28
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 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, 2004:
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 $ 25,314 $ 25,314
Securities available for sale 348 1,417 8,837 24,423 35,025
FHLBI and FRB stock 3,233 3,233
Fixed rate loans 15,374 37,256 70,806 13,895 137,331
Variable rate loans 263,181 263,181
Allowance for loan losses (5,608)
Other assets 22,641
-------- -------- ------- ------- --------
TOTAL ASSETS $304,217 $ 38,673 $79,643 $41,551 $481,117
======== ======== ======= ======= ========
LIABILITIES
Interest-bearing checking $ 27,787 $ 27,787
Savings accounts 12,936 12,936
Money market accounts 74,017 74,017
Time deposits < $100,000 20,697 16,581 31,921 21 69,220
Time deposits $100,000 and over 45,486 57,276 41,858 144,620
Short-term borrowings 200 200
FHLB advances 8,500 30,000 6,500 45,000
Junior subordinated debt 3,608 3,608
Noninterest-bearing checking 57,801
Other liabilities 1,915
-------- -------- ------- ------- --------
Total liabilities 189,623 103,857 80,279 3,629 437,104
STOCKHOLDERS' EQUITY 44,013
-------- -------- ------- ------- --------
Total sources of funds $189,623 $103,857 $80,279 $ 3,629 $481,117
-------- -------- ------- ------- --------
Net asset (liability) GAP $114,594 $(65,184) $ (636) $37,922 $
-------- -------- ------- ------- --------
CUMULATIVE GAP $114,594 $ 49,410 $48,774 $86,696 $
-------- -------- ------- ------- --------
PERCENT OF CUMULATIVE GAP TO
TOTAL ASSETS 23.8% 10.3% 10.1% 18.0% %
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
29
resulting from potential changes in market interest rates. Key assumptions in
the model include prepayment speeds on various 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, 2004. 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.
PRINCIPAL AMOUNT MATURING IN:
-------------------------------------------------------------------------------------
FAIR VALUE
($ in thousands) 2005 2006 2007 2008 2009 THEREAFTER TOTAL 12/31/2004
- ---------------- -------- ------- ------- ------- ------- ---------- -------- ----------
Rate sensitive assets:
Fixed interest rate loans $ 54,749 $29,484 $20,565 $13,656 $11,188 $ 7,688 $137,330 $137,843
Average interest rate 5.97% 6.09% 6.01% 5.85% 5.46% 5.40% 5.89%
Variable interest rate loans 125,038 69,953 40,298 9,957 14,308 3,627 263,181 263,181
Average interest rate 5.48% 5.47% 5.50% 5.53% 5.21% 5.59% 5.47%
Fixed interest rate securities 1,765 3,592 874 1,164 3,207 24,423 35,025 35,025
Average interest rate 3.03% 2.76% 4.32% 3.84% 4.26% 4.46% 4.17%
Other interest bearing assets 25,314 25,314 25,314
Average interest rate 2.36% 2.36%
Rate sensitive liabilities:
Interest bearing checking 8,690 8,690 6,241 4,150 15 27,786 27,786
Average interest rate 0.49% 0.49% 0.39% 0.34% 0.69% 0.44%
Savings accounts 5,743 5,743 1,450 12,936 12,936
Average interest rate 0.37% 0.37% 0.37% 0.37%
Money market accounts 71,534 2,483 74,017 74,017
Average interest rate 1.31% 1.02% 1.30%
Time deposits 140,039 49,744 13,071 2,607 8,356 23 213,840 213,668
Average interest rate 2.17% 2.98% 3.91% 3.73% 3.97% 3.93% 2.56%
Fixed interest rate borrowings 8,500 10,000 10,108 28,608 29,752
Average interest rate 2.58% 2.65% 5.41% 3.60%
Variable interest rate borrowings 20,200 20,200 20,200
Average interest rate 1.95% 1.95%
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Tower Financial Corporation
CONSOLIDATED BALANCE SHEETS
At December 31, 2004 and 2003
2004 2003
------------ ------------
ASSETS
Cash and due from banks $ 11,911,033 $ 12,708,817
Short-term investments and interest-earning deposits 8,109,456 4,017,755
Federal funds sold 17,204,536 11,115,643
------------ ------------
Total cash and cash equivalents 37,225,025 27,842,215
Securities available for sale, at fair value 35,024,966 24,324,935
FHLB and FRB stock 3,232,500 2,332,500
Loans 400,510,491 376,838,578
Allowance for loan losses (5,607,992) (5,259,273)
------------ ------------
Net loans 394,902,499 371,579,305
Premises and equipment, net 2,984,596 2,932,580
Accrued interest receivable 1,969,610 1,289,370
Other assets 5,777,805 6,168,085
------------ ------------
Total assets $481,117,001 $436,468,990
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing $ 57,800,311 $ 62,638,230
Interest-bearing 328,579,595 300,238,538
------------ ------------
Total deposits 386,379,906 362,876,768
Short-term borrowings 200,000 1,060,000
Federal Home Loan Bank (FHLB) advances 45,000,000 27,000,000
Junior subordinated debt 3,608,000 3,608,000
Accrued interest payable 559,213 278,964
Other liabilities 1,356,412 736,609
------------ ------------
Total liabilities 437,103,531 395,560,341
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; 4,003,156 and 3,942,519 shares issued and outstanding
at December 31, 2004 and December 31, 2003, respectively 37,952,860 37,322,694
Retained earnings 6,040,155 3,560,844
Accumulated other comprehensive income, net of tax
of $13,637 in 2004 and $16,741 in 2003 20,455 25,111
------------ ------------
Total stockholders' equity 44,013,470 40,908,649
------------ ------------
Total liabilities and stockholders' equity $481,117,001 $436,468,990
============ ============
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, 2004, 2003 and 2002
2004 2003 2002
----------- ----------- -----------
INTEREST INCOME:
Loans, including fees $19,205,012 $17,141,325 $15,673,401
Securities - taxable 1,093,255 376,849 361,612
Securities - tax exempt 489,690 116,362 54,994
Other interest income 176,897 191,152 404,391
----------- ----------- -----------
Total interest income 20,964,854 17,825,688 16,494,398
INTEREST EXPENSE:
Deposits 5,607,090 5,184,506 5,659,440
Short-term borrowings 9,358 36,495 21,963
FHLB advances 707,568 512,475 445,396
Junior subordinated debt 324,720 327,060 317,633
----------- ----------- -----------
Total interest expense 6,648,736 6,060,536 6,444,432
----------- ----------- -----------
Net interest income 14,316,118 11,765,152 10,049,966
PROVISION FOR LOAN LOSSES 2,360,000 2,185,000 1,765,000
----------- ----------- -----------
Net interest income after provision
for loan losses 11,956,118 9,580,152 8,284,966
NONINTEREST INCOME:
