ITEM 1. BUSINESS
General
Community Bank Shares of Indiana, Inc. (the "Company") is a multi-bank holding company headquartered in New Albany, Indiana. The Company's wholly-owned banking subsidiaries are Community Bank of Southern Indiana (CBSI) and Community Bank of Kentucky (CBKY). Until March 1, 2002, the Company also operated two bank branches in Clark County, Indiana under the name Heritage Bank of Southern Indiana (HBSI). On March 1, 2002, HBSI was merged with and into CBSI. CBSI and CBKY are state-chartered stock commercial banks headquartered in New Albany, Indiana and Bardstown, Kentucky, respectively, and at times are referred to herein collectively as the "Banks". CBSI is regulated by the Indiana Department of Financial Institutions and the Federal Deposit Insurance Corporation. CBKY is regulated by the Kentucky Department of Financial Institutions and the Federal Deposit Insurance Corporation.
CBSI was founded in 1934 as a federal mutual savings and loan association. CBSI converted to a federal mutual savings bank in 1989, and became a federal stock savings bank on May 1, 1991. On December 2, 1996, CBSI converted from a federal stock savings bank to a state chartered stock commercial bank. CBSI's deposits have been federally insured since 1934 by the Savings Association Insurance Fund ("SAIF") and its predecessor, the Federal Savings and Loan Insurance Corporation. CBSI has been a member of the Federal Home Loan Bank system since 1934.
On May 6, 1998, the Company completed its acquisition of CBKY (formerly NCF Bank and Trust CO) located in Bardstown, Kentucky through a merger with NCF Financial Corporation (NCF). CBKY, a state chartered commercial bank with total assets of $37.0 million and $35.6 million at May 6, 1998, and December 31, 1997, respectively, became a wholly-owned subsidiary of the Company through the exchange of 740,974 shares of the Company's common stock for all the outstanding common stock of NCF. The acquisition was accounted for as a pooling of interests.
The Company had total assets of $429.6 million, total deposits of $255.9 million, and stockholders' equity of $42.4 million as of December 31, 2001. The Company's principal executive office is located at 101 West Spring Street, New Albany, Indiana 47150, and the telephone number at that address is (812) 944-2224. The Company's Website is www.cbinonline.com.
Business Strategy
The Company's current business strategy is to operate well-capitalized, profitable and independent community banks with a significant presence in their primary market areas. The Company has sought to implement this strategy in recent years by: (1) emphasizing the origination of residential mortgage loans, commercial business & real estate loans, and consumer loans in the Company's primary market area; (2) controlling operating expenses; and (3) broadening the scope of services offered to its customers.
The Company's three subsidiaries are community-oriented financial institutions offering a variety of financial services to their local market areas. The subsidiaries are engaged primarily in the business of attracting deposits from the general public and using such funds to originate 1) secured and unsecured business loans of various terms to local businesses and professional organizations, and 2) consumer loans including home equity lines of credit, automobile and recreational vehicle, construction loans, and loans secured by deposit accounts. Depending on each subsidiary's liquidity, interest rate risk and balance sheet positions, fixed-rate mortgage loans are originated either for inclusion in the retained loan portfolio or for sale in the secondary market, while adjustable rate mortgage (ARM) loans are originated primarily for retention in each subsidiary's loan portfolio. To a lesser extent, the subsidiaries make home equity loans secured by the borrower's principal residence and other types of consumer loans such as auto loans. Although CBSI holds a small amount of multi-family residential real estate loans in its portfolio, the Company does not emphasize the origination of such loans. In addition, the Company invests in mortgage-backed, U.S. Government and agency, and state and municipal securities.
The Company continues to actively originate fixed-rate mortgage loans, generally with terms to maturity of between 15- to 30- years and secured by one-to-four family residential properties. One-to-four family fixed-rate loans generally are originated for sale in the secondary mortgage market. The Company sells mortgage loans with servicing either retained or released. The Company earns service fee income on those loans where servicing is retained.
Residential Real Estate Loans. The Company originates one-to-four family, owner-occupied, residential mortgage loans secured by property located in the Company's market area primarily for sale in the secondary market. The majority of the Company's residential mortgage loans consists of loans secured by owner-occupied, single family residences. The Company currently offers residential mortgage loans for terms up to 30 years, with adjustable or fixed interest rates. Origination of fixed-rate mortgage loans versus ARM loans is monitored continuously and is affected significantly by the level of market interest rates, customer preference, and loan products offered by the Company's competitors. Therefore, even if management's strategy is to emphasize ARM loans, market conditions may be such that there is greater demand for fixed-rate mortgage loans.
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The primary purpose of offering ARM loans is to make the Company's loan portfolio more interest rate sensitive. However, as the interest income earned on ARM loans varies with prevailing interest rates, such loans do not offer the Company predictable cash flows as would long-term, fixed-rate loans. ARM loans, however, can carry increased credit risk associated with potential higher monthly payments by borrowers as general market interest rates increase. It is possible, therefore, that during a period of rising interest rates, the risk of default on ARM loans may increase due to the upward adjustment of interest costs to the borrower.
