ITEM 1: BUSINESS
THE COMPANY AND SUBSIDIARIES
Blue Valley Ban Corp ("Blue Valley" or the "Company") is a bank holding company organized in 1989. In 2001, Blue Valley elected to become a financial holding company and such status was granted. The Company's wholly-owned subsidiary, Bank of Blue Valley (the "Bank") was also organized in 1989 to provide banking services to closely-held businesses and their owners, professionals and residents in Johnson County, Kansas, a high growth, demographically attractive area within the Kansas City, Missouri - Kansas Metropolitan Statistical Area (the "Kansas City MSA"). The focus of Blue Valley has been to take advantage of the current and anticipated growth in our market area as well as to serve the needs of small and mid-sized commercial borrowers - customers that we believe currently are underserved as a result of banking consolidation in the industry generally and within our market specifically. In addition, Blue Valley has established a national presence by originating residential mortgages nationwide through the Bank's InternetMortgage.com website.
We have experienced significant internal growth since our inception. We currently have five banking center locations in Johnson County, Kansas, including our main office and a mortgage operations office in Overland Park, both of which include lobby banking centers, and full-service offices in Leawood, Olathe and Shawnee, Kansas.
Our lending activities focus on commercial lending and residential mortgage origination services, and to a lesser extent, consumer lending and leasing. We strive to identify, develop and maintain diversified lines of business which provide acceptable returns on a risk-adjusted basis. Our primary lines of business consist of commercial lending, commercial real estate lending, construction lending, lease financing, residential real estate lending, consumer lending, and home equity loans.
We also seek to develop lines of business which diversify our revenue sources, increase our non-interest income and offer additional value-added services to our customers. We develop these new or existing lines of business while monitoring related risk factors. In addition to fees generated in conjunction with our lending activities, we derive non-interest income by providing mortgage origination services, deposit and cash management services, investment brokerage services and trust services.
In addition to the Bank, we have four wholly-owned subsidiaries: Blue Valley Building Corp., which owns the buildings and real property that comprise our headquarters, mortgage operations facility and the Leawood banking center; Blue Valley Insurance Services, Inc., an insurance agency created to offer insurance products to our customers; and BVBC Capital Trust II and BVBC Capital Trust III, which were created to offer the Company's trust preferred securities and to purchase our junior subordinated debentures. On December 31, 2004, Blue Valley Insurance Services, Inc. ceased operations as we decided not to further pursue this line of business.
We also have a 49% ownership in Homeland Title, LLC. Homeland Title, LLC was established in June 2005 and provides title and settlement services.
Consolidated financial information, including a measure of profit and loss and total assets can be found in Part IV of this report.
OUR MARKET AREA
We operate primarily as a community bank, serving the banking needs of small and medium-sized companies and individuals in the Kansas City MSA generally, and in suburban Johnson County, Kansas, in particular. Our trade area generally consists of Johnson County, Kansas. We believe that coupling our strategy of providing exceptional customer service and local decision making with attractive market demographics has led to a rate of growth which exceeds the national total asset and deposit growth rates of the banking industry as well as the growth experienced locally by many of our competitors.
The income levels and growth rate of Johnson County, Kansas compare favorably to national averages. Johnson County's population growth rate ranks in the top 8% of counties nationally, and its per capita income ranks in the top 2% of counties nationally. Johnson County is also a significant banking market in the State of Kansas and in the Kansas City MSA. According to available industry data, as of June 30, 2005, total deposits in Johnson County, including those of banks, thrifts and credit unions, were approximately $12.0 billion, which represented 24.84% of total deposits in the state of Kansas and 36.81% of total deposits in the Kansas City MSA.
As our founders anticipated, the trade area surrounding our main banking facility in Overland Park, Kansas has become one of the most highly developed retail areas in the Kansas City MSA. Our Olathe, Kansas facility is located approximately 10 miles west of our main office. We opened our Olathe facility in 1994 when we acquired the deposits of a branch of a failed savings and loan association. We made this acquisition because it was located in a contiguous market area and we believed that it represented a stable deposit base. The Shawnee, Kansas banking facility is approximately 20 miles northwest of our headquarters location. We entered into the Shawnee market in 1999 with the opening of a grocery store branch. During the first quarter of 2001, construction of our freestanding banking facility in Shawnee was completed and operations commenced, and then in 2004, we merged our Shawnee grocery store branch into our Shawnee freestanding facility. The Leawood, Kansas banking facility is approximately 5 miles southeast of our headquarters location. We entered into the Leawood market in 2002 with the opening of a grocery store branch. During the second quarter of 2004, we completed construction of our freestanding banking facility in Leawood and operations commenced. In 2005, we merged our Leawood grocery store branch into our Leawood freestanding facility. During 2003 we acquired an office building in Overland Park, Kansas approximately 1 mile northwest of our headquarters location. At this location, we consolidated our mortgage operations and opened a banking facility.
LENDING ACTIVITIES
Overview. Our principal loan categories include commercial, commercial real estate, construction, leasing and residential mortgages. We also offer a variety of consumer loans. Our primary source of interest income is interest earned on our loan portfolio. As of December 31, 2005, our loans represented approximately 72.96% of our total assets, our legal lending limit to any one borrower was $16.9 million, and our largest single borrower as of that date had outstanding loans of $7.4 million.
We have been successful in expanding our loan portfolio because of the commitment of our staff and the economic growth in our area of operation. Our staff has significant experience in lending and has been successful in offering our products to both potential customers and existing customers. We believe that we have been successful in maintaining our customers because of our staff's attentiveness to their financial needs and the development of professional relationships with them. We strive to become a strategic business partner with our customers, not just a source of funds.
We conduct our lending activities pursuant to the loan policies adopted by our board of directors. These policies currently require the approval of our loan committee of all commercial credits in excess of $1.25 million and all real estate credits in excess of $2.0 million. Credits up to $1.25 million on commercial loans and $2.0 million on real estate loans can be approved by the Bank's President and a combination of two senior loan management officers. Our management information systems and loan review policies are designed to monitor lending sufficiently to ensure adherence to our loan policies. The following table shows the composition of our loan portfolio at December 31, 2005.
LOAN PORTFOLIO
Commercial loans. As of December 31, 2005, approximately $112.5 million, or 22.35%, of our loan portfolio represented commercial loans. The Bank has developed a strong reputation in providing and servicing small business and commercial loans. We have expanded this portfolio through the addition of commercial lending staff, their business development efforts and our reputation. Commercial loans have historically been a significant portion of our loan portfolio and we expect to continue our emphasis on this loan category.
The Bank's commercial lending activities historically have been directed to small and medium-sized companies in or near Johnson County, Kansas, with annual sales generally between $100,000 and $20 million. The Bank's commercial customers are primarily firms engaged in manufacturing, service, retail, construction, distribution and sales with significant operations in our market areas. The Bank's commercial loans are primarily secured by real estate, accounts receivable, inventory and equipment, and the Bank may seek to obtain personal guarantees for its commercial loans. The Bank primarily underwrites its commercial loans on the basis of the borrowers' cash flow and ability to service the debt, as well as the value of any underlying collateral and the financial strength of any guarantors.
Approximately $6.8 million, or 6.01%, of our commercial loans are Small Business Administration (SBA) loans, of which $5.0 million is government guaranteed. The SBA guarantees the repayment of a portion of the principal on these loans, plus accrued interest on the guaranteed portion of the loan. Under the federal Small Business Act, the SBA may guarantee up to 85% of qualified loans of $150,000 or less and up to 75% of qualified loans in excess of $150,000, up to a maximum guarantee of $1.0 million. We are an active SBA lender in our market area and have been approved to participate in the SBA Certified Lender Program.
Commercial lending is subject to risks specific to the business of each borrower. In order to address these risks, we seek to understand the business of each borrower, place appropriate value on any personal guarantee or collateral pledged to secure the loan, and structure the loan amortization to maintain the value of any collateral during the term of the loan.
Commercial real estate loans. The Bank also makes loans to provide permanent financing for retail and office buildings, multi-family properties and churches. As of December 31, 2005, approximately $114.6 million, or 22.77%, of our loan portfolio represented commercial real estate loans. Our commercial real estate loans are underwritten on the basis of the appraised value of the property, the cash flow of the underlying property, and the financial strength of any guarantors.
Risks inherent in commercial real estate lending are related to the market value of the property taken as collateral, the underlying cash flows and documentation. Commercial real estate lending involves more risk than residential real estate lending because loan balances may be greater and repayment is dependent on the borrower's operations. We attempt to mitigate these risks by carefully assessing property values, investigating the source of cash flow servicing the loan on the property and adhering to our lending and underwriting policies and procedures.
Construction loans. Our construction loans include loans to developers, home building contractors and other companies and consumers for the construction of single-family homes, land development, and commercial buildings, such as retail and office buildings and multi-family properties. As of December 31, 2005, approximately $139.7 million, or 27.76%, of our loan portfolio represented real estate construction loans. The builder and developer loan portfolio has been a consistent and profitable component of our loan portfolio over our history. We attribute this success to our expertise, availability and prompt service. The Bank's experience and reputation in this area have grown, thereby enabling the Bank to focus on relationships with a smaller number of larger builders and increasing the total value of the Bank's real estate construction portfolio. Construction loans are made to qualified builders to build houses to be sold following construction, pre-sold houses and model houses. These loans are generally underwritten based upon several factors, including the experience and current financial condition of the borrowing entity, amount of the loan to appraised value, and general conditions of the housing market. Construction loans are also made to individuals for whom houses are being constructed by builders with whom the Bank has an existing relationship. Such loans are made on the basis of the individual's financial condition, the loan to value ratio, the reputation of the builder, and whether the individual will be pre-qualified for permanent financing.
Risks related to construction lending include assessment of the market for the finished product, reasonableness of the construction budget, ability of the borrower to fund cost overruns, and the borrower's ability to liquidate and repay the loan at a point when the loan-to-value ratio is the greatest. We seek to manage these risks by, among other things, ensuring that the collateral value of the property throughout the construction process does not fall below acceptable levels, ensuring that funds disbursed are within parameters set by the original construction budget, and properly documenting each construction draw.
Lease financing. Our lease portfolio includes capital leases that we have originated and leases that we have acquired from brokers or third parties. As of December 31, 2005, our lease portfolio totaled $18.2 million, or 3.62% of our total loan portfolio, consisting of $13.3 million principal amount of leases originated by us and $4.9 million principal amount of leases that we purchased. We provide lease financing for a variety of equipment and machinery, including office equipment, heavy equipment, telephone systems, tractor trailers and computers. Lease terms are generally from three to five years. Management believes this area is attractive because of its ability to provide a source of both interest and fee income. Our leases are generally underwritten based upon several factors, including the overall credit worthiness, experience and current financial condition of the lessee, the amount of the financing to collateral value, and general conditions of the market.
The primary risks related to our lease portfolio are the value of the underlying collateral and specific risks related to the business of each borrower. To address these risks, we attempt to understand the business of each borrower, value the underlying collateral appropriately and structure the loan amortization to ensure that the value of the collateral exceeds the lease balance during the term of the lease.
Residential real estate loans. Our residential real estate loan portfolio consists primarily of first and second mortgage loans on residential properties. As of December 31, 2005, $39.4 million, or 7.83%, of our loan portfolio represented residential mortgage loans. The terms of these loans typically include 2-5 year balloon payments based on a 15 to 30 year amortization, and accrue interest at a fixed or variable rate. By offering these products, we can offer credit to individuals who are self-employed or have significant income from partnerships or investments. These individuals are often unable to satisfy the underwriting criteria permitting the sale of their mortgages into the secondary market.
In addition, we also originate residential mortgage loans with the intention of selling these loans in the secondary market. During 2005, we originated approximately $675.6 million of residential mortgage loans, and we sold approximately $705.9 million in the secondary market. We originate conventional first mortgage loans through our internet website as well as through referrals from real estate brokers, builders, developers, prior customers and media advertising. We have offered customers the ability to apply for mortgage loans and to pre-qualify for mortgage loans over the Internet since 1999. In 2001, we expanded our internet mortgage application capacity with the acquisition of the internet domain name InternetMortgage.com and created a separate National Mortgage division. The timing of this expansion allowed us to establish this division in a relatively low-rate environment, and reap the benefits of a significant increase in mortgage originations and refinancing experienced from 2001 through 2003. While the volume of mortgage originations and refinancing declined in 2004 and 2005, we continue to take advantage of the national presence established in previous years and originate residential mortgage loans through
our InternetMortgage.com website. The origination of a mortgage loan from the date of initial application through closing normally takes 15 to 60 days. We acquire forward commitments from investors on mortgage loans that we intend to sell into the secondary market to reduce interest rate risk on mortgage loans to be sold in the secondary market.