Trust and brokerage fees 1,686,633 1,402,012 1,085,023
Service charges 619,951 635,917 417,471
Loan broker fees 326,835 813,051 781,909
Net gain on sale of loans 96,175
Net gain on sale of securities 154,338 190,766 180,351
Insurance settlement 860,000
Other fees 626,251 600,211 393,426
----------- ----------- -----------
Total noninterest income 4,274,008 3,641,957 2,954,355
NONINTEREST EXPENSE:
Salaries and benefits 6,867,061 5,515,892 4,604,488
Occupancy and equipment 1,620,794 1,237,281 1,044,155
Marketing 475,872 352,223 262,857
Data processing 379,221 356,092 282,737
Loan and professional costs 1,294,783 856,320 470,723
Office supplies and postage 333,622 274,576 230,032
Courier services 306,836 281,460 243,711
Business development 294,127 307,082 190,999
Other expense 827,060 1,172,067 1,086,490
----------- ----------- -----------
Total noninterest expense 12,399,376 10,352,993 8,416,192
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,830,750 2,869,116 2,823,129
Income taxes expense 1,351,440 1,069,050 1,107,500
----------- ----------- -----------
NET INCOME $ 2,479,310 $ 1,800,066 $ 1,715,629
=========== =========== ===========
BASIC EARNINGS PER COMMON SHARE $ 0.63 $ 0.46 $ 0.57
DILUTED EARNINGS PER COMMON SHARE $ 0.61 $ 0.45 $ 0.56
Average common shares outstanding 3,959,837 3,933,339 3,008,145
Average common shares and dilutive
potential common shares outstanding 4,054,040 4,007,036 3,069,648
The following notes are an integral part of the financial statements.
32
Tower Financial Corporation
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the years ended December 31, 2004, 2003 and 2002
COMMON RETAINED ACCUMULATED
STOCK AND EARNINGS OTHER
PAID-IN (ACCUMULATED COMPREHENSIVE
CAPITAL DEFICIT) INCOME (LOSS) TOTAL
----------- ------------ ------------- -----------
BALANCE, JANUARY 1, 2002 $23,469,770 $ 45,149 $ (9,580) $23,505,339
Comprehensive Income
Net income for 2002 1,715,629 1,715,629
Change in net unrealized
appreciation (depreciation)
on securities available
for sale, net of tax of $155,328 232,973 232,973
-----------
Total Comprehensive Income 1,948,602
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,
and related tax benefit 64,360 64,360
----------- ----------- --------- -----------
BALANCE, DECEMBER 31, 2002 37,190,692 1,760,778 223,393 39,174,863
Comprehensive Income
Net income for 2003 1,800,066 1,800,066
Change in net unrealized
appreciation (depreciation)
on securities available
for sale, net of tax of $(132,187) (198,282) (198,282)
-----------
Total Comprehensive Income 1,601,784
Issuance of 11,335 shares of common
stock for stock options exercised,
and related tax benefit 132,002 132,002
----------- --------- --------- -----------
BALANCE, DECEMBER 31, 2003 37,322,694 3,560,844 25,111 40,908,649
Comprehensive Income
Net income for 2004 2,479,311 2,479,311
Change in net unrealized
appreciation (depreciation)
on securities available
for sale, net of tax of $(3,104) (4,656) (4,656)
-----------
Total Comprehensive Income 2,474,655
Issuance of 60,637 shares of common
stock for stock options exercised,
and related tax benefit 630,166 630,166
----------- ---------- --------- -----------
BALANCE, DECEMBER 31, 2004 $37,952,860 $6,040,155 $ 20,455 $44,013,470
=========== ========== ========= ===========
The following notes are an integral part of the financial statements.
33
Tower Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------ ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,479,311 $ 1,800,066 $ 1,715,629
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization 678,163 602,589 405,672
Provision for loan losses 2,360,000 2,185,000 1,765,000
Earnings on life insurance (78,401) (127,384)
Net gain on sale of loans (96,175)
Net gain on sale of securities (154,338) (190,766) (180,351)
Net loss on sale of premises and equipment 2,778
FHLB stock dividend (59,300) (41,500)
Change in accrued interest receivable (680,240) (196,564) (138,001)
Change in other assets 471,785 (1,076,729) (668,356)
Change in accrued interest payable 280,249 6,661 (16,629)
Change in other liabilities 619,803 (375,154) 352,791
Origination of loans held for sale (15,956,100) (32,660,100)
Proceeds from sales of loans held for sale 21,725,800 31,183,750
------------ ------------ -------------
Net cash from operating activities 5,917,032 8,358,697 1,663,230
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in loans (36,945,617) (72,891,522) (113,770,421)
Net change in interest-earning deposits 2,806,000
Purchase of securities available for sale (AFS) (27,336,537) (21,755,180) (14,493,462)
Purchase of FHLB and FRB stock (840,700) (233,500) (960,000)
Purchase of life insurance (3,000,000)
Proceeds from maturities of securities AFS 10,211,986 5,193,600 3,087,096
Proceeds from sale of securities AFS 6,507,180 3,174,780 3,176,070
Proceeds from sale of participation loans 11,262,423 15,721,491 24,277,313
Purchase of equipment and leasehold expenditures (666,261) (819,613) (1,445,028)
------------ ------------ -------------
Net cash from investing activities (37,807,526) (74,609,944) (97,322,432)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits 23,503,138 52,292,781 54,430,920
Net change in short-term borrowings (860,000)
Gross proceeds from issuance of common stock
from exercise of stock options and related tax benefits 630,166 132,002 64,360
Net proceeds from issuance of common stock
from stock offering 13,656,562
Proceeds from FHLB advances 36,000,000 16,500,000 20,000,000
Repayment of FHLB advances (18,000,000) (11,000,000) (5,000,000)
------------ ------------ -------------
Net cash from financing activities 41,273,304 57,924,783 83,151,842
------------ ------------ -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 9,382,810 (8,326,464) (12,507,360)
Cash and cash equivalents, beginning of period 27,842,215 36,168,679 48,676,039
------------ ------------ -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 37,225,025 $ 27,842,215 $ 36,168,679
============ ============ =============
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 6,368,487 $ 6,053,875 $ 6,461,061
Income taxes 94,262 1,896,076 1,725,480
The following notes are an integral part of the financial statements.