The Company's fixed-rate mortgage loans are amortized on a monthly basis with principal and interest due each month. Residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option.
The Company's ARM loans generally adjust annually with interest rate adjustment limitations of two percentage points per year and six percentage points over the life of the loan. The Company also makes ARM loans with interest rates that adjust every one, three or five years. Under the Company's current practice, the interest rate on new ARM loans is initially derived from the one-year, three-year or five-year U.S. Treasury Constant Maturity Index plus a spread. The Company's policy is to qualify borrowers for one-year ARM loans based on the initial interest rate plus the maximum annual rate increase.
The Company has used different indices for its ARM loans such as the National Average Median Cost of Funds, the Sixth District Net Cost of Funds Monthly Index, the National Average Contract Rate for Previously Occupied Homes, the Average three year Treasury Bill Rate, and the Eleventh District Cost of Funds. Consequently, the adjustments in the Company's portfolio of ARM loans tend not to reflect any one particular change in any specific interest rate index, but general interest rate trends overall.
Regulations limit the amount that a bank may lend via conforming loans qualifying for sale in the secondary market in relationship to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Such regulations permit a maximum loan-to-value ratio of 95 percent for residential property and from 65 to 90 percent for all other real estate related loans. The Company's lending policies, however, generally limit the maximum loan-to-value ratio on both fixed-rate and ARM loans to 80 percent of the lesser of the appraised value or the purchase price of the property to serve as security for the loan, unless insured by a private mortgage insurer.
The Company occasionally makes real estate loans with loan-to-value ratios in excess of 80 percent. For real estate loans with loan-to-value ratios of between 80 and 90 percent, the Company requires the first 20 percent of the loan to be covered by private mortgage insurance. For real estate loans with loan-to-value ratios of between 90 percent and 95 percent, the Company requires private mortgage insurance to cover the first 25 to 30 percent of the loan amount. The Company requires fire and casualty insurance, as well as title insurance or an opinion of counsel regarding good title, on all properties securing real estate loans made by the Company.
Construction Loans. The Company originates loans to finance the construction of owner-occupied residential property. The Company makes construction loans to private individuals for the purpose of constructing a personal residence or to local real estate builders and developers. Construction loans generally are made with either adjustable or fixed-rate terms of up to six months. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. Construction loans are structured to be converted to permanent loans originated by the Company at the end of the construction period or to be terminated upon receipt of permanent financing from another financial institution.
Commercial Real Estate Loans. The Company's commercial real estate loans are secured by improved property such as offices, small business facilities, apartment buildings, nursing homes, warehouses and other non-residential buildings, most of which are located in the Company's primary market area and most of which are to be used or occupied by the borrowers. Commercial real estate loans have been offered at adjustable interest rates and at fixed rates with balloon provisions at the end of the term financing. The Company continues to originate commercial real estate loans, commercial real estate construction loans and land loans.
Loans secured by commercial real estate generally involve a greater degree of risk than residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentrations of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multifamily and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired. The Company has increased its origination of multi-family residential or commercial real estate loans over the last few years, but believes, based on currently available information, that it is adequately protected against the increased credit risk associated with these loans through its underwriting standards of imposing stringent loan-to-value ratios, requiring conservative debt coverage ratios, and continually monitoring the operation and physical condition of the collateral.
Commercial Business Loans. The Company also originates non-real estate related business loans to local small businesses and professional organizations. This type of commercial loan has been offered at both variable rates and fixed rates with balloon payments required at maturity. The Company has increased its origination of commercial business loans over the last few years. Such loans generally have shorter terms and higher interest rates than mortgage loans. However, commercial business loans also involve a higher level of credit risk because of the type and nature of the collateral.
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Consumer Loans. The principal types of consumer loans offered by the Company are equity lines of credit, auto loans, home improvement loans, and loans secured by deposit accounts. Equity lines of credit are predominately made at rates which adjust periodically and are indexed to the prime rate. Some consumer loans are offered on a fixed-rate basis depending upon the borrower's preference. The Company's equity lines of credit are generally secured by the borrower's principal residence and a personal guarantee.
The underwriting standards employed by the Company for consumer loans include a determination of the applicant's credit history and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Credit worthiness of the applicant is of primary consideration, however. The underwriting process also includes a comparison of the value of the security in relation to the proposed loan amount.
Loan Solicitation and Processing. Loan originations are derived from a number of sources such as loan sales staff, real estate broker referrals, existing customers, borrowers, builders, attorneys and walk-in customers. Processing procedures are affected by the type of loan requested and whether the loan will be funded by the Company or sold into the secondary market.