Our mortgage loan credit review process is consistent with the standards set by traditional secondary market sources. We review appraised value and debt service ratios, and we gather data during the underwriting process in accordance with various laws and regulations governing real estate lending. Loans originated by the Bank are sold with servicing released to increase current income and reduce the costs associated with retaining servicing rights. Commitments are obtained from the purchasing investor on a loan-by-loan basis on a 30, 45 or 60-day delivery commitment. Interest rates are committed to the borrower when a rate commitment is obtained from the investor. Loans are funded by the Bank and purchased by the investor within 30 days following closing pursuant to commitments obtained at the time of origination. We sell conventional conforming loans and all loans that are non-conforming as to credit quality to secondary market investors for cash on a limited recourse basis. Consequently, foreclosure losses on all sold loans are generally the responsibility of the investor and not that of the Bank.
As with other loans to individuals, the risks related to residential mortgage loans include primarily the value of the underlying property and the financial strength and employment stability of the borrower. We attempt to manage these risks by performing a pre-funding underwriting that consists of the verification of employment and utilizes a detailed checklist of loan qualification requirements, including the source and amount of down payments, bank accounts, existing debt and overall credit.
Consumer loans. As of December 31, 2005, our consumer loans totaled $45.2 million, or 8.99% of our total loan portfolio. A substantial part of this amount consisted of installment loans to individuals in our market area. Installment lending offered directly by the Bank in our market area includes automobile loans, recreational vehicle loans, home improvement loans, unsecured lines of credit and other loans to professionals, people employed in education, industry and government, as well as retired individuals and others. A significant portion of our consumer loan portfolio consists of indirect automobile loans offered through automobile dealerships located primarily in our trade area. As of December 31, 2005, approximately $32.9 million, or 6.56%, of our loan portfolio represented indirect installment loans. Our loans made through this program generally represent loans to purchase new or late model automobiles. There are currently 13 dealerships participating in this program. Our consumer and other loans are underwritten based on the borrower's income, current debt, past credit history, collateral, and the reputation of the originating dealership with respect to indirect automobile loans.
Consumer loans are subject to the same risks as other loans to individuals, including the financial strength and employment stability of the borrower. In addition, some consumer loans are subject to the additional risk that the loan is not secured by collateral. For some of the loans that are secured, the underlying collateral may be rapidly depreciating and not provide an adequate source of repayment if we are required to repossess the collateral. We attempt to mitigate these risks by requiring a down payment and carefully verifying and documenting the borrower's credit quality, employment stability, monthly income, and with respect to indirect automobile loans, understanding and documenting the value of the collateral and the reputation of the originating dealership.
Home equity loans. As of December 31, 2005, our home equity loans totaled $33.6 million, or 6.68% of our total loan portfolio. Home equity loans are generally secured by second liens on residential real estate and are underwritten in a similar manner as our consumer loans.
INVESTMENT ACTIVITIES
The objectives of our investment policies are to:
- secure the safety of principal;
- provide adequate liquidity;
- provide securities for use in pledging for public funds or repurchase agreements; and
- maximize after-tax income.
We invest primarily in obligations of agencies of the United States and bank-qualified obligations of state and local political subdivisions. Although direct obligations of the United States and obligations guaranteed as to principal and interest by the United States are permitted by our investment policy, we currently do not hold any in our portfolio. In order to ensure the safety of principal, we typically do not invest in mortgage-backed securities, corporate debt, or other securities even though they are permitted by our investment policy. In addition, we enter into federal funds transactions with our principal correspondent banks, and depending on our liquidity position, act as a net seller or purchaser of these funds. The sale of federal funds is effectively short-term loans from us to other banks; while conversely, the purchase of federal funds is effectively short-term loans from other banks to us.
DEPOSIT SERVICES
The principal sources of funds for the Bank are core deposits from the local market areas surrounding the Bank's offices, including demand deposits, interest-bearing transaction accounts, money market accounts, savings deposits and time deposits of less than $100,000. Transaction accounts include interest-bearing and non-interest-bearing accounts, which provide the Bank with a source of fee income and cross-marketing opportunities as well as a low-cost source of funds. Since 2001, the Bank has realized a significant level of deposit growth from commercial checking accounts. While these accounts do not earn interest, many of them receive an earnings credit on their average balance to offset the cost of other services provided by the Bank. The Bank also offers two types of short-term investment accounts. The Bank's money market account is a daily access account that bears a higher rate than a personal interest-bearing checking account and allows for limited check-writing ability. We also offer our Money Management Account, or "short-term parking account." The Money Management Account provides a hybrid of the features available from a traditional money market account and a traditional time deposit. The account requires a minimum balance of $10,000 and allows for daily deposits but limits withdrawals to the first day and the 15th day of each month. This account typically pays a tiered rate of interest which is higher than a customer could receive on a traditional money market account but lower than the rates generally available on time deposits. We believe that the trade-off to depositors between higher interest rates but more limited access to withdrawals has proven to be an attractive product in our market areas and provides us with a more attractive source of funds than other alternatives such as Federal Home Loan Bank borrowings, as it provides us with the potential to cross-sell additional services to these account holders. Time and savings accounts also provide a relatively stable customer base and source of funding. Because of the nature and behavior of these deposit products, management reviews and analyzes our pricing strategy in comparison not only to competitor rates, but versus other alternative funding sources to determine the most advantageous source. The Bank's Funds Management policy also allows for acceptance of brokered deposits which can be utilized to support the growth of the Bank. As of December 31, 2005, the Bank had $27.1 million in brokered deposits. The Bank does not anticipate brokered deposits becoming a significant percentage of its deposit base; however, we continue to evaluate their potential role in the Bank's overall funding and liquidity strategies. In pricing deposit rates, management considers profitability, the matching of term lengths with assets, the attractiveness to customers and rates offered by our competitors.
INVESTMENT BROKERAGE SERVICES
In 1999, the Bank began offering investment brokerage services through an unrelated broker-dealer. These services are currently offered at all of our locations. Four individuals responsible for providing these services are joint employees of the Bank and the registered broker-dealer. Investment brokerage services provide a source of fee income for the Bank. In 2005, the amount of our fee income generated from investment brokerage services was $233,000.
TRUST SERVICES
We began offering trust services in 1996. Until 1999, the Bank's trust services were offered exclusively through the employees of an unaffiliated trust company. The Bank hired a full-time officer in 1999 to develop the Bank's trust business. Trust services are marketed to both existing Bank customers and new customers. We believe that the ability to offer trust services as a part of our financial services to new customers of the Bank presents a significant cross-marketing opportunity. The services currently offered by the Bank's trust department include the administration of self-directed individual retirement accounts, qualified retirement plans, and custodial and directed trust accounts. As of December 31, 2005, the Bank's trust department administered 241 accounts, with assets under
administration of approximately $94.0 million. Trust services provide the Bank with a source of fee income and additional deposits. In 2005, the amount of our fee income from trust services was $367,000.
COMPETITION
We encounter competition primarily in seeking deposits and in obtaining loan customers. The level of competition for deposits in our market area is high. Our principal competitors for deposits are other financial institutions within a few miles of our locations including other banks, savings institutions and credit unions. Competition among these institutions is based primarily on interest rates offered, the quality of service provided, and the convenience of banking facilities. Additional competition for depositors' funds comes from U.S. government securities, private issuers of debt obligations and other providers of investment alternatives for depositors.
We compete in our lending, investment brokerage and trust activities with other financial institutions, such as banks and thrift institutions, credit unions, automobile financing companies, mortgage companies, securities firms, investment companies and other finance companies. Many of our competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks and state regulations governing state-chartered banks. As a result, these non-bank competitors have some advantages over us in providing certain products and services. Many of the financial institutions with which we compete are larger and possess greater financial resources, name recognition and market presence.
EMPLOYEES
At December 31, 2005, the Bank had approximately 265 full-time employees. The Company and its other subsidiaries did not have any employees. None of the Bank's employees are subject to a collective bargaining agreement. We consider the Bank's relationship with its employees to be excellent.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For each of our directors and our executive officers, we have set forth below their ages as of December 31, 2005, and their principal positions.
REGULATION AND SUPERVISION
Blue Valley and its subsidiaries are extensively regulated under both federal and state laws. Laws and regulations to which Blue Valley and the Bank are subject govern, among other things, the scope of business, investments, reserve levels, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. These laws and regulations are intended primarily to protect depositors, not stockholders. Any change in applicable laws or regulations may have a material effect on Blue Valley's business and prospects, and legislative and policy changes may affect Blue Valley's operations. Blue Valley cannot predict the nature or the extent of the effects on its business and earnings that fiscal or monetary policies, economic controls or new federal or state legislation may have in the future.
The following references to statutes and regulations affecting Blue Valley and the Bank are brief summaries only and do not purport to be complete and are qualified in their entirety by reference to the statutes and regulations.
APPLICABLE LEGISLATION
The enactment of legislation described below has significantly affected the banking industry generally and will have an on-going effect on Blue Valley and its subsidiaries.
USA PATRIOT ACT. The USA PATRIOT Act of 2001 was signed into law on October 26, 2001. This legislation enhances the powers of domestic law enforcement organizations and makes numerous other changes aimed at countering the international terrorist threat to the security of the United States. Title III of the legislation most directly affects the financial services industry. It is intended to enhance the federal government's ability to fight money laundering by monitoring currency transactions and suspicious financial activities. The USA PATRIOT Act has significant implications for depository institutions involved in the transfer of money. Under the
USA PATRIOT Act, a financial institution must establish due diligence policies, procedures, and controls reasonably designed to detect and report money laundering through correspondent accounts and private banking accounts. Financial institutions must follow regulations adopted by the Treasury Department to encourage financial institutions, their regulatory authorities, and law enforcement authorities to share information about individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money laundering activities. Financial institutions must follow regulations setting forth minimum standards regarding customer identification. These regulations require financial institutions to implement reasonable procedures for verifying the identity of any person seeking to open an account, maintain records of the information used to verify the person's identity, and consult lists of known or suspected terrorists and terrorist organizations provided to the financial institution by government agencies. Every financial institution must establish anti-money laundering programs, including the development of internal policies and procedures, designation of a compliance officer, employee training, and an independent audit function.
GRAMM-LEACH-BLILEY ACT. The Gramm-Leach-Bliley Act was signed into law on November 12, 1999. This major banking legislation expands the permissible activities of bank holding companies such as Blue Valley by permitting them to engage in activities, or affiliate with entities that engage in activities, that are "financial in nature." Activities that the Act expressly deems to be financial in nature include, among other things, securities and insurance underwriting and agency, investment management and merchant banking. The Federal Reserve and the Treasury Department, in cooperation with one another, determine what additional activities are "financial in nature." With certain exceptions, the Gramm-Leach-Bliley Act similarly expands the authorized activities of subsidiaries of national banks. The provisions of the Gramm-Leach-Bliley Act authorizing the expanded powers became effective March 11, 2000.
Bank holding companies that intend to engage in activities that are "financial in nature" must elect to become "financial holding companies." Financial holding company status is only available to a bank holding company if all of its affiliated depository institutions are "well capitalized" and "well managed," based on applicable banking regulations, and have a Community Reinvestment Act rating of at least "a satisfactory record of meeting community credit needs." Financial holding companies and banks may continue to engage in activities that are financial in nature only if they continue to satisfy the well capitalized and well managed requirements. Bank holding companies that do not elect to be financial holding companies or that do not qualify for financial holding company status may engage only in non-banking activities deemed "closely related to banking" prior to adoption of the Gramm-Leach-Bliley Act.
The Act also calls for "functional regulation" of financial services businesses in which functionally regulated subsidiaries of bank holding companies will continue to be regulated by the regulator that ordinarily has supervised their activities. As a result, state insurance regulators will continue to oversee the activities of insurance companies and agencies, and the Securities and Exchange Commission will continue to regulate the activities of broker-dealers and investment advisers, even where the companies or agencies are affiliated with a bank holding company. Federal Reserve authority to examine and adopt rules regarding functionally regulated subsidiaries is limited.
The Gramm-Leach-Bliley Act imposed an "affirmative and continuing" obligation on all financial service providers (not just banks and their affiliates) to safeguard consumer privacy and requires federal and state regulators, including the Federal Reserve and the FDIC, to establish standards to implement this privacy obligation. With certain exceptions, the Act prohibits banks from disclosing to non-affiliated parties any non-public personal information about customers unless the bank has provided the customer with certain information and the customer has had the opportunity to prohibit the bank from sharing the information with non-affiliates. The new privacy obligations became effective July 1, 2001.
The Gramm-Leach-Bliley Act has been and may continue to be the subject of extensive rule making by federal banking regulators and others.
ECONOMIC GROWTH AND REGULATORY PAPERWORK REDUCTION ACT OF 1996. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 became law on September 30, 1996. This Act streamlined the non-banking activities application process for well-capitalized and well-managed bank holding companies by permitting qualified bank holding companies to commence an approved non-banking activity without prior notice to the
Federal Reserve, although written notice is required within 10 days after commencing the activity. Also, the Act reduced the prior notice period to 12 days in the event of any non-banking acquisition or share purchase, assuming the size of the acquisition does not exceed 10% of risk-weighted assets of the acquiring bank holding company and the consideration does not exceed 15% of a bank holding company's Tier 1 capital.
