Item 1. Business - -----------------
FORWARD-LOOKING STATEMENTS
When used in this Annual Report on Form 10-K (the "Annual Report"), the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, the outcome of litigation, fluctuations in interest rates, demand for loans in the Company's market area, and competition that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
GENERAL
THE COMPANY. Ameriana Bancorp (the "Company") is a bank holding company subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the Bank Holding Company Act of 1956 ("BHCA"). The Company became the holding company for the Bank in 1990. The Company's principal subsidiary is Ameriana Bank and Trust, SB, an Indiana chartered savings bank headquartered in New Castle, Indiana (the "Bank"). The Company also holds a minority interest in a limited partnership organized to acquire and manage real estate investments, which qualify for federal tax credits.
THE BANK. The Bank began operations in 1890. Since 1935, the Bank has been a member of the Federal Home Loan Bank ("FHLB") System. Its deposits are insured to applicable limits by the Savings Association Insurance Fund ("SAIF"), administered by the FDIC. Effective June 29, 2002, the Bank converted to an Indiana savings bank and adopted its present name, "Ameriana Bank and Trust, SB." As a result of the conversion, the Bank become subject to regulation by the Indiana Department of Financial Institutions (the "DFI") and the Federal
Deposit Insurance Corporation ("FDIC") rather than by the Office of Thrift Supervision and the Company became a bank holding company. The Bank's main office is located at 2118 Bundy Avenue, New Castle, Indiana. The Bank also conducts business through ten Indiana branch offices located in New Castle, Middletown, Knightstown, Morristown, Greenfield, Anderson, Avon, McCordsville and New Palestine, Indiana. The Bank has three direct wholly-owned subsidiaries, Ameriana Insurance Agency ("AIA"), Ameriana Financial Services, Inc. ("AFS") and Ameriana Investment Management, Inc. ("AIMI"). AIA provides insurance sales from offices in New Castle, Greenfield and Avon, Indiana. AFS offers insurance products through its ownership of an interest in Family Financial Life Insurance Company, New Orleans, Louisiana, which offers a full line of credit, related insurance products. AIMI manages the Company's investment portfolio. In 2002, AFS acquired a 20.9% ownership interest in Indiana Title Insurance Company, LLC through which it offers title insurance. AFS also operates a brokerage facility in conjunction with Linsco/Private Ledger. The Bank maintains a website at www.ameriana.com. - -----------------
The business of the Bank consists primarily of attracting deposits from the general public and originating mortgage loans on single-family residences, multi-family housing and commercial real estate. The Bank also makes home improvement loans and consumer loans and, through its subsidiary, engages in insurance and brokerage activities. The Bank has a Business Services Division which provides specialized lending and other banking services for business customers. As a result of the Business Services Division, commercial real estate loan activity has increased significantly during 2003, 2002 and 2001.
The Bank operates a Trust Department, which provides trust, investment and estate planning services. The principal sources of funds for the Bank's lending activities include deposits received from the general public, funds borrowed from the FHLB, principal amortization and prepayment of loans. The Bank's primary sources of income are interest and fees on loans and interest on investments. The Bank has from time to time purchased loans and loan participations in the secondary market. The Bank also invests in various federal and government agency obligations and other investment securities permitted by applicable laws and regulations, including mortgage-backed, municipal and equity securities. The Bank's principal expenses are interest paid on deposit accounts and borrowed funds and operating expenses incurred in the operation of the Bank.
RECENT DEVELOPMENTS. On September 30, 2003, the Bank completed the sale of its two Cincinnati-area branches located in Deer Park and Landen, Ohio and recorded an after-tax gain of approximately $2,930,000 or $0.93 per diluted share in the third quarter 2003. The transaction included the Bank's real property related to the Deer Park branch and its leasehold on the premises for the Landen branch. Additionally, the Bank conveyed most of
the consumer and commercial loans at those branches as part of the transaction, as well as the branches' saving deposits, but retained and will continue to service certain single family residential mortgages originated in those locations.
On September 30, 2003, the Company charged-off the remaining balances of two troubled equipment lease pools originated by Commercial Money Center, a now bankrupt company, and recorded an after-tax loss of $3,534,000 or $1.12 per diluted share for the year ended December 31, 2003 (see Item 3 -- "Legal Proceedings").
REGULATORY ACTIONS. During the second quarter of 2002, the Bank entered into a memorandum of understanding ("MOU") with the FDIC and the DFI. Among other things, the MOU required the Bank to adopt written action plans with respect to certain classified assets, revise its lending policies, require greater financial information from borrowers, establish a loan review program and certain other internal controls. For a more detailed discussion of the terms and conditions of the MOU, see "Regulation and Supervision - Regulation and Supervision of the Bank - Capital Requirements" below.
LENDING AND INVESTMENT ACTIVITIES
GENERAL. The principal lending activity of the Bank has been the origination of conventional first mortgage loans secured by residential property, commercial real estate, equity lines of credit and consumer loans. The residential mortgage loans have been predominantly secured by single-family homes and have included construction loans.
The Bank may originate or purchase whole loans or loan participations secured by real estate located in any part of the United States. Notwithstanding this nationwide lending authority, the majority of the Bank's mortgage loan portfolio is secured by real estate located in Henry, Hancock, Hendricks, Madison, Shelby, Delaware and Marion counties in the State of Indiana and in Hamilton, Butler, Clermont and Warren counties in the State of Ohio.
The following table sets forth information concerning the Bank's aggregate loans by type of loan at the dates indicated.
The following table shows, at December 31, 2003, the Bank's aggregate loans based on their contractual terms to maturity (mortgage-backed securities are not included). Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. Contractual principal repayments of loans do not necessarily reflect the actual term of the loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans.
The following table sets forth the dollar amount of the Company's aggregate loans due after one year from December 31, 2003 which have predetermined interest rates and which have floating or adjustable interest rates (mortgage-backed securities are not included).
RESIDENTIAL REAL ESTATE LENDING. The Bank's primary lending activities are the origination of loans on one-to-four family residential dwelling units. The Bank currently offers fixed-rate, first and second mortgage loans. The fixed-rate mortgage loans provide for a maturity of ten to thirty years, with the thirty-year loan bearing a slightly higher rate of interest. The terms of the first mortgage loans generally conform to the guidelines established by the Federal Home Loan Mortgage Corporation ("FHLMC") and are, therefore, saleable in the secondary mortgage market. The Bank's fixed-rate second mortgage loans provide for a maturity of up to 15 years and bear interest at a rate slightly higher than that borne by the first mortgage loans. At the time the Bank makes a fixed-rate mortgage loan, it determines whether the loan will be held in portfolio or sold. Normally the Bank sells fixed-rate loans and
retains adjustable-rate loans. Once placed in portfolio, loans are not sold. Loans originated for sale are promptly sold in the secondary market. Fixed-rate mortgage loans in the amount of $150.3 million were originated for sale during 2003 and $154.5 million were sold at a gain of $1.9 million. Mortgage loans held for sale are those loans that have been committed to be sold, but have not closed as of the end of the year and were $730,000 at December 31, 2003.
The Bank emphasizes the origination of adjustable-rate mortgages ("ARMs") for portfolio. The Bank currently offers several types of ARMs either as first-lien mortgage loans or as second-lien mortgage loans that are adjustable semi-annually, annually, or on three-year, five-year or seven-year intervals and indexed to the yields on comparable United States Treasury securities.
The Bank limits the maximum loan-to-value ratio on one-to-four family residential first mortgages to 97% of the appraised value with the requirement that private mortgage insurance normally be obtained for loan-to-value ratios in excess of 80%. The Bank limits the loan-to-value ratio to 89.9% on second mortgages on one-to-four family dwellings.
The Bank's residential lending activities also include loans secured by multi-family residential structures, which are structures consisting of over four separate dwelling units. This has not constituted a significant portion of the Bank's lending activities to date. Multi-family residential structures are generally income-producing properties. The Bank generally does not lend above 80% of the appraised values of multi-family residences on first mortgage loans.
CONSTRUCTION AND COMMERCIAL REAL ESTATE LENDING. The Bank originates loans secured by existing commercial properties and construction loans on residential real estate. Churches, nursing homes, hotels/motels, and other income-producing properties secure the Bank's commercial real estate loans. The Bank's Business Services Division operation makes direct commercial real estate loans and purchases loan participations from other financial institutions. These participations in commercial real estate loans are reviewed and approved based upon the same credit standards as direct commercial real estate loans at the Bank. Loans secured by commercial real estate properties are generally larger and involve a greater degree of credit risk than one-to-four family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or by general economic conditions. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. To minimize the risks involved in originating such loans, the Bank considers, among other things, the credit worthiness
of the borrower, the location of the real estate, the condition and occupancy levels of the security and the quality of the organization managing the property.
The Bank originates and/or purchases construction loans on single-family residential properties in its primary market areas. The loans are secured by real estate, and most of the homes to be constructed are already subject to a sales contract at the time the construction loan is made. The Bank's construction loans generally range in size between $100,000 and $500,000, and the Bank's commercial real estate loans range from $100,000 to $4,000,000. Substantially all of the commercial real estate and construction loans originated and/or purchased by the Bank have either adjustable interest rates with maturities of 30 years or less or are loans with fixed interest rates and maturities of ten years or less.
Loans involving construction financing present a greater level of risk than loans for the purchase of existing homes since collateral value and construction costs can only be estimated at the time the loan is approved. The Bank has sought to minimize this risk by limiting construction lending to qualified borrowers in its market area and by limiting the number of construction loans outstanding at any time to individual builders. In addition, most of the Bank's construction loans are made on homes that are pre-sold, for which permanent financing is already arranged.
The Bank's underwriting criteria are designed to evaluate and minimize the risks of each construction loan. Among other things, the Bank considers evidence of the availability of permanent financing or a takeout commitment to the borrower; the reputation of the borrower and his or her financial condition; the amount of the borrower's equity in the project; independent appraisal and review of cost estimates; pre-construction sale and leasing information; and cash flow projections of the borrower.
CONSUMER LOANS. The consumer loans granted by the Bank have included loans on automobiles and other consumer goods, loans secured by savings accounts and secured and unsecured lines of credit.
Management believes that the shorter terms and the normally higher interest rates available on various types of consumer loans have been helpful in maintaining profitable spreads between average loan yields and costs of funds. Consumer loans do, however, pose additional risks of collection when compared to traditional types of loans granted by thrift institutions such as residential first mortgage loans. The Bank has sought to reduce this risk by primarily granting secured consumer loans.
COMMERCIAL BUSINESS LENDING. Under applicable law, the Bank is permitted to make secured and unsecured loans for commercial, corporate, business and agricultural purposes, including issuing letters of credit and
engaging in inventory financing and commercial leasing activities. The Bank does not, as a common practice, make unsecured commercial loans. The total lease and commercial portfolio at December 31, 2003 was $7.7 million.
ORIGINATIONS, PURCHASES AND SALES. Historically, most residential and commercial real estate loans have been originated directly by the Bank through salaried loan officers. Residential loan originations have been attributable to referrals from real estate brokers and builders, depositors and walk-in customers, and commissioned loan agents. The Bank also obtains consumer and commercial loans from paid brokers. The Bank obtained $1.5 million of loans from brokers and other financial institutions through loan participations in 2003. Commercial real estate and construction loan originations have also been obtained by direct solicitation. Consumer loan originations are attributable to walk-in customers who have been made aware of the Bank's programs by advertising as well as direct solicitation.
The Bank has previously sold whole loans to other financial institutions and institutional investors. Sales of loans generate income (or loss) at the time of sale, produce future servicing income and provide funds for additional lending and other purposes. When the Bank retains the servicing of loans it sells, the Bank retains responsibility for collecting and remitting loan payments, inspecting the properties, making certain insurance and tax payments on behalf of borrowers and otherwise servicing those loans. The Bank typically receives a fee of between 0.25% and 0.375% per annum of the loan's principal amount for performing this service. The right to service a loan has economic value and the Bank carries capitalized servicing rights on its books based on comparable market values and expected cash flows. At December 31, 2003, the Bank was servicing $193.0 million of loans for others. The aggregate book value of capitalized servicing rights at December 31, 2003 was $1.3 million.
Management believes that purchases of loans and loan participations are generally desirable, primarily when area mortgage demand is less than the supply of funds available for local mortgage origination or when loan terms are available in areas outside the Bank's local lending areas that are more favorable to its investment requirements. Additionally, purchases of loans may be made in order to diversify the Bank's lending portfolio. The Bank's loan purchasing activities fluctuate significantly. The seller generally performs the servicing of purchased loans. In order to cover servicing costs, the service provider retains a portion of the interest being paid by the borrower. In addition to whole loan purchases, the Bank also purchases participation interests in loans. Both whole loans and participations are purchased on a yield basis.
For additional information, see "Management's Discussion and Analysis -- Results of Operations" included in Item 7 of this Annual Report.
LOAN UNDERWRITING. During the loan approval process, the Bank assesses both the borrower's ability to repay the loan and the adequacy of the underlying security. Potential residential borrowers complete an application that is submitted to a salaried loan officer. As part of the loan application process, the Bank obtains information concerning the income, financial condition, employment, and credit history of the applicant. In addition, qualified appraisers inspect and appraise the property that is offered to secure the loan.
