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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2010

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: 0-25023

 

 

FIRST CAPITAL, INC.

(Exact name of registrant as specified in its charter)

 

Indiana   35-2056949

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

220 Federal Drive, N.W., Corydon, Indiana   47112
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (812) 738-2198

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share   Nasdaq Global Stock Market

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 whether the registrant has submitted electronically and posted on its corporate Web Site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

(Check one):   Large accelerated filer   ¨    Accelerated filer   ¨
  Non-accelerated filer   ¨    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates was $38.3 million, based upon the closing price of $15.00 per share as quoted on the Nasdaq Stock Market as of the last business day of the registrant’s most recently completed second fiscal quarter.

The number of shares outstanding of the registrant’s common stock as of March 10, 2011 was 2,787,271.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the 2010 Annual Report of Stockholders and of the Proxy Statement for the 2011 Annual Meeting of Stockholders are incorporated by reference in Parts II and III, respectively, of this Form 10-K.

 

 

 


Table of Contents

INDEX

 

          Page  
Part I  

Item 1.

   Business      1   

Item 1A.

   Risk Factors      25   

Item 1B.

   Unresolved Staff Comments      28   

Item 2.

   Properties      29   

Item 3.

   Legal Proceedings      29   

Item 4.

   [Removed and Reserved]      29   
Part II   

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      30   

Item 6.

   Selected Financial Data      31   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operation      33   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      42   

Item 8.

   Financial Statements and Supplementary Data      43   

Item 9.

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      43   

Item 9A.

   Controls and Procedures      43   

Item 9B.

   Other Information      44   
Part III   

Item 10.

   Directors, Executive Officers and Corporate Governance      44   

Item 11.

   Executive Compensation      44   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      44   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      45   

Item 14.

   Principal Accounting Fees and Services      45   
Part IV   

Item 15.

   Exhibits and Financial Statement Schedules      46   

SIGNATURES

     

 

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This report contains certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on First Capital, Inc.’s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Forward-looking statements are not guarantees of future performance. Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Numerous risks and uncertainties could cause or contribute to the Company’s actual results, performance and achievements to materially differ from those expressed or implied by the forward-looking statements. Factors which could affect actual results include, but are not limited to, interest rate trends; the general economic climate in the specific market area in which First Capital operates, as well as nationwide; First Capital’s ability to control costs and expenses; competitive products and pricing; loan delinquency rates; changes in federal and state legislation and regulation; and other factors disclosed periodically in the Company’s filings with the Securities and Exchange Commission. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements, whether included in this report or made elsewhere from time to time by the Company or on its behalf. Except as may be required by applicable law or regulation, First Capital assumes no obligation to update any forward-looking statements.

PART I

 

ITEM 1. BUSINESS

General

First Capital, Inc. (the “Company” or “First Capital”) was incorporated under Indiana law on September 11, 1998. On December 31, 1998, the Company became the holding company for First Federal Bank, A Federal Savings Bank (the “Bank”) upon the Bank’s reorganization as a wholly owned subsidiary of the Company resulting from the conversion of First Capital, Inc., M.H.C. (the “MHC”), from a federal mutual holding company to a stock holding company. On January 12, 2000, the Company completed a merger of equals with HCB Bancorp, the former holding company for Harrison County Bank, and the Bank changed its name to First Harrison Bank. On March 20, 2003, the Company acquired Hometown Bancshares, Inc. (“Hometown”), a bank holding company located in New Albany, Indiana.

The Company has no significant assets, other than all of the outstanding shares of the Bank and the portion of the net proceeds from the offering retained by the Company, and no significant liabilities. Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank in accordance with applicable regulations.

The Bank is regulated by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. The Bank’s deposits are federally insured by the Federal Deposit Insurance Corporation under the Deposit Insurance Fund. The Bank is a member of the Federal Home Loan Bank System.

 

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Availability of Information

The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available free of charge on the Company’s Internet website, www.firstharrison.com, as soon as practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. The contents of the Company’s website shall not be incorporated by reference into this Form 10-K or into any reports the Company files with or furnishes to the Securities and Exchange Commission.

Market Area and Competition

The Bank considers Harrison, Floyd, Clark and Washington counties in Indiana its primary market area. All of its offices are located in these four counties, which results in most of the Bank’s loans being made in these four counties. The main office of the Bank is located in Corydon, Indiana, 35 miles west of Louisville, Kentucky. The Bank aggressively competes for business with local banks, as well as large regional banks. Its most direct competition for deposit and loan business comes from the commercial banks operating in these four counties. Based on data published by the Federal Deposit Insurance Corporation, the Bank is the leader among FDIC-insured institutions in deposit market share in Harrison County, the Bank’s primary county of operation.

Lending Activities

General. Over the last few years, the Bank has continued to transform the composition of its balance sheet from that of a traditional thrift institution to that of a commercial bank. On the asset side, this is being accomplished in part by selling in the secondary market the newly-originated qualified fixed-rate residential mortgage loans while retaining variable rate residential mortgage loans in the portfolio. This transformation is also enhanced by an expanded commercial lending staff dedicated to growing commercial real estate and commercial business loans. The Bank also continues to originate consumer loans and residential construction loans for the loan portfolio. The Bank does not offer, and has not offered, Alt-A, sub-prime or no-document mortgage loans.

 

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Loan Portfolio Analysis. The following table presents the composition of the Bank’s loan portfolio by type of loan at the dates indicated.

 

    At December 31,  
    2010     2009     2008     2007     2006  
    Amount     Percent of
Total
    Amount     Percent of
Total
    Amount     Percent of
Total
    Amount     Percent of
Total
    Amount     Percent of
Total
 
    (Dollars in thousands)  

Mortgage Loans:

                   

Residential(1)

  $ 130,143        43.11   $ 139,085        43.45   $ 150,576        45.96   $ 161,554        47.11   $ 173,806        50.86

Land

    9,534        3.16        10,288        3.21        9,475        2.89        12,032        3.51        12,581        3.68   

Commercial real estate

    59,901        19.84        60,580        18.92        65,367        19.95        64,878        18.92        48,520        14.20   

Residential construction(2)

    8,151        2.70        13,862        4.33        9,577        2.92        12,963        3.78        17,435        5.10   
                                                                               

Total mortgage loans

    207,729        68.81        223,815        69.91        234,995        71.72        251,427        73.32        252,342        73.84   
                                                                               

Consumer Loans:

                   

Home equity and second

mortgage loans

    43,046        14.26        46,360        14.48        43,031        13.14        41,035        11.97        39,483        11.55  

Automobile loans

    19,384        6.42        17,714        5.53        16,523        5.04        15,645        4.56        15,637        4.57  

Loans secured by savings accounts

    1,042        0.34        1,361        0.43        1,972        0.60        2,406        0.70        2,263        0.66  

Unsecured loans

    3,076        1.02        2,677        0.84        2,807        0.86        2,848        0.83        2,895        0.85  

Other(3)

    5,732        1.90        5,321        1.66        5,419        1.65        5,349        1.56        4,406        1.29  
                                                                               

Total consumer loans

    72,280        23.94        73,433        22.94        69,752        21.29        67,283        19.62        64,684        18.92  
                                                                               

Commercial business loans

    21,911        7.25        22,861        7.15        22,881        6.99        24,210        7.06        24,730        7.24  
                                                                               

Total gross loans

    301,920        100.00     320,109        100.00     327,628        100.00     342,920        100.00     341,756        100.00 %
                                                                               

Less:

                   

Due to borrowers on loans in process

    3,119          4,372          2,828          6,430          6,029     

Deferred loan fees net of direct costs

    (222       (286       (247       (205       (168  

Allowance for loan losses

    4,473          4,931          2,662          2,232          2,320     
                                                 

Total loans, net

  $ 294,550        $ 311,092        $ 322,385        $ 334,463        $ 333,575     
                                                 

 

(1) Includes conventional one- to four-family and multi-family residential loans.
(2) Includes construction loans for which the Bank has committed to provide permanent financing.
(3) Includes loans secured by lawn and farm equipment, mobile homes and other personal property.

 

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Residential Loans. The Bank’s lending activities have concentrated on the origination of residential mortgages, both for sale in the secondary market and for retention in the Bank’s loan portfolio. Residential mortgages secured by multi-family properties are an immaterial portion of the residential loan portfolio. Substantially all residential mortgages are collateralized by properties within the Bank’s market area.

The Bank offers both fixed-rate mortgage loans and adjustable rate mortgage (“ARM”) loans typically with terms of 15 to 30 years. The Bank uses loan documents approved by the Federal National Mortgage Corporation (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) whether the loan is originated for investment or sale in the secondary market.

Historically, the Bank has retained its residential loan originations in its portfolio. Retaining fixed-rate loans in its portfolio subjects the Bank to a higher degree of interest rate risk. See “Item 1A. Risk Factors–Above Average Interest Rate Risk Associated with Fixed-Rate Loans” for a further discussion of the risks of rising interest rates. Beginning in 2004, one of the Bank’s strategic goals was to expand its mortgage business by originating mortgage loans for sale, while offering a full line of mortgage products to prospective customers. This practice increases the Bank’s lending capacity and allows the Bank to more effectively manage its profitability since it is not required to predict the prepayment, credit or interest rate risks associated with retaining either the loan or the servicing asset. During 2005, the Bank hired a mortgage banking manager, charged with hiring more mortgage originators and increasing the Bank’s secondary market business in Southern Indiana. For the year ended December 31, 2010, the Bank originated and funded $43.1 million of residential mortgage loans for sale in the secondary market. For a full discussion of the Bank’s mortgage banking operations, see “Item 1. Business–Mortgage Banking Activities.”

ARM loans originated have interest rates that adjust at regular intervals of one to five years, with up to 2.0% caps per adjustment period and 6.0% lifetime caps, based upon changes in the prevailing interest rates on United States Treasury Bills. The Bank also originates “hybrid” ARM loans, which are fixed for an initial period three or five years and adjust annually thereafter. The Bank may occasionally use below market interest rates and other marketing inducements to attract ARM loan borrowers. The majority of ARM loans provide that the amount of any increase or decrease in the interest rate is limited to 2.0% (upward or downward) per adjustment period and generally contains minimum and maximum interest rates. Borrower demand for ARMs versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and interest rates and loan fees for ARM loans. The relative amount of fixed-rate and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment.

The Bank’s lending policies generally limit the maximum loan-to-value ratio on fixed-rate and ARM loans to 80% of the lesser of the appraised value or purchase price of the underlying residential property unless private mortgage insurance to cover the excess over 80% is obtained, in which case the mortgage is limited to 95% (or 97% under a Freddie Mac program) of the lesser of appraised value or purchase price. The loan-to-value ratio, maturity and other provisions of the loans made by the Bank are generally reflected in the policy of making less than the maximum loan permissible under federal regulations, in accordance with established lending practices, market conditions and underwriting standards maintained by the Bank. The Bank requires title, fire and extended insurance coverage on all mortgage loans originated. All of the Bank’s real estate loans contain due on sale clauses. The Bank generally obtains appraisals on all its real estate loans from outside appraisers.

Construction Loans. Although the Bank originates construction loans that are repaid with the proceeds of a limited number of mortgage loans obtained by the borrower from another lender, the majority of the construction loans that the Bank originates are permanently financed in the secondary market by the Bank. Construction loans originated without a commitment by the Bank to provide permanent financing are generally originated for a term of six to 12 months and at a fixed interest rate based on the prime rate.

The Bank originates speculative construction loans to a limited number of builders operating and based in the Bank’s primary market area and with whom the Bank has well-established business relationships. At December 31, 2010, speculative construction loans, a construction loan for which there is not a

 

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commitment for permanent financing in place at the time the construction loan was originated, amounted to $1.7 million. The Bank limits the number of speculative construction loans outstanding to any one builder based on the Bank’s assessment of the builder’s capacity to service the debt.

Most construction loans are originated with a loan-to-value ratio not to exceed 80% of the appraised estimated value of the completed property. The construction loan documents require the disbursement of the loan proceeds in increments as construction progresses. Disbursements are based on periodic on-site inspections by an independent appraiser.