BANK HOLDING COMPANY REGULATION
Blue Valley is a registered bank holding company subject to periodic examination by the Federal Reserve and required to file periodic reports of its operations and such additional information as the Federal Reserve may require.
INVESTMENTS AND ACTIVITIES. A bank holding company must obtain approval from the Federal Reserve before:
- Acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the bank or bank holding company (unless it already owns or controls the majority of the shares);
- Acquiring all or substantially all of the assets of another bank or bank holding company; or
- Merging or consolidating with another bank holding company.
The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anticompetitive result unless the anticompetitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers.
With certain exceptions, a bank holding company is also prohibited from:
- Acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company; and
- Engaging, directly or indirectly, in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries.
Bank holding companies may, however, engage in businesses found by the Federal Reserve to be "financial in nature," as described above. As a financial holding company, Blue Valley is authorized to engage in the expanded activities permitted under the Gramm-Leach-Bliley Act as long as it continues to qualify for financial holding company status.
Finally, subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, and the Federal Reserve's implementing regulations, require Federal Reserve approval prior to any acquisition of "control" of a bank holding company, such as Blue Valley. In general, a person or company is presumed to have acquired control if it acquires 10% of the outstanding shares of a bank or bank holding company and is conclusively determined to have acquired control if it acquires 25% or more of the outstanding shares of a bank or bank holding company.
SOURCE OF STRENGTH. The Federal Reserve expects Blue Valley to act as a source of financial strength and support for the Bank and to take measures to preserve and protect the Bank in situations where additional investments in the Bank may not otherwise be warranted. The Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve's determination that the activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution's
financial condition. Blue Valley Building Corp., BVBC Capital Trust II, BVBC Capital Trust III and Homeland Title, LLC are Blue Valley's only active direct subsidiaries that are not banks.
CAPITAL REQUIREMENTS. The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies and banks. If the capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The Federal Reserve's capital guidelines establish a risk-based requirement expressed as a percentage of total risk-weighted assets and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital (which consists principally of stockholders' equity). The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3%.
The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels may be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions, which is Tier 1 capital less all intangible assets, well above the minimum levels.
DIVIDENDS. The Federal Reserve has issued a policy statement concerning the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which could only be funded in ways that weakened the bank holding company's financial health, such as by borrowing. Also, the Federal Reserve possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
BANK REGULATIONS
The Bank operates under a Kansas state bank charter and is subject to regulation by the Kansas Banking Department and the Federal Reserve Bank. The Kansas Banking Department and the Federal Reserve Bank regulate or monitor all areas of the Bank's operations, including capital requirements, issuance of stock, declaration of dividends, interest rates, deposits, record keeping, establishment of branches, acquisitions, mergers, loans, investments, borrowing, security devices and procedures and employee responsibility and conduct. The Kansas Banking Department places limitations on activities of the Bank including the issuance of capital notes or debentures and the holding of real estate and personal property and requires the Bank to maintain a certain ratio of reserves against deposits. The Kansas Banking Department requires the Bank to file a report annually showing receipts and disbursements of the Bank, in addition to any periodic report requested.
DEPOSIT INSURANCE. The FDIC, through its Bank Insurance Fund, insures the Bank's deposit accounts to a maximum of $100,000 for each insured depositor. The FDIC, through its Savings Association Insurance Fund, insures certain deposit accounts acquired by the Bank in 1994 from a branch of a failed savings institution. These deposit accounts are insured to a maximum of $100,000 for each insured depositor. The FDIC bases deposit insurance premiums on the perceived risk each bank presents to its deposit insurance fund. In addition, all Bank Insurance Fund-insured and Savings Association Insurance Fund-insured institutions currently pay an assessment based on insured deposits to service debt issued by the Financing Corporation, a federal agency established to finance the recapitalization of the former Federal Savings and Loan Insurance Corporation. The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC 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 in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management is not aware of any activity or condition that could result in termination of the deposit insurance of the Bank.
CAPITAL REQUIREMENTS. The FDIC has established the following minimum capital standards for state-chartered, insured non-member banks, such as the Bank: (1) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3%; and (2) a risk-based capital requirement consisting of a minimum ratio of total
capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. These capital requirements are minimum requirements, and higher capital levels may be required if warranted by the particular circumstances or risk profiles of individual institutions.
The federal banking regulators also have broad power to take "prompt corrective action" to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends upon whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Under the prompt corrective action rules, an institution is:
- "Well-capitalized" if the institution has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure;
- "Adequately capitalized" if the institution has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and a leverage ratio of 4% or greater;
- "Undercapitalized" if the institution has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage ratio that is less than 4%;
- "Significantly undercapitalized" if the institution has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or a leverage ratio that is less than 3%; and
- "Critically undercapitalized" if the institution has a ratio of tangible equity to total assets that is equal to or less than 2%.
The federal banking regulators must take prompt corrective action with respect to capital deficient institutions. Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include:
- Placing limits on asset growth and restrictions on activities, including the establishing of new branches;
- Requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired;
- Restricting transactions with affiliates;
- Restricting the interest rate the institution may pay on deposits;
- Requiring that senior executive officers or directors be dismissed;
- Requiring the institution to divest subsidiaries;
- Prohibiting the payment of principal or interest on subordinated debt; and
- Appointing a receiver for the institution.
Companies controlling an undercapitalized institution are also required to guarantee the subsidiary institution's compliance with the capital restoration plan subject to an aggregate limitation of the lesser of 5% of the institution's assets at the time it received notice that it was undercapitalized or the amount of the capital deficiency when the institution first failed to meet the plan. The Federal Deposit Insurance Act generally requires the appointment of a conservator or receiver within 90 days after an institution becomes critically undercapitalized.
As of December 31, 2005, the Bank had capital in excess of the requirements for a "well-capitalized" institution.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT. The Bank, having over $500 million in total assets, is subject to numerous reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Act (FDICIA 112). The primary purpose of FDICIA 112 is to provide a framework for early risk identification in financial management through independent audits, more stringent reporting requirements and an effective system of internal controls.
INSIDER TRANSACTIONS. The Bank is subject to restrictions on extensions of credit to executive officers, directors, principal stockholders or any related interest of these persons. Extensions of credit must be made on substantially the same terms, including interest rates and collateral as the terms available for third parties and must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is also subject to lending limits and restrictions on overdrafts to these persons.
COMMUNITY REINVESTMENT ACT REQUIREMENTS. The Community Reinvestment Act (CRA) of 1977 requires that, in connection with examinations of financial institutions within their jurisdiction, the federal banking regulators must evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. In its most recent CRA examination dated June 1, 2004, the Bank received a rating of "Satisfactory."
STATE BANK ACTIVITIES. With limited exceptions, FDIC-insured state banks, like the Bank, may not make or retain equity investments of a rate or in an amount that are not permissible for national banks and also may not engage as a principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member.
REGULATIONS GOVERNING EXTENSIONS OF CREDIT. The Bank is subject to restrictions on extensions of credit to Blue Valley and on investments in Blue Valley's securities and using those securities as collateral for loans. These regulations and restrictions may limit Blue Valley's ability to obtain funds from the Bank for its cash needs, including funds for acquisitions and for payment of dividends, interest and operating expenses. Further, the Bank Holding Company Act and Federal Reserve regulations prohibit a bank holding company and its subsidiaries from engaging in various tie-in arrangements in connection with extensions of credit, leases or sales of property or furnishing of services.
RESERVE REQUIREMENTS. The Federal Reserve requires all depository institutions to maintain reserves against their transaction accounts. Reserves of 3% must be maintained against net transaction accounts of $7.8 million to $48.3 million plus 10% must be maintained against that portion of net transaction accounts in excess $48.3 million (subject to adjustment by the Federal Reserve). The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements.
OTHER REGULATIONS
Interest and various other charges collected or contracted for by the Bank are subject to state usury laws and other federal laws concerning interest rates. The Bank's loan operations are also subject to federal laws applicable to credit transactions. The federal Truth in Lending Act governs disclosures of credit terms to consumer borrowers. The Home Mortgage Disclosure Act of 1975 requires financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves. The Equal Credit Opportunity Act prohibits discrimination on the basis of race, creed or other prohibited factors in extending credit. The Fair Credit Reporting Act of 1978 governs the use and provision of information to credit reporting agencies. The Fair Debt Collection Act governs the manner in which consumer debts may be collected by collection agencies. The various federal agencies charged with the responsibility of implementing these federal laws have adopted various rules and regulations. The deposit operations of the Bank are also subject to the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, and the Electronic Funds Transfer Act, and Regulation E issued by the Federal Reserve to implement that Act, which govern automatic deposits to and withdrawals from the use of ATMs and other electronic banking services.
ITEM 1A:
ITEM 1A: RISK FACTORS
Our operations may be adversely affected if we are unable to maintain and increase our deposit base and secure adequate funding.
We fund our banking and lending activities primarily through demand, savings and time deposits and, to a lesser extent, lines of credit, sale/repurchase facilities from various financial institutions, and Federal Home Loan Bank borrowings. The success of our business depends in part on our ability to maintain and increase our deposit base and our ability to maintain access to other funding sources. Our inability to obtain funding on favorable terms, on a timely basis, or at all, would adversely affect our operations and financial condition.
The loss of our key personnel could adversely affect our operations.
We are a relatively small organization and depend on the services of all of our employees. Our growth and development to date has depended in a large part on a few key employees who have primary responsibility for maintaining personal relationships with our largest customers. The unexpected loss of services of one or more of these key employees could have a material adverse effect on our operations. Our key employees are Robert D. Regnier, Mark A. Fortino, Ralph J. Schramp, Sheila C. Stokes and Gary L. Sherrer. Each of these persons is an officer of the Bank. We do not have written employment or non-compete agreements with any of these key employees. We carry a $1 million "key person" life insurance policy on the life of Mr. Regnier.
Changes in interest rates may adversely affect our earnings and cost of funds.
Changes in interest rates affect our operating performance and financial condition in diverse ways. A substantial part of our profitability depends on the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal monetary and fiscal policies, and economic conditions generally. Historically, net interest spreads for many financial institutions have widened and narrowed in response to these and other factors, which are often collectively referred to as "interest rate risk." We try to minimize our exposure to interest rate risk, but are unable to eliminate it.
Because our business is concentrated in the Kansas City MSA, a downturn in the economy of the Kansas City MSA may adversely affect our business.
Our success is dependent to a significant extent upon the general economic conditions in the Kansas City MSA, including Johnson County, Kansas, and, in particular, the conditions for the medium- and small-sized businesses that are the focus of our customer base. Although currently the economy in these areas is favorable, we do not know whether these conditions will continue. Adverse changes in economic conditions in the Kansas City MSA, including Johnson County, Kansas, could impair our ability to collect loans, reduce our growth rate and have a negative effect on our overall financial condition.
If our allowance for loan losses is insufficient to absorb in our loan portfolio, it will adversely affect our financial condition and results of operations.
Some borrowers may not repay loans that we make to them. This risk is inherent in the banking business. Like all financial institutions, we maintain an allowance for loan losses to absorb probable loan losses in our loan portfolio. However, we cannot predict loan losses with certainty, and we cannot assure you that our allowance will be sufficient. Loan losses in excess of our reserves would have an adverse effect on our financial condition and results of operations.
In addition, various regulatory agencies, as an integral part of the examination process, periodically review our loan portfolio. These agencies may require us to add to the allowance for loan losses based on their judgments and interpretations of information available to them at the time of their examinations. If these agencies require us to increase our allowance for loan losses, our earnings will be adversely affected in the period in which the increase occurs.
We may incur significant costs if we foreclose on environmentally contaminated real estate.
If we foreclose on a defaulted real estate loan to recover our investment, we may be subject to environmental liabilities in connection with the underlying real property. It is also possible that hazardous substances or wastes may be discovered on these properties during our ownership or after they are sold to a third party. If they are discovered on a property that we have acquired through foreclosure or otherwise, we may be required to remove those substances and clean up the property. We may have to pay for the entire cost of any removal and clean-up without the contribution of any other third parties. We may also be liable to tenants and other users of neighboring properties. These costs or liabilities may exceed the fair value of the property. In addition, we may find it difficult or impossible to sell the property prior to or following any environmental clean-up.
If we are not able to compete effectively in the highly competitive banking industry, our business will be adversely affected.
Our business is extremely competitive. Many of our competitors are, or are affiliates of, enterprises that have greater resources, name recognition and market presence than we do. Some of our competitors are not regulated as extensively as we are and, therefore, may have greater flexibility in competing for business. Some of these competitors are subject to similar regulation but have the advantages of established customer bases, higher lending limits, extensive branch networks, numerous ATMs, and more ability to absorb the costs of maintaining technology or other factors.