The Bank's loan officers and/or loan committee analyze the loan application and the property to be used as collateral and subsequently approve or deny the loan request. Individual salaried employees are authorized to approve loans up to their individual lending limits and loan parameters. A committee consisting of certain members of senior management must approve residential loans exceeding $500,000, and commercial loans between $350,000 and $1,000,000. The Board of Directors approves all loans in excess of $1,000,000. In connection with the origination of single-family, residential adjustable-rate loans, borrowers are qualified at a rate of interest equal to the second year rate, assuming the maximum increase. It is the policy of management to make loans to borrowers who not only qualify at the low initial rate of interest, but who would also qualify following an upward interest rate adjustment.
LOAN COMMITMENTS. Conventional loan commitments by the Bank are generally granted for periods of up to 60 days. The total amount of the Bank's aggregate outstanding commitments to originate real estate loans at December 31, 2003, was approximately $1.2 million of residential mortgage commitments and approximately $1.7 million of commercial commitments. It has been the Bank's experience that few commitments expire unfunded.
LOAN FEE AND SERVICING INCOME. In addition to interest earned on loans, the Bank receives income through servicing of loans and fees in connection with loan originations, loan modifications, late payments, and changes of property ownership and for miscellaneous services related to the loan. Income from these activities is volatile and varies from period to period with the volume and type of loans made.
When possible, the Bank charges loan origination fees on commercial loans that are calculated as a percentage of the amount borrowed and are charged to the borrower at the time of origination of the loan. These fees generally range from none to 1.00 point (one point being equivalent to 1% of the principal amount of the loan). In accordance with Statement of Financial Accounting Standard No. 91, loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of yield over the contractual life of the related loans.
For additional information, see Note 4 to the "Consolidated Financial Statements" included under Item 8 of this Annual Report.
DELINQUENCIES. When a borrower defaults upon a required payment on a loan, the Bank contacts the borrower and attempts to induce the borrower to cure the default. A late payment notice is mailed to the borrower and a telephone contact is made after a payment is 15 days past due. If the delinquency on a mortgage loan exceeds 90 days and is not cured through the Bank's normal collection procedures or an acceptable arrangement is not worked out with the borrower, the Bank will institute measures to remedy the default, including commencing foreclosure action.
NON-PERFORMING ASSETS AND ASSET CLASSIFICATION. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. Residential mortgage loans are placed on non-accrual status when either principal or interest is 90 days or more past due unless it is adequately secured and there is reasonable assurance of full collection of principal and interest. Consumer loans generally are charged off when the loan becomes over 120 days delinquent. Commercial business and real estate loans are placed on non-accrual status when the loan is 90 days or more past due. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are applied to the outstanding principal balance.
Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time as it is sold. When such property is acquired, it is recorded at the lower of the unpaid principal balance of the related loan or its fair value. Any subsequent deterioration of the property is charged off directly to income, reducing the value of the asset.
The following table sets forth information with respect to the Company's aggregate non-performing assets at the dates indicated.
- -------------------- (1) Other non-performing assets represents property acquired through foreclosure or repossession. This property is carried at the lower of its fair market value or the principal balance of the related loan.
The decrease of $9.9 million in non-accrual loans during 2003 is primarily due to the charge-off of the two troubled equipment lease pools for $10.9 million (see Item 3 -- "Legal Proceedings").
The Bank has real estate development/lot loans and single family residential loans on existing properties with a builder/developer group, and its related parties, totaling $3.5 million at December 31, 2003, that are currently in default and bankruptcy. There appears to be a considerable number of fraudulent transactions involved and there are multiple lien issues on a number of the properties. The Bank is working closely with the workout specialist hired by the bankruptcy trustee on liquidation of the properties involved in the bankruptcy and we are negotiating with the borrower and its related parties and their counsel for resolution of the remaining properties.
During 2003, the Bank would have recorded gross interest income of $596,000 on the loans set forth above as accounted for on a non-accrual basis, if such loans had been current in accordance with their terms. Instead, the Bank recorded interest income of $71,000 on those loans for the year.
For additional information regarding the Bank's problem assets and loss provisions recorded thereon, see "Management's Discussion and Analysis" in Item 7 of this Annual Report.
RESERVES FOR LOSSES ON LOANS AND REAL ESTATE
In making loans, management recognizes the fact that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the security for the loan.
It is management's policy to maintain reserves for estimated losses on loans. The Bank's personnel provide general loan loss reserves based on, among other things, estimates of the historical loan loss experience, evaluation of economic conditions in general and in various sectors of the Bank's customer base, and periodic reviews of loan portfolio quality. Specific reserves are provided for individual loans where the ultimate collection is considered questionable by management after reviewing the current status of loans which are contractually past due and considering the net realizable value of the security of the loan or guarantees, if applicable. It is management's policy to establish specific reserves for estimated losses on delinquent loans when it determines that losses are anticipated to be incurred on the underlying properties. At December 31, 2003, the Bank's allowance for loan losses amounted to $3.7 million.
Future reserves may be necessary if economic conditions or other circumstances differ substantially from the assumptions used in making the initial determinations. There can be no assurance that regulators, in reviewing the Bank's loan portfolio in the future, will not ask the Bank to increase its allowance for loan losses, thereby negatively affecting its financial condition and earnings.
The following table sets forth an analysis of the Bank's aggregate allowance for loan losses for the periods indicated.
The provision for loan losses in 2003 decreased to $6.4 million from $7.3 million from the prior year. The provision expense for both 2003 and 2002 was significantly higher than 1999 through 2001. The increases in 2002 and 2003 were primarily due to the non-accrual loans in the table under the heading "Non-Performing Assets and Asset Classification" earlier in this section. The two lease pools had 50% reserves at year-end 2002 due to an expected lengthy litigation process, and the remaining 50% was charged off in 2003 due to continuing uncertainty surrounding the prospects for eventual recovery from the sureties (see Item 3 -- "Legal Proceedings"). The loans to the builder/developer group, and its related parties had 25% reserves for $895,000 and $831,000 at year-end 2002 and 2003 respectively. The remaining reserves were necessary to reflect management's view on the risk in the loan
portfolio due to the change in the portfolio mix. See also "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Loans -- Credit Quality".
Net charge-offs for the year ended December 31, 2003 increased $11.0 million from 2002. The lease write-off in 2003 was $10.9 million. Net charge-offs for the year ended December 31, 2002 increased $245,000 from 2001.
The following table sets forth a breakdown of the Company's aggregate allowance for loan losses by loan category at the dates indicated. Management believes that the allowance can be allocated by category only on an approximate basis. 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.
INVESTMENT ACTIVITIES
Interest and dividends on investment securities, mortgage-backed securities, collateralized mortgage obligations, FHLB stock and other investments provide the second largest source of income for the Bank (after interest on loans), constituting 16.7% of the Bank's total interest income (and dividends) for fiscal 2003. The Bank maintains its liquid assets at levels believed adequate to meet requirements of normal banking activities and potential savings outflows.
As an Indiana savings bank, the Bank is authorized to invest without limitation in direct or indirect obligations of the United States, direct obligations of a United States territory, an insular possession and direct obligations of the state or a municipal corporation or taxing district in Indiana. The Bank is also permitted to invest in bonds or other securities of a national mortgage association and the stock and obligations of a Federal Home Loan Bank. Indiana savings banks may also invest in collateralized mortgage obligations to the same extent as national banks. An Indiana savings bank may also purchase for its own account other investment securities under such limits as the Department of Financial Institutions prescribes by rule provided that the savings bank may not invest more than 10% of its equity capital in the investment securities of any one issuer. Any Indiana savings bank may not invest in speculative bonds, notes or other indebtedness which are defined as securities and which are rated below the first four rating categories by a generally recognized rating service or are in default. An Indiana savings bank may purchase an unrated security if it obtains financial information adequate to document the investment quality of the security.
The Bank's investment portfolio consists primarily of obligations issued by federal agencies such as FNMA, FHLB and the FFCB System, mortgage-backed securities issued by GNMA, FNMA and FHLMC. The Bank has also invested in trust-preferred securities, municipal securities, mutual funds and maintains interest-bearing deposits in other financial institutions (primarily the FHLBs). As a member of the FHLB System, the Bank is also required to hold stock in the FHLBs of Indianapolis and Cincinnati. At December 31, 2003, the Bank had two investments which exceeded 10% of equity: securities issued by Shay Financial Services, Inc. with book values of $5.1 million and $4.6 million and market values of $5.0 million and $4.5 million as of that date.
During 2001, the Bank substantially increased its portfolio of mortgage-backed securities and collateralized mortgage obligations to offset declines in the loan portfolio due to refinancings and calls of federal agencies securities attributable in both cases to the radically declining interest rate environment. As interest rates stabilized at the end of 2001, the estimated lives of these securities increased significantly, exposing the Bank to unacceptable levels of interest rate risk. The Bank accordingly reclassified these securities, effective December 31, 2001, from held-to-maturity to available-for-sale and marked them to fair value, recording an accumulated other comprehensive loss of $696,000. The Bank disposed of these mortgage-backed securities and collateralized mortgage obligation portfolios in the first quarter of 2002 at an estimated after-tax loss of $1.9 million. All investments, as of December 31, 2003, was classified as available-for-sale.
The following table sets forth the carrying value of the Banks investments in federal agency obligations and mortgage-backed securities, collaterized mortgage obligations and other investments at the dates indicated.
- ---------------------- (1) Consist of overnight deposits and short-term non-negotiable certificates of deposit.
The following table sets forth information regarding maturity distribution and average yields for the Bank's investment securities portfolio at December 31, 2003. The Bank's federal agencies investment portfolio consists of obligations issued by FHLMC, FHLB, and the FFCB System.
(1) Note that these securities have no maturity date.
The Bank's mortgage-backed securities include both fixed and adjustable-rate securities. At December 31, 2003, the Bank's mortgage-backed securities consisted of the following:
SOURCES OF FUNDS
GENERAL. Savings accounts and other types of deposits have traditionally been an important source of the Bank's funds for use in lending and for other general business purposes. In addition to deposit accounts, the Bank derives funds from loan repayments, loan sales, borrowings and operations. The availability of funds from loan sales is influenced by general interest rates and other market conditions. Borrowings may be used on a short-term basis to compensate for reductions in deposits or deposit inflows at less than projected levels and may be used on a longer-term basis to support expanded lending activities.
DEPOSITS. The Bank attracts both short-term and long-term deposits from the general public by offering a wide assortment of deposit accounts and interest rates. The Bank offers regular savings accounts, NOW accounts, money market accounts, fixed interest rate certificates with varying maturities, and negotiated rate jumbo certificates
with various maturities. The Bank also offers tax-deferred individual retirement, Keogh retirement, and simplified employer plan retirement accounts.
As of December 31, 2003, approximately 45.8%, or $158.5 million, of the Bank's aggregate deposits consisted of various savings and demand deposit accounts from which customers are permitted to withdraw funds at any time without penalty.
Interest earned on passbook and statement accounts is paid from the date of deposit to the date of withdrawal and compounded semi-annually for the Bank. Interest earned on NOW and money market deposit accounts is paid from the date of deposit to the date of withdrawal and compounded and credited monthly. Management establishes the interest rate on these accounts.
The Bank also makes available to its depositors a number of certificates of deposit with various terms and interest rates to be competitive in its market area. These certificates have minimum deposit requirements as well.
The following table sets forth the change in dollar amount of deposits in the various types of deposit accounts offered by the Bank between the dates indicated.
The variety of deposit accounts offered by the Bank has permitted it to be competitive in obtaining funds and has allowed it to respond with flexibility to, but without eliminating the threat of, disintermediation (the flow of funds away from depository institutions such as savings institutions into direct investment vehicles such as government and corporate securities). In addition, the Bank has become much more subject to short-term fluctuation in deposit flows, as customers have become more interest rate conscious. The ability of the Bank to attract and maintain deposits and its costs of funds have been, and will continue to be, significantly affected by money market conditions. The Bank currently offers a variety of deposit products as options to the customer. They include noninterest-bearing and interest-bearing NOW accounts, interest-bearing Super NOW accounts, savings accounts, Money Market Deposit Accounts ("MMDA") and Certificates of Deposit ranging in terms from three months to seven years. In September of 2003, the Bank sold its Cincinnati branch locations. This sale included $38.3 million in Certificates of Deposits and $17.3 million in checking, savings and money market deposit accounts. The Bank introduced a Super NOW account in 2003 which had a portfolio balance of $36.5 million at December 31, 2003.
The following table sets forth the Bank's average aggregate balances and interest rates. Average balances in 2003 and 2002 are calculated from actual daily balances. Average balances for 2001 are derived from balances which management does not believe are materially different from daily balances (actual daily balances could not be obtained without undue effort and expense).
The following table sets forth the aggregate time deposits in the Bank classified by rates as of the dates indicated.
The following table sets forth the amount and maturities of the Bank's time deposits at December 31, 2003.
The following table indicates the amount of the Bank's certificates of deposit and other deposits of $100,000 or more by time remaining until maturity at December 31, 2003.
BORROWINGS. Deposits are the primary sources of funds for the Bank's lending and investment activities and for its general business purposes. The Bank also uses advances (borrowings) from the Federal Home Loan Bank ("FHLB") to supplement its supply of lendable funds, to meet deposit withdrawal requirements and to extend the terms of its liabilities. FHLB advances are typically secured by the Bank's FHLB stock, a portion of first mortgage loans, investment securities and overnight deposits. At December 31, 2003, the Bank had $9.6 million of FHLB advances outstanding.
The FHLB's function as central reserve banks providing credit for savings institutions and certain other member financial institutions. As a member, the Bank is required to own capital stock in its FHLB and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met.
The Company had a note payable to a third party financial institution with a current balance of $600,000 and bearing interest at 3.50% at December 31, 2003, the proceeds of which were used to finance stock repurchases during 1999.