Construction lending is inherently riskier than one- to four-family mortgage lending. Construction loans, on average, generally have higher loan balances than one- to four-family mortgage loans. In addition, the potential for cost overruns because of the inherent difficulties in estimating construction costs and, therefore, collateral values and the difficulties and costs associated with monitoring construction progress, among other things, are major contributing factors to this greater credit risk. Speculative construction loans have the added risk that there is not an identified buyer for the completed home when the loan is originated, with the risk that the builder will have to service the construction loan debt and finance the other carrying costs of the completed home for an extended time period until a buyer is identified. Furthermore, the demand for construction loans and the ability of construction loan borrowers to service their debt depends highly on the state of the general economy, including market interest rate levels and the state of the economy of the Bank’s primary market area. A material downturn in economic conditions could be expected to have a material adverse effect on the credit quality of the construction loan portfolio.

Commercial Real Estate Loans. Commercial real estate loans are generally secured by small retail stores, professional office space and, in certain instances, farm properties. Commercial real estate loans are generally originated with a loan-to-value ratio not to exceed 75% of the appraised value of the property. Property appraisals are performed by independent appraisers approved by the Bank’s board of directors. The Bank seeks to originate commercial real estate loans at variable interest rates based on the United States Treasury Bill rate for terms ranging from ten to 15 years and with interest rate adjustment intervals of five years. The Bank also originates fixed-rate balloon loans with a short maturity, but a longer amortization schedule.

Commercial real estate lending affords the Bank an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by such properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks by limiting the maximum loan-to-value ratio to 75% and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. The Bank also obtains loan guarantees from financially capable parties based on a review of personal financial statements.

Commercial Business Loans. Commercial business loans are generally secured by inventory, accounts receivable, and business equipment such as trucks and tractors. Many commercial business loans also have real estate as collateral. The Bank generally requires a personal guaranty of payment by the principals of a corporate borrower, and reviews the personal financial statements and income tax returns of the guarantors. Commercial business loans are generally originated with loan-to-value ratios not exceeding 75%.

Aside from lines of credit, commercial business loans are generally originated for terms not to exceed seven years with variable interest rates based on the prime lending rate. Approved credit lines totaled $23.8 million at December 31, 2010, of which $11.4 million was outstanding. Lines of credit are originated at fixed and variable interest rates for one-year renewable terms.

A director of the Bank is a shareholder of a farm implement dealership that contracts with the Bank to provide sales financing to the dealership’s customers. The Bank does not grant preferential credit under

 

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this arrangement. During the year ended December 31, 2010, the Bank granted approximately $753,000 of credit to customers of the dealership and such loans had an aggregate outstanding balance of $1.4 million at December 31, 2010. At December 31, 2010, 4 loans were delinquent 30 days or more with an aggregate outstanding balance of $67,000.

Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral-based lending with loan amounts based on predetermined loan-to-collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary, and often insufficient, source of repayment. The Bank has three commercial lenders and one commercial credit analyst committed to growing commercial business loans to facilitate the changes desired in the Bank’s balance sheet. The Bank also uses an outside loan review company to review selected commercial credits on a semi-annual basis.

Consumer Loans. The Bank offers a variety of secured or guaranteed consumer loans, including automobile and truck loans, home equity loans, home improvement loans, boat loans, mobile home loans and loans secured by savings deposits. In addition, the Bank offers unsecured consumer loans. Consumer loans are generally originated at fixed interest rates and for terms not to exceed seven years. The largest portion of the Bank’s consumer loan portfolio consists of home equity and second mortgage loans followed by automobile and truck loans. Automobile and truck loans are originated on both new and used vehicles. Such loans are generally originated at fixed interest rates for terms up to five years and at loan-to-value ratios up to 90% of the blue book value in the case of used vehicles and 90% of the purchase price in the case of new vehicles.

The Bank originates variable-rate home equity and fixed-rate second mortgage loans generally for terms not to exceed five years. The loan-to-value ratio on such loans is limited to 80%, taking into account the outstanding balance on the first mortgage loan.

The Bank’s underwriting procedures for consumer loans includes an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loans. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, to the proposed loan amount. The Bank underwrites and originates the majority of its consumer loans internally, which management believes limits exposure to credit risks relating to loans underwritten or purchased from brokers or other outside sources.

Consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by assets that depreciate rapidly, such as automobiles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and, therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by the borrower against the Bank as the holder of the loan, and a borrower may be able to assert claims and defenses that it has against the seller of the underlying collateral.

 

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Loan Maturity and Repricing

The following table sets forth certain information at December 31, 2010 regarding the dollar amount of loans maturing in the Bank’s portfolio based on their contractual terms to maturity, but does not include potential prepayments. Demand loans, which are loans having neither a stated schedule of repayments nor a stated maturity, and overdrafts are reported as due in one year or less. Loan balances do not include undisbursed loan proceeds, unearned income and allowance for loan losses.

 

     Within
One Year
     After
One Year
Through
3 Years
     After
3 Years
Through
5 Years
     After
5 Years
Through
10 Years
     After
10 Years
Through
15 Years
     After
15 Years
     Total  
     (Dollars in thousands)  

Mortgage loans:

                    

Residential

   $ 8,081       $ 15,104       $ 15,702       $ 28,387       $ 21,651       $ 41,218       $ 130,143   

Commercial real estate and

land loans

     13,766         9,465         12,648         15,132         9,894         8,530         69,435   

Residential construction(1)

     6,923         1,217         11         —           —           —           8,151   

Consumer loans

     16,233         29,229         21,866         3,957         100         895         72,280   

Commercial business

     9,054         7,653         2,905         1,894         360         45         21,911   
                                                              

Total gross loans

   $ 54,057       $ 62,668       $ 53,132       $ 49,370       $ 32,005       $ 50,688       $ 301,920   
                                                              

 

(1) Includes construction loans for which the Bank has committed to provide permanent financing.

The following table sets forth the dollar amount of all loans due after December 31, 2011, which have fixed interest rates and floating or adjustable interest rates.

 

     Fixed Rates      Floating or
Adjustable Rates
 
     (Dollars in thousands)  

Mortgage loans:

     

Residential

   $ 65,643       $ 56,419   

Commercial real estate and land loans

     18,534         37,135   

Residential construction

     28         1,200   

Consumer loans

     28,834         27,213   

Commercial business

     7,081         5,776   
                 

Total gross loans

   $ 120,120       $ 127,743   
                 

Loan Solicitation and Processing. A majority of the Bank’s loan originations are made to existing customers. Walk-ins and customer referrals are also a source of loan originations. Upon receipt of a loan application, a credit report is ordered to verify specific information relating to the loan applicant’s employment, income and credit standing. A loan applicant’s income is verified through the applicant’s employer or from the applicant’s tax returns. In the case of a real estate loan, an appraisal of the real estate intended to secure the proposed loan is undertaken, generally by an independent appraiser approved by the Bank. The mortgage loan documents used by the Bank conform to secondary market standards.

The Bank requires that borrowers obtain certain types of insurance to protect its interest in the collateral securing the loan. The Bank requires either a title insurance policy insuring that the Bank has a valid first lien on the mortgaged real estate or an opinion by an attorney regarding the validity of title. Fire and casualty insurance is also required on collateral for loans.

Loan Commitments and Letters of Credit. The Bank issues commitments for fixed- and adjustable-rate single-family residential mortgage loans conditioned upon the occurrence of certain events. Such commitments are made in writing on specified terms and conditions and are honored for up to 60 days from the date of application, depending on the type of transaction. The Bank had outstanding loan commitments of approximately $7.3 million at December 31, 2010.

 

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As an accommodation to its commercial business loan borrowers, the Bank issues standby letters of credit or performance bonds usually in favor of municipalities for whom its borrowers are performing services. At December 31, 2010, the Bank had outstanding letters of credit of $1.7 million.

Loan Origination and Other Fees. Loan fees and points are a percentage of the principal amount of the mortgage loan that is charged to the borrower for funding the loan. The Bank usually charges a fixed origination fee on one- to four-family residential real estate loans and long-term commercial real estate loans. Current accounting standards require loan origination fees and certain direct costs of underwriting and closing loans to be deferred and amortized into interest income over the contractual life of the loan. Deferred fees and costs associated with loans that are sold are recognized as income at the time of sale. The Bank had $222,000 of net deferred loan costs at December 31, 2010.

Mortgage Banking Activities. Mortgage loans originated and funded by the Bank and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. Aggregate market value is determined based on the quoted prices under a “best efforts” sales agreement with a third party. Net unrealized losses are recognized through a valuation allowance by charges to income. Realized gains on sales of mortgage loans are included in noninterest income.

Commitments to originate and fund mortgage loans for sale in the secondary market are considered derivative financial instruments to be accounted for at fair value. The Bank’s mortgage loan commitments subject to derivative accounting are fixed rate mortgage commitments at market rates when initiated. At December 31, 2010, the Bank had commitments to originate $670,000 in fixed-rate mortgage loans intended for sale in the secondary market after the loans are closed. Fair value is estimated based on fees that would be charged on commitments with similar terms.

Delinquencies. The Bank’s collection procedures provide for a series of contacts with delinquent borrowers. A late charge is assessed and a late charge notice is sent to the borrower after the 15th day of delinquency. After 20 days, the collector places a phone call to the borrower. When a payment becomes 60 days past due, the collector issues a default letter. If a loan continues in a delinquent status for 90 days or more, the Bank generally initiates foreclosure or other litigation proceedings.

Nonperforming Assets. Loans are reviewed regularly and when loans become 90 days delinquent, the loan is placed on nonaccrual status and the previously accrued interest income is reversed unless, in the opinion of management, the outstanding interest remains collectible. Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan when the likelihood of further loss on the loan is remote. Otherwise, the Bank applies the cost recovery method and applies all payments as a reduction of the unpaid principal balance.

 

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The following table sets forth information with respect to the Bank’s nonperforming assets for the dates indicated. Included in nonperforming loans are loans for which the Bank has modified the repayment terms, and therefore are considered to be troubled debt restructurings as described below. At December 31, 2010, troubled debt restructurings totaling $3.9 million and all troubled debt restructurings were on nonaccrual status at December 31, 2010. The Bank had no troubled debt restructurings classified as performing loans for the periods presented in the table below.

 

     At December 31,  
     2010     2009     2008     2007     2006  
     (Dollars in thousands)  

Loans accounted for on a nonaccrual basis:

          

Residential real estate

   $ 3,230      $ 2,295     $ 2,013     $ 1,684     $ 797  

Commercial real estate

     1,780        3,445       2,088       2,674       2,192  

Commercial business

     2,148        2,238       82       397       48  

Consumer

     390        456       258       124       208  
                                        

Total

     7,548        8,434       4,441       4,879       3,245  
                                        

Accruing loans past due 90 days or more:

          

Residential real estate

     334        563       735       633       776  

Commercial real estate

     —          202       27       —          —     

Commercial business

     20        —          —          23       144  

Consumer

     25        317       330       160       205  
                                        

Total

     379        1,082       1,092       816       1,125  
                                        

Foreclosed real estate, net

     591        877       881       833       941  
                                        

Total nonperforming assets

   $ 8,518      $ 10,393     $ 6,414     $ 6,528     $ 5,311  
                                        

Total loans delinquent 90 days or more to net loans

     2.69     3.06     1.72     1.70     1.31

Total loans delinquent 90 days or more to total assets

     1.75     2.09     1.21     1.26     0.96

Total nonperforming assets to total assets

     1.88     2.28     1.40     1.44     1.16

The Bank accrues interest on loans over 90 days past due when, in the opinion of management, the estimated value of collateral and collection efforts are deemed sufficient to ensure full recovery. The Bank recognized $16,000 in interest income on nonperforming loans for the fiscal year ended December 31, 2010. The Bank would have recorded interest income of $413,000 for the year ended December 31, 2010 had nonaccrual loans and troubled debt restructurings had been current in accordance with their original terms.

Restructured Loans. Periodically, the Bank modifies loans to extend the term or make other concessions to help borrowers stay current on their loans and avoid foreclosure. The Bank does not forgive principal or interest on loans or modify interest rates to rates that are below market rates. These modified loans are also referred to as “troubled debt restructurings.” At December 31, 2010, modified loans totaled $3.9 million.