ITEM 1B:
ITEM 1B: UNRESOLVED STAFF COMMENTS
No items are reportable.
ITEM 2:
ITEM 2: PROPERTIES
The Company's principal office is located at 11935 Riley on the corner of 119th and Riley streets in Overland Park, Kansas. In addition to the principal office, the Bank also has three banking center locations and one mortgage and banking center location.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
On October 13, 2004, we became a defendant in a lawsuit filed in the United States District Court, Kansas District by former mortgage loan originators. The plaintiffs claimed that the Bank did not compensate them appropriately for overtime hours worked in accordance with the Fair Labor Standards Act. On November 18, 2005, we entered into an agreement to settle the existing claims and potential claims asserted by the mortgage loan originators of approximately $1.1 million. Associated costs to defend the litigation totaled approximately $58,500 in 2004 and $189,600 in 2005. In consideration of payments to be made to the plaintiffs and plaintiffs' attorney, all claims and potential wage and hour claims asserted in and/or which could have been asserted by such plaintiffs were released. We currently do not anticipate any significant additional financial impact from this litigation. There are no other pending legal proceedings that are likely to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5:
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
MARKET FOR COMMON STOCK
We are a reporting company under the Securities Exchange Act as a result of a trust preferred securities offering we completed during July 2000. Shares of our common stock have traded on the Over-The-Counter Bulletin Board since July 2002 under the symbol "BVBC." As of February 28, 2006, there were approximately 192 stockholders of record of our common stock. The following table sets forth the high and low prices of the Company's common stock based on closing stock price quotations provided by Yahoo.com. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission.
DIVIDENDS
Our board of directors declared cash dividends on our common stock as follows:
Because our consolidated net income consists largely of the net income of the Bank, our ability to pay dividends on our common stock is subject to our receipt of dividends from the Bank. The ability of the Bank to pay dividends to us, and our ability to pay dividends to our stockholders, is regulated by federal banking laws. In addition, if we elect to defer interest payments on our outstanding junior subordinated debentures, we will be prohibited from paying dividends on our common stock during such deferral. At December 31, 2005, approximately $12,390,000 of retained earnings were available for dividend declaration without prior regulatory approval.
Our board of directors intends to declare future dividends, subject to limitations imposed by regulatory capital guidelines in addition to consideration of the Company's profitability and liquidity.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following table presents our consolidated financial data as of and for the five years ended December 31, 2005, and should be read in conjunction with the consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations," each of which is included elsewhere in this Form 10-K. The selected statements of condition and statements of income data, insofar as they relate to the five years in the five-year period ended December 31, 2005, have been derived from our audited consolidated financial statements.
- ---------- (1) Net interest income, on a full tax-equivalent basis, divided by average interest-earning assets.
(2) Non-interest expense less non-interest income divided by average total assets.
(3) Non-interest expense divided by the sum of net interest income plus non-interest income.
(4) Net income divided by average total assets.
(5) Net income divided by average common equity.
ITEM 7:
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following presents management's discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. You should read this discussion in conjunction with our "Selected Consolidated Financial Data," our consolidated financial statements and the accompanying notes, and the other financial data contained elsewhere in this report.
This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of those safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, can generally be identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Company is unable to predict the actual results of its future plans or strategies with certainty. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, fluctuations in market rates of interest and loan and deposit pricing; a deterioration of general economic conditions or the demand for housing in the Company's market areas; a deterioration in the demand for mortgage financing; legislative or regulatory changes; adverse developments in the Company's loan or investment portfolio; any inability to obtain funding on favorable terms; the loss of key personnel; significant increases in competition; potential unfavorable results of litigation, and the possible dilutive effect of potential acquisitions or expansions. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
CRITICAL ACCOUNTING POLICIES
Please refer to Note 1 of our consolidated financial statements where we present a listing and discussion of our most significant accounting policies. After a review of these policies, we determined that accounting for the allowance for loan losses, income taxes, and stock-based compensation are deemed critical accounting policies because of the valuation techniques used, and the sensitivity of certain financial statement amounts to the methods, as well as the assumptions and estimates, underlying these policies. Accounting for these critical areas requires the most subjective and complex judgments that could be subject to revision as new information becomes available.
As presented in Note 1 and Note 3 to the consolidated financial statements, the allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The adequacy of the allowance is analyzed monthly based on internal loan reviews and qualitative measurements of our loan portfolio. Management assesses the adequacy of the allowance for loan losses based upon a number of factors including, among others:
- analytical reviews of loan loss experience in relationship to outstanding loans and commitments;
- unfunded loan commitments;
- problem and non-performing loans and other loans presenting credit concerns;
- trends in loan growth, portfolio composition and quality;
- appraisals of the value of collateral; and
- management's judgment with respect to current economic conditions and their impact on the existing loan portfolio.
The Bank computes its allowance by assigning specific reserves to impaired loans, plus a general reserve based on loss factors applied to the rest of the loan portfolio. The specific reserve on impaired loans is computed as the amount of the loan in excess of the present value of the estimated future cash flows discounted at the loan's
effective interest rate, or based on the loan's observable market value or the fair value of the collateral if the loan is collateral dependent. The general reserve loss factors are determined based on such items as management's evaluation of risk in the portfolio, local economic conditions, and historical loss experience. The Bank has further refined its risk grading system by developing associated reserve factors for each risk grade.
The income tax amounts in Note 7 to the consolidated financial statements reflect the current period income tax expense for all periods presented, as well as future tax liabilities and benefits associated with differences in timing of expenses and income recognition for book and tax accounting purposes. Our current tax liability and expense amounts are determined using estimates and these estimates are subject to review and possible revision by taxing authorities.
We discuss our accounting for stock-based compensation in greater detail in Note 1 to our consolidated financial statements. Included in Note 1 is the effect on our net income if Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" is applied. This accounting standard will be effective for all fiscal periods beginning January 1, 2006. Our current policy follows Accounting Principles Board Opinion No. 25.
OVERVIEW
2005 was a year of transition for the Company's earnings composition. Compared to the previous two years, interest income from commercial lending had a much larger impact on the overall profitability of the Company compared to fee income from mortgage lending. During the year, we saw our net interest margin expand dramatically as eight 25 basis point increases in the prime lending rate had a positive effect on our net interest income. However, longer term interest rates continued to increase slightly and stabilize which further curtailed mortgage refinancing. This had an adverse effect on the mortgage origination side of our business, resulting in lower origination volumes and declining fee income. During most of 2005 we experienced moderate commercial loan growth, increasing our average loan balances during the year. However, this growth slowed and reversed during the final months of the year and our year-end 2005 loan balance ended up slightly below 2004's year-end balance. We also experienced moderate growth in deposits during 2005 and this growth, along with existing liquidity carried forward from 2004, was used to expand our investment portfolio. We expect moderate growth in both loans and deposits during 2006, and we expect that any further increases in the prime lending rate will continue to have a positive effect on our net interest margin.
Net income for 2005 was $4.6 million, a $2.6 million, or 136.73% increase from the $1.9 million earned in 2004. Diluted earnings per share increased 132.92% to $1.91 for the year ended December 31, 2005 from $0.82 in the previous year. The Company's returns on average assets and average stockholders' equity for 2005 were 0.66% and 10.44%, compared to 0.30% and 4.69%, respectively, for 2004.
Net interest income for 2005 was $22.4 million compared to $17.2 million earned during 2004. The increase of $5.2 million or 30.28% was primarily the result of increases in yields earned on average earning assets.
The provision for loan losses in 2005 was $230,000 compared to $2.0 million in 2004. The decrease in the provision in 2005 was essentially the result of decreases in net charge-offs, improvements in overall portfolio credit quality, and slower loan growth during 2005.
Non-interest income decreased 18.94% to $11.3 million in 2005 from $13.9 million in 2004. Increases in market interest rates and other demand factors resulted in a significant industry-wide decline in the volume of residential mortgage loans originated in 2005 compared to 2004, particularly refinancing volume. This trend resulted in lower origination fees during 2005 than during 2004 for our Company. Future market interest rate fluctuations and their resultant impact on loans held for sale fee income are difficult to project or quantify; however, it is likely that further increases in interest rates will have a detrimental impact on mortgage loan refinancing and loans held for sale fee income.
Total assets for the Company at December 31, 2005, were $689.6 million, an increase of $16.9 million, or 2.50%, from $672.7 million at December 31, 2004. Deposits and stockholders' equity at December 31, 2005 were
$529.3 million and $46.2 million, compared with $522.6 million and $41.4 million at December 31, 2004, increases of $6.7 million, or 1.28%, and $4.9 million, or 11.77%, respectively.
Loans at December 31, 2005 totaled $503.1 million, a decrease of $4.0 million, or 0.80%, compared to December 31, 2004. The loan to deposit ratio at December 31, 2005 was 95.05% compared to 97.04% at December 31, 2004. The decrease in the loan to deposit ratio was due to deposit growth which, on a relative basis, outpaced loan growth. Our funding philosophy for loans not held for sale has been to primarily increase deposits from retail and commercial deposit sources and secondarily use other borrowing sources as necessary to fund loans within the limits of the Bank's capital base.
Historically, our ratio of total non-performing assets to total assets reflects the Bank's conservative underwriting policies and aggressive management of impaired loans and has resulted in low levels of nonaccrual loans. For the five years ended December 31, 2005, our average year-end ratio of non-performing loans to total loans was 0.73%. As of December 31, 2005, our ratio of non-performing loans to total loans was 0.87%, which was slightly above, but well in line with, our historical averages. Our non-performing credit relationships are regularly reviewed and closely monitored. Our philosophy has been to value non-performing loans at their estimated collectible value and to aggressively manage these situations. Generally, the Bank maintains its allowance for loan losses in excess of its non-performing loans. As of December 31, 2005, our ratio of allowance for loan losses to non-performing loans was 153.27%, compared to 168.60% at December 31, 2004.
The average net charge-off ratio was 0.34% for the five years ended December 31, 2005. Our net charge-off ratio for the year ended December 31, 2005 was 0.17%, which was below our historical average. The Bank continues to aggressively manage defaults in the loan portfolio. Management intends to vigorously pursue collection of all charged-off loans.
NET INTEREST INCOME
A primary component of our net income is our net interest income. Net interest income is determined by the spread between the fully tax equivalent (FTE) yields we earn on our interest-earning assets and the rates we pay on our interest-bearing liabilities, as well as the relative amounts of such assets and liabilities. FTE net interest margin is determined by dividing FTE net interest income by average interest-earning assets. The following discussion should be read along with analysis of the "Average Balances, Yields and Rates" table on the next page.
Years ended December 31, 2005 and 2004. FTE net interest income for 2005 increased to $22.4 million from $17.4 million in 2004, a $5 million, or 29.00%, increase.
FTE interest income for 2005 was $40.4 million, an increase of $8.5 million, or 26.72%, from $31.9 million in 2004, primarily as a result of an increase in the yield on average earning assets. The yield on average earning assets increased 95 basis points to 6.31% in 2005 compared to 5.36% in 2004. Average interest earning assets increased $45.8 million, or 7.69%, during 2005. Due to the increase in the yield and in earning asset volume, loan interest and fee income increased to $37.5 million in 2005 from $29.2 million in 2004, an $8.3 million or 28.19% increase. Interest income on investment securities decreased by $147,000, or 5.90%, in 2005 compared to the prior year due to lower average balances of investment securities. Interest income earned on Federal Funds Sold increased $423,000 or 269.42% in 2005 compared to the prior year due primarily to higher yields on those earning assets.
Interest expense for 2005 was $18.0 million, up $3.5 million, or 23.97%, from $14.5 million in 2004. The increase resulted from an increase in the overall rate paid on our average interest-bearing liabilities as well as an increase in the level of interest bearing liabilities, primarily interest-bearing deposits. The rate paid on our total average interest bearing liabilities increased to 3.28% in 2005 compared to 2.79% in 2004, an increase of 49 basis points. This increase resulted from increases in rates paid on savings deposits, money market deposits, time deposits, and long-term debt. Total average interest bearing liabilities increased $28.5 million or 5.47% during 2005 primarily due to increases in time deposits.
Years ended December 31, 2004 and 2003. FTE net interest income for 2004 increased to $17.4 million from $17.2 million in 2003, a $221,000, or 1.29%, increase.
FTE interest income for 2004 was $31.9 million, an increase of $1.2 million, or 3.86%, from $30.7 million in 2003, as a result of growth in earning assets. Average interest earning assets increased $24.1 million, or 4.22%, during 2004. Due to the increase in earning asset volume, loan interest and fee income increased to $29.2 million in 2004 from $28.3 million in 2002, or 3.36%. Interest income on investment securities increased by $125,000, or 5.27%, in 2004 compared to the prior year. The yield on average interest-earning assets fell to 5.36%, as compared to 5.38% in 2003, a decline of 2 basis points.