The following table sets forth certain information regarding borrowings from the FHLBs at the dates and for the periods indicated.
AVERAGE BALANCE SHEET
The following table sets forth certain information relating to the Company's aggregate average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expenses by the average balance of assets or liabilities, respectively, for the periods presented. Average balances for 2003 and 2002 are calculated from actual daily balances. Average balances for 2001 are derived from balances which management does not believe are materially different from daily balances (actual daily balances could not be obtained without undue effort and expense).
- -------------------- (1) Includes interest-bearing deposits in other financial institutions, investment securities and FHLB stock.
TRUST ACTIVITIES
During 1999, the Bank began offering trust, investment and estate planning services through its Ameriana Trust and Investment Management Services division. Trust services consist of personal trusts, testamentary trusts, investment agency accounts (discretionary and directed), guardianships, rollover IRA's (discretionary and directed) and estates (personal representative). These accounts are offered to customers within the Bank's service areas in Indiana. Trust account balances of $75,000 and more can profitably be managed by the Bank. At December 31, 2003, the Bank had $15.6 million in trust assets under management.
SUBSIDIARY ACTIVITIES
The Bank has three direct wholly-owned subsidiaries; AFS, AIS and AIMI.
At December 31, 2003, the Bank's investments in its subsidiaries were approximately $137.8 million, consisting of direct equity investments.
Indiana savings banks may acquire or establish subsidiaries that engage in activities permitted to be performed by the savings bank itself or permitted to operating subsidiaries of national banks. Under FDIC regulations, a subsidiary of a state bank may not engage as principal in any activity that is not of a type permissible for a subsidiary of a national bank unless the FDIC determines that the activity does not impose a significant risk to the affected insurance fund.
COMPETITION
The Bank experiences substantial competition both in attracting and retaining savings deposits and in the making of mortgage and other loans. Direct competition for savings deposits comes from other savings institutions, commercial banks, and credit unions located in the Bank's market area. Additional significant competition for savings deposits comes from money market mutual funds and corporate and government debt securities.
The primary factors in competing for loans are interest rates and loan origination fees and the range of services offered by the various financial institutions. Competition for origination of real estate loans normally comes from other thrift institutions, commercial banks, mortgage bankers, mortgage brokers and insurance companies. The Bank has been able to compete effectively in its market area.
The Bank has branch offices in Henry, Hancock, Hendricks, Shelby and Madison Counties in Indiana. In addition to savings banks with offices in these counties, the Bank competes with several commercial banks and savings institutions in surrounding counties, many with assets which are substantially larger than the Bank.
REGULATION AND SUPERVISION
REGULATION AND SUPERVISION OF THE COMPANY
GENERAL. The Company is a public company registered with the Securities and Exchange Commission (the "SEC"), whose common stock trades on the Nasdaq Stock Market, Inc. (the "Nasdaq") and it is a bank holding company subject to regulation by the Federal Reserve Board under the BHCA. As a result, the activities of the Company are subject to certain requirements and limitations, which are described below. As a public reporting company, the Company is required to file annual, quarterly and current reports with the SEC and as a bank holding company, the Company is required to file annual and quarterly reports with the Federal Reserve Board and to furnish such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Company is also subject to regular examination by the Federal Reserve Board.
DIVIDENDS. The Federal Reserve Board has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company's capital needs, asset quality, and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay
dividends. Under the prompt corrective action regulations adopted by the Federal Reserve Board pursuant to FDICIA, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company's bank subsidiary is classified as "undercapitalized." See "Regulation and Supervision of the Bank-- Prompt Corrective Regulatory Action."
STOCK REPURCHASES. As a bank holding company, the Company is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Company's consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would violate any law, regulation, Federal Reserve Board order, directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. This requirement does not apply to bank holding companies that are "well-capitalized," "well-managed" and are not the subject of any unresolved supervisory issues.
SARBANES-OXLEY ACT OF 2002 AND RELATED REGULATIONS. On July 30, 2002, the Sarbanes-Oxley Act of 2002 ("SOX") was signed into law. SOX contains provisions addressing corporate and accounting fraud which both amended the Securities Exchange Act of 1934, as amended (the "Act") and directed the SEC to promulgate rules. SOX provided for the establishment of a new Public Company Accounting Oversight Board ("PCAOB"), to enforce auditing, quality control and independence standards for firms that audit public reporting companies and will be funded by fees from all public reporting companies. It is unlawful for any person that is not a registered public accounting firm ("RPAF") to audit a public reporting company. Under the Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The SEC has prescribed rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. SOX requires the RPAF that issues the audit report to attest to and report on management's assessment of the Company's internal controls. In addition, SOX requires that each financial report required to be prepared in accordance with (or reconciled to) generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC. SOX requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports
filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement.
SOX also increases the oversight and authority of audit committees of publicly traded companies. SOX imposed higher standards for auditor independence and restricts provisions of consulting services by auditing firms to companies they audit. Any non-audit services (subject to a 5% de minimis exception) being provided to an audit client require pre-approval by the Company's audit committee members. Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, all public reporting companies must disclose whether at least one member of the committee is an audit committee "financial expert" (as such terms is defined by the SEC rules) and if not, why not. Audit committees of Company's listed on the Nasdaq must be composed of three directors who meet the definition of "independent" set forth both in NASD Rule 4200(a)(15) and Section 10A(m) and Rule 10A-3 of the Act, and whose audit committee has a written charter containing specific elements set forth in these same NASD and SEC rules and sections. A Company with stock quoted on the Nasdaq that fails to be in compliance with these audit committee requirements, as well as additional Nasdaq requirements, will be delisted.
Due to SOX, longer prison terms will be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Act be deposited in a fund for the benefit of harmed investors.
Although the Company anticipates it will incur additional expense in complying with the provisions of the Act and the related rules, management does not expect that such compliance will have a material impact on the Company's financial condition or results of operations.
ACQUISITIONS. With certain exceptions, the BHCA prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities, which, by statute or by Federal Reserve Board regulation or order, have been identified
as activities closely related to the business of banking. The activities of the Company are subject to these legal and regulatory limitations under the BHCA and the related Federal Reserve Board regulations. Notwithstanding the Federal Reserve Board's prior approval of specific non-banking activities, the Federal Reserve Board has the power to order a holding company or its subsidiaries to terminate any activity, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that holding company.
Under Indiana banking law, prior approval of the Indiana Department of Financial Institutions is also required before any person may acquire control of an Indiana stock savings bank, bank or bank holding company. The Department will issue a notice approving the transaction if it determines that the persons proposing to acquire the savings bank or bank holding company are qualified in character, experience and financial responsibility, and the transaction does not jeopardize the interests of the public.
FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, legislation was enacted which could have a far-reaching impact on the financial services industry. The Gramm-Leach-Bliley Act ("GLB") authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and national banks to engage in a variety of new financial activities. Among the new activities that will be permitted to bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking. The Federal Reserve Board, in consultation with the Secretary of the Treasury, may approve additional financial activities. The GLB, however, prohibits future acquisitions of existing unitary savings and loan holding companies by firms which are engaged in commercial activities and limits the permissible activities of unitary holding companies formed after May 4, 1999.
CAPITAL REQUIREMENTS. The Federal Reserve Board has adopted guidelines regarding the capital adequacy of bank holding companies, which require bank holding companies to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See "--Regulation and Supervision of Banks - Capital Requirements."
REGULATION AND SUPERVISION OF THE BANK
GENERAL. The Bank is subject to extensive regulation by the Indiana Department of Financial Institutions ("DFI") and the FDIC. The lending activities and other investments of the Bank must comply with various regulatory requirements. The DFI and FDIC periodically examine the Bank for compliance with various regulatory
requirements. The Bank must file reports with the DFI and the FDIC describing its activities and financial condition. The Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board. This supervision and regulation is intended primarily for the protection of depositors. Certain of these regulatory requirements are referred to below or appear elsewhere herein.
CAPITAL REQUIREMENTS. Under FDIC regulations, state-chartered banks that are not members of the Federal Reserve System are required to maintain a minimum leverage capital requirement consisting of a ratio of Tier 1 capital to total assets of 3% if the FDIC determines that the institution is not anticipating or experiencing significant growth and has well-diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and in general a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System (the CAMELS rating system) established by the Federal Financial Institutions Examination Council. For all but the most highly rated institutions meeting the conditions set forth above, the minimum leverage capital ratio is 3% plus an additional "cushion" amount of at least 100 to 200 basis points with a minimum leverage capital requirement of not less than 4%. Tier 1 capital is the sum of common stockholders' equity, noncumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets (other than certain mortgage servicing assets, purchased credit card relationships, credit-enhancing interest-only strips and certain deferred tax assets) minus identified losses, investments in certain financial subsidiaries and nonfinancial equity investments.
In addition to the leverage ratio (the ratio of Tier I capital to total assets), state-chartered nonmember banks must maintain a minimum ratio of qualifying total capital to risk-weighted assets of at least 8% of which at least four percentage points must be Tier 1 capital. Qualifying total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items. Tier 2 capital items include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and preferred stock with a maturity of over 20 years, certain other capital instruments and up to 45% of pretax net unrealized holding gains on equity securities. The includable amount of Tier 2 capital cannot exceed the institution's Tier 1 capital. Qualifying total capital is further reduced by the amount of the bank's investments in banking and finance subsidiaries that are not consolidated for regulatory capital purposes, reciprocal cross-holdings of capital securities issued by other banks, most intangible assets and certain other deductions. Under the FDIC risk-weighted system, all of a bank's balance sheet assets and the credit equivalent amounts of certain off-balance sheet items are assigned to one of four broad risk weight categories from 0% to 100%, based on the risks inherent in the type of assets or item. The aggregate dollar amount of each category
is multiplied by risk weight assigned to that category. The sum of these weighted values equals the bank's risk-weighted assets.
At December 31, 2003, the Bank's ratio of Tier 1 capital to total assets was 9.38%, its ratio of Tier 1 capital to risk-weighted assets was 15.17% and its ratio of total risk-based capital to risk-weighted assets was 16.42%.
During the second quarter of 2002, the Bank entered into a memorandum of understanding ("MOU") with the FDIC and the DFI. Among other things, the MOU required the Bank to adopt written action plans with respect to certain classified assets, revise its lending policies in accordance with examiner recommendations, require greater financial information from borrowers, establish a loan review program, document Board review of the adequacy of loan losses, formulate a plan for improving the Bank's profitability, review staffing needs with particular emphasis on loan administration, strengthen certain internal controls and audit coverage and address other regulatory compliance issues raised in the most recent examination report by the FDIC and DFI. While the MOU is in effect, the Bank must maintain Tier 1 capital at or above 7% of assets.
The Company's Board of Directors have adopted resolutions providing that the Company will not cause the Bank to pay dividends if its Tier 1 capital would be less than 7% thereafter, that the Company will not incur additional debt without prior Federal Reserve approval, and that the Company will not purchase any treasury stock. The resolutions remain in effect until the MOU is lifted.
The Company believes that the Company and the Bank have taken all actions specified in the MOU and Board resolutions within the timeframes specified. The Company does not believe the MOU or Board resolutions will materially affect the operations of the Company or the Bank. A failure to comply with either the MOU or resolutions could lead to the initiation of formal enforcement action by the FDIC, DFI and the Federal Reserve.
DIVIDEND LIMITATIONS. The Bank may not pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of the Bank at the time of its conversion to stock form. In addition, the Bank may not pay dividends that exceed retained net income for the applicable calendar year to date, plus retained net income for the preceding two years without prior approval from the DFI. The Company's Board of Directors have also resolved not to cause the Bank to pay dividends if its Tier 1 capital would be less than 7% thereafter. At December 31, 2003, the shareholder's equity of the Bank was $38.3 million and approval is required by the Indiana Department of Financial Institutions to pay dividends to the Company.
Earnings of the Bank appropriated to bad debt reserves and deducted for Federal income tax purposes are not available for payment of cash dividends or other distributions to stockholders without payment of taxes at the then current tax rate by the Bank on the amount of earnings removed from the reserves for such distributions. See "Federal and State Taxation."
Under FDIC regulations, the Bank is prohibited from making any capital distributions if after making the distribution, the Bank would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%. For additional information about dividend limitations see Note 12 in the Consolidated Financial Statements.
DEPOSIT INSURANCE. The Bank is required to pay assessments to the FDIC for insurance of its deposits by the SAIF based on a percentage of its insured deposits. Under the FDIA, the FDIC is required to set semi-annual assessments for SAIF-insured institutions at a rate determined by the FDIC to be necessary to maintain the designated reserve ratio of the SAIF at 1.25% of estimated insured deposits or at a higher percentage of insured deposits that the FDIC determines to be justified for that year by circumstances raising a significant risk of substantial future losses to the SAIF. In the event that the SAIF should fail to meet its statutory reserve ratio, the FDIC would be required to set semi-annual assessment rates for SAIF members that are sufficient to increase the reserve ratio to 1.25% within one year or in accordance with such other schedule that the FDIC adopts by regulation to restore the reserve ratio in not more than 15 years.
The assessment rate for an insured depository institution is determined by the assessment risk classification assigned to the institution by the FDIC based on the institution's capital level and supervisory evaluations. Based on the data reported to regulators for date closest to the last day of the fourth month preceding the semi-annual assessment period, institutions are assigned to one of three capital groups -- well capitalized, adequately capitalized or undercapitalized -- using the same percentage criteria as in the prompt corrective action regulations. See "-- Prompt Corrective Regulatory Action." Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund.