Classified Assets. The Office of Thrift Supervision has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, Office of Thrift Supervision examiners have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard” assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. “Doubtful” assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss. All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful can be included in determining an institution’s regulatory capital,

 

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while specific valuation allowances for loan losses generally do not qualify as regulatory capital.

The Company holds a corporate collateralized mortgage obligation security that was downgraded to a substandard regulatory classification in 2009 due to a downgrade of the security’s credit quality rating by various rating agencies. At December 31, 2010, the amortized cost and fair value of this security was $711,000 and $668,000, respectively. The Company has evaluated the existence of a potential credit loss component related to the decline in fair value and based upon an independent third party analysis performed in December 2010, the Company expects to collect the contractual principal and interest cash flows for this security. As a result, no other-than-temporary impairment has been recognized for this security as of December 31, 2010. The Company will continue to monitor credit quality and receive the independent third-party analysis of the security on a quarterly basis. While management does not anticipate a credit-related impairment loss for this security at December 31, 2010, additional deterioration in market and economic conditions may have a material adverse impact on the credit quality of this security in the future.

At December 31, 2010, the Bank had $7.5 million in doubtful loans and $7.1 million in substandard loans, of which all but $6.7 million are included in total nonperforming loans disclosed in the above table. The Bank also had one investment security classified as substandard at December 31, 2010, with a market value of $668,000 as discussed above. In addition to regulatory classifications, the Bank also classifies loans as “special mention” or “watch” when they are currently performing in accordance with their contractual terms but exhibit potential weaknesses that must be monitored by management on an ongoing basis. At December 31, 2010, the Bank identified $9.6 million in loans as special mention or watch loans.

Current accounting rules require that impaired loans be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or if expedient, at the loan’s observable market price or the fair value of collateral if the loan is collateral dependent. A loan is classified as “impaired” by management when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due in accordance with the terms of the loan agreement. If the fair value, as measured by one of these methods, is less than the recorded investment in the impaired loan, the Bank establishes a valuation allowance with a provision charged to expense. Management reviews the valuation of impaired loans on a quarterly basis to consider changes due to the passage of time or revised estimates. Assets that do not expose the Bank to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated “special mention” by management.

An insured institution is required to establish and maintain an allowance for loan losses at a level that is adequate to absorb estimated credit losses associated with the loan portfolio, including binding commitments to lend. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities. When an insured institution classifies problem assets as “loss,” it is required either to establish an allowance for losses equal to 100% of the amount of the assets, or charge off the classified asset. The amount of its valuation allowance is subject to review by the Office of Thrift Supervision, which can order the establishment of additional general loss allowances. The Bank regularly reviews the loan portfolio to determine whether any loans require classification in accordance with applicable regulations.

At December 31, 2010, 2009 and 2008, the aggregate amounts of the Bank’s classified assets were as follows:

 

     At December 31,  
     2010      2009      2008  
     (Dollars in thousands)  

Classified assets:

        

Loss

   $ —         $ —         $ —     

Doubtful

     7,548         8,434         4,441   

Substandard

     7,788         6,718         9,148   

Special mention

     9,554         9,322         7,689   

 

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Loans classified as impaired in accordance with accounting standards included in the above regulatory classifications and the related allowance for loan losses are summarized below at the dates indicated:

 

     At December 31,  
     2010      2009      2008  
     (Dollars in thousands)  

Impaired loans with related allowance

   $ 1,497       $ 6,894       $ 3,201   

Impaired loans with no allowance

     6,430         2,622         2,332   
                          

Total impaired loans

   $ 7,927       $ 9,516       $ 5,533   
                          

Allowance for loan losses:

        

Related to impaired loans

   $ 2,492       $ 3,188       $ 719   

Related to other loans

     1,981         1,743         1,943   

Foreclosed Real Estate. Foreclosed real estate held for sale is carried at fair value minus estimated costs to sell. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. The net income from operations of foreclosed real estate held for sale is reported in non-interest income. At December 31, 2010, the Bank had foreclosed real estate totaling $591,000.

Allowance for Loan Losses. Loans are the Bank’s largest concentration of assets and continue to represent the most significant potential risk. In originating loans, the Bank recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral. The Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance for loan losses represents management’s estimate of probable loan losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the loan portfolio, including historical loan loss experience, delinquencies, known and inherent risks in the nature and volume of the loan portfolio, information about specific borrower situations, estimated collateral values, and economic conditions.

The loan portfolio is reviewed quarterly by management to evaluate the adequacy of the allowance for loan losses to determine the amount of any adjustment required after considering the loan charge-offs and recoveries for the quarter. Management applies a systematic methodology that incorporates its current judgments about the credit quality of the loan portfolio. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews the Bank’s allowance for loan losses and may require the Bank to make additional provisions for estimated losses based on their judgments about information available to them at the time of their examination.

The methodology used in determining the allowance for loan losses includes segmenting the loan portfolio by identifying risk characteristics common to pools of loans, determining and measuring impairment of individual loans based on the present value of expected future cash flows or the fair value of collateral, and determining and measuring impairment for pools of loans with similar characteristics by applying loss factors that consider the qualitative factors which may affect the loss rates.

Specific allowances related to impaired loans and other classified loans are established where management has identified significant conditions or circumstances related to a loan that management believes indicate that a probable loss has been incurred. The identification of these loans results from the loan review process that identifies and monitors credits with weaknesses or conditions which call into question the full collection of the contractual payments due under the terms of the loan agreement. Factors considered by management include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.

 

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For loans evaluated on a pool basis, management applies loss factors to pools of loans with common risk characteristics (i.e., residential mortgage loans, home equity loans, credit card loans). The loss factors are derived from the Bank’s historical loss experience or, where the Bank does not have loss experience, the peer group historical loss experience. Peer group historical loss experience is used after evaluating the attributes of the Bank’s loan portfolio as compared to the peer group which is considered to be community banks located in the central region of the United States. Loss factors are adjusted for significant qualitative factors that, in management’s judgment, affect the collectability of the loan portfolio segment. The significant qualitative factors include the levels and trends in charge-offs and recoveries, trends in volume and terms of loans, levels and trends in delinquencies, the effects of changes in underwriting standards and other lending practices or procedures, the experience and depth of the lending management and staff, effects of changes in credit concentration, changes in industry and market conditions and national and local economic trends and conditions. Management evaluates these conditions on a quarterly basis and evaluates and modifies the assumptions used in establishing the loss factors.

The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated.

 

     Year Ended December 31,  
     2010     2009     2008     2007     2006  

Allowance at beginning of period

   $ 4,931      $ 2,662      $ 2,232      $ 2,320      $ 2,104   

Provision for loan losses

     2,037        4,289        1,570        558        810   
                                        
     6,968        6,951        3,802        2,878        2,914   
                                        

Recoveries:

          

Residential real estate

     9        26        4        2        14   

Commercial real estate

     4        6        —          —          —     

Commercial business

     9        14        13        13        4   

Consumer

     214        209        179        121        92   
                                        

Total recoveries

     236        255        196        136        110   
                                        

Charge-offs:

          

Residential real estate

     620        425        357        216        87   

Commercial real estate

     1,326        920        96        36        57   

Commercial business

     29        181        210        77        115   

Consumer

     756        749        673        453        445   
                                        

Total charge-offs

     2,731        2,275        1,336        782        704   
                                        

Net (charge-offs) recoveries

     (2,495     (2,020     (1,140     (646     (594
                                        

Balance at end of period

   $ 4,473      $ 4,931      $ 2,662      $ 2,232      $ 2,320   
                                        

Ratio of allowance to total loans outstanding at the end of the period

     1.48     1.54     0.81     0.65     0.68

Ratio of net charge-offs to average loans outstanding during the period

     0.80     0.63     0.35     0.19     0.18

 

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Allowance for Loan Losses Analysis

The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.

 

    At December 31,  
    2010     2009     2008     2007     2006  
    Amount     Percent of
Outstanding
Loans
in Category
    Amount     Percent of
Outstanding
Loans
in Category
    Amount     Percent of
Outstanding
Loans
in Category
    Amount     Percent of
Outstanding
Loans
in Category
    Amount     Percent of
Outstanding
Loans
in Category
 
    (Dollars in thousands)  

Residential real estate(1)

  $ 1,045        45.81   $ 1,297        47.78   $ 608        48.88   $ 440        50.89   $ 539        55.96

Commercial real estate and land loans

    1,106        23.00       1,772        22.13       737        22.84       764        22.43       697        17.88  

Commercial business

    1,251        7.25       1,264        7.15       240        6.99       200        7.06       209        7.24  

Consumer

    1,071        23.94       598        22.94       1,077        21.29       828        19.62       875        18.92  
                                                                               

Total allowance for loan losses

  $ 4,473        100.00   $ 4,931        100.00   $ 2,662        100.00   $ 2,232        100.00   $ 2,320        100.00
                                                                               

 

(1) Includes residential construction loans.

Investment Activities

Federally chartered savings institutions have authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the applicable Federal Home Loan Bank, certificates of deposit of federally insured institutions, certain bankers’ acceptances and federal funds. Subject to various restrictions, such savings institutions may also invest a portion of their assets in commercial paper, corporate debt securities and mutual funds, the assets of which conform to the investments that federally chartered savings institutions are otherwise authorized to make directly. Savings institutions are also required to maintain minimum levels of liquid assets that vary from time to time. The Bank may decide to increase its liquidity above the required levels depending upon the availability of funds and comparative yields on investments in relation to return on loans.

The Bank is required under federal regulations to maintain a minimum amount of liquid assets and is also permitted to make certain other securities investments. The balance of the Bank’s investments in short-term securities in excess of regulatory requirements reflects management’s response to the significantly increasing percentage of deposits with short maturities. Management intends to hold securities with short maturities in the Bank’s investment portfolio in order to enable the Bank to match more closely the interest-rate sensitivities of its assets and liabilities.

The Bank periodically invests in mortgage-backed securities, including mortgage-backed securities guaranteed or insured by Ginnie Mae, Fannie Mae or Freddie Mac. Mortgage-backed securities generally increase the quality of the Bank’s assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Bank. Of the Bank’s total mortgage-backed securities portfolio at December 31, 2010, securities with a market value of $704,000 have adjustable rates as of that date.

The Bank also invests in collateralized mortgage obligations (CMOs) issued by Ginnie Mae, Fannie Mae and Freddie Mac, as well as private issuers. CMOs are complex mortgage-backed securities that restructure the cash flows and risks of the underlying mortgage collateral.

At December 31, 2010, neither the Company nor the Bank had an investment in securities (other than United States Government and agency securities), which exceeded 10% of the Company’s consolidated stockholders’ equity at that date.

 

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The following table sets forth the securities portfolio at the dates indicated.