Interest expense for 2004 was $14.5 million, up $964,000, or 7.11%, from $13.5 million in 2003. The increase resulted from an increase in the level of interest bearing liabilities, primarily interest-bearing deposits, as well as an increase in the overall rate paid on our average interest-bearing liabilities. Total average interest bearing liabilities increased $22.1 million or 4.44% during 2004 mostly due to increases in money market and time deposits. The rate paid on our total average interest bearing liabilities increased to 2.79% in 2004 compared to 2.72% in 2003, an increase of 7 basis points. This increase resulted from increases in rates paid on savings deposits, money market deposits, time deposits, and long-term debt.
Average Balance Sheets. The following table sets forth for the periods and as of the dates indicated, information regarding our average balances of assets and liabilities as well as the dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities and the resultant rates or costs. Ratio, yield and rate information are based on average daily balances where available; otherwise, average monthly balances have been used. Nonaccrual loans are included in the calculation of average balances for loans for the periods indicated.
AVERAGE BALANCES, YIELDS AND RATES
(1) Presented on a fully tax-equivalent basis assuming a tax rate of 34%. For the three years ended December 31, 2005, 2004 and 2003, the tax equivalency adjustment amounted to $31,000, $194,000, and 300,000, respectively.
(2) Includes average balances and income from loans on nonaccrual status
Analysis of Changes in Net Interest Income Due to Changes in Interest Rates and Volumes. The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increase or decrease related to changes in balances and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to:
- changes in rate, reflecting changes in rate multiplied by the prior period volume; and
- changes in volume, reflecting changes in volume multiplied by the current period rate.
CHANGES IN INTEREST INCOME AND EXPENSE VOLUME AND RATE VARIANCES
(1) Presented on a fully tax-equivalent basis assuming a tax rate of 34%.
PROVISION FOR LOAN LOSSES
We make provisions for loan losses in amounts management deems necessary to maintain the allowance for loan losses at an appropriate level. During the year ended December 31, 2005, we provided $230,000 for loan losses, as compared to $2.0 million for the year ended December 31, 2004, a decrease of $1.7 million, or 88.30%. During 2005, our provision for loan losses decreased due to overall improvement in the credit quality of the loan portfolio as well as a decrease in net charge-offs and impaired loans. In addition, the size of the loan portfolio actually declined during the last few months of 2005 making the existing allowance for loan losses sufficient to cover the inherent losses in the loan portfolio. The loan portfolio decreased 0.80% to $503.1 million in 2005 from $507.2 million at December 31, 2004. Total impaired loans decreased 13.76% to $11.1 million at December 31, 2005, with a related reserve of $1.2 million, from $12.8 million at December 31, 2004, with a related reserve of $1.8 million. Net charge-offs decreased to $859,000 in 2005 from $1.7 million in 2004. During 2004, the provision for
loan losses increased due to overall growth in the loan portfolio as well as an increase in net charge-offs and impaired loans. During the year ended December 31, 2004, we provided $2.0 million for loan losses, as compared to $1.4 million for the year ended December 31, 2003, an increase of $615,000, or 45.56%.
The allowance for loan losses as a percentage of loans was 1.33% at December 31, 2005, compared to 1.45% in 2004 and 1.66% in 2003. The decrease in this percentage from December 31, 2004 was primarily due to net charge-offs as well as a lower provision for loan loss during the year.
Overall, we decreased the total balance of the allowance for loan losses in 2005 and 2004 based upon an analysis of several factors, including an analysis of impaired loans, the general reserve factor analysis referred to in our Critical Accounting Policies and changes in the loan mix. The allowance for loan losses represents our best estimate of probable losses that have been incurred as of the respective balance sheet dates.
NON-INTEREST INCOME
The following table describes the items of our non-interest income for the periods indicated:
NON-INTEREST INCOME
Non-interest income decreased to $11.3 million, or 18.94%, during 2005, from $13.9 million during 2004. This decrease is attributable to a decrease in loans held for sale fee income of $3.0 million. We experienced a decline in our loans held for sale fee income due to a decline in residential mortgage origination and refinancing resulting from higher interest rates. The volume of closed residential mortgages fell to $675.6 million in 2005 from $883.4 million and $1.5 billion in 2004 and 2003, respectively. Sustainability of the level of our loans held for sale fee income is primarily dependent upon the interest rate environment, and secondarily dependent on our ability to develop new products and alternative delivery channels. In 2004, we realized $524,000 of net gains on the sale of available-for-sale securities. We took advantage of opportunities to mitigate the risk of long-term rate volatility in our available-for-sale investment portfolio and also provide a funding source for loan growth by selling some of our longer-term bonds. We sold no securities during 2005. Other income increased $1.1 million or 179.90% due primarily to gains on the sale of our old Olathe banking facility and an increase in rental income from subleases in our Leawood facility. Future growth of other non-interest income categories is dependent upon new product development, and growth in our customer base.
Non-interest income decreased to $13.9 million, or 38.14%, during 2004, from $22.5 million during 2003. This decrease is attributable to a decrease in loans held for sale fee income of $9.5 million. We experienced a decline in our loans held for sale fee income due to a decline in residential mortgage origination and refinancing resulting from higher interest rates. The volume of closed residential mortgages fell to $883.4 million in 2004 from $1.5 billion and $1.3 billion in 2003 and 2002, respectively. Sustainability of the level of our loans held for sale fee income is primarily dependent upon the interest rate environment, and secondarily dependent on our ability to develop new products and alternative delivery channels. Other service charge income, which includes trust services income, investment brokerage income, merchant bankcard processing and debit card processing income, increased by $191,000 or 20.67% from 2003 to 2004. In 2004, we realized $524,000 of net gains on the sale of available-for-sale securities. We took advantage of opportunities to mitigate the risk of long-term rate volatility in our available-for-sale investment portfolio and also provide a funding source for loan growth by selling some of our longer-term
bonds. Future growth of other non-interest income categories is dependent upon new product development, and growth in our customer base.
NON-INTEREST EXPENSE
The following table describes the items of our non-interest expense for the periods indicated.
NON-INTEREST EXPENSE
Non-interest expense decreased 1.65% to $26.1 million during 2005, compared to $26.6 million in the prior year primarily due to a decrease in salaries and employee benefits. Our salaries and employee benefits expense decreased 4.11% to $16.0 million in 2005 from $16.7 million in 2004, mainly due to a decline in incentive compensation related to mortgage origination activity. General and administrative expenses increased $373,000 or 5.92% primarily due to increased data processing costs and other miscellaneous expenses.
Non-interest expense decreased 9.27% to $26.6 million during 2004, as compared to $29.3 million in the prior year primarily due to a decrease in salaries and employee benefits. Our salaries and employee benefits expense decreased 15.25% to $16.7 million in 2004 from $19.7 million in 2003, mainly due to a decline in incentive compensation related to mortgage origination activity. This decline was partially offset by increases in staffing costs due to the opening of our Leawood banking center as well as a $550,000 accrued expense recorded in 2004 to reflect the estimated potential cost of litigation related to claimed violations of the Fair Labor Standards Act. Occupancy expenses increased 9.43% to $3.4 million in 2004 from $3.1 million in 2003, primarily due to the opening of our Leawood banking center in May 2004 and the incremental costs associated with the operation of our Mortgage Banking facility for a full year.
INCOME TAXES
Our income tax expense during 2005 was $2.8 million, compared to $665,000 during 2004, and $3.1 million during 2003. The increase in 2005 reflects our higher earnings for the current fiscal year. In addition, the Company recognized tax reserves provided in prior tax years during 2004. Our consolidated effective income tax rates of 37.69%, 25.63% and 35.71% for the three years ended December 31, 2005, 2004, and 2003, respectively, varies from the statutory rate principally due to the effects of state income taxes and interest income earned on our municipal securities portfolio which is generally tax-exempt for federal income tax purposes.
FINANCIAL CONDITION
Lending Activities. Our loan portfolio is a key source of income, and since our inception, has been a principal component of our revenue growth. Our loan portfolio reflects an emphasis on commercial and commercial real estate, construction, lease financing, residential real estate, consumer and home equity lending. We emphasize commercial lending to professionals, businesses and their owners. Commercial loans and loans secured by commercial real estate accounted for 45.12%, 48.07% and 46.45% of our total loans at December 31, 2005, 2004 and 2003, respectively.
Loans were $503.1 million at December 31, 2005, a decrease of $4.1 million, or 0.80%, compared to December 31, 2004. Loans were $507.2 million at December 31, 2004, an increase of $82.6 million, or 19.44%, compared to December 31, 2003. The loan to deposit ratio decreased to 95.05%, compared to 97.04% at December 31, 2003, and 90.25% at December 31, 2003.
We experienced increases in construction, residential real estate, and home equity loan categories during 2005. The growth of our construction, residential real estate, and home equity portfolios is a result of the economic growth and development of our market area, coupled with the efforts and experience of our lending staff. The Company targets consumer lending lines of business in an effort to broadly diversify our risk across multiple lines of business. The following table sets forth the composition of our loan portfolio by loan type as of the dates indicated. The amounts in the following table are shown net of discounts and other deductions.
Collateral and Concentration. Management monitors concentrations of loans to individuals or businesses involved in a single industry over 5% of total loans. At December 31, 2005, 2004 and 2003, substantially all of our loans were collateralized with real estate, inventory, accounts receivable and/or other assets or were guaranteed by the Small Business Administration. Loans to individuals and businesses in the construction industry totaled $139.7 million, or 27.76%, of total loans, as of December 31, 2005. The Bank does not have any other concentrations of loans to individuals or businesses involved in a single industry exceeding 5% of total loans. The Bank's lending limit under federal law to any one borrower was $16.9 million at December 31, 2005. The Bank's largest single borrower, net of participations, at December 31, 2005 had outstanding loans of $7.4 million.
The following table presents the aggregate maturities of loans in each major category of our loan portfolio as of December 31, 2005, excluding the allowance for loan and valuation losses. Additionally, the table presents the dollar amount of all loans due more than one year after December 31, 2005 which have predetermined interest rates (fixed) or adjustable interest rates (variable). Actual maturities may differ from the contractual maturities shown below as a result of renewals and prepayments or the timing of loan sales.
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
NON-PERFORMING ASSETS
Non-performing assets consist primarily of loans past due 90 days or more, nonaccrual loans and foreclosed real estate. The following table sets forth our non-performing assets as of the dates indicated:
NON-PERFORMING ASSETS
Non-performing assets. Non-performing assets decreased to $5.1 million at December 31, 2005 from $7.0 million at December 31, 2004. The decrease related primarily to decreases in commercial and all other loans, residential real estate loans and foreclosed assets held for sale. Foreclosed assets held for sale declined $1.9 million during 2005, as the Company sold one foreclosed residential real estate property for $2.4 million.
Impaired Loans. A loan is considered impaired when it is probable that we will not receive all amounts due according to the contractual terms of the loan. This includes loans that are delinquent 90 days or more, nonaccrual loans, and certain other loans identified by management. Accrual of interest is discontinued, and interest accrued and unpaid is removed, at the time the loans are delinquent 90 days or when management believes that full collection of principal and interest under the original loan contract is unlikely to occur. Interest is recognized for nonaccrual loans only upon receipt, and only after all principal amounts are current according to the terms of the contract.
Impaired loans totaled $11.1 million at December 31, 2005, $12.8 million at December 31, 2004, and $10.2 million at December 31, 2003, with related allowances for loan losses of $1.2 million, $1.8 million, and $1.5 million, respectively.
Total interest income of $742,000, $745,000 and $736,000 was recognized on average impaired loans of $10.4 million, $13.8 million and $11.7 million for 2005, 2004 and 2003, respectively. Included in this total is cash basis interest income of $15,000, $46,000 and $67,000 recognized on nonaccrual impaired loans during 2005, 2004 and 2003, respectively.
Allowance For Loan Losses. The allowance for loan losses is increased by provisions charged to expense and reduced by loans charged off, net of recoveries. The adequacy of the allowance is analyzed monthly based on internal loan reviews and quality measurements of our loan portfolio. The Bank computes its allowance by assigning specific reserves to impaired loans, and then applies general reserves, based on loss factors, to the remainder of the loan portfolio. The loss factors are determined based on such items as management's evaluation of risk in the portfolio, local economic conditions, and historical loss experience. Specific allowances are accrued on specific loans evaluated for impairment for which the basis of each loan, including accrued interest, exceeds the discounted amount of expected future collections of interest and principal or, alternatively, the fair value of the loan collateral.
The following table sets forth information regarding changes in our allowance for loan and valuation losses for the periods indicated.
SUMMARY OF LOAN LOSS EXPERIENCE AND RELATED INFORMATION
The following table shows our allocation of the allowance for loan losses by specific category at the end of each of the periods shown. Management attempts to allocate specific portions of the allowance for loan losses based on specifically identifiable problem loans. However, the allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
Investment securities. The primary objectives of our investment portfolio are to secure the safety of principal, to provide adequate liquidity and to provide securities for use in pledging for public funds or repurchase agreements. Income is a secondary consideration. As a result, we generally do not invest in mortgage-backed securities and other higher yielding investments.