Mortgage loans that are sold into the secondary market are submitted, when possible, for Automated Underwriting, which allows for faster approval and an expedited closing. The Company's responsibility on these loans is the fulfillment of the loan purchaser's requirement. These loans often have reduced underwriting features and may be made without an appraisal or credit report at the option of the purchaser. A review signature is required to signify compliance with the terms of the commitment. Loans that are reviewed in a more traditional manner, which are mostly loans held for the Company's own portfolio, require credit reports, appraisals, and income verification before they are approved or disapproved. These loans must be reviewed by two designated Company officials who then make a decision on whether to extend credit. Loans funded by the Company that exceed GNMA maximum loan values require approval by the President of the subsidiary bank extending the loan. Private mortgage insurance is required on all loans with a ratio of loan to appraised value of greater than 80%. Property insurance and flood certifications are required on all real estate loans.
Installment loan documentation varies by the type of collateral offered to secure the loan. In general, an application and credit report is required before a loan is submitted for underwriting. The underwriter determines the necessity of any additional documentation, such as income verification or appraisal of collateral. An authorized loan officer approves or disapproves the loan after review of all applicable loan documentation collected during the underwriting process.
Commercial loans are underwritten by the commercial loan officer who makes the initial contact with the customer applying for credit. The underwriting of these loans are reviewed after the fact for compliance to the Company's general underwriting standards. Loans exceeding the authority of the underwriting loan officer are presented to a loan committee for approval or disapproval.
Loan Commitments. The Company issues standby loan origination commitments to qualified borrowers primarily for the construction and purchase of residential real estate and commercial real estate. Such commitments are made with specified terms and conditions for periods of up to 60 days, during which time the interest rate is locked-in. If a loan is not scheduled to close immediately after approval, the Company charges a fee for a loan commitment based on a percentage of the loan amount. The loan commitment fee is credited towards the closing costs of the loan if the borrower receives the loan from the Company. If the potential borrower chooses to borrow funds from another institution, the commitment fee is nonrefundable.
Employees
As of December 31, 2001, the Company had 141 employees, 122 full-time and 19 part-time. CBSI employed 41 full-time and 9 part-time employees, HBSI employed 19 full-time and 1 part-time employee, and CBKY employed 12 full-time and 3 part-time employees as of December 31, 2001. None of these entity's employees are represented by a collective bargaining group. Neither the Company nor any subsidiary has ever experienced a work stoppage.
Competition
The banking business is highly competitive, and as such the affiliate banks compete not only with other commercial banks, but also with savings and loan associations, trust companies and credit unions for deposits and loans, as well as stock brokerages, insurance companies, and other entities providing one or more of the services and products offered by the Banks. In addition to competition, the Company's business and operating results are significantly affected by the general economic conditions prevalent in its market area.
The Banks' primary market area consists of the counties of Floyd, Clark and Harrison, which are located in Southern Indiana along the Ohio River, and Nelson County, which is located approximately 40 miles southeast of Louisville, Kentucky. Clark, Floyd, and Harrison counties are three of the seven counties comprising the Louisville, Kentucky Standard Metropolitan Statistical Area, which has a population in excess of one million. The aggregate population of Floyd, Clark and Harrison counties is approximately 203,000. The population of Nelson County is approximately 37,000. Counties surrounding Nelson County include: Spencer, Anderson, Hardin, Washington, Marion, Larue, and Bullitt counties, which together have a population in excess of 220,000. The Company's headquarters are in New Albany, Indiana, a city of 48,000 located approximately three miles from the center of Louisville. ________________________________________________________________________________
5. Regulation and Supervision
As a bank holding company, the Company is regulated under the Bank Holding Company Act of 1956, as amended (the "Act"). The Act limits the business of bank holding companies to banking, managing or controlling banks and other subsidiaries authorized under the Act, performing certain servicing activities for subsidiaries and engaging in such other activities as the Board of Governors of the Federal Reserve System ("Federal Reserve Board") may determine to be closely related to banking. The Company is registered with and is subject to regulation by the Federal Reserve Board. Among other things, applicable statutes and regulations require the Company to file an annual report and such additional information as the Federal Reserve Board may require pursuant to the Act and the regulations which implement the Act. The Federal Reserve Board also conducts examinations of the Company.
The Act provides that a bank holding company must obtain the prior approval of the Federal Reserve Board to acquire more than 5 percent of the voting stock or substantially all the assets of any bank or bank holding company. The Company currently has no formal agreement or commitments about any such transaction. However, the Company evaluates opportunities to invest in or acquire other banks or bank holding companies as they arise and may engage in these transactions in the future. The Act also provides that, with certain exceptions, a bank holding company may not (i) engage in any activities other than those of banking or managing or controlling banks and other authorized subsidiaries, or (ii) own or control more than 5 percent of the voting shares of any company that is not a bank, including any foreign company. In addition, the Federal Reserve Act restricts the Bank's extension of credit to the Company.