Tower Financial Corporation
34
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. The
Company's wholly-owned, statutory trust subsidiary, Tower Capital Trust 1
("TCT1"), was formed on November 1, 2001 for the single purpose of issuing
trust preferred securities.
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, 2004, commercial
and commercial real estate loans totaled approximately 78.5% of total
loans, residential real estate loans totaled approximately 11.3% and home
equity and consumer loans totaled approximately 10.2%. Categories by
industry of commercial loans at December 31, 2004 exceeding 30% of year-end
stockholders' equity are as follows: real estate (including owner-occupied
and investment) - $124.6 million, or 31.1% of total loans; wholesale and
retail trade - $46.0 million, or 11.5% of total loans; building,
development and general contracting - $63.7 million, or 15.9% of total
loans; health care and social assistance - $26.9 million, or 6.7% of total
loans; manufacturing - $16.2 million, or 4.0% of total loans; and
professional, scientific and technical services - $12.2 million, or 3.0% 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, TCT1 had previously been consolidated with the Company
and 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 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
35
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. Declines in fair value
of securities below their cost that are other than temporary are reflected
as realized losses. In estimating other-than-temporary losses, management
considers: (1) the length of time and extent that fair value has been less
than cost, (2) the financial condition and near term prospects of the
issuer, and (3) the Company's ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value.
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.
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 incurred losses 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 to identified
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, as well as peer industry data of comparable banks.
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 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
36
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, 39 years; site improvements, 15
years; leasehold improvements, 10 years; furniture and equipment, 5 to 8
years; and software and computer equipment, 3 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 $3,205,785 and $3,127,384, at December 31, 2004 and 2003
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.
2004 2003 2002
---------- ---------- ----------
Net income as reported $2,479,311 $1,800,066 $1,715,629
Deduct: Stock-based compensation expense
determined under fair value-based method (131,737) (146,607) (126,673)
---------- ---------- ----------
Pro forma net income $2,347,574 $1,653,459 $1,588,956
Basic earnings per share as reported $ 0.63 $ 0.46 $ 0.57
Pro forma basic earnings per share 0.59 0.42 0.53
Diluted earnings per share as reported 0.61 0.45 0.56
Pro forma diluted earnings per share 0.58 0.41 0.52
The pro forma effects are computed using option pricing models, which
incorporate the following weighted average assumptions as of grant date.
2004 2003 2002
------- ------- -------
Risk-free interest rate 4.08% 3.20% 4.81%
Expected option life 8 years 6 years 8 years
Expected stock price volatility 36.70% 25.74% 25.78%
Dividend yield None None None
37
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 2004 or 2003.
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.
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 $3.7 million and $4.0 million was required to meet regulatory
reserve and clearing requirements at December 31, 2004 and 2003,
respectively. These balances do not earn interest.
ADOPTION OF NEW ACCOUNTING STANDARDS: During 2004, the Company did not
adopt any new standards.
EFFECT OF NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS: FAS 123,
Revised, requires all public companies to record compensation cost for
stock options provided to employees in return for employee service. The
cost is measured at the fair value of the options when granted, and this
cost is expensed over the employee service period, which is normally the
38
vesting period of the options. This will apply to awards granted or
modified after the first quarter or year beginning June 15, 2005.
Compensation cost will also be recorded for prior option grants that vest
after the date of adoption. The effect on results of operations will depend
on the level of future option grants and the calculation of the fair value
of the options granted at such future date, as well as the vesting periods
provided, and so cannot currently be predicted. Existing options that will
vest after adoption date are expected to result in additional compensation
expense of approximately $131,000 during the balance of 2005, $71,400 in
2006, $36,000 in 2007, and $17,000 in 2008. There will be no significant
effect on financial position as total equity will not change.
RECLASSIFICATIONS: Certain items from the prior period financial statements
were reclassified to conform to the current presentation.
Note 2 - SECURITIES AVAILABLE FOR SALE
The fair value of securities available for sale at December 31, 2004 and
2003 were as follows:
2004
-------------------------------------------------
CARRYING GROSS UNREALIZED GROSS UNREALIZED
VALUE GAINS LOSSES
----------- ---------------- ----------------
U.S. Government agency debt obligations $14,926,445 $ 17,388 $ (65,205)
Obligations of states and political
subdivisions 12,796,879 153,005 (68,458)
Mortgage-backed securities 7,301,642 10,860 (13,498)
----------- -------- ---------
TOTAL $35,024,966 $181,253 $(147,161)
=========== ======== =========
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 $24,324,935 $118,323 $(76,471)
=========== ======== ========
The fair values of debt securities available for sale at December 31, 2004, 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.