 

    At December 31,  
    2010     2009     2008  
    Fair
Value
    Amortized
Cost
    Percent
of
Portfolio
    Weighted
Average
Yield(1)
    Fair
Value
    Amortized
Cost
    Percent
of
Portfolio
    Weighted
Average
Yield(1)
    Fair
Value
    Amortized
Cost
    Percent
of
Portfolio
    Weighted
Average
Yield(1)
 
    (Dollars in thousands)  

Securities Held to Maturity(2)

                       

Municipal:

                       

Due in one year or less

  $ 14      $ 14        0.01     10.23   $ 22      $ 21        0.02     10.23   $ 21      $ 20        0.03     10.23

Due after one year through five years

    —          —          —          —          15        14        0.02        10.23     37        35        0.04        10.23

Due after five years through ten years

    —          —          —          —          —          —          —          —          —          —          —          —     

Due after ten years

    —          —          —          —          —          —          —          —          —          —          —          —     

Mortgage-backed securities(3)

    18        18        0.02        2.64     27        27        0.03        3.36     31        31        0.04        4.08
                                                                             
  $ 32      $ 32        0.03     $ 64      $ 62        0.07     $ 89      $ 86        0.11  
                                                                             

Securities Available for Sale

                       

Debt securities:

                       

U.S. agency:

                       

Due in one year or less

  $ —        $ —          —          —        $ 7,389      $ 7,301        7.85     3.04   $ 4,055      $ 4,000        4.86     3.89

Due after one year through five years

    13,161        13,056        13.02     1.94     11,861        11,789        12.67        2.62     16,798        16,572        20.12        3.39

Due after five years through ten years

    7,071        7,023        7.00        2.14     11,655        11,741        12.62        3.35     4,606        4,545        5.52        4.32

Due after ten years through fifteen years

    22,148        22,321        22.26        2.09     5,704        5,734        6.16        3.03     —          —          —          —     

Mortgage-backed securities and CMOs (3)

    26,301        25,776        25.70        3.33     25,847        25,428        27.34        4.65     31,892        31,578        38.32        4.76

Municipal:

                       

Due in one year or less

    1,529        1,518        1.51        4.25     2,785        2,761        2.97        4.73     1,481        1,476        1.79        4.54

Due after one year through five years

    3,873        3,775        3.77        5.13     5,692        5,549        5.97        4.96     6,585        6,467        7.85        5.28

Due after five years through ten years

    5,288        5,208        5.19        5.44     4,958        4,874        5.24        5.68     4,589        4,558        5.53        5.73

Due after ten years

    18,766        18,865        18.82        5.81     15,057        14,982        16.11        5.94     11,223        11,460        13.91        5.83

Equity securities:

                       

Mutual funds

    2,714        2,705        2.70        N/A        2,781        2,794        3.00        N/A        1,504        1,637        1.99        N/A   
                                                                             
  $ 100,851      $ 100,247        99.97     $ 93,729      $ 92,953        99.93     $ 82,733      $ 82,293        99.89  
                                                                             

 

(1) Yields are calculated on a fully taxable equivalent basis using a marginal federal income tax rate of 34%. Weighted average yields are calculated using average prepayment rates for the most recent three-month period.
(2) Securities held to maturity are carried at amortized cost.
(3) The expected maturities of mortgage-backed securities and CMOs may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty.

 

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Deposit Activities and Other Sources of Funds

General. Deposits and loan repayments are the major source of the Bank’s funds for lending and investment activities and for its general business purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowing may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or may also be used on a longer-term basis for interest rate risk management.

Deposit Accounts. Deposits are attracted from within the Bank’s primary market area through the offering of a broad selection of deposit instruments, including non-interest bearing checking accounts, negotiable order of withdrawal (“NOW”) accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. Deposit account terms vary, according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Bank considers the rates offered by its competition, profitability to the Bank, matching deposit and loan products and its customer preferences and concerns. The Bank generally reviews its deposit mix and pricing weekly.

The following table presents the maturity distributions of time deposits of $100,000 or more as of December 31, 2010.

 

      Amount at
December 31, 2010
 

Maturity Period

   (Dollars in thousands)  

Three months or less

   $ 3,998   

Over three through six months

     4,877   

Over six through 12 months

     10,931   

Over 12 months

     14,659   
        

Total

   $ 34,465   
        

The following table sets forth the balances of deposits in the various types of accounts offered by the Bank at the dates indicated.

 

     At December 31,  
     2010     2009     2008  
     Amount      Percent
of
Total
    Increase/
(Decrease)
    Amount      Percent
of
Total
    Increase/
(Decrease)
    Amount      Percent
of
Total
    Increase/
(Decrease)
 
     (Dollars in thousands)  

Non-interest bearing demand

   $ 40,774         10.79   $ 301      $ 40,473         10.81   $ 3,705      $ 36,768         10.33   $ 1,476   

NOW accounts

     154,385         40.84        21,133        133,252         35.58        23,960        109,292         30.71        38,718   

Savings accounts

     43,488         11.50        1,966        41,522         11.09        5,155        36,367         10.22        7,285   

Money market accounts

     13,559         3.59        (671     14,230         3.80        (3,213     17,443         4.90        (8,919

Fixed rate time deposits which mature:

                     

Within one year

     81,214         21.48        (4,650     85,864         22.93        (15,418     101,282         28.46        (10,415

After one year, but within three years

     36,523         9.66        (12,760     49,283         13.16        7,319        41,964         11.79        (5,986

After three years, but within five years

     7,939         2.10        (1,652     9,591         2.56        (2,478     12,069         3.39        5,586   

After five years

     58         0.02        (137     195         0.05        (449     644         0.18        (7

Club accounts

     63         0.02        (3     66         0.02        4        62         0.02        2   
                                                                           

Total

   $ 378,003         100.00   $ 3,527      $ 374,476         100.00   $ 18,585      $ 355,891         100.00   $ 27,740   
                                                                           

 

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The following table sets forth the amount and maturities of time deposits by rates at December 31, 2010.

 

     Amount Due                
     Less Than
One Year
     1 - 3
Years
     3 - 5
Years
     After 5
Years
     Total      Percent
of Total
 
     (Dollars in thousands)  

0.00% — 0.99%

   $ 25,265       $ 142       $ —         $ —         $ 25,407         20.21

1.00% — 1.99%

     20,696         15,229         3,784         —           39,709         31.58   

2.00% — 2.99%

     16,565         10,575         3,852         —           30,992         24.65   

3.00% — 3.99%

     13,462         3,973         45         —           17,480         13.90   

4.00% — 4.99%

     4,799         6,526         136         58         11,519         9.16   

5.00% — 5.99%

     426         78         122         —           626         0.50   

6.00% — 6.99%

     —           —           —           —           —           0.00   

7.00% — 7.99%

     —           —           —           —           —           0.00   

8.00% — 8.99%

     1         —           —           —           1         0.00   
                                                     

Total

   $ 81,214       $ 36,523       $ 7,939       $ 58       $ 125,734         100.00
                                                     

Borrowings. The Bank has at times relied upon advances from the Federal Home Loan Bank of Indianapolis to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the Federal Home Loan Bank of Indianapolis are secured by certain first mortgage loans and investment and mortgage-backed securities. The Bank also uses retail repurchase agreements as a source of borrowings.

The Federal Home Loan Bank functions as a central reserve bank providing credit for savings and loan associations and certain other member financial institutions. As a member, the Bank is required to own capital stock in the Federal Home Loan Bank and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness. Under its current credit policies, the Federal Home Loan Bank generally limits advances to 20% of a member’s assets, and short-term borrowing of less than one year may not exceed 10% of the institution’s assets. The Federal Home Loan Bank determines specific lines of credit for each member institution.

The following table sets forth certain information regarding the Bank’s use of Federal Home Loan Bank advances.

 

     At or For the Years Ended December 31,  
     2010     2009     2008  
     (Dollars in thousands)  

Maximum balance at any month end

   $ 29,001      $ 45,430      $ 60,294   

Average balance

     23,116        40,500        53,639   

Period end balance

     15,729        24,776        47,830   

Weighted average interest rate:

      

At end of period

     4.05     4.32     4.68

During the period

     4.37     5.54     4.78

 

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The following table sets forth certain information regarding the Bank’s use of retail repurchase agreements.

 

     At or For the Years Ended December 31,  
     2010     2009     2008  
     (Dollars in thousands)  

Maximum balance at any month end

   $ 9,223      $ 7,949      $ 17,698   

Average balance

     8,142        5,428        11,759   

Period end balance

     8,669        7,949        4,552   

Weighted average interest rate:

      

At end of period

     0.76     0.91     1.00

During the period

     0.90     0.94     2.11

Subsidiary Activities

The Bank is the Company’s only subsidiary, and is wholly-owned by the Company. First Harrison Investments, Inc. and First Harrison Holdings, Inc. are wholly-owned Nevada corporate subsidiaries of the Bank that jointly own First Harrison, LLC, a Nevada limited liability corporation that holds and manages an investment securities portfolio. First Harrison REIT, Inc. was incorporated on July 3, 2008 to hold a portion of the Bank’s real estate mortgage loan portfolio. First Harrison REIT, Inc. is a wholly-owned subsidiary of First Harrison Holdings, Inc.

Personnel

As of December 31, 2010, the Bank had 118 full-time employees and 31 part-time employees. A collective bargaining unit does not represent the employees and the Bank considers its relationship with its employees to be good.

REGULATION AND SUPERVISION

General

As a savings and loan holding company, the Company is required by federal law to report to, and otherwise comply with the rules and regulations of, the Office of Thrift Supervision. The Bank, an insured federal savings association, is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer.

The Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the Federal Deposit Insurance Corporation. The Bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation concerning its activities and financial condition and obtain regulatory approvals before entering into certain transactions such as mergers with, or acquisitions of, other savings associations. The Office of Thrift Supervision and/or the Federal Deposit Insurance Corporation conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation or Congress, could have a material adverse impact on the Company, the Bank and their operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed by the President on July 21, 2010, provides for the regulation and supervision of federal savings institutions like the Bank to be transferred from the Office of Thrift Supervision to the Office of the Comptroller of the Currency, the agency that regulates national banks. The Office of the Comptroller of the Currency will assume primary responsibility for

 

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examining the Bank and implementing and enforcing many of the laws and regulations applicable to federal savings institutions. The Office of Thrift Supervision will be eliminated. The transfer will occur one year from July 21, 2010 enactment of the Dodd-Frank Act, subject to a possible six month extension. At the same time, the responsibility for supervising and regulating savings and loan holding companies will be transferred to the Federal Reserve Board, which currently supervises bank holding companies. The Dodd-Frank Act also provides for the creation of a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the Federal Reserve Board, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators. However, institutions of $10 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by, and subject to the primary enforcement authority of, the prudential regulator rather than the Consumer Financial Protection Bureau.

Certain regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The summary of statutory provisions and regulations applicable to savings associations and their holding companies set forth below and elsewhere in this document does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company and is qualified in its entirety by reference to the actual laws and regulations.

Holding Company Regulation

General. The Company is a unitary savings and loan holding company within the meaning of federal law. As such, the Company is registered with the Office of Thrift Supervision and subject to Office of Thrift Supervision regulations, examination, supervision and reporting requirements. In addition, the Office of Thrift Supervision has enforcement authorities over the Company and its non-savings association subsidiaries. Among other things, that authority permits the OTS to restrict or prohibit activities that one determined to be a serious risk to the subsidiary savings association.

The Dodd-Frank Act regulatory restructuring transfers to the Federal Reserve Board the responsibility for regulating and supervising savings and loan holding companies. That will occur one year from the July 21, 2010 effective date of the Dodd-Frank Act, subject to a possible six month extension.

Activities Restrictions. Upon any non-supervisory acquisition by the Company of another savings association or savings bank that meets the qualified thrift lender test and is deemed to be a savings association by the Office of Thrift Supervision, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain activities authorized by Office of Thrift Supervision regulation. The Dodd-Frank Act added that any savings and loan holding company that engages in activities permissible for a financial holding company must meet the qualitative requirements for a bank holding company to be a financial holding company and conducts the activities in accordance with the requirements that would apply to a financial holding company’s conduct of the activity.

A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company, without prior written approval of the Office of Thrift Supervision and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings associations, the Office of Thrift Supervision considers, among other things, factors such as the financial and managerial resources and future prospects of the Company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive effects.

The Office of Thrift Supervision may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

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Capital. Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital as is currently the case with bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.

Source of Strength. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

Dividends. The Bank must notify the Office of Thrift Supervision thirty (30) days before declaring any dividend to the Company. The financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.

Acquisition of the Company. Under the Federal Change in Control Act, a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company or savings association. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the Company’s outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in control of the Company. A change in control definitively occurs upon the acquisition of 25% or more of the Company’s outstanding voting stock. Under the Change in Control Act, the Office of Thrift Supervision generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.

Federal Savings Association Regulation

Business Activities. The activities of federal savings banks are governed by federal laws and regulations. Those laws and regulations delineate the nature and extent of the business activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.

The Dodd-Frank Act authorizes the payment of interest on commercial checking accounts, effective July 21, 2011.