The FDIC has adopted an assessment schedule for SAIF deposit insurance pursuant to which the assessment rate for well-capitalized institutions with the highest supervisory ratings have been reduced to zero and institutions in the worst risk assessment classification will be assessed at the rate of 0.27% of insured deposits. At
December 31, 2003, the Bank is considered well capitalized. In addition, FDIC-insured institutions are required to pay assessments to the FDIC to help fund interest payments on certain bonds issued by the Financing Corporation ("FICO"), an agency of the federal government established to finance takeovers of insolvent thrifts.
PROMPT CORRECTIVE REGULATORY ACTION. Under FDICIA, the federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements, including a leverage limit, a risk-based capital requirement, and any other measure deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements. An institution that fails to meet the minimum level for any relevant capital measure (an "undercapitalized institution") may be: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of businesses. The capital restoration plan must include a guarantee by the institution's holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable up to the lesser of 5% of the institution's total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan. A "significantly undercapitalized" institution, as well as any undercapitalized institution that does not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution. Any company controlling the institution may also be required to divest the institution or the institution could be required to divest subsidiaries. The senior executive officers of a significantly undercapitalized institution may not receive bonuses or increases in compensation without prior approval and the institution is prohibited from making payments of principal or interest on its subordinated debt. In their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective provisions. If an institution's ratio of tangible capital to total assets falls below the "critical capital level"
established by the appropriate federal banking regulator, the institution will be subject to conservatorship or receivership within specified time periods.
Under the implementing regulations, the federal banking regulators generally measure an institution's capital adequacy on the basis of its total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). The following table shows the capital ratios required for the various prompt corrective action categories.
- ----------- * 3.0% if institution has a composite 1 CAMELS rating.
A "critically undercapitalized" institution is defined as an institution that has a ratio of "tangible equity" to total assets of less than 2.0%. Tangible equity is defined as core capital plus cumulative perpetual preferred stock (and related surplus) less all intangible assets other than qualifying supervisory goodwill and certain purchased mortgage servicing rights. The FDIC may reclassify a well capitalized depository institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically undercapitalized) if the FDIC determines, after notice and an opportunity for a hearing, that the savings institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any CAMELS rating category.
SAFETY AND SOUNDNESS GUIDELINES. Under FDICIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"), each federal banking agency was required to establish safety and soundness standards for institutions under its authority. The interagency guidelines require depository institutions to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution's business. The guidelines also establish certain basic standards for loan documentation, credit underwriting, interest rate risk exposure, and asset growth. The guidelines further provide that depository institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and should take into account factors such as comparable compensation practices at comparable institutions. If the appropriate federal banking agency determines
that a depository institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines. A depository institution must submit an acceptable compliance plan to its primary federal regulator within 30 days of receipt of a request for such a plan. Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions. Management believes that the Bank meets all the standards adopted in the interagency guidelines.
RESERVE REQUIREMENTS. Under Federal Reserve Board regulations, the Bank currently must maintain average daily reserves equal to 3% of net transaction accounts over $6.0 million up to $42.1 million, plus 10% on the remainder. This percentage is subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. At December 31, 2003, the Bank met applicable Federal Reserve Board reserve requirements.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks governed and regulated by the Federal Housing Finance Board ("FHFB"). As a member, the Bank is required to purchase and hold stock in the FHLB of Indianapolis in an amount equal to the greater of 1% of its aggregate unpaid home loan balances at the beginning of the year or an amount equal to 5% of FHLB advances outstanding, whichever is greater. As of December 31, 2003, the Bank held stock in the FHLB of Indianapolis in the amount $6.0 million was in compliance with the above requirement.
The FHLB of Indianapolis serves as a reserve or central bank for the member institutions within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of FHLB System. It makes loans (i.e., advances) to members in accordance with policies and procedures established by the FHLB System and the Board of Directors of the FHLB of Indianapolis.
The Bank is also a member of the FHLB of Cincinnati due to remaining borrowings after the merger of Ameriana-Ohio and the Bank. As of December 31, 2003, the Bank held stock in the FHLB of Cincinnati in the amount of $1.0 million and was in compliance with requirements of membership.
LOANS TO EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS. Loans to directors, executive officers and principal stockholders of a state non-member bank like the Bank must be made on substantially the same terms as those prevailing for comparable transactions with persons who are not executive officers, directors, principal stockholders or employees of the Bank unless the loan is made pursuant to a compensation or benefit plan that is widely available to employees and does not favor insiders. Loans to any executive officer, director and
principal stockholder together with all other outstanding loans to such person and affiliated interests generally may not exceed 15% of the bank's unimpaired capital and surplus and all loans to such persons may not exceed the institution's unimpaired capital and unimpaired surplus. Loans to directors, executive officers and principal stockholders, and their respective affiliates, in excess of the greater of $25,000 or 5% of capital and surplus (up to $500,000) must be approved in advance by a majority of the board of directors of the bank with any "interested" director not participating in the voting. State non-member banks are prohibited from paying the overdrafts of any of their executive officers or directors unless payment is made pursuant to a written, pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or transfer of funds from another account at the bank. Loans to executive officers may not be made on terms more favorable than those afforded other borrowers and are restricted as to type, amount and terms of credit. In addition, Section 106 of the BHCA prohibits extensions of credit to executive officers, directors, and greater than 10% stockholders of a depository institution by any other institution which has a correspondent banking relationship with the institution, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features.
TRANSACTIONS WITH AFFILIATES. A state non-member bank or its subsidiaries may not engage in "covered transactions" with any one affiliate in an amount greater than 10% of such bank's capital stock and surplus, and for all such transactions with all affiliates a state non-member bank is limited to an amount equal to 20% of capital stock and surplus. All such transactions must also be on terms substantially the same, or at least as favorable, to the bank or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. An affiliate of a state non-member bank is any company or entity which controls or is under common control with the state non-member bank and, for purposes of the aggregate limit on transactions with affiliates, any subsidiary that would be deemed a financial subsidiary of a national bank. In a holding company context, the parent holding company of a state non-member bank (such as the Company) and any companies which are controlled by such parent holding company are affiliates of the state non-member bank. The BHCA further prohibits a depository institution from extending credit to or offering any other services, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or certain of its affiliates or not obtain services of a competitor of the institution, subject to certain limited exceptions.
PATRIOT ACT. The Patriot Act is intended to strengthen U.S. law enforcement's and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
INDIANA BANKING LAW
BRANCHING. An Indiana savings bank is entitled to establish one or more branches de novo or by acquisition in any location or locations in Indiana. The savings bank is required to file an application with the Department of Financial Institutions. Approval of the application is contingent upon the Department's determination that after the establishment of the branch, the savings bank will have adequate capital, sound management and adequate future earnings.
LENDING LIMITS. Indiana savings banks are not subject to percentage of asset or capital limits on their commercial, consumer and non-residential mortgage lending, and accordingly, have more flexibility in structuring their portfolios than federally chartered savings banks.
OTHER ACTIVITIES. The Bank is authorized to engage in a variety of agency and fiduciary activities including acting as executors of an estate, transfer agent and in other fiduciary capacities. On approval from the Department of Financial Institutions, the Bank would be permitted to exercise any right granted to national banks.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION. The Company and its subsidiaries file a consolidated federal income tax return on a calendar year end. Saving Banks are subject to the provisions of the Internal Revenue Code of 1986 (the "Code") in the same general manner as other corporations. However, institutions such as the Bank which met certain definitional tests and other conditions prescribed by the Code benefited from certain favorable provisions regarding their deductions from taxable income for annual additions to their bad debt reserve.
The Company's federal income tax returns have not been audited in recent years.
STATE TAXATION. The State of Indiana imposes a franchise tax which is assessed on qualifying financial institutions, such as the Bank. The tax is based upon federal taxable income before net operating loss carryforward deductions (adjusted for certain Indiana modifications) and is levied at a rate of 8.5% of apportioned adjusted taxable income.
The Company's state income tax returns have not been audited in recent years.
EMPLOYEES
As of December 31, 2003, the Company and subsidiaries had approximately 164 full-time and 7 part-time employees. The employees are not represented by a collective bargaining agreement. Management believes the Company and its subsidiaries enjoy good relations with their personnel.
Unless otherwise noted, all officers have held the position described below for at least the past five years.
HARRY J. BAILEY has been President of the Company and the Bank since May 1990, and was appointed Chief Executive Officer in December 1990. Mr. Bailey had been the Executive Vice President and Chief Operating Officer of the Company since its formation in 1989 and of the Bank since February 1984. He has been a Director of the Bank since 1987 and a Director of the Company since its formation. From June 1983 to January 1984, Mr. Bailey, an attorney, acted as a consultant to financial institutions and for 15 years before, served in the legal department and as operations officer for thrift institutions in the Chicago area. He is a Trustee of the Henry County Memorial Hospital, Director of the New Castle/Henry County Economic Development Corporation, is a past member of the Board of Directors of the Federal Home Loan Bank of Indianapolis, past Chairman and Director of the Indiana Bankers Association, and past Director of the Henry County Community Foundation.
TIMOTHY G. CLARK joined the Bank as Executive Vice President and Chief Operating Officer on September 2, 1997. He was elected Executive Vice President and Chief Operating Officer of the Company on October 23, 2000. He previously held the position of Regional Executive and Area President at National City Bank of Indiana in Seymour, Indiana for 5 years and prior to that held senior management positions with Central National Bank in Greencastle, Indiana for 5 years and Hancock Bank & Trust in Greenfield, Indiana for 13 years.
BRADLEY L. SMITH, a certified public accountant, joined the Bank as a Senior Vice President-Treasurer and Chief Financial Officer of the Bank and Company on April 10, 2002. Prior to joining the Bank, he was the Executive Vice President of Finance Center Federal Credit Union in Indianapolis where he had been employed since 1992.
NANCY A. ROGERS was elected as Senior Vice President - Marketing Services in March 1995 and was also appointed Secretary of the Company and the Bank in 1998. She has been employed at the Bank since 1964 and most recently served as Vice President and Director of Advertising and Public Relations.
TED R. GIRTON was elected as Senior Vice President - Credit Administration of the Bank in June 2002. Prior to joining the Bank, he was Vice President and Head of Credit Administration for the Commercial Lending Unit at Union Federal Bank in Indianapolis.
GROVER F. ARCHER joined the Bank as Senior Vice President - Retail Banking in January 1999. Prior to joining the Bank he held the position of Area President for one year, as Regional Administrative Manager for six years and Senior Vice President and Director of Retail Banking for six years at National City Bank of Indiana and its predecessor in Anderson, Indiana. Prior to that time Mr. Archer was in senior management positions with Indiana Lawrence Bank in North Manchester, Indiana for 16 years.
DEBORAH A. BELL was elected as Senior Vice President - Information Technology in May 1998. She has been employed at the Bank since 1976 and most recently served as Vice President and Director of Data Processing since 1991 after serving in that department since July 1985.
RONALD M. HOLLOWAY has been employed by the Bank since 1973 and was elected Senior Vice President and Chief Lending Officer in December 1995. Mr. Holloway previously was responsible for the Bank's loan servicing department.
JAN F. WRIGHT was elected as Senior Vice President - Business Services at the Bank in January 1998 and prior to that served as Senior Vice President - Branch Operations since March 1995. He previously held the position of Vice President and Director of Loan Origination and Processing and has been employed by the Bank since 1972.
ITEM 2.
ITEM 2. PROPERTIES ------------------
The following table sets forth the location of the Company's office facilities at December 31, 2003 and certain other information relating to these properties at that date.
The Bank purchased land in 2003 for future bank use. The total investment for the land was $236,000. The value of the land is not included in the table above. The Bank uses on-line processing terminals. Most of the data processing is done by an in-house data processing center. At December 31, 2003, the total net book value of the Company's offices and equipment (including leasehold improvements) was $ 7.9 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------
The Bank is involved in a variety of litigation in regard to its interests in two pools of equipment leases originated by the Commercial Money Center, Inc. ("CMC"), a California based equipment leasing company which is now in bankruptcy.
In June and September 2001, the Bank purchased the income streams from two separate pools of leases totaling $12,003,000. Each lease within each pool is supported by a surety bond issued by one of two insurance companies, which were rated at least "A" by Moody's at the time that the surety bonds were issued. The bonds guarantee payment of all amounts due under the leases in the event of default by the lessee. Each pool was sold by the terms of a Sales and Servicing Agreement which provides that the insurers will service the leases. In each case the insurers have assigned their servicing rights and responsibilities to Commercial Service Center, a company which has also filed bankruptcy.
When the lease payments went into default, notice was given to each insurer. One then made payments for a few months under a reservation of rights; the other paid nothing. Both insurers claim they were defrauded by Commercial Money Center (CMC), the company which sold the lease pools. Both are now denying responsibility for payment.
Many other financial institutions have purchased lease pools from CMC. All of the lease pools are in default and in litigation. The Panel on Multidistrict Litigation has taken control of the many actions and assigned them to the U.S. District Court for the Northern District of Ohio, Eastern Division. The actions have been consolidated for the purpose of discovery.
The Bank has also been named as a defendant in a suit filed by a group of lessees in California state court. The California suit alleges that the leases are usurious and uncollectable under California law. None of the plaintiffs in the California suit is a lessee in either of the lease pools purchased by the Bank.
The Company believes the surety bonds are enforceable against the insurers. The current unpaid balance for the pools of $10,900,000 was fully charged-off in September of 2003.