A bank holding company is permitted, however, to acquire shares of any company, the activities of which the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Federal Reserve Board's regulations state specific activities that are permissible under that exception. The Company does not currently have any agreements or commitments to engage in any nonbanking activities.
In approving acquisitions by bank holding companies of banks and companies engaged in banking-related activities, the Federal Reserve Board considers whether any such activity by an affiliate of the holding company can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh any possible adverse effects such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. The Federal Reserve Board has cease-and-desist powers over parent holding companies and nonbanking subsidiaries if their actions constitute a serious threat to the safety, soundness, or stability of a subsidiary bank.
A bank holding company may also acquire shares of a company which furnishes or performs services for a bank holding company and acquire shares of the kinds and in the amounts eligible for investment by national banking associations. In addition, under the financial modernization legislation enacted by Congress in November 1999, a bank holding company that meets the eligibility requirements and elects to be a financial holding company may engage in expanded financial activities and acquire companies engaged in those activities, such as securities underwriters and dealers and insurance companies. The Board of Directors of the Company at this time has no plans for these investments or broader financial activities.
On November 12, 1999, Congress enacted the Gramm-Leach-Bliley Act (previously known as the Financial Services Modernization Act of 1999). The Gramm-Leach-Bliley Act permits bank holding companies to qualify as "financial holding companies" that may engage in a broad range of financial activities, including underwriting, dealing in and making a market in securities; insurance underwriting and agency activities; and merchant banking. The Federal Reserve Board is authorized to expand the list of permissible financial activities. The Gramm-Leach-Bliley Act also authorizes banks to engage through financial subsidiaries in nearly all of the activities permitted for financial holding companies. The Company has not elected the status of financial holding company.
The Gramm-Leach-Bliley Act also imposes significant new financial obligations and reporting requirements on banks as well as on other financial institutions. Among other things, financial institutions are required to (a) establish privacy policies and disclose them to customers both at the time of establishing the customer relationship and on an annual basis, and (b) permit customers to opt out of the financial institution's disclosure of customer nonpublic personal information to third parties that are not affiliated with the financial institution.
As state chartered commercial banks, CBSI and CBKY are subject to examination, supervision and extensive regulation by the FDIC and their respective Departments of Financial Institutions (the "DFIs"). CBSI is a member of and owns stock in the FHLB of Indianapolis, while CBKY is a member of and owns stock in the FHLB of Cincinnati. The FHLB institutions located in Indianapolis and Cincinnati are each one of the twelve regional banks in the Federal Home Loan Bank System. CBSI and CBKY are also subject to regulation by the Federal Reserve Board, which governs reserves to be maintained against deposits and regulates certain other matters. The extensive system of banking laws and regulations to which the Banks are subject are intended primarily for the protection of their customers and depositors, and not shareholders.
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The FDIC and the DFIs regularly examine the Banks and prepare a report for the consideration of each Bank's Board of Directors on any deficiencies that it may find in their operations. The relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in such matters as the ownership of savings accounts and the form and content of the Banks' mortgage documents.
Federal Regulation of Commercial Banks. The FDIC has extensive authority over the operations of all insured commercial banks. As part of this authority, the Banks are required to file periodic reports with the FDIC and the DFIs and are subject to periodic examinations by both agencies. In the course of these examinations, the examiners may require the Banks to provide for higher general loan loss reserves. (Financial institutions in various regions of the United States have been called upon by examiners to write down assets to their fair market values and to establish increased levels of reserves, primarily as a result of perceived weaknesses in real estate values and a more restrictive regulatory climate).
The investment and lending authority of a state-chartered bank is prescribed by federal laws and regulations, and such banks are prohibited from engaging in any activities not permitted by such laws and regulations. These laws and regulations generally are applicable to all state chartered banks.
CBSI is subject to the same current national bank limits on maximum loans to one borrower; it may not lend to a single or related group of borrowers on an unsecured basis an amount in excess of the greater of $500,000 or 15 percent of the bank's unimpaired capital and surplus. An additional amount may be lent, equal to 10 percent of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities, but generally does not include real estate. CBKY is subject to legal lending limits of 20 percent of unimpaired capital and surplus for unsecured loans and 30 percent of unimpaired capital and surplus for secured loans.
Federal Regulations
Sections 22(h) and (g) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a bank, and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the institution's loans to one borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit to all insiders cannot exceed the institution's unimpaired capital and surplus. At December 31, 2001 the Banks were in compliance with the above restrictions.
Safety and Soundness. The Federal Deposit Insurance Act ("FDIA"), as amended by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and the Riegle Community Development and Regulatory Improvement Act of 1994, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to the internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest-rate-risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits and such other operational and managerial standards as the agencies may deem appropriate. The federal bank regulatory agencies adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.