Total investment securities increased by $33.6 million or 50.69% during 2005, as we utilized the liquidity carried forward from 2004 and growth in deposits to expand our investment portfolio.
As of December 31, 2005, all of the securities in our investment portfolio were classified as available-for-sale in order to provide us with an additional source of liquidity when necessary and as pledging requirements permitted.
The following table presents the composition of our available for sale investment portfolio by major category at the dates indicated.
INVESTMENT SECURITIES PORTFOLIO COMPOSITION
The following table sets forth the maturities, carrying value, and average yields for securities in our investment portfolio at December 31, 2005. Yields are presented on a tax equivalent basis. Expected maturities will differ from contractual maturities due to unscheduled repayments.
MATURITY OF INVESTMENTS IN AVAILABLE-FOR-SALE SECURITIES
Deposits. Deposits grew by $6.7 million, or 1.28%, for the year ended December 31, 2005, compared to 2004 year-end. The primary source of deposit growth in 2005 was in demand and time deposit balances, which increased by $9.7 million and $31.9 million, respectively. The increase in time deposit balances was primarily due to our purchase of $27 million of brokered time deposits. We have traditionally offered market-competitive rates on our time deposit products and believe they provide us with a more attractive source of funds than other alternatives such as Federal Home Loan Bank borrowings, due to our ability to cross-sell additional services to these account holders. However, we continue to analyze alternative strategies to grow our deposits including opening additional banking centers in markets management considers underserved, offering new products, and obtaining brokered deposits as allowed by our Funds Management policy and as deemed prudent by management and our board of directors.
The following table sets forth the balances for each major category of our deposit accounts and the weighted-average interest rates paid for interest-bearing deposits for the periods indicated:
DEPOSITS
The following table sets forth the amount of our time deposits that are greater than $100,000 by time remaining until maturity as of December 31, 2005:
AMOUNTS AND MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. Liquidity is measured by a financial institution's ability to raise funds through deposits, borrowed funds, capital, or the sale of marketable assets, such as residential mortgage loans or a portfolio of SBA loans. Other sources of liquidity, including cash flow from the repayment of loans, are also considered in determining whether liquidity is satisfactory. Liquidity is also achieved through growth of core deposits and liquid assets, and accessibility to the money and capital markets. The funds are used to meet deposit withdrawals, maintain reserve requirements, fund loans and operate the organization. Core deposits, defined as demand deposits, interest-bearing transaction accounts, savings deposits and time deposits less than $100,000 (excluding brokered deposits), were 74.26% of our total deposits at December 31, 2005, and 81.56% and 76.20% of total deposits at December 31, 2004 and 2003, respectively. Generally, the Company's funding strategy is to utilize Federal Home Loan Bank of Topeka ("FHLBank") borrowings to fund originations of mortgage loans held for sale and fund balances generated by other lines of business with deposits. Advance availability with the FHLBank is determined quarterly and at December 31, 2005, approximately $68.1 million was available. The Company's FHLBank advance availability fluctuates depending on levels of available collateral, which includes mortgage loans held for sale. In addition, the Company uses other forms of short-term borrowings for cash management and liquidity management purposes on a limited basis. These forms of borrowings include federal funds purchased and revolving lines of credit (see Note 8 of the Financial Statements). The Company's Asset-Liability Management Committee utilizes a variety of liquidity monitoring tools, including an asset/liability modeling service, to analyze and manage the Company's liquidity.
The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks governed and regulated by the Federal Housing Finance Board. The Federal Home Loan Banks provide a central credit facility for member institutions. The Bank, as a member of the FHLBank of Topeka, is required to acquire and hold shares of capital stock in the FHLBank of Topeka in an amount at least equal to 1.00% of the aggregate principal amount of its unpaid residential mortgage loans or 5.00% of our total outstanding FHLBank advances. The Bank is currently in compliance with this requirement, with a $7.2 million investment in stock of the FHLBank of Topeka as of December 31, 2005. The Bank had $47.5 million and $48.5 million in outstanding long-term advances from the FHLBank of Topeka at December 31, 2005 and 2004, respectively.
On July 29, 2005 the Company completed a pooled offering of $11.5 million in trust preferred securities through a newly formed and wholly-owned trust subsidiary, BVBC Capital Trust III. The proceeds of the debt securities were used on September 30, 2005 to redeem, in whole, the Company's $11.5 million Junior Subordinated Debentures issued by BVBC Capital Trust I in July 2000.
Management has established internal guidelines and analytical tools to measure liquid assets, alternative sources of liquidity, as well as relevant ratios concerning asset levels and purchased funds. These indicators are reported to the board of directors monthly.
The following table sets forth a summary of our short-term borrowings during and as of the end of each period indicated.
SHORT-TERM BORROWINGS
- ---------- (1) Calculations are based on daily averages where available and monthly averages otherwise.
Capital Resources. At December 31, 2005, our total stockholders' equity was $46.2 million, and our equity to asset ratio was 6.71%. At December 31, 2004, our total stockholders' equity was $41.4 million, and our equity to asset ratio was 6.15%.
The Federal Reserve Board's risk-based guidelines establish a risk-adjusted ratio, relating capital to different categories of assets and off-balance sheet exposures, such as loan commitments and standby letters of credit. These guidelines place a strong emphasis on tangible stockholder's equity as the core element of the capital base, with appropriate recognition of other components of capital. At December 31, 2005, our Tier 1 capital ratio was 10.25%, while our total risk-based capital ratio was 12.04%, both of which exceed the capital minimums established in the risk-based capital requirements.
Our risk-based capital ratios at December 31, 2005, 2004 and 2003 are presented below.
RISK-BASED CAPITAL
(1) Federal Reserve guidelines for calculation of Tier 1 capital limits the amount of cumulative trust preferred securities which can be included in Tier 1 capital to 25% of total Tier 1 capital (Tier 1 capital before reduction of intangibles). Approximately $15.6 million, $13.9 million and $13.2 million of the trust preferred securities have been included as Tier 1 capital as of December 31, 2005, 2004 and 2003, respectively. The balance of the trust preferred securities have been included as Tier 2 capital.
CONTRACTUAL OBLIGATIONS
Our known contractual obligations outstanding as of December 31, 2005 are presented below.
INFLATION
The consolidated financial statements and related data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as inflation. Additional discussion of the impact of interest rate changes is included in Item 7A:
ITEM 7A: QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
As a continuing part of our financial strategy, we attempt to manage the impact of fluctuations in market interest rates on our net interest income. This effort entails providing a reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield. Our funds management policy is established by our Bank Board of Directors and monitored by our Asset/Liability Management Committee. Our funds management policy sets standards within which we are expected to operate. These standards include guidelines for exposure to interest rate fluctuations, liquidity, loan limits as a percentage of funding sources, exposure to correspondent banks and brokers, and reliance on non-core deposits. Our funds management policy also establishes the reporting requirements to our Bank Board of Directors. Our investment policy complements our funds management policy by establishing criteria by which we may purchase securities. These criteria include approved types of securities, brokerage sources, terms of investment, quality standards, and diversification.
We use an asset/liability modeling system to analyze the Company's current sensitivity to instantaneous and permanent changes in interest rates. The system simulates the Company's asset and liability base and projects future net interest income results under several interest rate assumptions. This allows management to view how changes in interest rates will affect the spread between the yield received on assets and the cost of deposits and borrowed funds.
The asset/liability modeling system is also used to analyze the net economic value of equity at risk under instantaneous shifts in interest rates. The "net economic value of equity at risk" is defined as the market value of assets less the market value of liabilities plus/minus the market value of any off-balance sheet positions. By effectively looking at the present value of all future cash flows on or off the balance sheet, the net economic value of equity modeling takes a longer-term view of interest rate risk.
We strive to maintain a position such that current changes in interest rates will not affect net interest income or the economic value of equity by more than 5%, per 50 basis points. The following table sets forth the estimated percentage change in the Bank's net interest income over the next twelve month period and net economic value of equity at risk at December 31, 2005 based on the indicated instantaneous and permanent changes in interest rates.
The above table indicates that, at December 31, 2005, in the event of a sudden and sustained increase in prevailing market rates, our net interest income would be expected to increase as our assets would be expected to reprice quicker than our liabilities, while a decrease in rates would indicate just the opposite. Generally, in the decreasing rate scenarios, not only would adjustable rate assets (loans) reprice to lower rates faster than our liabilities, but our liabilities - long-term FHLBank advances and existing time deposits - would not decrease in rate as much as market rates. In addition, fixed rate loans might experience an increase in prepayments, further decreasing yields on earning assets and causing net interest income to decrease. Another consideration with a rising interest rate scenario is the impact on mortgage loan refinancing, which would likely decline, leading to lower loans held for sale fee income, though the impact is difficult to quantify or project.
The above table also indicates that, at December 31, 2005, in the event of a sudden decrease in prevailing market rates, the economic value of our equity would decrease. Given our current asset/liability position, a 200 basis point decline in interest rates will result in a lower economic value of our equity as the change in estimated loss on liabilities exceeds the change in estimated gain on assets in these interest rate scenarios. Currently, under a falling rate environment, the Company's estimated market value of loans could increase as a result of fixed rate loans, net of possible prepayments. The estimated market value of investment securities could also rise as our portfolio contains higher yielding securities. However, the estimated market value increase in fixed rate loans and investment securities is offset by time deposits unable to reprice to lower rates immediately and fixed-rate callable advances from FHLB. The likelihood of advances being called in a decreasing rate environment is diminished resulting in the advances existing until final maturity, which has the effect of lowering the economic value of equity.
The following table summarizes the anticipated maturities or repricing of our interest-earning assets and interest-bearing liabilities as of December 31, 2005, based on the information and assumptions set forth below.
INTEREST-RATE SENSITIVITY ANALYSIS
Certain assumptions are contained in the above table which affect the presentation. Although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes
in market interest rates, while interest rates on other types of assets and liabilities lag behind changes in market interest rates.
Disclosures about fair values of financial instruments, which reflect changes in market prices and rates, can be found in note 17 to the consolidated financial statements included in this report.
ITEM 8:
ITEM 8: CONSOLIDATED FINANCIAL STATEMENTS OF BLUE VALLEY BAN CORP
See index to Blue Valley Ban Corp financial statements on page.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
No items are reportable.
ITEM 9A:
ITEM 9A: CONTROLS AND PROCEDURES
Management, including the Company's Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of December 31, 2005. Based upon the evaluation, management concluded that the Company's disclosure controls and procedures are effective to ensure that all material information requiring disclosure in this annual report was made known to them in a timely manner.
During the year, the Company made no significant changes in internal controls over financial reporting or in other factors that could materially affect the Company's internal control over financial reporting.
ITEM 9B:
ITEM 9B: OTHER INFORMATION
On August 17, 2005 the Board increased the size of Class I directors and approved Michael J. Brown as a new director of the Company.
On December 31, 2005 C. Ted McCarter resigned as Class II director of the Company. Mr. McCarter's position on the Board currently remains vacant.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's directors and executive officers is included in the Company's Proxy Statement for the 2006 Annual Meeting of Stockholders and is hereby incorporated by reference.
Information regarding the Bank's directors and executive officers is included in Part I of this Form 10-K under the caption "Directors and Executive Officers of the Registrant."
The Company has adopted a code of conduct that applies to our principal executive, financial, and accounting officers. A copy of our code of conduct can be obtained by contacting us directly at:
Investor Relations 11935 Riley Overland Park, KS 66213 913.338.1000 Email: ir@bankbv.com
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
This information is included in the Company's Proxy Statement for the 2006 Annual Meeting of Stockholders and is hereby incorporated by reference.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
This information is included in the Company's Proxy Statement for the 2006 Annual Meeting of Stockholders and is hereby incorporated by reference.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Bank periodically makes loans to our executive officers and directors, the members of their immediate families and companies that they are affiliated with. As of December 31, 2005, the Bank had aggregate loans outstanding to such persons of approximately $12.3 million, which represented 26.50% of our stockholders' equity of $46.2 million on that date. These loans:
- were made in the ordinary course of business;
- were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons; and
- did not involve more than the normal risk of collectibility or present other unfavorable features.
ITEM 14:
ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
This information is included in the Company's Proxy Statement for the 2006 Annual Meeting of Stockholders and is hereby incorporated by reference.
PART IV
ITEM 15:
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The financial statements and financial statement schedules listed in the accompanying index to consolidated financial statements and financial statement schedules are filed as part of this Form 10-K.
(b) The exhibits listed in the accompanying exhibit index are filed as part of this Form 10-K.