The Bank has also been named in a suit filed by the Trustee in the CMC and CSC bankruptcies. The suit alleges that the Bank received preferential treatment when it received payments from one of the lease pools and seeks repayment of approximately $86,000 received by the Bank. Additionally, the suit seeks a determination that the transaction represents a loan in which the Bank failed to properly perfect its interest such that the Trustee is entitled to all future payments. The Bank believes the transaction is a true sale in which no perfection is required. The Bank is vigorously defending its position.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASERS OF EQUITY SECURITIES - --------------------------------------------------------------------------------
The Company's common stock, par value $1.00 per share (the "Common Stock"), is traded on the Nasdaq National MarketSM under the symbol "ASBI." As of March 12, 2004, the Company had 3,148,788 shares of Common Stock outstanding and had 601 stockholders of record and approximately 1,373 beneficial owners holding shares in nominee or "street" name. The Company began paying quarterly dividends during the fourth quarter of fiscal year 1987. The Company's ability to pay dividends is dependent on dividends received from the Bank. See Note 12 to the "Consolidated Financial Statements" included under Item 8 of this Annual Report for a discussion of the restrictions on the payment of cash dividends by the Company.
The following table sets forth the high, low and closing sales prices for the Common Stock as reported on the Nasdaq National MarketSM and the cash dividends declared on the Common Stock for each full quarterly period during the last two fiscal years.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(1) Based on total dividends per share declared and net income per share for the year. (2) NM - Not meaningful.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------
EXECUTIVE SUMMARY - -----------------
The Company was incorporated under Indiana law for the purpose of becoming the holding company for the Bank. The Bank has three direct wholly-owned subsidiaries, Ameriana Insurance Agency ("AIA"), Ameriana Financial Services, Inc. ("AFS") and Ameriana Investment Management, Inc. ("AIMI"). AIA operates a general insurance agency in three locations. AFS has a brokerage operation and owns a partial interest in a life insurance company and a title insurance company. AIMI manages the Company's investment portfolio. On June 29, 2001, the Bank converted from a federal savings bank to an Indiana chartered state savings bank and changed its name to "Ameriana Bank and Trust, SB". The Company also owns a minority interest in a limited partnership organized to acquire and manage real estate investments, which qualify for federal tax credits.
The Company returned to profitability in 2003 with net income of $2,418,000 or $0.77 per diluted share compared with a net loss of $3,075,000 or $0.98 per diluted share in 2002. The Company's net income for the full year 2003 included charges totaling $5,890,000, or $3,534,000 after tax or $1.12 per diluted share, taken in the second and third quarters primarily to write off the troubled lease portfolio. These charges were offset to some extent by a gain of $5,511,000, or $2,930,000 after tax or $0.93 per diluted share, on the third quarter sale of two branches in Ohio. The Company's net loss for 2002 reflected both the additional reserves set aside in the fourth quarter of 2002 as well as a charge of $3,212,000, or $1,900,000 after tax or $0.61 per diluted share, associated with the restructuring of the Company's investment portfolio in the first quarter of 2002. Despite the unfavorable charges mentioned above, the Company's capital ratios remain strong. The Company's risk based capital to risk-weighted assets improved to 16.42% at December 31, 2003 from 13.89% at December 31, 2002, and continues to be classified as "well capitalized" by regulatory standards.
As with most banks, the Company's largest source of revenue has historically been the net interest margin, which is derived from the spread earned between its interest income and interest expense. The interest-rate environment continued at a 40-year low point in 2003, and actually improved the Company's net interest margin. The net interest margin improved to 3.23% in 2003 from 2.63% in 2002, primarily due to the cost of interest bearing liabilities, which declined greater than the yield earned on interest earning assets. Management expects the net interest margin to contract in the coming year should interest rates remain low.
The low interest rate environment in 2003 and 2002 also kept the demand for mortgage loan refinancing at a high level. The Company continued to sell new fixed rate mortgage production to minimize potential long-term
interest rate risk associated with such long-term, low-interest loans. As a result, gain on sale of loans and servicing rights was $1.9 million in 2003 and $1.4 million in 2002. Due to the rate structure in early 2004 and the large volume of loans refinanced during 2003 and 2002, current estimates indicate that the gain on sale of loans during 2004 will be significantly less than 2003 or 2002.
Employee pension and legal expenses increased in 2003. Like many other organizations, the Company's defined-benefit pension cost continues to rise. Unfavorable market conditions since 2000 reduced earnings in the pension fund and accordingly caused a significant increase in the contribution required by the Company. The Company's pension expense was $768,000 in 2003 compared to $215,000 in 2002 and $5,000 in 2001. Management expects pension expense to continue to increase in 2004. Litigation that started in 2002 continues with the troubled lease portfolio. Legal and professional fees increased to $731,000 in 2003 from $386,000 in 2002.
The Company's profitability is also affected by outside sources beyond management's control. These outside sources include the economy, the regulatory environment, and government monetary and fiscal policies. Management started initiatives in 2004 to improve profits in the areas the Company can control, such as limiting expense growth, expanding fee income, and enhancing operational efficiency.
The statements contained within this report contains forward-looking statements within the meaning of the federal securities laws. Statements in this release that are not strictly historical are forward-looking and are based upon current expectations that may differ materially from actual results. These forward-looking statements, identified by words such as "view" and "believe," involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statements made herein. These risks and uncertainties involve general economic trends and changes in interest rates, increased competition, changes in consumer demand for financial services, the possibility of unforeseen events affecting the industry generally, the uncertainties associated with newly developed or acquired operations, the amount of losses incurred from the liquidation of certain of the Company's investments, the eventual outcome of litigation to enforce certain surety agreements, and market disruptions and other effects of terrorist activities. The Company undertakes no obligation to release revisions to these forward-looking statements publicly to reflect events or circumstances after the date hereof or to reflect the occurrence of unforeseen events, except as required to be reported under the rules and regulations of the Securities and Exchange Commission.
CRITICAL ACCOUNTING POLICIES - ---------------------------- The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company's significant accounting policies are described in detail in the Notes to the Company's Consolidated Financial Statements for the year ended December 31, 2003. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company's financial condition and results, and they require management to make estimates that are difficult, subjective or complex.
ALLOWANCE FOR CREDIT LOSSES. The allowance for credit losses provides coverage for probable losses in the Company's loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management's estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.
The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan's observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan's effective interest rate.
Regardless of the extent of the Company's analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors, including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger, non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company's evaluation of imprecision risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.
MORTGAGE SERVICING RIGHTS. Mortgage servicing rights ("MSRs") associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.
GOODWILL AND OTHER INTANGIBLES. The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required by Statement of Financial Accounting Standards ("SFAS") No. 141. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded, and subsequent impairment analysis, requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition.
SALE OF TWO CINCINNATI BRANCHES IN 2003 - ---------------------------------------
On April 7, 2003, the Company announced that it had agreed to sell its two Cincinnati-area branches to Peoples Community Bancorp, Inc. (NASDAQ/NM: PCBI)("PCBI") of West Chester, Ohio. The two branches are located in Deer Park and Landen, Ohio. On September 30, 2003, the Company announced the completion of the sale of the two branches to PCBI. In connection with the sale, the Company recorded an after-tax gain of approximately $2,930,000 or $0.93 per diluted share in the third quarter 2003.
The transaction included the Company's real property related to the Deer Park branch and its leasehold on the premises for the Landen branch. Additionally, the Company conveyed most consumer and commercial loans at those branches as part of the transaction, as well as the branches' saving deposits, but retained and will continue to service certain single family residential mortgages originated in those locations.
INVESTMENTS SOLD IN 2002 - ------------------------
The interest rate risk position of the Bank for the prior period ending December 31, 2001, was reviewed by management. Management determined that a significant deterioration had occurred in the Company's CMO portfolio, which resulted in a large increase in the Company's exposure to future increases in interest rate risk. Upon further review, management determined that the increase in the exposure was significant enough to call into question the prudence of continuing to hold the securities to maturity. In order to take the necessary action to reduce this exposure, management decided to move the entire securities portfolio from the "Held to Maturity" accounting classification to the "Available for Sale" classification as of December 31, 2001.
In 2002, the Company determined that most of its investments no longer fit its risk profile, given the unsettled, uncertain and volatile nature of the market and the possibility that interest rates could move against the portfolio. The decelerating speed of prepayments on these instruments during the first quarter of 2002 was remarkable, significantly extending the practical maturity of the portfolio to a level that exceeded the Bank's risk parameters. The alternatives to taking immediate action to mitigate the potential losses, including long-term funding strategies, hedging strategies and partial liquidations, were felt to be inadequate in the circumstances. The Company decided to liquidate the majority of the investment portfolio. In March 2002, the Bank disposed of $137.0 million in securities at a pretax loss of $3.2 million, or approximately $1.9 million after tax.
The proceeds from the liquidation of the Company's investments were first applied towards repayment of short-term borrowings from the FHLB. This increased the Company's flexibility to retain more of its self-originated
loans in portfolio and to purchase loan participations in the region as they became available. The balance of the proceeds were used to purchase short-term liquid investments, including limited maturity MBS, which present less interest rate risk than the liquidated investments, and an ARM mutual fund. The Company also used some proceeds to invest in intermediate-term MBS to provide a balance to its portfolio between interest rate risk reduction and maintenance of higher net interest income levels.
In September 2002, the Bank determined it could improve its net interest margin by paying down the majority of FHLB advances with the sale of a similar amount of investment securities. The Company sold an additional $44.6 million of investments in the third quarter 2002 and realized a gain of approximately $1.2 million on the sale, which offset to some extent the loss on disposition of investments realized earlier in the year. The proceeds from this latest investment sale were used to pay off higher-rate FHLB advances, which included a prepayment penalty of approximately $1.1 million. Aside from the de-leveraging effect, these transactions are expected to improve the Company's net interest margin through the reduction of higher-rate debt with proceeds from the sale of lower-earning investments.
TROUBLED LEASE PORTFOLIO WRITE-OFF - ----------------------------------
On September 30, 2003, the Company wrote-off the remaining balances of two troubled equipment lease pools originated by Commercial Money Center, a now bankrupt company and recorded an after-tax loss of $3,534,000 or $1.12 per diluted share for the year ended December 31, 2003. The Bank entered into these leases pools, which at the time had receivables totaling $12,003,000, consisting primarily of equipment leases, in June and September of 2001. Each lease within each pool is supported by a surety bond issued by insurance companies which were rated at least "A" by Moodys at the time the Company entered into the lease pools. When the issuer of the lease pools filed for bankruptcy in 2002 the outstanding balance on these pools was $10,900,000. The insurers of the lease pools have denied responsibility for payment of the default on the lease pools alleging fraud on the part of Commercial Money Center. At December 31, 2002, the Company established reserves against the two lease pools of $5,450,000, which was equal to approximately 50% of the outstanding amount in default. At the end of the second quarter of 2003, the Company set aside an additional $900,000 in specific reserves for one of the two lease pools. Subsequently, due to continued uncertainty surrounding the prospects for eventual recovery from the sureties, the fact that one of the insurance companies had its credit rating down-graded to "D" by A.M. Best, and that the litigation with respect to the enforcement of the surety bonds was proving more protracted and challenging
than originally anticipated, in keeping with the Company's policy for reserving against its assets, the Company determined to charge-off the remaining balances of the lease pools.
FINANCIAL CONDITION - -------------------
Total assets decreased $54.3 million or 11.9% to $402.5 million at December 31, 2003, from $456.8 million at December 31, 2002. The decrease was primarily due to the sale of the Ohio branches to Peoples Community Bancorp, Inc. which reduced assets approximately $55.6 million (See "Sale of Two Cincinnati Branches in 2003").
CASH AND CASH EQUIVALENTS
Cash and cash equivalents decreased $31.2 million to $14.5 million at December 31, 2003, from $45.7 million at December 31, 2002. The decrease was the result of investing cash and cash equivalents in investment securities.
SECURITIES - ----------
Investment securities increased approximately $79.6 million to $137.8 million at December 31, 2003, from $58.2 million at December 31, 2002. This was mainly due to a decline in the loan portfolio during 2003 which resulted from refinanced mortgage loans. Due to the rate environment in 2003, the Bank continued to sell the majority of its fixed-rate originations.
The following table identifies changes in the investment securities carrying values:
(1) NM - Not meaningful.
The following table identifies the percentage composition of the investment securities:
The following table identifies changes in net unrealized gains and losses in investment securities:
See Note 3 to the "Consolidated Financial Statements" for more information on investment securities.
LOANS - -----
The following table shows the percentage change of the loan portfolio by category calculated as of December 31 (loans in process and deferred fees are not included in this table):
The loan portfolio declined $107.5 million to $214.1 million at year end 2003 from $321.6 million at year end 2002. The sale of the Ohio branches accounted for $28.8 million of the loan portfolio decline, with mortgage loan refinancing accounting for most of the remainder.
The sale of the Ohio branches included $649,000 in residential real estate mortgage loans, $25.0 million in commercial mortgage real estate loans, and $3.2 million in consumer loans. The portfolio shift to commercial real estate loans continued in 2003 and 2002 with commercial loans comprising 37.2% of the overall portfolio at year-end 2003 compared to 27.5% at year-end 2002. Fixed-rate residential mortgage loan production were sold in the secondary market in 2003 and 2002, which is the main cause for the decline in residential mortgage loans. Proceeds from loans sold in the secondary markets were $154.5 million in 2003, and $113.0 million in 2002. Fixed mortgage
loan rates have been at historic lows during this two-year period, which has increased the volume of refinances. The fixed-rate residential loans are sold to minimize the Bank's exposure to interest rate risk. Due to the consumer demand for fixed-rate loans, the Bank's residential loan portfolio has declined. The Bank generally retains loan servicing on loans originated and sold in Indiana, and sold loans and loan servicing rights for loans previously originated and sold in Ohio. Loans serviced by the Bank for investors, primarily the Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") and the Federal Home Loan Bank ("FHLB"), totaled approximately $193.0 million in 2003 and $177.4 million in 2002. Loans sold and subsequently serviced by the Bank generate a steady source of fee income, with servicing fees ranging from 0.25% to 0.375%.