If an insured depository institution or its holding company fail to meet any of the standards promulgated by regulation, then such institution or company will be required to submit a plan within 30 days to the FDIC specifying the steps it will take to correct the deficiency. In the event that an institution or company fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the agency, Section 39 of the FDIA provides that the FDIC must order the institution or company to correct the deficiency and may (1) restrict asset growth; (2) require the institution or company to increase its ratio of tangible equity to assets; (3) restrict the rates of interest that the institution or company may pay; or (4) take any other action that would better carry out the purpose of prompt corrective actions.
The FDIC generally is authorized to take enforcement action against a financial institution that fails to meet its capital requirements; such action may include restrictions on operations and banking activities, the imposition of a capital directive, a cease and desist order, civil money penalties or harsher measures such as the appointment of a receiver or conservator or a forced merger into another institution. In addition, under current regulatory policy, an institution that fails to meet its capital requirements is prohibited from paying any dividends. Except under certain circumstances, further disclosure of final enforcement action by the FDIC is required.
Prompt Corrective Action. Under Section 38 of the FDIA, as amended by the FDICIA, each federal banking agency was required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies, including the FDIC, adopted substantially similar regulations to implement Section 38 of the FDIA, effective as of December 19, 1992. Under the regulations, an institution is deemed to be (i) "well-capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (ii) "adequately-capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized," (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% ( 3.0% under certain circumstances), (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier II average capital ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Section 38 of the FDIA and the regulations promulgated thereunder also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). At December 31, 2001, the Company and each of the subsidiary Banks was deemed well-capitalized for purposes of the above regulations. ________________________________________________________________________________
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Federal Home Loan Bank System. CBSI is a member of the FHLB of Indianapolis, and CBKY is a member of the FHLB of Cincinnati. The FHLB of Indianapolis and the FHLB of Cincinnati are each one of the 12 regional FHLB's that, prior to the enactment of FIRREA, were regulated by the Federal Home Loan Bank Board (FHLBB). FIRREA separated the home financing credit function of the FHLB's from the regulatory functions of the FHLB's regarding savings institutions and their insured deposits by transferring oversight over the FHLB's from the FHLBB to a new federal agency, the Federal Home Financing Board ("FHFB").
As members of the FHLB Banking system, each of CBSI and CBKY is required to purchase and maintain stock in the FHLB in an amount equal to the greater of one percent of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year, or 1/20 (or such greater fraction as established by the FHLB) of outstanding FHLB advances. At December 31, 2001, $5.9 million, $900,000, and $888,000 of FHLB stock were outstanding for CBSI, HBSI, and CBKY, respectively, which was in compliance with this requirement. In past years, CBSI, HBSI, and CBKY have received dividends on their FHLB stock.
Certain provisions of FIRREA require all 12 FHLB's to provide financial assistance for the resolution of troubled savings institutions and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low-and moderate-income housing projects. These contributions could cause rates on the FHLB advances to increase and could affect adversely the level of FHLB dividends paid and the value of FHLB stock in the future.
Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. At December 31, 2001, the Company had $89 million in advances from the FHLB.
Accounting. An FDIC policy statement applicable to all banks clarifies and re-emphasizes that the investment activities of a bank must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with generally accepted accounting principles. Under the policy statement, management must support its classification of and accounting for loans and securities (i.e., whether held to maturity, available for sale or available for trading) with appropriate documentation. The Banks are in compliance with these amended rules.
Insurance of Accounts. Each Bank's deposits are insured up to $100,000 per insured member (as defined by law and regulation). Deposits of CBSI and CBKY are insured by the Savings Association Insurance Fund (SAIF), while HBSI's deposits assumed by CBSI upon the merger of HBSI into CBSI are insured by the Bank Insurance Fund (BIF). This insurance is backed by the full faith and credit of the United States Government. The SAIF and the BIF are both administered and managed by the FDIC. As insurer, the FDIC is authorized to conduct examinations of and to require reporting by SAIF and BIF insured institutions. It also may prohibit any insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to either fund. The FDIC also has the authority to initiate enforcement actions against financial institutions. The annual assessment for deposit insurance is based on a risk-related premium system. Each insured institution is assigned to one of three capital groups: well capitalized, adequately capitalized or under capitalized. Within each capital group, institutions are assigned to one of three subgroups (A, B, or C) on the basis of supervisory evaluations by the institution's primary federal supervisor and if applicable, state supervisor. Assignment to one of the three capital groups, coupled with assignment to one of three supervisory subgroups, will determine which of the nine risk classifications is appropriate for an institution. Institutions are assessed insurance rates based on their assigned risk classifications. The well capitalized, subgroup "A" category institutions are assessed the lowest insurance rate, while institutions assigned to the under capitalized subgroup "C" category are assessed the highest insurance rate. As of December 31, 2001 the subsidiary banks were assigned to the well-capitalized, subgroup "A" category. During 2001, CBSI, HBSI and CBKY paid an annual insurance rate of 1.9 cents per $100 of deposits.