(c) None
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 24, 2006 By: /s/ Robert D. Regnier ------------------------------------ Robert D. Regnier, President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities listed on the dates indicated
Date: March 24, 2006 By: /s/ Robert D. Regnier ------------------------------------ Robert D. Regnier, President, Chief Executive Officer and Director (Principal Executive Officer)
Date: March 24, 2006 By: /s/ Mark A. Fortino ------------------------------------ Mark A. Fortino, Chief Financial Officer (Principal Financial [and Accounting] Officer)
Date: March 24, 2006 By: /s/ Donald H. Alexander ------------------------------------ Donald H. Alexander, Director
Date: March 24, 2006 By: /s/ Michael J. Brown ------------------------------------ Michael J. Brown, Director
Date: March 24, 2006 By: /s/ Wayne A. Henry, Jr. ------------------------------------ Wayne A. Henry, Jr., Director
Date: March 24, 2006 By: /s/ Thomas A. McDonnell ------------------------------------ Thomas A. McDonnell, Director
Exhibits
3.1 Amended and Restated Articles of Incorporation of Blue Valley Ban Corp. *
3.2 Bylaws, as amended, of Blue Valley Ban Corp. *
4.1 1998 Equity Incentive Plan. *
4.2 1994 Stock Option Plan. *
4.3 Form of Agreement as to Expenses and Liabilities. *
4.4 Form of Indenture dated April 10, 2003, between Blue Valley Ban Corp and Wilmington Trust Company **
4.5 Amended and Restated Declaration of Trust dated April 10, 2003 **
4.6 Guarantee Agreement dated April 10, 2003 **
4.7 Fee Agreement dated April 10, 2003 **
4.8 Specimen of Floating Rate Junior Subordinated Debt Security **
4.9 Form of Indenture dated as of July 29, 2005 between Blue Valley Ban Corp and Wilmington Trust Company***
4.10 Amended and Restated Declaration of Trust dated July 29, 2005***
4.11 Guarantee Agreement dated July 29, 2005***
10.1 Promissory Note of Blue Valley Building dated July 15, 1994. *
10.2 Mortgage, Assignment of Leases and Rents and Security Agreement between Blue Valley Building and Businessmen's Assurance Company of America, dated July 15, 1994. *
10.3 Assignment of Leases and Rents between Blue Valley Building and Businessmen's Assurance Company of America dated July 15, 1994. *
10.4 Line of Credit Note with JP Morgan Chase dated June 15, 2005 ****
10.5 Term Note with JP Morgan Chase dated June 15, 2005 ****
11.1 Statement regarding computation of per share earnings. Please see p. .
21.1 Subsidiaries of Blue Valley Ban Corp.
23.3 Consent of BKD, LLP.
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
32.1 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Filed with the Commission on April 10, 2000 as an Exhibit to Blue Valley's Registration Statement on Form S-1, Amendment No. 1, File No. 333-34328. Exhibit incorporated herein by reference.
** Filed with the Commission on March 19, 2004 as an Exhibit to Blue Valley's Annual Report on Form 10-K. Exhibit incorporated herein by reference.
*** Filed with the Commission on July 29, 2005 as an Exhibit to Blue Valley's Current Report on Form 8-K. Exhibit incorporated herein by reference.
**** Filed with the Commission on March 24, 2005 as an Exhibit to Blue Valley's Annual Report on Form 10-K. Exhibit incorporated herein by reference.
BLUE VALLEY BAN CORP
DECEMBER 31, 2005, 2004 AND 2003
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders Blue Valley Ban Corp Overland Park, Kansas
We have audited the accompanying consolidated balance sheets of Blue Valley Ban Corp (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Blue Valley Ban Corp as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
/s/ BKD, LLP
Kansas City, Missouri February 17, 2006
BLUE VALLEY BAN CORP
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004 (dollars in thousands, except share data)
ASSETS
See Notes to Consolidated Financial Statements
BLUE VALLEY BAN CORP
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004 (dollars in thousands, except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
See Notes to Consolidated Financial Statements
BLUE VALLEY BAN CORP
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (dollars in thousands, except per share data)
See Notes to Consolidated Financial Statements
BLUE VALLEY BAN CORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (dollars in thousands, except share data)
See Notes to Consolidated Financial Statements
BLUE VALLEY BAN CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (dollars in thousands)
See Notes to Consolidated Financial Statements
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Company is a holding company for Bank of Blue Valley (the Bank), Blue Valley Building Corp., Blue Valley Insurance Services, Inc., BVBC Capital Trust II and BVBC Capital Trust III through 100% ownership of each. In addition, the Company owns 49% of Homeland Title, LLC.
The Bank is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers in southern Johnson County, Kansas. The Bank also originates residential mortgages locally and nationwide through its InternetMortgage.com website. The Bank is subject to competition from other financial institutions. The Bank also is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.
The Blue Valley Building Corp. is primarily engaged in leasing real property at its facilities in Overland Park and Leawood, Kansas.
BVBC Capital Trust II and III are Delaware business trusts created in 2003 and 2005, respectively, to offer trust preferred securities and to purchase the Company's prior subordinated debentures. The Trusts have terms of 35 years, but may dissolve earlier as provided in their trust agreements.
Homeland Title, LLC is a company providing title and settlement services.
OPERATING SEGMENT
The Company provides community banking services through its subsidiary bank, including such products and services as loans; time deposits, checking and savings accounts; mortgage originations; trust services; and investment services. These activities are reported as a single operating segment.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held for sale, management obtains independent appraisals for significant properties.
Management believes that the allowances for loan losses and the valuation of foreclosed assets held for sale are adequate. While management uses available information to recognize losses on loans and foreclosed assets held for sale, changes in economic conditions may necessitate revision of these estimates in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowances for loan losses and valuation of foreclosed assets held for sale. Such agencies may require the Company to recognize additional losses based on their judgments of information available to them at the time of their examination.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Blue Valley Ban Corp and its 100% owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.
CASH EQUIVALENTS
The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2005, cash equivalents consisted of federal funds sold.
The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 2005 was $824,000.
INVESTMENT IN DEBT SECURITIES
Available-for-sale securities, which include any security for which the Company has no immediate plan to sell, but which may be sold in the future, are carried at fair value. Realized gains and losses, based on amortized cost of the specific security, are included in other income. Unrealized gains and losses are recorded, net of related income tax effects, in stockholders' equity. Premiums and discounts are amortized and accreted, respectively, to interest income using a method which approximates the level-yield method over the period to maturity.
Interest on investments in debt securities is included in income when earned.
OTHER INVESTMENTS
The Company, as a member of the Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) systems, is required to maintain an investment in capital stock of both the FHLB and FRB. No ready market exists for either stock, and the stocks have no quoted market value. Such stock is recorded at cost.
The Company uses the equity method of accounting for Homeland Title, LLC. As such, the Company's investment in Homeland Title, LLC is included in Other Assets and its share of Homeland Title, LLC's net income is included in Other Income.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are carried at the lower of cost or fair value, determined using an aggregate basis. Write-downs to fair value are recognized as a charge to earnings at the time the decline in value occurs. Forward commitments to sell mortgage loans are acquired to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sale. Amounts paid to investors to obtain forward commitments, if any, are deferred until such time as the related loans are sold. The fair values of the forward commitments are not recognized in the financial statements if their terms match those of the underlying mortgage. Gains and losses resulting from sales of mortgage loans are recognized when the respective loans are sold to investors. Gains and losses are determined by the difference between the selling price and the carrying amount of the loans sold, net of discounts collected or paid, commitment fees paid and considering a normal servicing rate. Fees received from borrowers to guarantee the funding of mortgage loans held for sale are recognized as income or expense when the loans are sold or when it becomes evident that the commitment will not be used.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-offs are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.
ALLOWANCE FOR LOAN LOSSES
The allowance is management's estimate of probable losses which have occurred as of the balance sheet date based on management's evaluation of risk in the loan portfolio. The allowance for loan losses is increased by provisions charged to expense and reduced by loans charged off when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The adequacy of the allowance is evaluated on a monthly basis by management based on management's periodic review of the collectibility of the loans in consideration of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The Bank computes its allowance by assigning specific reserves to impaired loans, and then applies general reserve factors to the rest of the loan portfolio. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management when determining impairment include payment status, collateral value and probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of delay, the reason for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price or the fair value of the collateral if the loan is collateral dependent.
PREMISES AND EQUIPMENT
Depreciable assets are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line method over the estimated useful lives of the assets.
FORECLOSED ASSETS HELD FOR SALE
Assets acquired by foreclosure or in settlement of debt and held for sale are valued at their estimated fair value as of the date of foreclosure, and a related valuation allowance is provided for estimated costs to sell the assets. Management evaluates the value of foreclosed assets held for sale periodically and increases the valuation allowance for any subsequent declines in fair value. Increases in the valuation allowance and gains/losses on sales of foreclosed assets are included in non-interest expenses, net.
CORE DEPOSIT INTANGIBLE ASSETS
Unamortized core deposit intangible assets aggregated $823,000 and $976,000 (originally $2,576,000) at December 31, 2005 and 2004, respectively, and are amortized over a 15-year period using the straight-line method.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CORE DEPOSIT INTANGIBLE ASSETS (CONTINUED)
Amortization expense related to core deposit intangible assets was $152,000 for each of the years 2005, 2004 and 2003. Expected amortization for each of the next five years is $152,000 and $63,000 in total thereafter.
FEE INCOME
Loan origination fees, net of direct origination costs, are recognized as income using the level-yield method over the term of the loans.
RECLASSIFICATION
Certain reclassifications have been made to the 2004 and 2003 financial statements to conform to the 2005 financial statement presentation. These reclassifications had no effect on net income.
INCOME TAXES
Deferred tax liabilities and assets are recognized for the tax effect of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.
EARNINGS PER SHARE
Basic earnings per share is computed based on the weighted average number of shares outstanding during each year. Diluted earnings per share is computed using the weighted average common shares and all potential dilutive common shares outstanding during the year. The computation of per share earnings is as follows:
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its Equity Incentive Plan and no compensation cost has been recognized. Had compensation cost for the Company's stock options issued under its Equity Incentive Plan been determined based on the fair value of the options at the grant dates using the minimum value method under Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation," the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated as follows:
The expected life of options outstanding is based on the historical experience of the Company. During 2005, 2004 and 2003, the Company issued no stock options.
NOTE 2: AVAILABLE-FOR-SALE SECURITIES
The amortized cost and estimated fair value of available-for-sale securities are as follows:
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 2: AVAILABLE-FOR-SALE SECURITIES (CONTINUED)
The amortized cost and estimated fair value of available-for-sale securities at December 31, 2005, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The book value and estimated fair value of securities pledged as collateral to secure public deposits amounted to $20,736,000 at December 31, 2005 and $24,968,000 at December 31, 2004.
The Company enters into sales of securities under agreements to repurchase. The amounts deposited under these agreements represent short-term borrowings and are reflected as a liability in the consolidated balance sheets. The securities underlying the agreements are book-entry securities. During the period, securities held in safekeeping were pledged to the depositors under a written custodial agreement that explicitly recognizes the depositors' interest in the securities. At December 31, 2005, or at any month end during the period, no material amount of agreements to repurchase securities sold was outstanding with any individual entity. Information on sales of securities under agreements to repurchase is as follows:
Gross gains of $0, $606,000, and $0 were realized in 2005, 2004 and 2003, respectively, and no gross losses were realized in 2005, 2004 and 2003, respectively, from sales of available-for-sale securities. During 2004, the Company recorded an $82,000 loss on an investment security for an impairment which was determined to be other than temporary.
Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost. These declines in fair value resulted primarily from increases in market interest rates. Based on evaluation of available information and evidence, particularly recent volatility in market yields on debt securities, management believes the declines in fair value for these securities are temporary. Should the impairment of any of these become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period in which the other-than-temporary impairment is identified.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 2: AVAILABLE-FOR-SALE SECURITIES (CONTINUED)
Unrealized losses and fair value, aggregated by investment type and length of time that individual securities have been in a continuous unrealized loss position are as follows:
NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES
Categories of loans at December 31, 2005 and 2004 include the following:
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
Activity in the allowance for loan losses was as follows:
Impaired loans totaled $11,080,000 and $12,847,000 at December 31, 2005 and 2004, respectively, with related allowances for loan losses of $1,200,000 and $1,754,000, respectively. At December 31, 2005 and 2004, accruing loans delinquent 90 days or more totaled $2.0 million and $2.2 million respectively. Non-accrual loans were $2.4 million and $2.2 million at December 31, 2005 and 2004, respectively.
Total interest income of $742,000, $745,000 and $736,000 was recognized on average impaired loans of $10.4 million, $13.8 million and $11.7 million for 2005, 2004 and 2003, respectively. Included in this total is cash-basis interest income of $15,000, $46,000 and $67,000 recognized on impaired loans on nonaccrual during 2005, 2004 and 2003, respectively.