39
Note 2 - SECURITIES AVAILABLE FOR SALE (CONTINUED)
12/31/2004 12/31/2003
WEIGHTED 12/31/2004 WEIGHTED 12/31/2003
AVERAGE CARRYING AVERAGE CARRYING
YIELD (1) VALUE YIELD (1) VALUE
---------- ----------- ---------- ----------
AGENCIES:
Due in one year or less 2.44% $ 992,050 % $
Due after one to five years 3.36% 5,958,900 3.49% 5,013,815
Due after five years 4.63% 7,975,495 3.13% 4,038,209
---- ----------- ---- ----------
Total Agencies 4.26% $14,926,445 3.33% $9,052,024
---- ----------- ---- ----------
MORTGAGE-BACKED SECURITIES:
Mortgage-backed securities 4.13% $ 7,301,642 3.87% $7,419,187
---- ----------- ---- ----------
OBLIGATIONS OF STATE AND POLITICAL SUBDIVISIONS:
Due in one year or less 5.83% $ 618,496 5.17% $ 632,935
Due after one to five years 5.31% 791,748 5.70% 1,175,579
Due after five years 6.46% 11,386,635 6.48% 6,045,210
---- ----------- ---- ----------
Total Obligations of state and political subdivisions 6.36% $12,796,879 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 2004 totaled
$6,507,180. Gross gains and losses realized were $154,338 and $0, with an
approximate tax provision of $55,550 and $0. 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, with an approximate tax provision of
$68,700 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,
with an approximate tax provision of $65,000 and $0.
Securities with a carrying value of $16,823,718 and $12,434,104 were pledged to
secure borrowings from the FHLB at December 31, 2004 and 2003, respectively. At
December 31, 2004, 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 2004 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 $11,917,092 $ (65,205) $ $ $11,917,092 $ (65,205)
obligations
Obligations of states and political
subdivisions 4,282,565 (68,458) 4,282,565 (68,458)
Mortgage-backed securities 5,002,392 (13,498) 5,002,392 (13,498)
----------- --------- --- --- ----------- ---------
Total temporarily impaired $21,202,049 $(147,161) $ $ $21,202,049 $(147,161)
=========== ========= === === =========== =========
40
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 $3,017,775 $(30,815) $ $ $3,017,775 $(30,815)
obligations
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.
The Company evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to the length of time and extent to
which fair value has been less than cost, the financial condition and near-term
prospects of the issuer, and the intent and ability of the Company to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. In analyzing an issuer's financial
condition, the Company may consider whether the securities issued by the federal
government or its agencies, whether downgrades by bond rating agencies have
occurred, and the results of reviews of the issuer's financial condition.
41
Note 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans at December 31, 2004 and 2003 were as follows:
2004 2003
-------------------- --------------------
BALANCE % BALANCE %
------------ ----- ------------ -----
Commercial $189,716,723 47.4% $198,063,494 52.6%
Commercial real estate 124,721,982 31.2% 100,309,154 26.6%
Residential real estate 45,080,544 11.3% 40,648,402 10.8%
Home equity 28,430,284 7.1% 25,943,402 6.9%
Consumer 12,239,365 3.1% 11,593,808 3.1%
------------ ----- ------------ -----
Total loans 400,188,898 100.0% 376,558,260 100.0%
Net deferred loan costs 321,593 280,318
Allowance for loan losses (5,607,992) (5,259,273)
------------ ------------
NET LOANS $394,902,499 $371,579,305
============ ============
Activity in the allowance for loan losses during 2004, 2003, 2002, 2001 and 2000
was as follows:
2004 2003 2002 2001 2000
----------- ----------- ---------- ---------- ----------
Beginning balance, January 1 $ 5,259,273 $ 4,745,672 $3,480,205 $2,364,509 $1,009,509
Provision charged to operating
expense 2,360,000 2,185,000 1,765,000 1,120,000 1,355,000
Charge-offs:
Commercial (926,781) (940,306) (479,375) (4,304)
Commercial real estate (1,007,783) (54,442) (579)
Residential real estate (489,326)
Home equity (114,903) (97,600) (22,284)
Consumer (7,394) (123,379) (1,834)
----------- ----------- ---------- ---------- ----------
Total Charge-offs (2,056,861) (1,705,053) (504,072) (4,304) --
----------- ----------- ---------- ---------- ----------
Recoveries:
Commercial 29,374 2,417
Commercial real estate 579 472
Residential real estate 11,000
Home equity 16,206 866 4,067
Consumer 18,792
----------- ----------- ----------
Total Recoveries 45,580 33,654 4,539
----------- ----------- ---------- ---------- ----------
Total Net Charge-offs (2,011,281) (1,671,399) (499,533) (4,304) --
----------- ----------- ---------- ---------- ----------
ENDING BALANCE, DECEMBER 31 $ 5,607,992 $ 5,259,273 $4,745,672 $3,480,205 $2,364,509
=========== =========== ========== ========== ==========
42
Note 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
Impaired loans were as follows:
at December 31,
----------------------------------
2004 2003 2002
---------- ---------- --------
Year-end loans with no allocated allowance
for loan losses $ $ 154,499 $
Year-end loans with allocated allowance
for loan losses 5,095,389 2,001,005 632,137
---------- ---------- --------
TOTAL IMPAIRED LOANS $5,095,389 $2,155,504 $632,137
========== ========== ========
Amount of the allowance for loan losses allocated $1,808,000 $ 807,000 $181,100
Average of impaired loans during the year $5,567,582 $1,732,787 $727,286
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,
-----------------------------------------------------
2004 2003 2002 2001 2000
----------- ---------- -------- -------- ----
Loans past due over 90 days
still accruing $ 676,866 $ 290,375 $ 87,304 $347,233 $
Nonaccrual loans 1,580,003 1,614,447 632,137 468,863
---------- ---------- -------- -------- ----
Total nonperforming loans 2,256,869 1,904,822 719,441 816,096
---------- ---------- -------- -------- ----
Other real estate owned 430,000 80,000
---------- ---------- -------- -------- ----
TOTAL NONPERFORMING ASSETS $2,686,869 $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, 2004 and 2003 for $253,131, included in impaired loans. There
were no troubled debt restructurings at December 31, 2002. There were two
other real estate owned properties at December 31, 2004 for $430,000 and
one at December 31, 2003 for $80,000. There was no other real estate owned
property at year-end in prior years.