In August 1995, the FDIC substantially reduced the deposit insurance premiums for well-capitalized, well-managed financial institutions that are members of the BIF. Under the new assessment schedule, approximately 92% of BIF members paid a minimum assessment of $1,000 per year while SAIF members continued to be assessed under the existing rate schedule of 23 cents to 31 cents per $100 of insured deposits.
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On September 30, 1996, all SAIF member institutions were charged a one-time assessment to increase SAIF's reserves to $1.25 per $100 of insured deposits. The aggregate one-time assessment paid by CBSI and CBKY amounted to $1.3 million with an after tax impact of approximately $779,000.
The FDIC may terminate the deposit insurance of any insured depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. The FDIC also may suspend deposit insurance temporarily for any financial institution during the hearing process for the permanent termination of insurance, if the Bank has no tangible capital. If insurance of accounts is terminated, the insured accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC.
The FDIC has passed regulations, under the FDIA, that generally prohibit payments to directors, officers and employees contingent upon termination of their affiliation with an FDIC-insured institution or its holding company (i.e., "golden parachute payments") if the payment is received after or in contemplation of, among other things, insolvency, a determination that the institution or holding company is in "troubled condition", or the assignment of a composite examination rating of "4" or "5" for the institution. Certain types of employee benefit plans are not subject to the prohibition. The regulations, which are not currently applicable to the Company, would also generally prohibit certain indemnification payments regarding any administrative proceeding instituted against a person that results in a final order pursuant to which the person is assessed civil money penalties or subjected to other enforcement action. The Company has no such agreements with any directors or employees.
The Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits. As of December 31, 2001, no reserves were required to be maintained on the first $5.5 million of transaction accounts, reserves of 3% were required to be maintained against the next $41.3 million of net transaction accounts (with such dollar amounts subject to adjustment by the Federal Reserve Board), and a reserve of 10% (which is subject to adjustment by the Federal Reserve Board to a level between 8% and 14%) against all remaining net transaction accounts. Because required reserves must be maintained in the form of vault cash or a non-interest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce an institution's earning assets.
Banks are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require banks to exhaust other reasonable alternative sources of funds, including FHLB advances, before borrowing from the Federal Reserve Bank.
Federal Taxation. For federal income tax purposes, the Company and its subsidiaries file a consolidated federal income tax return on a calendar year basis. Consolidated returns have the effect of eliminating intercompany distributions, including dividends, from the computation of consolidated taxable income for the taxable year in which the distributions occur.
The Company and its subsidiaries are subject to the rules of federal income taxation generally applicable to corporations under the Internal Revenue Code of 1986, as amended (the "Code").
The Company is subject to the corporate alternative minimum tax which is imposed to the extent it exceeds the Company's regular income tax for the year. The alternative minimum tax will be imposed at the rate of 20 percent of a specially computed tax base. Included in this base will be a number of preference items, including the following: (i) 100 percent of the excess of a financial institution's bad debt deduction over the amount that would have been allowable on the basis of actual experience; (ii) interest on certain tax-exempt bonds issued after August 7, 1986; and (iii) for years beginning in 1988 and 1989 an amount equal to one-half of the amount by which a institution's "book income" (as specially defined) exceeds its taxable income with certain adjustments, including the addition of preference items (for taxable years commencing after 1989 this adjustment item is replaced with a new preference item relating to "adjusted current earnings" as specially computed). In addition, for purposes of the new alternative minimum tax, the amount of alternative minimum taxable income that may be offset by net operating losses is limited to 90 percent of alternative minimum taxable income.
The Company has not been audited by the Internal Revenue Service for the past ten years.
Indiana Taxation. Effective January 1, 1990, the State of Indiana imposed a franchise tax assessed on the net income (adjusted gross income as defined in the statute) of financial institutions. The new tax replaced the gross receipts tax, excise tax and supplemental net income tax imposed prior to 1990. This new financial institution's tax is imposed at the rate of 8.5 percent of the Company's adjusted gross income. In computing adjusted gross income, no deductions are allowed for municipal interest, U.S. Government interest and pre-1990 net operating losses. The Company's state franchise tax returns have been audited through the tax year ended December 31, 1997.
In 2000, the Indiana financial institution tax law was amended to treat resident financial institutions the same as nonresident financial institutions by providing for apportionment of Indiana income based on receipts in Indiana. This revision allowed for the exclusion of receipts from out of state sources and federal government and agency obligations.
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9.
ITEM 2.
ITEM 2. PROPERTIES
The Company conducts its business through its corporate headquarters located in New Albany, Indiana. CBSI operates a main office and eight branch offices in Clark and Floyd Counties, Indiana, while CBKY operates a main office and one branch in Nelson County, Kentucky. The following table sets forth certain information concerning the main offices and each branch office at December 31, 2001. The aggregate net book value of premises and equipment was $11.2 million at December 31, 2001.