Capital Requirements. The Office of Thrift Supervision capital regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio; a 4% tier 1 capital to total assets leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift Supervision regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is generally defined as common

 

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stockholders’ equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital (Tier 2 Capital) includes cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible debt securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets, and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

The Office of Thrift Supervision also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular circumstances.

At December 31, 2010, the Bank met each of its capital requirements. See Note 19 in the accompanying Notes to Consolidated Financial Statements.

Prompt Corrective Regulatory Action. The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, a savings association that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be “undercapitalized.” A savings association that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be “significantly undercapitalized” and a savings association that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator within specified time frames for an institution that is “critically undercapitalized.” The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings association is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company up to the lesser of 5% of the savings association’s total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.

Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation.

Under the Federal Deposit Insurance Corporation’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by Federal Deposit Insurance Corporation regulations. Assessment rates currently range from seven to 77.5 basis points of assessable deposits. The Federal Deposit Insurance Corporation may adjust the scale uniformly, except that no adjustment can deviate more than three basis points from the base scale without notice and comment. No institution may pay a dividend if in default of the federal deposit insurance assessment.

On February 7, 2011, the Federal Deposit Insurance Corporation approved a final rule that implemented changes to the deposit insurance assessment system mandated by the Dodd-Frank Act. The final rule, which will take effect for the quarter beginning April 1, 2011, requires that the base on which deposit insurance assessments are charged be revised from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. Under the final rule, insured depository institutions are required to report their average consolidated total assets on a daily basis, using the regulatory accounting methodology established for reporting total assets. For purposes of the final rule, tangible equity is defined as Tier 1 capital. Prior to the April 1,

 

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2011 effective date of the final rule, the Federal Deposit Insurance Corporation will continue to calculate the assessment base from adjusted domestic deposits.

The Federal Deposit Insurance Corporation imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital (as of June 30, 2009), capped at ten basis points of an institution’s deposit assessment base, in order to cover losses to the Deposit Insurance Fund. That special assessment was collected on September 30, 2009. The Federal Deposit Insurance Corporation provided for similar assessments during the final two quarters of 2009, if deemed necessary.

In lieu of further special assessments, however, the Federal Deposit Insurance Corporation required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012. The estimated assessments, which included an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 30, 2009. As of December 31, 2009, and each quarter thereafter, a charge to earnings is recorded for each regular assessment with an offsetting credit to the prepaid asset.

Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000. That coverage was made permanent by the Dodd-Frank Act. In addition, the Federal Deposit Insurance Corporation adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, and certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the Federal Deposit Insurance Corporation through June 30, 2012, or in some cases, December 31, 2012. The Bank opted to participate in the unlimited noninterest- bearing transaction account coverage and the Bank and the Company opted not to participate in the unsecured debt guarantee program. The Dodd-Frank Act extended the unlimited coverage for certain noninterest-bearing transaction accounts from January 1, 2011 until December 31, 2012 without the opportunity for opt out.

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. That payment is established quarterly and during the four quarters ended December 31, 2010 averaged 1.05 basis points of assessable deposits.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The Federal Deposit Insurance Corporation must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the Federal Deposit Insurance Corporation and the Federal Deposit Insurance Corporation has recently exercised that discretion by establishing a long range fund ratio of 2%.

The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

Loans to One Borrower. Federal law provides that savings associations are generally subject to the limits on loans to one borrower applicable to national banks. Generally, subject to certain exceptions, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.

QTL Test. Federal law requires savings associations to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to

 

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20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities but also including education, credit card and small business loans) in at least 9 months out of each 12 month period.

A savings association that fails the qualified thrift lender test is subject to certain operating restrictions. The Dodd-Frank Act makes noncompliance with the qualified thrift lender test also potentially subject to agency enforcement action for a violation of law. As of December 31, 2010, the Bank maintained 69% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.

Limitation on Capital Distributions. Federal regulations impose limitations upon all capital distributions by a savings association, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and prior approval of the Office of Thrift Supervision is required before any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under Office of Thrift Supervision regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to the Office of Thrift Supervision of the capital distribution if, like the Bank, it is a subsidiary of a holding company. If the Bank’s capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it was in need of increased supervision, the Bank’s ability to make capital distributions could be restricted. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determines that such distribution would constitute an unsafe or unsound practice.

Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the Office of Thrift Supervision determines that a savings association fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require the institution to submit an acceptable plan to achieve compliance with the standard.

Transactions with Related Parties. The Bank’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with the Bank, including the Company and its other subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings association’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings associations are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings association may purchase the securities of any affiliate other than a subsidiary.

The Sarbanes-Oxley Act of 2002 generally prohibits loans by the Company to its executive officers and directors. However, the law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The laws limit both the individual and aggregate amount of loans that the Bank may make to insiders based, in part, on the Bank’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.

 

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Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over savings associations and has authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action to be taken with respect to a particular savings association. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

The Office of the Comptroller of the Currency will assume the Office of Thrift Supervision’s enforcement authority as to federal savings associations pursuant to the Dodd-Frank Act regulatory restructuring.

Assessments. Savings associations are required to pay assessments to the Office of Thrift Supervision to fund the agency’s operations. The general assessments, paid on a semi-annual basis, are computed based upon the savings association’s (including consolidated subsidiaries) total assets, financial condition and complexity of its portfolio. The Office of Thrift Supervision assessments paid by the Bank for the fiscal year ended December 31, 2010 totaled $121,000.

The Office of the Comptroller of the Currency, which will succeed to the Office of Thrift Supervision’s supervision of federal savings banks under the Dodd-Frank Act regulatory restructuring, similarly supports its operations through assessments on regulated institutions.

Federal Home Loan Bank System

The Bank is a member of the Federal Home Loan Bank System, which consists of (12) regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. The Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2010 of $3.2 million.

The Federal Home Loan Banks have been required to provide funds for the resolution of insolvent thrifts in the late 1980s and contribute funds for affordable housing programs. These and similar requirements, or general economic conditions, could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank’s net interest income would likely also be reduced.

Federal Reserve System

The Federal Reserve Board regulations require savings associations to maintain non-interest earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal (NOW) and regular checking accounts). For 2010, the regulations generally provided that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio was assessed on net transaction accounts up to and including $55.2 million; a 10% reserve ratio was applied above $55.2 million. The first $10.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) were exempted from the reserve requirements. The amounts are adjusted annually and, for 2011, require a 3% ratio for up to $58.8 million and an exemption of $10.7 million. The Bank complies with the foregoing requirements.

Regulatory Restructuring Legislation

On July 21, 2010, President Obama signed the Dodd-Frank Act, which is legislation that restructures the regulation of depository institutions. In addition to eliminating the Office of Thrift Supervision and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, requires changes in the way that institutions are assessed for deposit insurance, mandates the imposition of consolidated capital requirements on

 

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savings and loan holding companies, requires that originators of securitized loans retain a percentage of the risk for the transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees, reduces the federal preemption afforded to federal savings associations and contains a number of reforms related to mortgage originations. Many of the provisions of the Dodd-Frank Act contain delayed effective dates and/or require the issuance of regulations. As a result, it will be some time before their impact on operations can be assessed by management. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in an increased regulatory burden and higher compliance, operating, and possibly, interest costs for the Company and the Bank.

FEDERAL AND STATE TAXATION

Federal Taxation

General. The Company and the Bank report their income on a calendar year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank’s reserve for bad debts, as discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Bank has not been audited by the Internal Revenue Service in the past five years.

Bad Debt Reserve. For taxable years beginning after December 31, 1995, the Bank is entitled to take a bad debt deduction for federal income tax purposes which is based on its current or historic net charge-offs by applying the experience reserve method for banks. For tax years beginning before December 31, 1995, the Bank as a qualifying thrift had been permitted to establish a reserve for bad debts and to make annual additions to such reserve, which were deductible for federal income tax purposes. Under such prior tax law, generally the Bank recognized a bad debt deduction equal to 8% of taxable income.

Under the 1996 Tax Act, the Bank was required to recapture all or a portion of its additions to its bad debt reserve made subsequent to the base year (which is the Bank’s last taxable year beginning before January 1, 1988). This recapture was required to be made, after a deferral period based on certain specified criteria, ratably over a six-year period commencing in the Bank’s calendar 1998 tax year. All post-1987 additions to the statutory bad debt reserve have been recaptured in taxable income as of December 31, 2002.

Potential Recapture of Base Year Bad Debt Reserve. The Bank’s bad debt reserve as of the base year is not subject to automatic recapture as long as the Bank continues to carry on the business of banking and does not meet the definition of a “large bank” as discussed below. If the Bank no longer qualifies as a bank, the balance of the pre-1988 reserves (the base year reserves) are restored to income over a six-year period beginning in the tax year the Bank no longer qualifies as a bank. Such base year bad debt reserve is subject to recapture to the extent that the Bank makes “non-dividend distributions” that are considered as made from the base year bad debt reserve. To the extent that such reserves exceed the amount that would have been allowed under the experience method (“Excess Distributions”), then an amount based on the amount distributed will be included in the Bank’s taxable income. Non-dividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank’s current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank’s bad debt reserve. Thus, any dividends to the Company that would reduce amounts appropriated to the Bank’s bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. If the Bank makes a “non-dividend distribution,” then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state and local taxes). The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserve.

Further recapture of the Bank’s tax bad debt reserve is also triggered if the Bank meets the definition of a “large bank” as defined in the Internal Revenue Code. Under the Internal Revenue Code, if a bank’s average adjusted assets exceeds $500 million for any tax year it is considered a “large bank” and must utilize the specific

 

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charge-off method to compute tax bad debt deductions. For additional information, see Note 12 in the accompanying Notes to Consolidated Financial Statements.

Corporate Alternative Minimum Tax. The Internal Revenue Code imposes a tax on alternative minimum taxable income (“AMTI”) at a rate of 20%. The excess of the bad debt reserve deduction claimed by the Bank over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating loss carry-overs, of which the Bank currently has none. AMTI is increased by an amount equal to 75% of the amount by which the Bank’s adjusted current earnings exceed its AMTI (determined without regard to this preference and before reduction for net operating losses). In addition, for taxable years beginning after June 30, 1986 and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modifications) over $2.0 million is imposed on corporations, including the Bank, whether or not an Alternative Minimum Tax (“AMT”) is paid. The Bank does not expect to be subject to the AMT.

Dividends Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank own more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted.

Indiana Taxation

Indiana imposes an 8.5% franchise tax based on a financial institution’s adjusted gross income as defined by statute. In computing adjusted gross income, deductions for municipal interest, United States Government interest, the bad debt deduction computed using the reserve method and pre-1990 net operating losses are disallowed. During the past five years, the Bank’s Indiana state income tax returns for the years 2003 through 2005 were audited, with no changes made.

 

ITEM 1A. RISK FACTORS

Above average interest rate risk associated with fixed-rate loans may have an adverse effect on our financial position or results of operations.

The Bank’s loan portfolio includes a significant amount of loans with fixed rates of interest. At December 31, 2010, $150.5 million, or 49.9% of the Bank’s total loans receivable, had fixed interest rates all of which were held for investment. The Bank offers ARM loans and fixed-rate loans. Unlike ARM loans, fixed-rate loans carry the risk that, because they do not reprice to market interest rates, their yield may be insufficient to offset increases in the Bank’s cost of funds during a rising interest rate environment. Accordingly, a material and prolonged increase in market interest rates could be expected to have a greater adverse effect on the Bank’s net interest income compared to other institutions that hold a materially larger portion of their assets in ARM loans or fixed-rate loans that are originated for committed sale in the secondary market. For a discussion of the Bank’s loan portfolio, see “Item 1. Business– Lending Activities.”

Higher loan losses could require the Company to increase its allowance for loan losses through a charge to earnings.

When we loan money we incur the risk that our borrowers do not repay their loans. We reserve for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential

 

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severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. Our allowance for loan losses at any particular date may not be sufficient to cover future loan losses. We may be required to increase our allowance for loan losses, thus reducing earnings.

Commercial business lending may expose the Company to increased lending risks.