NOTE 4: PREMISES AND EQUIPMENT
Major classifications of these assets are as follows:
NOTE 5: INTEREST-BEARING DEPOSITS
Interest-bearing time deposits in denominations of $100,000 or more were $132,143,000 on December 31, 2005 and $95,819,000 on December 31, 2004. The Company acquires brokered deposits in the normal course of business. At December 31, 2005 and 2004, brokered deposits of $27,073,000 and $471,000, respectively, were included in the Company's time deposit balance.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 5: INTEREST-BEARING DEPOSITS (CONTINUED)
At December 31, 2005, the scheduled maturities of time deposits are as follows:
NOTE 6: OPERATING LEASES
Blue Valley Building Corp. leases office space to others under noncancellable operating leases expiring in various years through 2012. Minimum future rent receivable under noncancellable operating leases at December 31, 2005 was as follows:
Effective June 30, 2005, the Company no longer leases space from others under noncancellable operating leases. Consolidated rental and operating lease expenses were $34,000 in 2005 and $289,000 in 2004 and 2003.
NOTE 7: INCOME TAXES
The provision for income taxes consists of the following:
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 7: INCOME TAXES (CONTINUED)
A reconciliation of income tax expense at the statutory rate to the Company's actual income tax expense is shown below:
The tax effects of temporary differences related to deferred taxes shown on the December 31, 2005 and 2004 consolidated balance sheets are as follows:
NOTE 8: SHORT TERM DEBT
The Company has a $15 million operating line of credit with a bank bearing a variable interest rate of the Federal Funds rate plus 1.63%. The line of credit is secured by stock in the Company's subsidiary bank and matures during 2006. As of December 31, 2005 and 2004, the Company had no outstanding balance on this line of credit.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 9: LONG TERM DEBT
Long-term debt at December 31, 2005 and 2004 consisted of the following components:
(A) Due in December 2012, payable in quarterly installments of principal plus interest at the Federal Funds Rate plus 1.63%; collateralized by common stock of the Company's subsidiary bank. The interest rate on this note has been fixed at 5.45% by the use of a swap agreement (see Note 10).
(B) Two notes due in 2017; payable in monthly installments totaling $70,084 including interest at 5.19%; collateralized by land, buildings, and assignment of future rents.
(C) Due in 2008, 2010, 2011, 2013 and 2015; collateralized by various assets including mortgage-backed loans. The interest rates on the advances range from 1.84% to 5.682%. Federal Home Loan Bank advance availability is determined quarterly and at December 31, 2005, approximately $68,094,000 was available.
(D) Due in 2030; interest only at 10.375% due quarterly; fully and unconditionally guaranteed by the Company on a subordinated basis to the extent that the funds are held by the Trust. The Company prepaid the subordinated debentures on September 30, 2005.
(E) Due in 2033; interest only at LIBOR + 3.25% due quarterly; fully and unconditionally guaranteed by the Company on a subordinated basis to the extent that the funds are held by the Trust. The Company may prepay the subordinated debentures beginning in 2008, in whole or in part, at their face value plus accrued interest.
(F) Due in 2035; interest only at LIBOR + 1.60% due quarterly; fully and unconditionally guaranteed by the Company on a subordinated basis to the extent that the funds are held by the Trust. Subordinated to the trust preferred securities (E) due in 2033. The Company may prepay the subordinated debentures beginning in 2010, in whole or in part, at their face value plus accrued interest.
Aggregate annual maturities of long-term debt at December 31, 2005 are as follows:
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 10: DERIVATIVE FINANCIAL INSTRUMENTS
As a strategy to reduce the exposure to the risk of changes in future cash flows due to interest rate fluctuations, the Company entered into an interest rate swap agreement for a portion of its floating rate debt (see Note 9). The agreement provides for the Company to receive interest from the counterparty at an amount which offsets the note's variable rate and to pay interest to the counterparty at a fixed rate of 5.45% on the notional amount over the term of the note. Under the agreement, the Company pays or receives the net interest amount quarterly, with the quarterly settlements included in interest expense.
Management has designated the interest rate swap agreement as a cash flow hedging instrument. The hedge was fully effective through December 31, 2005. No gain or loss has been recognized related to the derivative as the amount is insignificant to the financial statements.
NOTE 11: REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below). Management believes, as of December 31, 2005, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2005, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category.
The Company and the Bank's actual capital amounts and ratios are also presented in the table.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 11: REGULATORY MATTERS (CONTINUED)
The Bank is subject to certain restrictions on the amounts of dividends that it may declare without prior regulatory approval. At December 31, 2005, approximately $12,390,000 of retained earnings were available for dividend declaration without prior regulatory approval.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 12: TRANSACTIONS WITH RELATED PARTIES
At December 31, 2005 and 2004, the Company had loans outstanding to executive officers, directors and to companies in which the Bank's executive officers or directors were principal owners, in the amounts of $12,258,000 and $14,195,000, respectively. Related party transactions for 2005 and 2004 were as follows:
In management's opinion, such loans and other extensions of credit and deposits were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. Further, in management's opinion, these loans did not involve more than the normal risk of collectibility or present other unfavorable features.
NOTE 13: PROFIT SHARING AND 401(K) PLANS
The Company's profit sharing and 401(k) plans cover substantially all employees. Contributions to the profit sharing plan are determined annually by the Board of Directors, and participant interests are vested over a five-year period. The Company's 401(k) plan permits participants to make contributions by salary reduction, based on which the Company matches a ratable portion. The Company's matching contributions to the 401(k) plan are vested immediately. Combined Company contributions charged to expense for 2005, 2004 and 2003 were $698,000, $658,000 and $681,000, respectively.
NOTE 14: EQUITY INCENTIVE COMPENSATION
The Company has an Equity Incentive Plan (the "Plan") which allows the Company to issue equity incentive compensation awards to its employees and directors in the forms of stock options, restricted shares or deferred share units.
Under the fixed option provisions of the Plan, the Company may grant options that vest two years from the date of grant to its employees for shares of common stock. At December 31, 2005, the Company had 228,334 shares available to be granted (options granted prior to 1998 were subject to an earlier plan with similar terms). The exercise price of each option is intended to equal the fair value of the Company's stock on the date of grant, and maximum terms are 10 years.
During 2005, 2004 and 2003, the Company granted no stock options, but did grant 12,400, 14,100 and 13,275 shares of restricted common stock, respectively. Recipients of the restricted stock grant who are employees vest in the stock after three years from the date of the grant. Recipients of the restricted stock grant who are directors vest in the stock after three years for the 2003 grant, two years for the 2004 grant, and one year for the 2005 grant. The basis of the restricted shares granted, equal to the fair value of the Company's stock on the date of grant, will be amortized to compensation expense ratably over the applicable vesting period. During 2005, 2004 and 2003, 2,925, 500 and 0 shares of restricted stock were forfeited, respectively.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
A summary of the status of option shares under the plan at December 31, 2005, 2004 and 2003, and changes during the years then ended, is presented below:
NOTE 14: EQUITY INCENTIVE COMPENSATION (CONTINUED)
The weighted-average remaining contractual life of option shares at December 31, 2005 was 5.30 years. Exercise prices ranged from $6.25 to $25.00. Information about options outstanding and exercisable as of December 31, 2005 is set forth in the following table.
Options Outstanding and Exercisable
NOTE 15: EMPLOYEE STOCK PURCHASE PLAN
The 2004 Blue Valley Ban Corp employee stock purchase plan ("ESPP") provides the right to subscribe to 100,000 shares of common stock to substantially all employees of the Company and subsidiaries, except those who are 5% or greater shareholders of the Company. The purchase price for shares under the plan is determined by the Company's Board of Directors (or a designated Committee thereof) and was set to 85% of the market price on either the grant date or the offering date, whichever is lower, for the plan year beginning in February, 2004. At the end of the plan year ending January 2005, 4,060 shares were purchased under this plan at a price of $19.55 per share.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 16: OTHER INCOME/EXPENSE
Other operating expenses consist of the following:
Other income consists of the following:
NOTE 17: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS
For these short-term instruments, the carrying amount approximates fair value.
AVAILABLE-FOR-SALE SECURITIES
Fair values for available-for-sale securities, which also are the amounts recognized in the consolidated balance sheets, equal quoted market prices if available. If quoted market prices are not available, fair values are estimated based on quoted market prices of similar securities.
MORTGAGE LOANS HELD FOR SALE
For homogeneous categories of loans, such as mortgage loans held for sale, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.
LOANS
The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans with similar characteristics were aggregated for purposes of the calculations. The carrying amount of accrued interest approximates its fair value.
FEDERAL HOME LOAN BANK STOCK, FEDERAL RESERVE BANK STOCK, AND OTHER SECURITIES
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
The carrying amounts for these securities approximate their fair value.
NOTE 17: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
DEPOSITS
The fair value of demand deposits, savings accounts, NOW accounts and certain money market deposits is the amount payable on demand at the reporting date (i.e., their carrying amount). The fair value of fixed maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.
SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE AND OTHER LIABILITIES
For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
SHORT-TERM AND LONG-TERM DEBT
Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
COMMITMENTS TO EXTEND CREDIT, LETTERS OF CREDIT AND LINES OF CREDIT
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit and lines of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.
The following table presents estimated fair values of the Company's financial instruments. The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments, and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 17: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
NOTE 18: COMMITMENTS AND CREDIT RISKS
The Company extends credit for commercial real estate mortgages, residential mortgages, working capital financing and consumer loans to businesses and residents principally in southern Johnson County. The Bank also purchases indirect leases from various leasing companies throughout Kansas and Missouri.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.
At December 31, 2005 and 2004, the Company had outstanding commitments to originate loans aggregating approximately $13,513,000 and $36,980,000, respectively. The commitments extend over varying periods of time with the majority being disbursed within a one-year period.
Mortgage loans in the process of origination represent amounts that the Company plans to fund within a normal period of 60 to 90 days and which are intended for sale to investors in the secondary market.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 18: COMMITMENTS AND CREDIT RISKS (CONTINUED)
Forward commitments to sell mortgage loans are obligations to deliver loans at a specified price on or before a specified future date. The Bank acquires such commitments to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sale.
Total mortgage loans in the process of origination amounted to $36,179,000 and $57,378,000 and mortgage loans held for sale amounted to $13,906,000 and $44,144,000 at December 31, 2005 and 2004, respectively. Related forward commitments to sell mortgage loans amounted to approximately $50,085,000 and $101,522,000 at December 31, 2005 and 2004, respectively. Mortgage loans in the process of origination represent commitments to originate loans at both fixed and variable rates.
Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
The Company had total outstanding letters of credit amounting to $14,679,000 and $13,604,000 at December 31, 2005 and 2004, respectively.
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Management uses the same credit policies in granting lines of credit as it does for on-balance sheet instruments.
At December 31, 2005 and 2004, unused lines of credit borrowings aggregated approximately $182,983,000 and $168,840,000, respectively.
Additionally, the Company periodically has excess funds, which are loaned to other banks as federal funds sold. At December 31, 2005 and 2004, federal funds sold totaling $11,401,000 and $2,500,000, respectively, were loaned to various banks, as approved by the Board of Directors, with the largest balance at any one bank being $8,401,000 and $2,500,000 on those dates, respectively.
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 19: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents the unaudited results of operations for the past two years by quarter. See discussion on earnings per share in "Note 1: Nature of Operations and Summary of Significant Accounting Policies" in the Company's Consolidated Financial Statements.
The above unaudited financial information reflects all adjustments that are, in the opinion of management, necessary to present a fair statement of the results of operations for the interim periods presented.
NOTE 20: LEGAL PROCEEDINGS
On October 13, 2004, we became a defendant in a lawsuit filed in the United States District Court, Kansas District by former mortgage loan originators. The plaintiffs claimed that the Bank did not compensate them appropriately for overtime hours worked in accordance with the Fair Labor Standards Act. On November 18, 2005, we entered into an agreement to settle the existing claims and potential claims asserted by the mortgage loan originators of approximately $1.1 million. Associated costs to defend the litigation totaled approximately $58,500 in 2004 and $189,600 in 2005. In consideration of payments to be made to the plaintiffs and plaintiffs' attorney, all claims and potential wage and hour claims asserted in and/or which could have been asserted by such plaintiffs were released. We currently do not anticipate any significant additional financial impact from this litigation. There are no other pending legal proceedings that are likely to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.
NOTE 21: FUTURE CHANGE IN ACCOUNTING PRINCIPLE
In December 2004, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), Share Based Payment, which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, and focuses primarily on accounting for transactions in which an entity obtains employee services. The SFAS requires a public entity to measure the cost of employee services received in exchange for its equity instruments based on the fair value at the grant date (with limited
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
exceptions) and recognize that cost over the service period. SFAS 123 (revised 2004) revises SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
NOTE 21: FUTURE CHANGE IN ACCOUNTING PRINCIPLE (CONTINUED)
Employees." The provisions of SFAS 123 (revised 2004) will be effective for the Company's first interim reporting period beginning after December 15, 2005. We do not expect the adoption of SFAS 123 (revised 2004) will have a material impact on the consolidated financial statements.
NOTE 22: CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS DECEMBER 31, 2005 AND 2004
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 22: CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) (CONTINUED)
CONDENSED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
BLUE VALLEY BAN CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003
NOTE 22: CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003