Location Year Opened Owned or Leased
Community Bank of Southern Indiana: 101 West Spring St. - Main Office 1937 Owned New Albany, IN 47150
401 East Spring St. - Drive Thru for Main Office 2001 Owned New Albany, IN 47150
2626 Charlestown Road 1995 Owned New Albany, IN 47150
480 New Albany Plaza 1974 Leased New Albany, IN 47130
901 East Highway 131 1981 Owned Clarksville, IN 47130
701 Highlander Point Drive 1990 Owned Floyds Knobs, IN 47119
102 Heritage Square 1992 Owned Sellersburg, IN 47172
201 W. Court Ave. 1996 Owned Jeffersonville, IN 4710
5112 Highway 62 1997 Owned Jeffersonville, IN 47130
Community Bank of Kentucky: 106A West John Rowan Blvd. - Main Office 1997 Leased Bardstown, KY 40004
119 East Stephen Foster Ave. 1972 Owned Bardstown, KY 40004
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are various claims and law suits in which the Company or its subsidiaries are periodically involved, such as claims to enforce liens, condemnation proceedings on properties in which the Banks hold security interests, claims involving the making and servicing of real property loans and other issues incident to the Banks' business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 2001.
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10.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
See page 21 of the Annual Report to Stockholders incorporated herein as Exhibit 13, which is incorporated herein by reference to information under the heading "Market and Dividend Information."
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
See page 4 of the Annual Report to Stockholders incorporated herein as Exhibit 13, which is incorporated herein by reference to information under the headings "Selected Consolidated Financial Data."
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
See pages 5 - 21 of the Annual Report to Stockholders incorporated herein as Exhibit 13, which are incorporated herein by reference to information under the heading "Management's Discussion and Analysis."
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See pages 19 - 21 of the Annual Report to Stockholders incorporated herein as Exhibit 13, which are incorporated herein by reference to information under the heading "Market Risk Analysis."
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
See pages 28 - 52 of the 2001 Annual Report to Stockholders incorporated herein as Exhibit 13, which are incorporated herein by reference to information under the headings "Consolidated Balance Sheets," "Consolidated Statements of Income," "Consolidated Statements of Changes in Stockholders' Equity," "Consolidated Statements of Cash Flows," and "Notes to Consolidated Financial Statements."
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On March 1, 2001, the board of directors of the Company determined to engage Crowe, Chizek and Company LLP as its independent auditors for the fiscal year ended December 31, 2001. On March 1, 2001, the registrant orally notified Monroe Shine & Co., Inc. ("Monroe Shine"), its current independent auditors, of this determination and that Monroe Shine would not be engaged for the fiscal year ending December 31, 2001. The determination to replace Monroe Shine was recommended by the audit committee and approved by the full board of directors of the Company.
The report of Monroe Shine on the consolidated financial statements of the Company for the years ended December 31, 2000 and 1999 contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. During the years ended December 31, 2000 and 1999 and during the period from December 31, 2000 to March 1, 2001, there were no disagreements between the registrant and Monroe Shine concerning accounting principles or practices, financial statement disclosures, or auditing scope or procedure.
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11.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT
Information concerning Directors and executive officers of the Registrant and reporting under Section 16 of the Securities Exchange Act of 1934 is incorporated herein by reference to information under the headings "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2002.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference to the information under the headings "Executive Compensation", "Compensation of Directors", "Defined Benefit Pension Plan", "Employment and Retirement Agreements", and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2002.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain owners and management is incorporated herein by reference to the information under the heading "Stock Ownership by Directors and Executive Officers" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2002.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning relationships and transactions is incorporated herein by reference to the information under the headings "Compensation Committee Interlocks and Insider Participation", "Indebtedness of Management", and "Other Transactions with Management and Related Parties" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2002.
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12.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The following information, appearing in the Registrant's Annual Report to Stockholders for the year ended December 31, 2001, is incorporated by reference in this Annual Report on Form 10-K as Exhibit 13.
Page in Annual Annual Report Section Report
Selected Consolidated Financial Data 4
Management's Discussion and Analysis of Financial Condition and Results of Operations 5-21
Change in or Disagreements with Accountants 22
Independent Auditor's Report 26-27
Consolidated Balance Sheets 28
Consolidated Statements of Income 29
Consolidated Statements of Changes in Stockholders' Equity 30
Consolidated Statements of Cash Flows 31
Notes to Consolidated Financial 32-52
(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted as the required information is inapplicable or the required information has been included in the Consolidated Financial Statements or notes thereto.
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13.
(a) (3) Exhibits
Exhibit Number Document 3.1 Articles of Incorporation (1) 3.2 Bylaws (1) 4.0 Common Stock Certificate (1) 10.1 Employment Agreement with Dale L. Orem * (2) 10.2 Retirement Agreement with Robert E. Yates * (2) 10.3 Employment Agreement with James D. Rickard * (3) 10.4 Community Bank Shares of Indiana, Inc. 1997 Stock Incentive Plan * (4) 10.5 Community Bank Shares of Indiana, Inc. Dividend Reinvestment Plan * (5) 13.0 Annual Report to Security Holders 21.0 Subsidiaries of Registrant 23.0 Consent of Crowe, Chizek and Company LLP 23.0 Consent of Monroe Shine & Co., Inc.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Report pursuant to Item 601 of Regulation S-K.