In 2001, the Bank purchased two separate pools of lease receivables, totaling $12.0 million, which is the reason for the substantial increase in commercial loans and leases in 2001. In 2002 these two pools went into default and were charged-off in 2003 (see "Troubled Lease Portfolio Charged-Off").
Consumer loans made up 3.68% and 4.21% of the total loan portfolio for 2003 and 2002, respectively. Consumer loans declined $5.6 million, to $7.9 million at December 31, 2003, from $13.5 million at December 31, 2002. The decline was primarily due to reduced loan volume as market competitive rates were below minimums established by the Company and the sale of loans included in the Ohio branch sale which included $3.2 million in consumer loans.
Total loan production was strong for 2003 and 2002. New loan production was $229.9 million and $217.0 million in 2003 and 2002, respectively. Since the Bank sells most of its fixed-rate mortgage loans in the secondary market, the loan volume is not fully reflected in the balance sheet.
CREDIT QUALITY - --------------
Non-performing assets, totaling $8.4 million, declined in 2003. This represents a decrease of $10.0 million from the 2002 non-performing assets total of $18.4 million. The main cause for the decrease was the two lease pools totaling $10.9 million that were charged-off in 2003 (see "Troubled Lease Portfolio Charged-Off").
The Bank also has a number of real estate development/lot loans and single-family residential loans on existing properties with a builder/developer group, and its related parties, that are currently in default and bankruptcy. The Bank is working closely with the workout specialist hired by the bankruptcy trustee on liquidation of the properties involved in the bankruptcy, and the Bank is negotiating with the borrower and its counsel for resolution of the remaining properties. The total outstanding balance of the various loans totaled $3.5 million as of December 31, 2003.
The following table compares delinquent loans as a percentage of total loans:
(1) Still accruing
The Bank's charged-off loans, less recoveries, were $11,362,000 and $364,000 in 2003 and 2002, respectively. The percentage of net charge-offs to average assets were 2.51% and .07% in 2003 and 2002, respectively.
DEPOSITS - --------
Interest rates paid on Bank deposits stayed at historic lows in 2003 as market interest rates continued to fall. The fed funds interest rate, the rate banks charge other banks on overnight loans, was at a 42-year low. Fed fund rates generally affect the prime lending rate, which was at a 45-year historic low. The Federal Reserve has cut the fed funds rate 12 times since 2001, with the last rate cut of .50% in November 2002. Short-term deposits (deposits with maturities of one year or less, including certificate accounts, checking, savings and money market accounts) comprised 77% of the Bank's deposit portfolio as of year-end 2003, compared with 80% for the same period in 2002. With such a high percentage of deposit accounts staying short-term, an increase in rates in the near future may squeeze the Bank's net interest margin in the short term, since loans are slower to re-price at new market rates.
Deposits declined $56.5 million, or 14.0%, in 2003 for a year-end portfolio balance of $345.7 million. The deposit portfolio at year-end 2002 was $402.2 million. The main reason for the decline was the sale of the two Cincinnati branches which included the transfer of $55.6 million in deposits.
The following table shows deposit changes by category:
(Dollars in thousands)
BORROWINGS - ----------
Borrowings increased in 2003. FHLB advances increased $4.0 million to $9.6 million at year-end 2003 from $5.6 million at year-end 2002. The increase was mainly due to a $5.0 million putable FHLB advance taken in November 2003. Putable advances offer a low fixed rate of interest in exchange for the borrower's selling the FHLB the option to convert the advance before maturity on any given conversion date to an adjustable rate advance based on a predetermined index for the remaining term to maturity, at the FHLB's sole discretion. The putable advance has a 10 year maturity with a rate of 3.90% guaranteed for two years and could convert to an adjustable advance should the three month LIBOR index reach 8.0%.
Notes payable by the Company declined $240,000 to $600,000 at year-end 2003, from $840,000 at year-end 2002. The notes payable consists of a note payable to a third-party financial institution with a balance of $600,000 and $750,000 bearing interest at 3.50% and 4.25% at December 31, 2003 and December 31, 2002 respectively, the proceeds of which were used to finance stock repurchases during 1999. Notes payable with a balance of $90,000 at December 31, 2002 and paid off in 2003 were 6.0% notes payable to former stockholders of Cardinal State Bank.
INTEREST RATE RISK - ------------------
The Bank is subject to interest rate risk to the degree that its interest-bearing liabilities, primarily deposits and borrowings from the FHLB, mature or reprice at different rates than its interest-earning assets. Although having liabilities that mature or reprice more frequently on average than assets may not be beneficial in times of rising interest rates, such an asset/liability structure could result in higher net income during periods of declining interest rates, unless offset by other factors.
The Asset-Liability Management Committee and the Board of Directors review the Bank's exposure to interest rate changes and market risk on a quarterly basis. This review is accomplished by the use of a cash flow simulation model using detailed securities, loan, deposit, borrowings and market information to estimate fair values
of assets and liabilities using discounted cash flows. The difference between the Bank's estimated fair value of assets and the estimated fair value of liabilities, is the fair value of equity, also referred to as net present value of equity ("NPV"). The change in the NPV is calculated at different interest rate intervals. This tests the interest rate risk exposure from movements in interest rates to determine the change in the Bank's NPV. The model also tests the impact various interest rate scenarios have on net interest income and net income over a stated period of time (one year, for example).
The model uses a number of assumptions, including the relative levels of market interest rates and prepayments or extension in maturity and repayment in loans, MBS and CMO, and certain types of callable investments. These computations do not contemplate actions management may undertake to reposition the assets and liabilities, and should not be relied upon as indicative of actual results. In addition, certain shortcomings are inherent in the model of computing NPV. Should interest rates remain or decrease below present levels, the portion of adjustable rate loans could decrease in future periods due to loan refinancing or payoff activity. In the event of an interest rate change, pre-payment levels would likely be different from those assumed in the model and the ability of borrowers to repay their adjustable rate loans may decrease during rising interest rate environments.
The Bank's information below provides an assessment of the risk of NPV in the event of sudden and sustained 200-basis-point increases and decreases in the prevailing interest rates as of December 31, 2003.
The Bank information below provides an assessment of the risk of NPV in the event of sudden and sustained 200 basis point increases and decreases in the prevailing interest rates as of December 31, 2002.
The interest rate risk position of the Bank for the prior period ending December 31, 2003, was within the Bank's risk parameters specified in its interest rate risk policy.
YIELDS EARNED AND RATES PAID - ----------------------------
The following tables set forth the weighted average yields earned on the Company's interest-earning assets and the weighted average interest rates paid on the Company's interest-bearing liabilities, together with the net yield on interest-earning assets.
RATE/VOLUME ANALYSIS
The following table sets forth certain information regarding changes in interest income, interest expense and net interest income of the Company for the periods indicated. For each category of interest earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in volume (changes in volume multiplied by old rate) and (2) changes in rate (changes in rate multiplied by new volume). No material amounts of loan fees or out-of-period interest are included in the table. Dollars are in thousands.
RESULTS OF OPERATIONS
PART 1 2003 COMPARED TO 2002 - ------------------------------
Net Income (Loss) - ------------------
The Company had a net profit of $2.4 million or $0.77 per diluted share for the year-end 2003. The Company incurred a provision expense of $6.4 million in 2003 which was offset by a net gain on the sale of branches of $5.5 million for the same period. The provision expense decreased approximately $900,000 in 2003 compared to 2002. The provision expense was $7.3 million in 2002.
The provision expense included specific reserves of approximately $5.45 million taken in both 2003 and 2002 was largely due to two pools of equipment lease receivables. (see "Troubled Lease Portfolio Charged-Off").
For a quarterly breakdown of earnings, see Note 18 to the "Consolidated Financial Statements."
The table below shows selected performance data:
(1) Based on total dividends per share declared and net income per share for the year. NM - not meaningful.
NET INTEREST INCOME - -------------------
The Company derives the majority of its income from net interest income. The following table shows a breakdown of net interest income for 2003 compared to 2002.
Net interest income increased 4.8% or $598,000 in 2003. Most of the increase was rate-related. See "Rate/Volume Analysis" for more information. The net interest spread, which is the mathematical difference between the yield on average interest-earning assets and cost of interest-bearing liabilities, was 3.08% in 2003 and 2.36% in 2002. The net interest margin on interest-earning assets, which is interest income as a percentage of average earning assets, was 3.23% in 2003 and 2.63% in 2002. The improvements in the interest spread and margin are the results of high cost certificates that repriced at maturity to a lower rate, and an overall shift from certificates to short-term money market, Super Now accounts, and lower borrowing cost. The lower borrowing costs were the result of paying off higher costing FHLB advances with lower yielding investments in September 2002.
PROVISION FOR LOAN LOSSES - -------------------------
The Company's provision for loan losses was $6.4 million for 2003, compared with 7.3 million in 2002. The provision is the amount that is added to the allowance for loan losses to absorb inherent losses in the loan portfolio. The provision expense for both 2003 and 2002 consisted of specific reserves for the troubled lease pools (see "Troubled Lease Portfolio Charged-Off").
Specific reserves of $895,000 were established in 2002 for business/development loans and its related parties. The business/development loans had a principal balance of $3.5 million and 3.6 million at December 31, 2003 and December 31, 2002 respectively. The reserves are approximately 25% of the principal balance at December 31 2003 and December 31, 2002.
Net loan charge-offs were $11.4 million and $364,000 for the years 2003 and 2002, respectively. The allowance for loan losses as a percent of loans was 1.80% at December 31, 2003, and 2.77% at December 31, 2002. Non-performing loans, which consists of non-accrual loans and loans delinquent over 90 days and still accruing, decreased by $10.0 million during 2003. Non-performing loans were $8.4 million at December 31, 2003, and $18.4 million at December 31, 2002. The decrease in non-performing loans was mainly due to the charge-off of the troubled lease portfolio (see "Troubled Lease Portfolio Charged-Off").
The Company believes it has established an adequate allowance for loan losses in accordance with generally accepted accounting principles. The variation in the amount of provision charged against income is directly related to changes in loan charge-offs, non-performing loans, loan delinquencies, economic conditions in the Company's lending area and loan portfolio mix during each year.
NON-INTEREST INCOME - -------------------
Non-interest income was $10.5 million in 2003 and $2.9 million in 2002, for an overall increase of $7.6 million or 257.4%. The main cause of the change was due to the net gain on sale of branches of $5.5 million in 2003 (See "Sale of Two Cincinnati Branches in 2003") and net losses on securities sold in 2002 of $2.0 million (See
"Investments Sold in 2002"). Excluding the net gain on sale of branches and security losses, non-interest income would have improved 1.11%. Gains on sales of loans and servicing rights improved to $1.9 million for 2003 from $1.4 million for 2002, an increase of 31.97%. Interest rates have steadily declined since 2001, which has created a higher demand from consumers for fixed-rate mortgage loans. Proceeds from loans sold in the secondary market were $154.5 million in 2003 and $113.0 million in 2002. The increase in gains on sales of loans was the result of a continued increase in refinancing during the first nine months of 2003. Due to the rate structure in early 2004 and the large amount of loans that refinanced during 2003 and 2002, current estimates indicate that the gain on sale of loans during 2004 will be significantly less than 2003 or 2002. Other fees and service charges improved 6.31%, while brokerage and insurance commissions were down 4.48%. The Bank invested in life insurance on employees and directors, with a balance or cash surrender value of $19.7 million and $18.9 million, respectively, at December 31, 2003 and 2002. The majority of these policies were purchased in 1999. The nontaxable increase in cash surrender value of life insurance declined to $773,000 in 2003 from $897,000 in 2002. The decline was due to declining interest rates. Operating losses associated with the limited partnership amounted to a loss of $81,000 in 2003 and a gain of $92,000 in 2002 and are included in other income. The Company incurred an allocated gain of $191,000 and tax credit recapture of $33,000 due to the termination of ownership in one of the properties in 2002. The Company also reflected federal income tax credits of $174,000 and $159,000 for the year ended December 31, 2003, and December 31, 2002.
NON-INTEREST EXPENSE - --------------------
Non-interest expense was $13.6 million in 2003 and $13.7 million in 2002, for an overall decrease of $73,000 or 0.53%. Non-interest expense in 2002 included penalties charged for early payoff of FHLB advances of $1.1 million (See "Investments Sold in 2002"). Excluding the advance early payoff penalties, non-interest expense would have increased $1.1 million or 7.96%. The largest component of non-interest expense is salaries and employee benefits, which made-up 59.42% of total non-interest expenses in 2003.
Salaries and employee benefits increased $483,000 to $8.1 million in 2003, compared with $7.6 million in 2002. The Bank's employee retirement plan expense increased to $768,000 in 2003 from $215,000 in 2002. Prior to 2002 the stock market generally provided enough earnings to cover increases required in the employee retirement fund. With the decline of the stock market, the Bank's retirement expense in rose substantially in 2002 and 2003. Other insurance benefits, comprised mainly of medical insurance, increased to $1.2 million in 2003 from $1.0 million in 2002, for an overall increase in insurance benefits expense of $200,000. Please see Note 11 to the
"Consolidated Financial Statements" for more information regarding benefits.