Note 4 - PREMISES AND EQUIPMENT, NET
Premises and equipment at December 31, 2004 and 2003 were as follows:
2004 2003
----------- -----------
Land $ 350,179 $ 350,179
Buildings 200,442 200,442
Leasehold improvements 970,893 749,707
Furniture and equipment 3,538,318 3,096,747
----------- -----------
Subtotal 5,059,832 4,397,075
Accumulated depreciation (2,075,236) (1,464,495)
----------- -----------
PREMISES AND EQUIPMENT, NET $ 2,984,596 $ 2,932,580
=========== ===========
Information regarding lease commitments and commitments to purchase fixed
assets is provided in Note 12.
43
Note 5 - DEPOSITS
Deposits at December 31, 2004 and 2003 are summarized as follows:
2004 2003
-------------------- --------------------
BALANCE % BALANCE %
------------ ----- ------------ -----
Noninterest-bearing demand $ 57,800,311 15.0% $ 62,638,230 17.3%
Interest-bearing checking 27,786,693 7.2% 23,543,523 6.5%
Money market 74,017,465 19.2% 98,250,351 27.1%
Savings 12,935,798 3.3% 10,575,908 2.9%
Time, under $100,000 69,220,287 17.9% 63,028,461 17.4%
Time, $100,000 and over 144,619,352 37.4% 104,840,295 28.8%
------------ ----- ------------ -----
TOTAL DEPOSITS $386,379,906 100.0% $362,876,768 100.0%
============ ===== ============ =====
The following table shows the maturity distribution for certificates of
deposit at December 31, 2004.
UNDER $100,000
$100,000 AND OVER TOTAL
----------- ------------ ------------
2005 $37,331,850 $102,761,489 $140,093,339
2006 23,045,844 26,617,335 49,663,179
2007 7,121,994 5,949,135 13,071,129
2008 1,216,656 1,418,345 2,635,001
2009 482,663 7,873,048 8,355,711
2010 & thereafter 21,280 -- 21,280
----------- ------------ ------------
TOTAL $69,220,287 $144,619,352 $213,839,639
=========== ============ ============
Deposits accepted from brokers totaled $63.3 million and $25.2 at December
31, 2004 and 2003, respectively.
Note 6 - SHORT-TERM BORROWINGS
Information relating to short-term borrowings, comprised of federal funds
purchased at December 31, 2004 and 2003 is summarized below:
2004 2003
---------- ----------
Outstanding balance at year-end $ 200,000 $1,060,000
Interest rate at year-end 2.19% 0.69%
Average balance during the year $ 656,183 $1,257,260
Average interest rate during the year 1.37% 1.03%
Maximum month-end balance during the year $1,085,000 $1,060,000
At December 31, 2004 and 2003, the Bank had $23,500,000 and $27,000,000,
respectively, in lines of credit available from correspondent banks to
purchase federal funds.
44
Note 7 - FEDERAL HOME LOAN BANK ADVANCES
At December 31, 2004 and 2003, advances from the Federal Home Loan Bank
("FHLB") were:
2004 2003
----------- -----------
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
1.95% variable rate advance, principal due at maturity June 27, 2005 15,000,000
1.95% variable rate advance, principal due at maturity June 29, 2005 5,000,000
2.60% bullet advance, principal due at maturity June 20, 2005 1,000,000
2.00% bullet advance, principal due at maturity March 10, 2006 5,000,000
3.29% bullet advance, principal due at maturity June 19, 2006 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 3,000,000
2.37% bullet advance, principal due at maturity December 29, 2005 3,000,000 3,000,000
3.42% bullet advance, principal due at maturity June 18, 2004 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 $45,000,000 $27,000,000
=========== ===========
Of the total FHLB borrowings at December 31, 2004 and 2003, 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.
At December 31, 2004 scheduled principal reductions on these FHLB advances
were as follows:
YEAR ADVANCES
---------- -----------
2005 $28,500,000
2006 10,000,000
2007 --
2008 --
2009 --
Thereafter 6,500,000
-----------
TOTAL $45,000,000
===========
At December 31, 2004, in addition to FHLB stock, the Company pledged
securities with the FHLB totaling $16.8 million. In addition, as of
December 31, 2004, the Company pledged loans totaling approximately $129.9
million under a blanket collateral agreement to secure advances
outstanding. Also, the Company had unpledged interest-bearing deposits with
the FHLB at December 31, 2004 totaling $8.4 million.
45
Note 8 - JUNIOR SUBORDINATED DEBENTURES AND TRUST PREFERRED SECURITIES
On November 16, 2001, TCT1 sold 3,500 of 9.00% fixed rate Trust Preferred
Securities with a par value of $1,000. The proceeds of the sale 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 thereunder 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, TCT1 was consolidated in the Company's financial statements,
with the Trust Preferred Securities issued by TCT1 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, TCT1 is no longer consolidated with the
Company. Accordingly, the Company does not report the securities issued by
TCT1 as liabilities, and instead reports as liabilities the junior
subordinated debentures issued by the Company and held by TCT1, 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 TCT1 does not
significantly change the amounts reported as the Company's assets,
liabilities, equity, or interest expense.