At December 31, 2010, the Bank’s commercial business loan portfolio amounted to $21.9 million, or 7.3% of total loans. Subject to market conditions and other factors, the Bank intends to expand its commercial business lending activities within its primary market area. Commercial business lending is inherently riskier than one- to four-family mortgage lending. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation value of these assets in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. See “Item 1. Business–Lending Activities–Commercial Business Loans.”

Commercial real estate lending may expose the Company to increased lending risks.

At December 31, 2010, the Bank’s commercial real estate loan portfolio amounted to $59.9 million, or 19.8% of total loans. Commercial real estate lending is inherently riskier than one- to-four family mortgage lending. Because payments on loans secured by commercial properties often depend upon the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy, among other things. See “Item 1. Business–Lending Activities–Commercial Real Estate Loans.”

A continuation of recent turmoil in the financial markets could have an adverse effect on our financial position or results of operations.

Beginning in 2008, United States and global financial markets have experienced severe disruption and volatility, and general economic conditions have declined significantly. Adverse developments in credit quality, asset values and revenue opportunities throughout the financial services industry, as well as general uncertainty regarding the economic, industry and regulatory environment, have had a marked negative impact on the industry. Dramatic declines in the U.S. housing market over the past eighteen months, with falling home prices, increasing foreclosures and increasing unemployment, have negatively affected the credit performance of mortgage loans and resulted in significant write-downs of asset values by many financial institutions. The United States and the governments of other countries have taken steps to try to stabilize the financial system, including investing in financial institutions, and have also been working to design and implement programs to improve general economic conditions. Notwithstanding the actions of the United States and other governments, these efforts may not succeed in restoring industry, economic or market conditions and may result in adverse unintended consequences. Factors that could continue to pressure financial services companies, including the Company, are numerous and include (i) worsening credit quality, leading among other things to increases in loan losses and reserves, (ii) continued or worsening disruption and volatility in financial markets, leading among other things to continuing reductions in asset values, (iii) capital and liquidity concerns regarding financial institutions generally, (iv) limitations resulting from or imposed in connection with governmental actions intended to stabilize or provide additional regulation of the financial system, or (v) recessionary conditions that are deeper or last longer than currently anticipated.

The current economic recession could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.

Our business activities and earnings are affected by general business conditions in the United States and in our primary market area. These conditions include short-term and long-term interest rates, inflation, unemployment levels, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets and the strength of the economy in the United States generally and in our primary market area in particular. In the current recession, the national economy has experienced general economic downturns, with rising unemployment levels, declines in real estate values and erosion in consumer confidence. The current economic recession has also had a negative impact on our primary market area, which has experienced a softening of the local real estate market and reductions in local property values. A prolonged or more severe economic downturn, continued elevated levels

 

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of unemployment, further declines in the values of real estate, or other events that affect household and/or corporate incomes could impair the ability of our borrowers to repay their loans in accordance with their terms. The economic downturn could also result in reduced demand for credit or fee-based products and services, which also would decrease our revenues.

Increased and/or special Federal Deposit Insurance Corporation assessments will hurt our earnings.

The recent economic recession has caused a high level of bank failures, which has dramatically increased Federal Deposit Insurance Corporation resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the Federal Deposit Insurance Corporation has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the Federal Deposit Insurance Corporation imposed a special assessment on all insured institutions. Our special assessment, which was reflected in earnings for the quarter ended June 30, 2009, was $205,000. In lieu of imposing an additional special assessment, the Federal Deposit Insurance Corporation required all institutions to prepay their assessments for all of 2010, 2011 and 2012, which for us totaled $2.3 million. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.

Strong competition within the Bank’s market area could hurt the Company’s profit and growth.

The Bank faces intense competition both in making loans and attracting deposits. This competition has made it more difficult for it to make new loans and at times has forced it to offer higher deposit rates. Price competition for loans and deposits might result in the Bank earning less on loans paying more on deposits, which would reduce net interest income. Competition also makes it more difficult to grow loans and deposits. Some of the institutions with which the Bank competes have substantially greater resources and lending limits than it has and may offer services that the Bank does not provide. Future competition will likely increase because of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. The Company’s profitability depends upon the Bank’s continued ability to compete successfully in its market area.

The Bank and the Company operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.

The Company and the Bank are subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, their chartering authority, and by the Federal Deposit Insurance Corporation, as insurer of the Bank’s deposits. The Company and the Bank are both subject to regulation and supervision by the Office of Thrift Supervision. Such regulations and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and depositors. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including to imposition of restrictions on operations, the classification of assets and determination of the level of allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory claim may have a material impact on the Bank’s operations.

Recently enacted legislative reforms and future regulatory reforms required by such legislation could have a significant impact on our business, financial condition and results of operations.

The Dodd-Frank Act will have a broad impact on the financial services industry, including significant regulatory and compliance changes. Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. In addition, the Dodd-Frank Act restructures the existing regulatory regime for depository institutions insured by the Federal Deposit Insurance Corporation. The Office of Thrift Supervision will be merged into the Office of the Comptroller of the Currency over a one year transition period (subject to a possible six month extension by the Secretary of the Treasury). While our federal savings association charter is preserved, federal thrifts will be regulated by the Office of the Comptroller of the Currency, along with national banks and federal branches and agencies of foreign banks. The Federal Reserve Board will continue to supervise all bank holding companies and will assume jurisdiction over savings and loan holding companies. The Dodd-Frank Act codifies the

 

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Federal Reserve Board’s existing “source of strength” policy that holding companies act as a source of strength to their insured institution subsidiaries by providing capital, liquidity and other support in times of distress. While it is difficult to predict at this time what specific impact the Dodd-Frank Act and the related yet to be written implementing rules and regulations will have on us, we expect that, at a minimum, our operating and compliance costs will increase, and our interest expense could increase, as a result of these new rules and regulations.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES

The following table sets forth certain information regarding the Bank’s offices as of December 31, 2010.

 

Location

   Year
Opened
     Net Book
Value(1)
     Owned/
Leased
    Approximate
Square
Footage
 
            (Dollars in
thousands)
              

Main Office:

          

220 Federal Drive, N.W.

Corydon, Indiana 47112

     1997       $ 1,667         Owned        12,000   

Branch Offices:

          

391 Old Capital Plaza, N.E.

Corydon, Indiana 47112

     1997         8         Leased (2)      425   

8095 State Highway 135, N.W.

New Salisbury, Indiana 47161

     1999         648         Owned        3,500   

710 Main Street

Palmyra, Indiana 47164

     1991         943         Owned        6,000   

9849 Highway 150

Greenville, Indiana 47124

     1986         208         Owned        2,484   

5100 State Road 64 (Edwardsville Branch)

Georgetown, Indiana 47122

     2008         1,458         Owned        4,988   

317 East U.S. Highway 150

Hardinsburg, Indiana 47125

     1996         118         Owned        1,834   

4303 Charlestown Crossing

New Albany, Indiana 47150

     1999         772         Owned        3,500   

3131 Grant Line Road

New Albany, Indiana 47150

     2003         1,284         Owned        12,200   

5609 Williamsburg Station Road

Floyds Knobs, Indiana 47119

     2003         546         Owned        4,160   

2744 Allison Lane

Jeffersonville, Indiana 47130

     2003         1,255         Owned        4,090   

1312 S. Jackson Street

Salem, Indiana 47167

     2007         1,106         Owned        3,400   

2420 Barron Avenue NE

Lanesville, Indiana 47136

     2010         954         Owned        1,450   

 

(1) Represents the net value of land, buildings, furniture, fixtures and equipment owned by the Bank.
(2) Lease expires in April 2015.

 

ITEM 3. LEGAL PROCEEDINGS

At December 31, 2010, neither the Company nor the Bank was involved in any pending legal proceedings believed by management to be material to the Company’s financial condition or results of operations. From time to time, the Bank is involved in legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company’s financial condition, results of operations or cash flows.

 

ITEM 4. [REMOVED AND RESERVED]

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The common shares of the Company are traded on the NASDAQ Capital Market under the symbol “FCAP.” As of December 31, 2010, the Company had 1,246 stockholders of record and 2,787,301 common shares outstanding. This does not reflect the number of persons whose shares are in nominee or “street” name accounts through brokers. See Note 18 in the accompanying Notes to Consolidated Financial Statement for information regarding dividend restrictions applicable to the Company.

The following table lists quarterly market price and dividend information per common share for the years ended December 31, 2010 and 2009 as reported by NASDAQ.

 

     High
Sale
     Low
Sale
     Dividends      Market price
end of period
 

2010:

           

First Quarter

   $ 16.90       $ 13.55       $ 0.18       $ 14.60   

Second Quarter

     15.73         14.25         0.18         15.00   

Third Quarter

     16.00         14.19         0.19         15.24   

Fourth Quarter

     16.69         14.80         0.19         16.64   

2009:

           

First Quarter

   $ 15.28       $ 11.77       $ 0.18       $ 14.90   

Second Quarter

     18.49         14.10         0.18         17.35   

Third Quarter

     18.27         15.75         0.18         17.50   

Fourth Quarter

     17.88         13.17         0.18         15.19   

The following table provides certain information with regard to shares repurchased by the Company in the fourth quarter of 2010.

 

Period

   (a) Total
Number of
Shares
Purchased
     (b) Average
Price Paid Per
Share
     (c) Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
     (d) Maximum
Number of Shares
that May Yet Be
Purchased Under
the Plans or
Programs
 

October 1 through October 31, 2010

     —           N/A         —           191,890   

November 1 through November 30, 2010

     8       $ 15.82         8         191,882   

December 1 through December 31, 2010

     —           N/A         —           191,882   
                       

Total

     8            8      
                       

On August 19, 2008, the board of directors authorized the repurchase of up to 240,467 shares of the Company’s outstanding common stock. The stock repurchase program will expire upon the purchase of the maximum number of shares authorized under the program, unless the board of directors terminates the program earlier.

 

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ITEM 6. SELECTED FINANCIAL DATA

The consolidated financial data presented below is qualified in its entirety by the more detailed financial data appearing elsewhere in this report, including the Company’s audited consolidated financial statements.

 

FINANCIAL CONDITION DATA:    At December 31,  
     2010      2009     2008      2007      2006  
     (In thousands)  

Total assets

   $ 452,378       $ 455,534      $ 458,625       $ 453,179       $ 457,105   

Cash and cash equivalents (1)

     21,575         15,857        22,149         15,055         24,468   

Securities available for sale

     100,851         93,729        82,733         72,991         71,362   

Securities held to maturity

     32         62        86         1,050         1,118   

Net loans

     294,550         311,092        322,385         334,463         333,575   

Deposits

     378,003         374,476        355,891         328,151         331,143   

Retail repurchase agreements

     8,669         7,949        4,552         15,562         19,228   

Advances from Federal Home Loan Bank

     15,729         24,776        47,830         60,694         59,461   

Stockholders’ equity, net of noncontrolling interest in subsidiary

     47,893         45,944        47,522         45,736         44,089   
OPERATING DATA:    For the Year Ended
December 31,
 
     2010      2009     2008      2007      2006  
     (In thousands)  

Interest income

   $ 21,834       $ 22,969      $ 25,686       $ 27,085       $ 26,211   

Interest expense

     5,502         8,388        10,745         13,699         12,741   
                                           

Net interest income

     16,332         14,581        14,941         13,386         13,470   

Provision for loan losses

     2,037         4,289        1,570         558         810   
                                           

Net interest income after provision for loan losses

     14,295         10,292        13,371         12,828         12,660   
                                           

Noninterest income

     3,906         3,373        3,573         3,524         3,471   

Noninterest expense

     12,762         13,473        11,846         11,349         10,551   
                                           

Income before income taxes

     5,439         192        5,098         5,003         5,580   

Income tax expense (benefit)

     1,561         (586     1,529         1,591         1,872   
                                           

Net Income

     3,878         778        3,569         3,412         3,708   
                                           

Less: net income attributable to non-controlling interest in subsidiary

     13         12        —           —           —     
                                           

Net Income Attributable to First Capital, Inc.