Net occupancy and furniture and equipment expense was $1.6 million in 2003, compared with $1.7 million 2002, for an overall expense decrease of $104,000, or 6.30%. The decrease was mainly due to real estate taxes which declined $142,000 due to a reduction in Indiana real estate tax assessments. Legal and professional expenses were $345,000 higher in 2003 from 2002 mainly due to the CMC leases litigation and the sale of the Ohio branches. Data processing, printing and supplies, and all other expenses increased $279,000, or 9.42%, in 2003 from 2002 mainly due to higher federal deposit insurance and loan processing expense. Federal deposit insurance was $119,000 higher due to an increase in the Bank's insurance premium rate in mid 2002 and loan processing expense was $87,000 higher due to a greater volume of loans originated and sold in 2003 from 2002.
INCOME TAX EXPENSE - ------------------
The Company incurred income tax expense of $1.1 million in 2003, compared to an income tax benefit of $2.5 million in 2002. The effective tax rate was 31.5% in 2003 and (45.0)% in 2002. The 2003 income taxes were composed of a $847,000 credit for current taxes and a $2.0 million expense for deferred taxes. The 2002 income taxes were composed of a $796,000 expense for current taxes and a $3.3 million credit for deferred taxes. The deferred tax expense in 2003 was mainly due to net charge-offs in 2003 exceeding the loan provision expense. The deferred tax credit in 2002 was mainly due to the loan provision expense in 2002 which exceeded net charge-offs. The primary difference between the effective tax rates and the statutory tax rates in 2003 relates to tax credits, cash value of life insurance and the disposition of goodwill resulting from the sale of the Ohio branches. The primary difference between the effective tax rates and the statutory tax rates in 2002 relate to tax credits and cash value of life insurance. See Note 10 to the "Consolidated Financial Statements" for more information.
PART 2 2002 COMPARED TO 2001 - ------------------------------
NET INCOME (LOSS) - -----------------
The Company had a net loss of $3.1 million for the year-end 2002, due primarily to security losses and large loan provision expenses.
The total provision for loan and lease losses increased substantially in 2002. Provision expense increased $6.9 million for a total provision expense of $7.3 million in 2002. This increase was necessary to establish specific reserves for the additional non-accrual loans, which increased by $16.1 million in 2002, for a year-end total of $18.3 million. In 2002, the Bank set aside specific reserves in the amount of $5.5 million for two lease pools with a principal balance of $10.9 million at December 31, 2002, in addition to specific reserves of $795,000 for
business/development loans and its related parties with a principal balance of $3.6 million at December 31, 2002. These specific reserves account for $6.2 million of the $6.9 million increase in the provision for loan and lease losses. The Bank also increased its general reserves due to the weak economy and to reflect the Bank's current risk in the loan portfolio due to the change in the portfolio mix.
For a quarterly breakdown of earnings, see Note 18 to the "Consolidated Financial Statements."
NET INTEREST INCOME - -------------------
The Company derives the majority of its income from net interest income. The following table shows a breakdown of net interest income for 2002 compared with 2001.
Net interest income declined 3.8% or $495,000 in 2002. Most of the decrease was volume related. See "Rate/Volume Analysis" for more information. The net interest spread, which is the mathematical difference between the yield on average interest-earning assets and cost of interest-bearing liabilities, was 2.36% in 2002 and 2.40% in 2001. The net interest margin on interest-earning assets, which is interest income as a percentage of average earning assets, was 2.63% in 2002 and 2.68% in 2001.
PROVISION FOR LOAN LOSSES - -------------------------
The Company significantly increased the provision for loan losses for a total provision expense of $7.3 million for 2002, compared with $360,000 in 2001. The provision is the amount that is added to the allowance for loan losses to absorb inherent losses in the loan portfolio. Net loan charge-offs were $364,000 and $119,000 for the years 2002 and 2001, respectively. The allowance for loan losses as a percent of loans was 2.77% at December 31, 2002, and .49% at December 31, 2001, and represents management's best estimate of the inherent losses in the loan portfolio. The provision increase in 2002 was necessary to increase the allowance for loan and lease losses to a sufficient level of specific and general reserves. Non-performing loans, which consists of non-accrual loans and loans delinquent over 90 days and still accruing, substantially increased by $15.8 million during 2002. Non-performing loans were $18.4 million at December 31, 2002, and $2.6 million at December 31, 2001. The increase in
non-performing loans was mainly due to a few large loans. Please see "Credit Quality" for more information.
The following table breaks out non-performing loans by category.
The Company believes it has established an adequate allowance for loan losses in accordance with generally accepted accounting principles. The variation in the amount of provision charged against income is directly related to changes in loan charge-offs, non-performing loans, loan delinquencies, economic conditions in the Company's lending area and loan portfolio mix during each year.
NON-INTEREST INCOME - -------------------
Non-interest income was $2.9 million in 2002 and $4.0 million in 2001, for an overall decrease of 27.50%. The main cause of the decline was due to the net losses on securities sold in 2002 of $2.0 million (See "Investments Sold in 2002"). Excluding the security losses, non-interest income would have improved 22.94%. Gains on sales of loans and servicing rights improved to $1.4 million for 2002 from $804,000 for 2001, an increase of 77.00%. Interest rates have steadily declined since 2001, which has created a higher demand from consumers for fixed-rate mortgage loans. Proceeds from loans sold in the secondary market were $113.0 million in 2002 and $86.8 million in 2001. Other fees and service charges improved 5.25%, while brokerage and insurance commissions were up 1.01%. The Bank invested in life insurance on employees and directors, with a balance or cash surrender value of $18.9 million and $18.0 million, respectively, at December 31, 2002 and 2001. The majority of these policies were purchased in 1999. The nontaxable increase in cash surrender value of life insurance was $897,000 in 2002 and $945,000 in 2001. Overall, the increase in cash value of life insurance declined 5.08% in 2002 compared with 2001. Operating losses associated with the limited partnership amounted to a gain of $92,000 in 2002 and a loss of $172,000 in 2001 and are included in other income. The Company incurred an allocated gain of $191,000 and tax credit recapture of $33,000 due to the termination of ownership in one of the properties in 2002. The Company also reflected federal income tax credits of $159,000 (after-tax credit recapture) and $210,000 for the year ended December 31, 2002, and December 31, 2001.
NON-INTEREST EXPENSE - --------------------
Non-interest expense was $13.7 million in 2002 and $11.3 million in 2001, for an overall increase of 20.51%. The main cause of the increase was the penalties charged for early payoff of FHLB advances in 2002 of $1.1 million (See "Investments Sold in 2002"). Excluding the advance early payoff penalties, non-interest expense would have increased 11.02%. The largest component of non-interest expense is salaries and employee benefits, which make up 55.57% of total non-interest expenses.
Salaries and employee benefits increased $879,000 to $7.6 million in 2002, compared with $6.7 million in 2001. In 2002, the Bank paid a former executive officer severance pay for a non-recurring expense of $289,000. The Bank's employee retirement plan expense increased to $215,000 in 2002 from $5,000 in 2001. The retirement expense incurred in 2001 was for general administrative expenses of the retirement fund. In 2001, the stock market generally provided enough earnings to cover increases required in the employee retirement fund. With the decline of the stock market, the Bank's retirement expense in 2002 rose substantially. Other insurance benefits, comprised mainly of medical insurance, increased to $1.0 million in 2002 from $748,000 in 2001, for an overall increase in insurance benefits expense of $280,000. There were 11 new positions added during 2002 in several areas Bank. Please see Note 11 to the "Consolidated Financial Statements" for more information regarding benefits.
Net occupancy and furniture and equipment expense was $1.7 million in 2002, compared with $1.4 million 2001, for an overall expense increase of $271,000, or 19.62%, in 2001. The increase was mainly due to building equipment maintenance expense, utilities, equipment rental and depreciation expense that increased $74,000, $17,000, $22,000, $14,000, respectively, in 2002 from 2001. Data processing, printing and supplies, and all expenses increased $32,000, or 1.10%, in 2002 from 2001.
INCOME TAX EXPENSE - ------------------
The Company incurred a $2.5 million income tax benefit in 2002 compared income tax expense of $1.5 million in 2001. The effective tax rate was (45.0)% in 2002 and 27.8% in 2001. 2002 income taxes were composed of $796,000 expense for current taxes and a $3.3 million credit for deferred The 2001 income taxes were composed of $1.7 million expense for current taxes and $229,000 credit for taxes. The deferred tax credits in 2002 were mainly due to the loan provision expense in 2002. For both 2002 and 2001 , the primary difference between the effective tax rates and the statutory tax rates relate to tax credits and cash value of life insurance. See Note 10 to the "Consolidated Financial Statements" for more information.
LIQUIDITY AND CAPITAL RESOURCES - -------------------------------
Historically, funds provided by operations, loan principal repayments and new deposits have been the Company's principal sources of liquid funds. In addition, the Company has the ability to obtain funds through the sale of new mortgage loans and through borrowings from the FHLB system. At December 31, 2003, the Company's commitments for loans in process totaled $5.9 million and conditional commitments for lines of credit receivable totaled $21.4 million. Management believes that the Company's liquidity and other sources of funds will be sufficient to fund all outstanding commitments and other cash needs. A portion of these commitments is for fixed-rate mortgage loans, which will be sold immediately into the secondary market.
An amendment of the 1996 Stock Option Plan, which provides for the granting of incentive and non-qualified stock options, was approved by the shareholders in April 1998 and extended the plan's term to ten years and increased the number of shares reserved under the plan from 176,000 to 352,000 shares. Options for 825 shares in 2003 were exercised. Options for 9,713 shares in 2002 were exercised. See Notes 1 and 11 to the "Consolidated Financial Statements" for the pro forma effect on net income and option activity.
OFF-BALANCE SHEET ARRANGEMENTS - ------------------------------
The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect of the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
CONTRACTUAL OBLIGATIONS - -----------------------
Either the Company or the Bank has the following known contractual obligations as of December 31, 2003:
IMPACT OF INFLATION AND CHANGING PRICES - ---------------------------------------
The consolidated financial statements and related data presented in this report have been prepared in accordance with generally accepted accounting principles. This requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation.
Virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or at the same rate as changes in the prices of goods and services, which are directly affected by inflation, although interest rates may fluctuate in response to perceived changes in the rate of inflation.
CURRENT ACCOUNTING ISSUES - -------------------------
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for classification and measurement in the statement of financial position of certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability. The FASB's Staff Position 150-3 deferred indefinitely the guidance in SFAS No. 150 on certain mandatorily redeemable noncontrolling interests. At December 31, 2003, the Company has no financial instruments with characteristics of both liabilities and equity.
In January of 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, and in December 2003 the FASB deferred certain effective dates of Interpretation No. 46. For all variable interest entities other than special purpose entities, the revised Interpretation is effective for periods ending after March 15, 2004. For variable interest entities meeting the definition of special purpose entities under earlier accounting rules, the Interpretation remains effective for periods ending after December 31, 2003. The Interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling interest through ownership of a majority voting interest in the entity. The Company has determined that it has no such interests.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-based Compensation - Transition and Disclosure, which provides guidance for transition from the intrinsic value method of accounting for stock-based compensation under Accounting Principles Board ("APB") Opinion No. 25 to SFAS No. 123's fair value method of accounting, if a company so elects. The Company applies APB Opinion No. 25 and related Interpretations in accounting for the stock option plan. Accordingly, no compensation costs have been recognized, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation cost for the Company's stock option plan been recorded based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123, net income and net income per share would have been adjusted to the proforma amounts indicated in Note 1.
In November 2002, FASB Interpretation No. 45 ("FIN 45"), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others was issued. FIN 45 requires the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The most significant FIN45 instruments of the Company are standby letters of credit. The Company has determined that its standby letters of credit obligations under FIN 45 are not material for disclosure.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK - -------------------------------------------------------------------
Reference is made to the discussion captioned "Interest Rate Risk" in Item 7 of this Annual Report.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Accountants' Report
To the Shareholders and Board of Directors Ameriana Bancorp New Castle, Indiana
We have audited the accompanying consolidated balance sheets of Ameriana Bancorp as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These consolidated 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits 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 described above present fairly, in all material respects, the consolidated financial position of Ameriana Bancorp as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As more fully discussed in Note 7, the Company changed its method of accounting for goodwill in 2002.
/s/ BKD, LLP
Indianapolis, Indiana February 6, 2004
F-(1)
Ameriana Bancorp Consolidated Balance Sheets (in thousands, except share data)
See notes to consolidated financial statements.
F-(2)
Ameriana Bancorp Consolidated Statements of Operations (in thousands, except share data)
See notes to consolidated financial statements.
F-(3)
Ameriana Bancorp Consolidated Statements of Shareholders' Equity (in thousands, except per share data)
See notes to consolidated financial statements.
F-(4)
Ameriana Bancorp Consolidated Statements of Cash Flows (in thousands)
See notes to consolidated financial statements.
F-(5)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Ameriana Bancorp (the "Company") and its wholly-owned subsidiary, Ameriana Bank and Trust, SB ("the Bank"), and the Bank's wholly-owned subsidiaries, Ameriana Investment Management, Inc. ("AIMI"), Ameriana Financial Services, Inc., and Ameriana Insurance Agency, Inc. All significant intercompany accounts and transactions have been eliminated.