46
Note 9 - INCOME TAXES
The consolidated provision for income taxes for the following years ended
December 31 are as follows:
2004 2003 2002
---------- ---------- ----------
Federal - current $ 997,516 $ 596,296 $1,270,967
- deferred 28,744 231,874 (348,598)
State - current 352,005 177,355 301,062
- deferred (26,825) 63,525 (115,931)
---------- ---------- ----------
TOTAL INCOME TAXES EXPENSE $1,351,440 $1,069,050 $1,107,500
========== ========== ==========
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:
2004 2003 2002
---- ---- ----
Statutory tax rate 34.0% 34.0% 34.0%
State tax, net of federal income tax effect 5.6% 5.5% 4.3%
Tax exempt interest (4.4)% (1.4)% (0.7)%
Earnings on life insurance (0.7)% (1.5)%
Other 0.7% 0.7% 1.6%
---- ---- ----
EFFECTIVE TAX RATE 35.2% 37.3% 39.2%
==== ==== ====
The net deferred tax asset included the following amounts of deferred tax
assets and liabilities at December 31, 2004 and 2003:
2004 2003
---------- ----------
DEFERRED TAX ASSETS:
Provision for loan losses $1,790,680 $1,761,583
Start-up / pre-opening expenses 4,930
Deferred compensation 71,101 39,843
Accrued Directors Fees 99,164 67,527
Other
---------- ----------
Total deferred tax assets 1,960,945 1,873,883
---------- ----------
DEFERRED TAX LIABILITIES:
Depreciation (279,809) (263,865)
Prepaid expenses (69,899) (67,395)
Net deferred loan costs (123,775) (108,679)
Net unrealized appreciation on securities
available for sale (13,637) (20,666)
Other (59,311) (3,874)
---------- ----------
Total deferred tax liabilities (546,431) (464,479)
---------- ----------
Net deferred tax asset before asset valuation 1,414,514 1,409,404
Valuation allowance for deferred tax assets
---------- ----------
NET DEFERRED TAX ASSET $1,414,514 $1,409,404
========== ==========
47
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:
2004 2003 2002
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-------- -------- -------- -------- -------- --------
Beginning balance, January 1 400,353 $10.68 374,438 $10.35 337,400 $ 9.96
Granted 18,150 13.59 44,250 13.37 44,000 13.32
Exercised (60,637) 10.15 (11,335) 10.27 (5,952) 10.00
Forfeited (32,450) 12.38 (7,000) 11.03 (1,010) 10.19
-------- -------- --------
ENDING BALANCE, DECEMBER 31 325,416 10.75 400,353 10.68 374,438 10.35
======== ======== ========
Options exercisable at year-end 261,134 10.22 306,901 10.06 287,388 9.97
Weighted average fair value of
options granted during year $ 6.48 $ 4.32 $ 5.73
Options outstanding at December 31, 2004 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 5.97 500 $ 7.63
$8.00 - $8.99 3,250 8.32 5.88 2,875 8.31
$9.00 - $9.99 24,880 9.09 5.17 23,160 9.08
$10.00 - $10.99 219,886 10.06 4.33 213,411 10.05
$12.00 - $12.99 6,150 12.84 9.46 -- --
$13.00 - $13.99 63,250 13.48 7.89 21,188 13.48
$14.00 - $14.99 7,500 14.00 9.48 -- --
------- -------
TOTALS 325,416 261,134
======= =======
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, 2004 and 2003, the Bank had
$19,722,902 and $23,260,123, respectively in loan commitments to directors
and executive officers, of which $14,656,372 and $17,617,429 were funded at
the respective year-ends, as reflected in the following table.
48
LOANS TO DIRECTORS AND EXECUTIVE OFFICERS
2004 2003
----------- -----------
Beginning balance, January 1 $17,617,429 $16,608,693
New loans 7,746,452 10,418,320
Repayments (6,428,774) (8,112,787)
Other Changes (4,278,735) (1,296,797)
----------- -----------
ENDING BALANCE, DECEMBER 31 $14,656,372 $17,617,429
=========== ===========
Other changes include adjustments for loans applicable to one reporting
period that are excludable from the other reporting period.
During 2004, 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. 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. In March 2004, an amendment was
executed to add 8,336 square feet to the leased premises under the same
terms as the original lease. The total amount paid to Tippmann Properties
by the Company and the Bank for rent and maintenance was $483,901, $415,824
and $348,130 during 2004, 2003 and 2002, 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, 2004 and 2003, the rates on existing off-balance-sheet
instruments were equivalent to current market rates, considering the
underlying credit standing of the counterparties.
49
The Bank's maximum exposure to credit losses for loan commitments and
standby letters of credit outstanding at December 31, 2004 and 2003 was as
follows:
2004 2003
------------ -----------
Commitments to extend credit - Variable Rate $ 99,467,157 $79,025,623
Commitments to extend credit - Fixed Rate 4,686,934 3,723,720
Standby letters of credit 2,858,636 2,347,361
------------ -----------
TOTAL $107,012,727 $85,096,704
============ ===========
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, 2004 are as
follows:
YEAR LEASE COMMITMENTS
----- -----------------
2005 $ 696,726
2006 701,399
2007 757,014
2008 760,452
2009 763,977
Thereafter 2,765,043
----------
TOTAL $6,444,611
==========
The lease expense paid for operating leases for the facilities leased were
$615,227, $489,976 and $417,316 for 2004, 2003 and 2002, respectively.
EMPLOYMENT CONTRACTS: Under the terms of certain employment contracts, upon
the occurrence of certain events resulting in the severance of certain
senior officers' employment with the Company, payments may be required to
be made in excess of amounts that have been accrued.
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, 2004 and 2003, management had accrued a liability for this plan of
approximately $191,000 and $180,000, respectively, which is included in
other liabilities in the consolidated balance sheets. While the increase
from 2003 is minimal, the total bonus calculated for 2004 was $520,000, of
which $329,000 was paid out in December 2004.
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 2004, 2003 and 2002 plan year
matching 50% of the first 6% of the compensation contributed.
50
This contribution was also approved for 2004. The total contribution made
by the Company during 2004, 2003 and 2002 was approximately $107,000,
$102,000 and $83,000, 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 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 2004, 2003 and 2002 was approximately $10,000,
$(1,000) and $22,000 respectively, resulting in a deferred compensation
liability of approximately $42,000 and $31,000 as of December 31, 2004 and
2003.
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 2004 and 2003 was approximately $82,000 and $66,000
resulting in a deferred compensation liability of approximately $185,000
and $103,000 as of December 31, 2004 and 2003 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 plan's was approximately $216,000 and $139,000 at
December 31, 2004 and 2003 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 and was
approximately $77,000 in 2004 and $72,000 in 2003.