   $ 3,865       $ 766      $ 3,569       $ 3,412       $ 3,708   
                                           

PER SHARE DATA (2):

             

Net income - basic

   $ 1.39       $ 0.28      $ 1.27       $ 1.21       $ 1.31   

Net income - diluted

     1.39         0.28        1.27         1.20         1.30   

Dividends

     0.74         0.72        0.71         0.68         0.68   

 

(1) Includes cash and due from banks, interest-bearing deposits in other depository institutions and federal funds sold.
(2) Per share data excludes net income attributable to non-controlling interest in subsidiary.

 

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SELECTED FINANCIAL RATIOS:    At or For the Year Ended
December 31,
 
     2010     2009     2008     2007     2006  

Performance Ratios:

          

Return on assets (1)

     0.84     0.17     0.79     0.76     0.84

Return on average equity (2)

     8.10     1.62     7.65     7.74     8.64

Dividend payout ratio (3)

     53.24     257.14     55.91     56.20     51.91

Average equity to average assets

     10.43     10.34     10.31     9.87     9.66

Interest rate spread (4)

     3.74     3.26     3.30     2.82     2.90

Net interest margin (5)

     3.96     3.56     3.68     3.31     3.34

Non-interest expense to average assets

     2.79     2.95     2.62     2.54     2.38

Average interest earning assets to average interest bearing liabilities

     116.24     115.08     114.89     114.94     114.25

Regulatory Capital Ratios (Bank only):

          

Tier I - adjusted total assets

     9.32     8.66     8.98     8.25     7.95

Tier I - risk based

     14.83     13.39     14.10     12.63     12.57

Total risk-based

     15.54     13.99     14.77     13.20     13.15

Asset Quality Ratios:

          

Nonperforming loans as a percent of net loans (6)

     2.69     3.06     1.72     1.70     1.31

Nonperforming assets as a percent of total assets (7)

     1.88     2.28     1.40     1.44     1.16

Allowance for loan losses as a percent of gross loans receivable

     1.48     1.54     0.81     0.65     0.68

 

(1) Net income attributable to First Capital, Inc. divided by average assets.
(2) Net income attributable to First Capital, Inc. divided by average equity.
(3) Dividends declared per share divided by net income per share.
(4) Difference between weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities.
     Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 34%.
(5) Net interest income as a percentage of average interest-earning assets.
(6) Nonperforming loans consist of loans accounted for on a nonaccrual basis and accruing loans 90 days or more past due.
(7) Nonperforming assets consist of nonperforming loans and real estate acquired in settlement of loans.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

General

As the holding company for the Bank, the Company conducts its business primarily through the Bank. The Bank’s results of operations depend primarily on net interest income, which is the difference between the income earned on its interest-earning assets, such as loans and investments, and the cost of its interest-bearing liabilities, consisting primarily of deposits, retail repurchase agreements and borrowings from the Federal Home Loan Bank of Indianapolis. The Bank’s net income is also affected by, among other things, fee income, provisions for loan losses, operating expenses and income tax provisions. The Bank’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the intended actions of the regulatory authorities.

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company and the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes to consolidated financial statements included elsewhere in this report.

Operating Strategy

The Company is the parent company of an independent community-oriented financial institution that delivers quality customer service and offers a wide range of deposit, loan and investment products to its customers. The commitment to customer needs, the focus on providing consistent customer service, and community service and support are the keys to the Bank’s past and future success. The Company has no other material income other than that generated by the Bank and its subsidiaries.

The Bank’s primary business strategy is attracting deposits from the general public and using those funds to originate one-to-four-family residential mortgage loans, multi-family residential loans, commercial real estate and business loans and consumer loans. The Bank invests excess liquidity primarily in interest-bearing deposits with the Federal Home Loan Bank of Indianapolis and other financial institutions, federal funds sold, U.S. government and agency securities, local municipal obligations and mortgage-backed securities.

In recent years, the Company’s operating strategy has also included strategies designed to enhance profitability by increasing sources of noninterest income and improving operating efficiency while managing its capital and limiting its credit risk and interest rate risk exposures. To accomplish these objectives, the Company has focused on the following:

 

   

Monitoring asset quality and credit risk in the loan and investment portfolios, with an emphasis on reducing nonperforming assets and originating high-quality commercial and consumer loans.

 

   

Being active in the local community, particularly through our efforts with local schools, to uphold our high standing in our community and marketing to our next generation of customers.

 

   

Improving profitability by expanding our product offerings to customers and investing in technology to increase the productivity and efficiency of our staff.

 

   

Continuing to emphasize commercial real estate and other commercial business lending as well as consumer lending. The Bank will also continue to focus on increasing secondary market lending as a source of noninterest income.

 

   

Growing commercial and personal demand deposit accounts which provide a low-cost funding source.

 

   

Evaluating vendor contracts for potential cost savings and efficiencies.

 

   

Continuing our capital management strategy to enhance shareholder value through the repurchase of Company stock and the payment of dividends.

 

   

Evaluating growth opportunities to expand the Bank’s market area and market share through acquisitions of other financial institutions or branches of other institutions.

 

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Critical Accounting Policies and Estimates

The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that require management to make assumptions about matters that are highly uncertain at the time an accounting estimate is made; and different estimates that the Company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the Company’s financial condition, changes in financial condition or results of operations. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under generally accepted accounting principles.

Significant accounting policies, including the impact of recent accounting pronouncements, are discussed in Note 1 of the accompanying Notes to Consolidated Financial Statements. Those policies considered to be critical accounting policies are described below.

Allowances for Loan Losses. Management’s evaluation of the adequacy of the allowance for loan losses is the most critical of accounting estimates for a financial institution. The methodology for determining the allowance for loan losses and the related provision for loan losses is described below in “Allowance for Loan Losses.” This accounting estimate is highly subjective and requires a significant amount of judgment because a multitude of factors can influence the ultimate collection of a loan. The methodology for determining the allowance for loan losses attempts to identify the amount of probable losses in the loan portfolio. However, there can be no assurance that the methodology will successfully identify all probable losses as the factors and conditions that influence the estimate are subject to significant change and management’s judgments. As a result, additional provisions for loan losses may be required that would adversely impact earnings in future periods. For additional discussion of the allowance for loan losses methodology, see Note 1 and Note 4 of the accompanying Notes to Consolidated Financial Statements.

Other-Than-Temporary Impairment of Securities. The Company reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment (“OTTI”) on a periodic basis. In evaluating the investment portfolio for OTTI, management considers the issuer’s credit rating, credit outlook, payment status and financial condition, the length of time the investment has been in a loss position, the size of the loss position and other meaningful information. Generally changes in market interest rates that result in a decline in value of an investment security are considered to be temporary, since the value of such investment can recover in the foreseeable future as market interest rates return to their original levels. However, such declines in value that are due to the underlying credit quality of the issuer or other adverse conditions that cannot be expected to improve in the foreseeable future, may be considered to be other-than-temporary. The Company recognizes credit-related OTTI on debt securities in earnings, while noncredit-related OTTI on debt securities not expected to be sold is recognized in accumulated other comprehensive income. Management believes this is a critical accounting policy because this evaluation of the underlying credit or analysis of other conditions contributing to the decline in value involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters. As of December 31, 2010, the Company has not recognized any OTTI charges. See Note 3 of the accompanying Notes to Consolidated Financial Statements for additional information regarding OTTI.

Valuation Methodologies. In the ordinary course of business, management applies various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, particularly when active markets do not exist for the items being valued. Generally, in evaluating various assets for potential impairment, management compares the fair value to the carrying value. Quoted market prices are referred to when estimating fair values for certain assets, such as investment securities. However, for those items for which market-based prices do not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include goodwill and other intangible assets, estimated present value of impaired loans, value ascribed to stock-based compensation and certain other financial investments. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company’s results of operations.

 

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Results of Operations for the Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009

Net Income. Net income attributable to the Company was $3.9 million ($1.39 per share diluted; weighted average common shares outstanding of 2,786,227, as adjusted) for the year ended December 31, 2010 compared to $766,000 ($0.28 per share diluted; weighted average common shares outstanding of 2,784,080, as adjusted) for the year ended December 31, 2009.

Net Interest Income. Net interest income increased $1.8 million, or 12.0%, from $14.6 million in 2009 to $16.3 million in 2010 primarily due to an increase in the interest rate spread.

Total interest income decreased 4.9% from $23.0 million in 2009 to $21.8 million in 2010. This decrease was primarily a result of the average tax-equivalent yield of interest-earning assets decreasing from 5.53% for the year ended December 31, 2009 to 5.24% for 2010. Interest on loans decreased $979,000 as a result of the average tax-equivalent yield on loans decreasing from 6.09% in 2009 to 5.99% in 2010 and the average balance of loans decreasing from $322.0 million in 2009 to $310.8 million in 2010. Interest on investment securities decreased $152,000 during 2010 due to the average tax-equivalent yield of investment securities decreasing from 4.42% in 2009 to 3.69% in 2010 partially offset by the average balance of investment securities increasing from $87.6 million in 2009 to $101.3 million in 2010. Management continued to focus loan origination efforts on commercial and consumer loans during 2010. The majority of the new commercial loans are adjustable-rate loans. Adjustable-rate loans now comprise 50% of the total loan portfolio, compared to 48% at the end of 2009. Market interest rates remained at near historic lows throughout 2010, so as loans and investment securities mature or pay down they are replaced with lower yielding new originations and purchases.

Total interest expense decreased $2.9 million, from $8.4 million for 2009 to $5.5 million for 2010, primarily due to a decrease in the average cost of funds from 2.27% in 2009 to 1.50% in 2010. The decrease was primarily due to the average cost of interest-bearing deposits, which decreased from 1.88% in 2009 to 1.32% in 2010 due to the continued repricing of time deposits. The average cost of Federal Home Loan Bank advances decreased from 5.54% in 2009 to 4.37% in 2010, and the average balance of Federal Home Loan Bank advances decreased from $40.5 million in 2009 to $23.1 million in 2010, due to the Bank pre-paying $8.0 million in advances in December 2009 and the maturity of additional higher-rate advances in 2010. The advances paid off in December 2009 had a weighted average interest rate of 5.97%, and the Bank incurred a prepayment penalty of $295,000 that was reported as interest expense in 2009. This additional interest expense increased the average cost of advances by 0.73% in 2009 and for all interest-bearing liabilities by 0.08% during the period. For further information, see “Average Balance Sheets” below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2010 and 2009 are shown in the schedule captioned “Rate/Volume Analysis” included herein.

Provision for Loan Losses. The provision for loan losses was $2.0 million for 2010 compared to $4.3 million in 2009. The consistent application of management’s allowance methodology resulted in a decrease in the provision for loan losses during 2010. During 2009, the Bank provided for specific reserves of $2.3 million on two commercial relationships totaling $4.6 million, which were secured by commercial real estate and equipment. One of those commercial relationships, totaling $2.6 million at December 31, 2009, was fully satisfied during 2010 as a result of the liquidation of collateral and charge-off of the remaining $1.4 million balance, and was the primary factor contributing to a decrease in nonperforming loans from $9.5 million at December 31, 2009 to $7.9 million at December 31, 2010. Net charge offs increased when comparing the two periods, from $2.0 million during 2009 to $2.5 million during 2010. The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year and to allow for inherent loss exposure due to weakened general economic conditions such as depreciating collateral values, job losses and continued pressures on household budgets in the Bank’s market area.

Provisions for loan losses are charges to earnings to maintain the total allowance for loan losses at a level considered reasonable by management to provide for probable known and inherent loan losses based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank’s control. While the Bank maintains the allowance for loan losses at a level that it considers adequate to provide for estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts.

Noninterest income. Noninterest income increased $533,000 to $3.9 million for 2010 compared to $3.4 million for 2009. Service charges on deposit accounts increased $325,000 when comparing the two periods due to an increase in debit card income. Gains on the sale of mortgage loans also increased $210,000 when comparing the two periods due primarily to an improvement in the spread realized when the loans are sold.