(1) Incorporated herein by reference to Registration Statement on Form S-1 filed December 9, 1994 (File No. 33-87228). (2) Incorporated by reference to the Annual Report on Form 10-K filed April 2, 2001. (3) Incorporated by reference to the Quarterly Report on Form 10-Q filed November 14, 2000. (4) Incorporated by reference from the exhibits filed with the Registration Statement on Form S-8, and any amendments thereto, Registration statement No. 333- 60089. (5) Incorporated by reference from the exhibits filed with the Registration statement on Form S-3, and any amendments thereto, Registration Statement No. 333-40211.
(b) Reports on Form 8-K:
Filing date Event reported 03/06/2001 Change in Registrant's Certifying Accountant from Monroe Shine & Co., Inc. to Crowe, Chizek and Company LLP 03/21/2001 Increase in Quarterly Dividend to Common Stockholders from $0.135 Per Share to $0.145 Per Share 04/16/2001 Announcement of First Quarter 2001 Financial Results 05/15/2001 $3.0 Million Common Share Repurchase Program 06/27/2001 Appointment of George M. Ballard of Bardstown, Kentucky to the Board of Directors. 07/19/2001 Announcement of Second Quarter 2001 Financial Results 10/23/2001 Announcement of Third Quarter 2001 Financial Results 11/15/2001 Resignation of Senior Vice President 01/29/2002 Announcement of Fourth Quarter and Annual 2001 Financial Results
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14.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
COMMUNITY BANK SHARES OF INDIANA, INC.
Date: March 30, 2002 By: \s\ James D. Rickard -------------------- JAMES RICKARD President, Chief Executive Officer and Director
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15.
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: \s\ C. Thomas Young By: \s\ Timothy T. Shea -------------------- ------------------- C. THOMAS YOUNG, TIMOTHY T. SHEA, Chairman of the Board Vice Chairman of the Board of Directors of Directors Date: March 30, 2002 Date: March 30, 2002
By: \s\ Robert J. Koetter, Sr. By: \s\ Steven R. Stemler -------------------------- --------------------- ROBERT J. KOETTER, SR., STEVEN R. STEMLER, Director Director Date: March 30, 2002 Date: March 30, 2002
By: \s\ Gary L. Libs By: \s\ Dale L. Orem ------------------- ---------------- GARY L. LIBS, DALE L. OREM, Director Director Date: March 30, 2002 Date: March 30, 2002
By: \s\ James W. Robinson By: \s\ Paul A. Chrisco --------------------- ------------------- JAMES W. ROBINSON, PAUL A. CHRISCO, Director Senior Vice President, Date: March 30, 2002 Chief Financial Officer Date: March 30, 2002
By: \s\ George M. Ballard --------------------- George M. Ballard, Director Date: March 30, 2002
By: \s\ Gordon L. Huncilman --------------------- GORDON L. HUNCILMAN, Director Date: March 30, 2002
By: \s\ Kerry M. Stemler --------------------- KERRY M. STEMLER, Director Date: March 30, 2002
By: \s\ James D. Rickard -------------------- JAMES D. RICKARD, President, Chief Executive Officer, and Director Date: March 30, 2002
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16.
Exhibit Index
Exhibit Number Document 3.1 Articles of Incorporation (1) 3.2 Bylaws (1) 4.0 Common Stock Certificate (1) 10.1 Employment Agreement with Dale L. Orem * (2) 10.2 Retirement Agreement with Robert E. Yates * (2) 10.3 Employment Agreement with James D. Rickard * (3) 10.4 Community Bank Shares of Indiana, Inc. 1997 Stock Incentive Plan * (4) 10.5 Community Bank Shares of Indiana, Inc. Dividend Reinvestment Plan * (5) 13.0 Annual Report to Security Holders 21.0 Subsidiaries of Registrant 23.0 Consent of Crowe, Chizek and Company LLP 23.0 Consent of Monroe Shine & Co., Inc.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Report pursuant to Item 601 of Regulation S-K.
(1) Incorporated herein by reference to Registration Statement on Form S-1 filed December 9, 1994 (File No. 33-87228). (2) Incorporated by reference to the Annual Report on Form 10-K filed April 2, 2001. (3) Incorporated by reference to the Quarterly Report on Form 10-Q filed November 14, 2000. (4) Incorporated by reference from the exhibits filed with the Registration Statement on Form S-8, and any amendments thereto, Registration statement No. 333- 60089. (5) Incorporated by reference from the exhibits filed with the Registration statement on Form S-3, and any amendments thereto, Registration Statement No. 333-40211.
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