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, 2004 and
2003. Items which are not financial instruments are not shown.
2004 2003
----------------------------- -----------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
------------- ------------- ------------- -------------
FINANCIAL ASSETS:
Cash and cash equivalents $ 37,225,025 $ 37,225,025 $ 27,842,215 $ 27,842,215
Securities available for sale 35,024,966 35,024,966 24,324,935 24,324,935
FHLBI and FRB stock 3,232,500 3,232,500 2,332,500 2,332,500
Loans, net 394,902,499 395,416,000 371,579,305 371,671,000
Accrued interest receivable 1,969,610 1,969,610 1,289,370 1,289,370
FINANCIAL LIABILITIES:
Deposits (386,379,906) (386,209,000) (362,876,768) (363,387,000)
Short-term borrowings (200,000) (200,000) (1,060,000) (1,060,000)
FHLB advances (45,000,000) (46,132,000) (27,000,000) (27,333,000)
Junior subordinated debt (3,608,000) (3,620,000) (3,608,000) (4,030,000)
Accrued interest payable (559,213) (559,213) (278,964) (278,964)
51
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 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, 2004 and 2003, that the Company and
the Bank had met all capital adequacy requirements to which they are
subject.
As of December 31, 2004, 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, 2004 and 2003:
52
TOTAL TIER 1 TIER 1
RISK-BASED RISK-BASED LEVERAGE
2004 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, 2004
Company 12.29% 11.08% 9.87%
Bank 11.87% 10.62% 9.66%
AT DECEMBER 31, 2004:
Required capital for minimum capital adequacy
Company $34,305,653 $17,152,827 $18,876,099
Bank 34,314,883 17,157,442 18,864,289
Required capital to be well capitalized
Company 42,882,066 25,729,240 24,055,850
Bank 42,893,604 25,736,162 24,061,533
Actual capital
Company 52,684,690 47,493,015 47,493,015
Bank 50,932,538 45,567,796 45,567,796
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
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, 2004, 2003 and 2002.
Options for 0, 0, and 40,000 shares of common stock were not included in
the computation of diluted earnings per share for the years 2004, 2003 and
2002, respectively, because they were not dilutive.
53
2004 2003 2002
---------- ---------- ----------
BASIC
Net income $2,479,311 $1,800,066 $1,715,629
---------- ---------- ----------
Weighted average common shares outstanding 3,959,837 3,933,339 3,008,145
---------- ---------- ----------
Basic earnings per common share $ 0.63 $ 0.46 $ 0.57
DILUTED
Net income $2,479,311 $1,800,066 $1,715,629
---------- ---------- ----------
Weighted average common shares outstanding 3,959,837 3,933,339 3,008,145
Add: dilutive effect of assumed stock option exercises 95,103 73,697 61,503
---------- ---------- ----------
Weighted average common shares and dilutive
potential common shares outstanding 4,054,940 4,007,036 3,069,648
---------- ---------- ----------
Diluted earnings per common share $ 0.61 $ 0.45 $ 0.56
Note 17 - PARENT COMPANY-ONLY CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company (the Company's) financial statements
as of December 31, 2004 and 2003 and for the years ended December 31, 2004,
2003, 2002:
CONDENSED BALANCE SHEETS
2004 2003
----------- -----------
ASSETS
Cash and cash equivalents $ 2,359,671 $ 7,212,620
Investment in Tower Bank & Trust Company 45,588,250 37,631,140
Investment in the Tower Capital Trust 1 171,057 173,397
Other assets 7,060 6,772
----------- -----------
Total assets $48,126,038 $45,023,929
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 504,568 $ 507,280
Junior subordinated debt 3,608,000 3,608,000
Stockholders' equity 44,013,470 40,908,649
----------- -----------
Total liabilities and stockholders' equity $48,126,038 $45,023,929
=========== ===========
54
CONDENSED STATEMENTS OF OPERATIONS
2004 2003 2002
---------- ---------- ----------
INCOME
Interest income $ $ $
Dividend income from Tower Capital Trust 1 7,380 9,720 9,720
---------- ---------- ----------
Total income 7,380 9,720 9,720
EXPENSE
Interest expense 324,720 327,060 327,353
Professional fees 347,043 154,974 97,531
Other expense 131,502 108,776 32,659
---------- ---------- ----------
Total expense 803,265 590,810 457,543
LOSS BEFORE INCOME TAXES BENEFIT
AND EQUITY IN UNDISTRIBUTED NET
INCOME OF SUBSIDIARIES (795,885) (581,090) (447,823)
Income taxes benefit (313,430) (229,920) (179,100)
Equity in undistributed net income of Tower Bank
& Trust Company 2,961,766 2,151,236 1,984,352
---------- ---------- ----------
NET INCOME $2,479,311 $1,800,066 $1,715,629
========== ========== ==========
COMPREHENSIVE INCOME $2,474,655 $1,601,784 $1,948,602
========== ========== ==========
55
CONDENSED STATEMENTS OF CASH FLOWS
2004 2003 2002
----------- ----------- -----------
Cash flows from operating activities
Net income $ 2,479,311 $ 1,800,066 $ 1,715,629
Adjustments to reconcile net income to net cash
from operating activities:
Equity in undistributed income of subsidiary (2,961,766) (2,151,236) (1,984,352)
Change in other assets 2,052 (4,387) 1,993
Change in other liabilities (2,712) 129,086 205,234
----------- ----------- -----------
Net cash from operating activities (483,115) (226,471) (61,496)
Cash flows from investing activities
Capital investment into Tower Bank & Trust Company (5,000,000) (7,000,000)
----------- ----------- -----------
Net cash from investing activities (5,000,000) (7,000,000)
Cash flows from financing activities
Proceeds from issuance of common stock
from exercise of stock options and tax benefit 630,166 132,002 64,360
Proceeds from issuance of common stock
from stock offering 14,998,744
Payment of underwriters' fee and offering costs (1,342,182)
----------- ----------- -----------
Net cash from financing activities 630,166 132,002 13,720,922
----------- ----------- -----------
Net change in cash and cash equivalents (4,852,949) (94,469) 6,659,426
Cash and cash equivalents, beginning of period 7,212,620 7,307,089 647,663
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,359,671 $ 7,212,620 $ 7,307,089
=========== =========== ===========
56
Note 18 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as
follows.