 

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Noninterest expense. Noninterest expense decreased $711,000, or 5.3%, to $12.8 million for 2010 compared to $13.5 million for 2009. The decrease was primarily due to decreases in data processing expenses, deposit insurance premiums and other operating expenses of $439,000, $303,000 and $258,000, respectively. The decrease in data processing expenses was primarily due to a decrease of $454,000 in ATM processing fees, related to a disputed charge paid in 2009 of which the Bank recovered $278,000 in 2010 that was partially offset by a $225,00 incentive received by the Bank in 2009 for switching its ATM processor. The decrease in deposit insurance premiums is primarily due to the 2009 special assessment imposed on all banks by the FDIC totaling $205,000. The decrease in other operating expenses was primarily due to decreases in loan expense, foreclosed real estate expenses and general office expenses.

Income tax expense. The Company recognized income tax expense of $1.6 million during 2010 compared to an income tax benefit of $586,000 for 2009. The income tax expense for 2010 is primarily due to an increase in income before taxes for the year. The effective tax rate for 2010 was 28.7%. See Note 12 in the accompanying Notes to Consolidated Financial Statements.

 

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Average Balances and Yields. The following table sets forth certain information for the periods indicated regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earnings assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average historical cost balances of assets or liabilities, respectively, for the periods presented and do not give effect to changes in fair value that are included as a separate component of stockholders’ equity. Average balances are derived from daily balances. Tax-exempt income on loans and investment securities has been adjusted to a tax equivalent basis using the federal marginal tax rate of 34%.

 

    Year Ended December 31,  
    2010     2009     2008  
(Dollars in thousands)   Average
Balance
    Interest     Average
Yield/
Cost
    Average
Balance
    Interest     Average
Yield/
Cost
    Average
Balance
    Interest     Average
Yield/
Cost
 

Interest-earning assets:

                 

Loans (1) (2):

                 

Taxable (3)

  $ 310,644      $ 18,598        5.99   $ 319,510      $ 19,517        6.11   $ 327,698      $ 22,013        6.72

Tax-exempt

    187        13        6.95     2,502        104        4.16     2,220        149        6.71
                                                     

Total loans

    310,831        18,611        5.99     322,012        19,621        6.09     329,918        22,162        6.72
                                                     

Investment securities:

                 

Taxable (3)

    74,313        2,132        2.87     62,149        2,354        3.79     53,478        2,420        4.53

Tax-exempt

    27,029        1,606        5.94     25,450        1,521        5.98     23,475        1,397        5.95
                                                     

Total investment securities

    101,342        3,738        3.69     87,599        3,875        4.42     76,953        3,817        4.96
                                                     

Federal funds sold and interest-bearing deposits with banks

    14,679        35        0.24     15,800        25        0.16     13,436        233        1.73
                                                     

Total interest-earning

assets

    426,852        22,384        5.24     425,411        23,521        5.53     420,307        26,212        6.24
                                                     

Noninterest-earning assets

    30,738            31,193            31,823       
                                   

Total assets

  $ 457,590          $ 456,604          $ 452,130       
                                   

Interest-bearing liabilities:

                 

Interest-bearing demand deposits

  $ 159,286      $ 1,224        0.77   $ 130,848      $ 1,102        0.84   $ 108,230      $ 1,283        1.19

Savings accounts

    43,990        103        0.23     39,964        149        0.37     33,183        247        0.74

Time deposits

    132,693        3,092        2.33     152,916        4,844        3.17     159,012        6,404        4.03
                                                     

Total deposits

    335,969        4,419        1.32     323,728        6,095        1.88     300,425        7,934        2.64
                                                     

Retail repurchase agreements

    8,142        73        0.90     5,428        51        0.94     11,759        248        2.11

FHLB advances

    23,116        1,010        4.37     40,500        2,242        5.54     53,639        2,563        4.78
                                                     

Total interest-bearing liabilities

    367,227        5,502        1.50     369,656        8,388        2.27     365,823        10,745        2.94
                                                     

Noninterest-bearing

liabilities:

                 

Noninterest-bearing deposits

    41,220            38,547            37,069       

Other liabilities

    1,407            1,168            2,611       
                                   

Total liabilities

    409,854            409,371            405,503       

Stockholders’ equity

    47,736            47,233            46,627       
                                   

Total liabilities and Stockholders’ equity (4)

  $ 457,590          $ 456,604          $ 452,130       
                                   

Net interest income

    $ 16,882          $ 15,133          $ 15,467     
                                   

Interest rate spread

        3.74         3.26         3.30
                                   

Net interest margin

        3.96         3.56         3.68
                                   

Ratio of average interest – earning assets to average interest-bearing liabilities

        116.24         115.08         114.89
                                   

 

(1) Interest income on loans includes fee income of $633,000, $642,000 and $620,000 for the years ended December 31, 2010, 2009, and 2008, respectively.
(2) Average loan balances include loans held for sale and nonperforming loans.
(3) Includes taxable debt and equity securities and Federal Home Loan Bank Stock.
(4) Stockholders’ equity attributable to First Capital, Inc.

 

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Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income and interest expense computed on a tax-equivalent basis. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) effects attributable to changes in rate and volume (change in rate multiplied by changes in volume). Tax exempt income on loans and investment securities has been adjusted to a tax-equivalent basis using the federal marginal tax rate of 34%.

 

     2010 Compared to 2009
Increase (Decrease) Due to
    2009 Compared to 2008
Increase (Decrease) Due to
 
     Rate     Volume     Rate/
Volume
    Net     Rate     Volume     Rate/
Volume
    Net  
     (In thousands)  

Interest-earning assets:

                

Loans:

                

Taxable

   $ (385   $ (545   $ 11      $ (919   $ (1,996   $ (550   $ 50      $ (2,496

Tax-exempt

     70        (96     (65     (91     (57     19        (7     (45
                                                                

Total investment securities

     (315     (641     (54     (1,010     (2,053     (531     43        (2,541
                                                                

Investment securities:

                

Taxable

     (571     461        (112     (222     (395     393        (64     (66

Tax-exempt

     (10     96        (1     85        5        118        1        124   
                                                                

Total investment securities

     (581     557        (113     (137     (390     511        (63     58   
                                                                

Federal funds sold and interest-bearing deposits with banks

     13        (2     (1     10        (211     40        (37     (208
                                                                

Total net change in income on interest- earning assets

     (883     (86     (168     (1,137     (2,654     20        (57     (2,691
                                                                

Interest-bearing liabilities:

                

Interest-bearing deposits

     (1,833     226        (69     (1,676     (2,277     615        (177     (1,839

Retail repurchase agreements

     (2     25        (1     22        (137     (134     74        (197

FHLB advances

     (473     (962     203        (1,232     407        (628     (100     (321
                                                                

Total net change in expense on interest- bearing liabilities

     (2,308     (711     133        (2,886     (2,007     (147     (203     (2,357
                                                                

Net change in net interest income

   $ 1,425      $ 625      $ (301   $ 1,749      $ (647   $ 167      $ 146      $ (334
                                                                

 

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Comparison of Financial Condition at December 31, 2010 and 2009

Total assets decreased 0.7% from $455.5 million at December 31, 2009 to $452.4 million at December 31, 2010 primarily due to a decrease in net loans partially offset by increases in securities available for sale and cash and cash equivalents.

Net loans decreased 5.3% from $311.1 million at December 31, 2009 to $294.6 million at December 31, 2010. The primary contributing factor to the decrease in net loans was a decrease of $8.9 million in residential mortgage loans as the Bank continued to sell the majority of newly originated residential mortgage loans in the secondary market. The Bank originated $43.1 million in new residential mortgages for sale in the secondary market during 2010 compared to $41.8 million in 2009. These loans were originated and funded by the Bank and sold in the secondary market. Of this total, $14.8 million paid off existing loans in the Bank’s portfolio. Originating mortgage loans for sale in the secondary market allows the Bank to better manage its interest rate risk, while offering a full line of mortgage products to prospective customers. In addition to residential mortgage loans, residential construction loans and consumer loans also decreased by $4.5 million and $1.2 million, respectively, during 2010.

Securities available for sale, at fair value, consisting primarily of U. S. agency and privately-issued mortgage-backed obligations, U. S. agency notes and bonds, and municipal obligations, increased $7.1 million, from $93.7 million at December 31, 2009 to $100.9 million at December 31, 2010. Purchases of securities available for sale totaled $57.8 million in 2010. These purchases were offset by maturities of $36.9 million and principal repayments of $12.7 million. The Bank invests excess cash in securities that provide safety, liquidity and yield. Accordingly, we purchase mortgage-backed securities to provide cash flow for loan demand and deposit changes, we purchase federal agency notes for short-term yield and low risk, and municipals are purchased to improve our tax equivalent yield focusing on longer term profitability.

The investment in securities held to maturity, consisting of federal agency mortgage-backed securities and municipal obligations, decreased from $62,000 at December 31, 2009 to $32,000 at December 31, 2010. During 2010, the Bank had maturities of $21,000 and principal repayments of $9,000.

Cash and cash equivalents increased from $15.9 million at December 31, 2009 to $21.6 million at December 31, 2010. The increase is due primarily to loan repayments and an increase in deposits.

Total deposits increased 0.9%, from $374.5 million at December 31, 2009 to $378.0 million at December 31, 2010. Interest-bearing demand deposits, money market and savings accounts increased a total of $22.4 million during 2010 while time deposits decreased $19.2 million during the period. Part of the increase in interest-bearing demand deposits resulted from the Bank’s successful efforts to attract operating accounts of public entities, such as counties, cities and school corporations. Time deposits have decreased as some customers are unwilling to lock into long-term commitments while interest rates are at their current low levels. Noninterest-bearing demand deposits increased 0.7% to $40.8 million at December 31, 2010.

Federal Home Loan Bank borrowings decreased $9.0 million from $24.8 million at December 31, 2009 to $15.7 million at December 31, 2010. New advances totaling $9.5 million were drawn during the year. Principal payments on advances totaled $18.5 million during 2010.

Retail repurchase agreements, which represent overnight borrowings from business and local municipal deposit customers, increased from $7.9 million at December 31, 2009 to $8.7 million at December 31, 2010, primarily due to normal balance fluctuations.

Total stockholders’ equity attributable to the Company increased from $45.9 million at December 31, 2009 to $47.9 million at December 31, 2010. This increase is primarily the result of net income of $3.9 million and the exercise of $289,000 in stock options, offset by dividends paid of $2.1 million and repurchases of treasury stock of $43,000. During 2010 the Company repurchased 2,827 shares of its stock at a weighted average price of $14.89 per share. As of December 31, 2010, the Company had repurchased 48,585 shares of the 240,467 authorized by the Board of Directors under the current stock repurchase program which was announced in August 2008 and 377,119 shares since the original repurchase program began in 2001.

 

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Off-Balance-Sheet Arrangements

The Company is a party to financial instruments with off-balance-sheet risk including commitments to extend credit under existing lines of credit and commitments to originate loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements.

Off-balance-sheet financial instruments whose contract amounts represent credit and interest rate risk are summarized as follows:

 

     At December 31,  
     2010      2009  
     (In thousands)  

Commitments to originate new loans

   $ 7,295       $ 9,734   

Undisbursed portion of construction loans

     3,119         4,372   

Unfunded commitments to extend credit under existing commercial and personal lines of credit

     34,039         32,717   

Standby letters of credit

     1,689         2,074   

The Company does not have any special purpose entities, derivative financial instruments or other forms of off-balance-sheet financing arrangements.

Commitments to originate new loans or to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Most equity line commitments are for a term of 5 to 10 years and commercial lines of credit are generally renewable on an annual basis. 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 Company evaluates each customer’s creditworthiness on a case-by-case basis. The amounts of collateral obtained, if deemed necessary by the Company upon extension of credit, are based on management’s credit evaluation of the borrower.

Contractual Obligations

The following table summarizes information regarding the Company’s contractual obligations as of December 31, 2010:

 

     Payments due by period  
     Total      Less than
1 Year
     1 – 3 Years      3 – 5 Years      More than
5 Years
 
     (In thousands)  

Deposits

   $ 378,003       $ 333,483       $ 36,523       $ 7,939       $ 58   

Federal Home Loan Bank advances

     15,729         3,379         12,350         —           —     

Retail repurchase agreements

     8,669         8,669         —           —           —     

Operating lease obligations

     64         15         30         19