2004 2003 2002
--------- --------- ---------
Unrealized holding gains and losses on
available-for-sales securities $ 146,578 $(139,703) $ 568,652
Less reclassification adjustments for gains
and losses later recognized in income (154,338) (190,776) (180,351)
--------- --------- ---------
Net unrealized gains and losses (7,760) (330,479) 388,301
Tax expense (benefit) (3,104) (132,187) 155,328
--------- --------- ---------
Other comprehensive income (loss) $ (4,656) $(198,292) $ 232,973
========= ========= =========
Note 19 - QUARTERLY FINANCIAL DATA (UNAUDITED)
EARNINGS PER SHARE
INTEREST NET INTEREST NET ------------------
INCOME INCOME INCOME BASIC DILUTED
----------- ------------ ----------- ----- -------
2004
First quarter $ 4,749,222 $ 3,269,445 $ 480,438 $0.12 $0.12
Second quarter 4,904,640 3,289,886 454,436 0.12 0.11
Third quarter 5,399,599 3,674,982 629,208 0.16 0.16
Fourth quarter 5,911,394 4,081,806 915,229 0.23 0.23
----------- ----------- ----------- ----- -----
Total $20,964,855 $14,316,119 $ 2,479,311 $0.63 $0.62
=========== =========== =========== ===== =====
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
=========== =========== =========== ===== =====
Note: Earnings per share data may not agree to annual amounts due to
rounding
Net income and diluted earnings per share results for the first quarter of
2004 were significantly higher than the same quarterly period in 2003
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 for the fourth quarter 2004 was
significantly higher due to the rise in interest rates, along with an
$860,000 insurance reimbursement against losses recorded for the
unauthorized mortgage activity.
57
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2004 and 2003 and the related consolidated
statements of operations, comprehensive income, changes in stockholders' equity,
and cash flows for the years ended December 31, 2004, 2003 and 2002. 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 the standards of the Public Company
Accounting Oversight Board, United States. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tower Financial
Corporation as of December 31, 2004 and 2003 and the results of its operations
and its cash flows for the years ended December 31, 2004, 2003 and 2002 in
conformity with U.S. generally accepted accounting principles.
South Bend, Indiana /s/ Crowe Chizek and Company LLC
February 10, 2005
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 required 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, 2004, 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 2004 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item concerning the directors 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 2005 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.
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 2005 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 incorporated
herein by reference to the Company's definitive Proxy Statement for its 2005
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.
59
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 2005 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 2005 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 FINANCIAL STATEMENT SCHEDULES.
(a) 1. Financial Statements. The following consolidated financial statements
of Registrant are included herein under Item 8 of Part II:
Consolidated Balance Sheets at December 31, 2004 and 2003 ....... 30
Consolidated Statements of Operations - for the years ended
December 31, 2004, 2003 and 2002 ............................. 31
Consolidated Statements of Changes in Stockholders' Equity - for
the years ended December 31, 2004, 2003 and 2002 ............. 32
Consolidated Statements of Cash Flows - for the years ended
December 31, 2004, 2003 and 2002 ............................. 33
Notes to Consolidated Financial Statements ...................... 34
Report of Independent Registered Public Accounting Firm ......... 55
2. Financial Statement Schedules.
All financial statement schedules are omitted because they are not
applicable or the required information is included in the consolidated
financial statements or notes thereto.
(b) 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.
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 10, 2005 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 10, 2005
- -------------------------------- Chief Executive Officer and
Donald F. Schenkel Director (Principal Executive Officer)
/s/ Michael D. Cahill Executive Vice President, Chief March 10, 2005
- -------------------------------- Financial Officer and Secretary
Michael D. Cahill (Principal Financial Officer
and Principal Accounting Officer)
/s/ Keith E. Busse Director March 10, 2005
- --------------------------------
Keith E. Busse
/s/ Kathryn D. Callen Director March 10, 2005
- --------------------------------
Kathryn D. Callen
/s/ Michael S. Gouloff Director March 10, 2005
- --------------------------------
Michael S. Gouloff
/s/ Jerome F. Henry, Jr. Director March 10, 2005
- --------------------------------
Jerome F. Henry, Jr.
/s/ R.V. Prasad Mantravadi, M.D. Director March 10, 2005
- --------------------------------
R.V. Prasad Mantravadi, M.D.
/s/ Michael J. Mirro, M.D. Director March 10, 2005
- --------------------------------
Michael J. Mirro, M.D.
/s/ Debra A. Niezer Director March 10, 2005
- --------------------------------
Debra A. Niezer
/s/ William G. Niezer Director March 10, 2005
- --------------------------------
William G. Niezer
61
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Joseph D. Ruffolo Director March 10, 2005
- --------------------------------
Joseph D. Ruffolo
/s/ Larry L. Smith Director March 10, 2005
- --------------------------------
Larry L. Smith
/s/ John V. Tippmann, Sr. Director March 10, 2005
- --------------------------------
John V. Tippmann, Sr.
/s/ Irene A. Walters Director March 10, 2005
- --------------------------------
Irene A. Walters
62
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1 (1) Restated Articles of Incorporation of the Registrant
3.2 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 Agreement dated June 1, 2004 between Registrant and Michael
D. Cahill
10.6* (2) Employment Agreement dated April 25, 2002 between the
Registrant and Curtis A. Brown
10.7* Summary Sheet of Director and Executive Compensation
10.8 Code of Business Conduct and Ethics
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
10.15* Amendment to Employment Agreement dated January 29, 2004
between Registrant and Donald F. Schenkel
10.16* Form of Award Agreement between Registrant and Employees
10.17* Form of Award Agreement between Registrant and Directors
10.18* Restated Supplemental Executive Retirement Plan, dated
January 1, 2004
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
63
10.22 (10) Lease Agreement dated April 7, 2003 between Registrant and
MER Group.
21 Subsidiaries of the Registrant
23 Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a).
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.
64
* 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-K for the year ended December 31, 2003 is incorporated herein by
reference.
65