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.
The Company is a bank holding company whose principal activity is the ownership and management of the Bank and its subsidiaries. The Company provides various banking services and engages in loan servicing activities for investors and operates in a single significant business segment. The Bank is subject to the regulation of the Indiana Department of Financial Institutions and the Federal Deposit Insurance Corporation. The Company's gross revenues are substantially earned from the various banking services provided by the Bank. The Company also earns brokerage and insurance commissions from the services provided by the other subsidiaries. AIMI manages the Company's investment portfolio.
The Bank generates loans and receives deposits from customers located primarily in east central Indiana and southwestern Ohio. Loans are generally secured by specific items of collateral including real property and consumer assets. The Company has sold various loans to investors while retaining the servicing rights.
CASH AND CASH EQUIVALENTS consist of cash on hand and in other institutions and interest-bearing demand deposits.
INVESTMENT SECURITIES: Debt securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Securities held to maturity are carried at amortized cost. Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses reported separately in accumulated other comprehensive income, net of tax.
Amortization of premiums and accretion of discounts are recorded using the interest method as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method.
STOCK IN FEDERAL HOME LOAN BANK ("FHLB") is stated at cost and the amount of stock the Company is required to own is determined by regulation.
LOANS are carried at the principal amount outstanding. A loan is impaired when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with insignificant delays not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially delinquent loans may be considered to be impaired. Generally, loans are placed on non-accrual status at 90 days past due and interest is considered a loss, unless the loan is well-secured and in the process of collection. The Company considers its investment in one-to-four family residential loans and installment loans to be homogeneous and therefore excluded from separate identification of evaluation of impairment. Interest income is accrued on the principal balances of loans. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed when considered uncollectible. Interest income is subsequently recognized only to the extent cash payments are received. Certain loan fees and direct costs are being deferred and amortized as an adjustment of yield on the loans over the contractual lives of the loans. When a loan is paid off or sold, any unamortized loan origination fee balance is credited to income.
F-(6)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
ALLOWANCE FOR LOAN LOSSES is maintained at a level believed adequate by management to absorb inherent losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio including consideration of past loan loss experience, current economic conditions, volume, growth and composition of the loan portfolio, the probability of collecting all amounts due, and other relevant factors. Impaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loan, if collateral dependent. The allowance is increased by provisions for loan losses charged against income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that as of December 31, 2003, the allowance for loan losses is adequate based on information currently available. A worsening or protracted economic decline in the areas within which the Company operates would increase the likelihood of additional losses due to credit and market risks and could create the need for additional loss reserves.
PREMISES AND EQUIPMENT are stated at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over the estimated useful lives of the related assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.
GOODWILL is annually tested for impairment. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements.
EARNINGS PER SHARE is computed by dividing net income by the weighted-average number of common and potential common shares outstanding during each year.
MORTGAGE SERVICING RIGHTS on originated loans are capitalized by estimating the fair value of the streams of net servicing revenues that will occur over the estimated life of the servicing arrangement. Capitalized servicing rights, which include purchased servicing rights, are amortized in proportion to and over the period of estimated servicing revenues.
STOCK OPTIONS - The Company has a stock-based employee compensation plan, which is described more fully in Note 11. The Company accounts for this plan under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the grant date. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
F-(7)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
INCOME TAX in the consolidated statements of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes. The Company and its subsidiaries file consolidated tax returns. The parent company and subsidiaries are charged or given credit for income taxes as though separate returns were filed.
RECLASSIFICATIONS of certain amounts in the 2002 and 2001 consolidated financial statements have been made to conform to the 2003 presentation.
2. RESTRICTION ON CASH AND DUE FROM BANKS
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, 2003 was $2,934,000.
3. INVESTMENT SECURITIES
F-(8)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
The amortized cost and fair value of securities available for sale at December 31, 2003, 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.
Certain investments in debt and equity securities are reported in the financial statements at an amount less than their historical cost. These declines primarily resulted from recent increases in market interest rates and failure of certain investments to maintain consistent credit quality ratings or meet projected earnings targets.
Based on evaluation of available evidence, including recent changes in market interest rates and credit rating information, management believes the declines in fair value for these securities are temporary.
The Company's temporarily impaired investment securities at December 31, 2003 are shown below.
No investment securities were pledged at December 31, 2003. Investment securities with a total carrying value of $1,811,000 were pledged at December 31, 2002 to secure FHLB advances.
Gross gains of $41,000 and $1,247,000 and gross losses of $0 and $3,272,000 resulting from sales of available-for-sale securities were realized for 2003 and 2002.
In 2001, the Company determined that because of its interest rate risk, it would not be able to continue to hold its investment securities to maturity. Accordingly, the Company transferred its held-to-maturity investments to available for sale as of December 31, 2001, and recorded an accumulated other comprehensive loss of $696,000 as of that date.
F-(9)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
4. LOANS
Loans being serviced by the Company for investors, primarily the Federal Home Loan Mortgage Corporation and Federal National Mortgage Association, totaled approximately $193,016,000, $177,392,000 and $162,017,000 as of December 31, 2003, 2002 and 2001. Such loans are not included in the preceding table.
The aggregate fair value of capitalized mortgage servicing rights at December 31, 2003 and 2002 is based on comparable market values and expected cash flows, with impairment assessed based on portfolio characteristics including product type, investor type and interest rates. No valuation allowance was necessary at December 31, 2003 and 2002.
F-(10)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
At December 31, 2003 and 2002, the Company had outstanding commitments to originate loans of approximately $2,845,000 and $8,379,000, which were primarily for adjustable-rate mortgages with rates that are determined just prior to closing or fixed-rate mortgage loans with rates locked in at the time of loan commitment. In addition, the Company had $21,409,000 and $22,231,000 of conditional commitments for lines of credit receivables at December 31, 2003 and 2002. Exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual or notional amount of those instruments. The same credit policies are used in making such commitments as are used for instruments that are included in the consolidated balance sheets. 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 payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's credit worthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include accounts receivable, inventory, real estate, equipment, and income-producing commercial properties. In addition, the Company had $3,584,000 of letters of credit outstanding at December 31, 2003 and 2002. Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
5. ALLOWANCE FOR LOAN LOSSES
At December 31, 2003 and 2002, impaired loans totaled $6,952,000 and $16,669,000 with an allocation of the allowance for loan losses of $1,304,000 and $6,646,000.
Interest of $154,000 and $119,000 was recognized on average impaired loans of $14,471,000 and $11,076,000 for 2003 and 2002. All interest recognized on impaired loans during 2003 and 2002 was on a cash basis.
Impaired loans were immaterial at and during the year ended December 31, 2001.
At December 31, 2003 and 2002, accruing loans delinquent 90 days or more totaled $74,000 and $135,000. Non-accruing loans at December 31, 2003 and 2002 were $8,383,000 and $18,307,000.
F-(11)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
6. PREMISES AND EQUIPMENT
7. GOODWILL
During 2002, the Company changed its method of accounting and financial reporting for goodwill and other intangible assets by adopting the provisions of SFAS No. 142. Had the new method been applied retroactively, the previously reported 2001 net income would have increased by $120,000.
During 2003, $727,000 of goodwill was eliminated in connection with the sale of two Ohio branches. On September 29, 2003, the branches located in Deer Park and Landen, Ohio were sold to Peoples Community Bancorp, Inc. of West Chester, Ohio. The transaction included the Company's real property related to the Deer Park branch and its leasehold on the premises for the Landen branch. Additionally, the Company conveyed most consumer and commercial loans at those branches as part of the transaction, as well as the branches' saving deposits. The Company retained and will continue to service certain single family residential mortgages originated in those locations.
8. DEPOSITS
F-(12)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
Certificates maturing in years ending after December 31, 2003:
Interest paid on deposits approximated interest expense in 2003, 2002 and 2001.
9. BORROWINGS
Borrowings at December 31, 2003 and 2002 include Federal Home Loan Bank advances totaling $9,630,000 and $5,592,000 with a weighted-average rate of 5.38% and 6.83%. The advances are secured by a combination of first-mortgage loans, investment securities and overnight deposits. Some advances are subject to restrictions or penalties in the event of prepayment.
Borrowings at December 31, 2003 and 2002 also include a note payable for $600,000 and $750,000 to another financial institution with a rate of 3.50% and 4.25%. The note is secured by the outstanding common stock of the Bank. The note outstanding at December 31, 2002 was due at July 24, 2003 and was renewed at that date to January 24, 2004.
A promissory note of $90,000 was included in borrowings at December 31, 2002. The interest rate on the note was 6.0%.
Interest paid on borrowings was $414,000, $3,092,000, and $5,881,000 for 2003, 2002 and 2001.
F-(13)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
10. INCOME TAXES
The effective income tax rate on income from continuing operations is reconciled to the statutory corporate tax rate as follows:
F-(14)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
The provision (credit) for income taxes consists of the following:
As of December 31, 2003, the Company had approximately $4,700,000 of state tax loss carryforward available to offset future franchise tax. Also, at December 31, 2003, the Company had approximately $72,000 of tax credits available to offset future federal income tax. Both the state loss carryforward and the tax credits expire in 2023.
The Company paid $1,503,000, $290,000 and $969,000 of state and federal income taxes in 2003, 2002 and 2001.
11. EMPLOYEE BENEFITS
The Company is a participating employer in a multi-employer defined-benefit pension plan and a 401(k) plan. The plans cover substantially all full-time employees of the Company. Since the defined-benefit pension plan is a multi-employer plan, no separate actuarial valuations are made with respect to each participating employer. Pension expense for the plans totaled $768,000, $215,000, and $5,000 in 2003, 2002 and 2001, respectively.
The Company has arrangements that provide retirement and death benefits to certain officers and directors. The accrual of benefits totaled $991,000, $744,000 and $420,000 for 2003, 2002 and 2001. In connection with these and other benefits, life insurance has been purchased with the proceeds from the policies to be utilized for the payment of benefits.
The Company has entered into employment agreements with certain officers that provide for the continuation of salary and certain benefits for a specified period of time under certain conditions. Under the terms of the agreements, these payments could occur in the event of a change in control of the Company, as defined, along with other specific conditions. The contingent liability under these agreements is generally three times the annual salary of the officer.
F-(15)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
Under the 1987 Stock Option Plan and the 1996 Stock Option and Incentive Plan ("1996 Plan"), which are accounted for under the recognition and measurement principles of APB No. 25, Accounting for Stock Issued to Employees, and related interpretations, the Company has granted options to individuals to purchase common stock at a price equal to the fair market value at the date of grant, subject to the terms and conditions of the plans. Plan terms permit certain nonincentive stock options to be granted at less than market value at plan committee discretion. Options vest and are fully exercisable when granted or over an extended period subject to continuous employment or under other conditions set forth in the plans. The period for exercising options shall not exceed ten years from the date of grant. The plans also permit grants of stock appreciation rights. An amendment of the 1996 Plan extended the plan's term by five years and increased the number of shares reserved under the plan from 176,000 to 352,000 shares.
The following is a summary of the status of the Company's stock option plans and changes in those plans as of and for the years ended December 31, 2003, 2002 and 2001.
As of December 31, 2003, selected other information in exercise price ranges for options outstanding and exercisable is as follows:
There were 178,442 shares under the 1996 Plan available for grant at December 31, 2003.
Although the Company has elected to follow APB No. 25, SFAS No. 123 requires pro forma disclosures of net income and earnings per share as if the Company had accounted for its employee stock options under that Statement. The fair value of each option grant was estimated on the grant date using an option-pricing model with the following assumptions:
The proforma effect on net income is disclosed in Note 1.
F-(16)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
12. SHAREHOLDERS' EQUITY
The payment of dividends by the Company depends substantially upon receipt of dividends from the Bank, which is subject to various regulatory restrictions on the payment of dividends. Under current regulations the Bank may not declare or pay a cash dividend or repurchase any of its capital stock if the effect thereof would cause the net worth of this entity to be reduced below regulatory capital requirements or the amount required for its liquidation accounts.
In addition, without prior approval, current regulations allow the Bank to pay dividends to the Company not exceeding retained net income for the applicable calendar year to date, plus retained net income for the preceding two years. Application is required by the Bank to pay dividends in excess of this restriction and the Company's Board of Directors have resolved not to cause the Bank to pay dividends if its Tier 1 capital would be less than 7% thereafter. At December 31, 2003, the shareholder's equity of the Bank was $38,325,000 and approval is required by the Indiana Department of Financial Institutions to pay dividends to the Company.
13. EARNINGS (LOSS) PER SHARE
Options to purchase 131,700, 199,022 and 138,420 shares of common stock at exercise prices of $14.25 to $18.30, $9.43 to $18.30 and $14.32 to $18.30 per share were outstanding at December 31, 2003, 2002 and 2001 but were not included in the computation of diluted earnings per share because the options were anti-dilutive.
14. OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows:
F-(17)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
15. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies and is assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures. The capital category assigned can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios.
There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. At December 31, 2003 and 2002, the Bank is categorized as well capitalized and met all subject capital adequacy requirements. There are no conditions or events since December 31, 2003, that management believes have changed this classification.
Actual and required capital amounts and ratios for the Bank are as follows:
(1) As defined by regulatory agencies
(1) As defined by regulatory agencies
During the second quarter of 2002, the Bank entered into a memorandum of understanding (the "MOU") with the Federal Deposit Insurance Corporation (the "FDIC") and the Indiana Department of Financial Institutions (the "DFI"). Among other things, the MOU required the Bank to adopt written action plans with respect to certain classified assets, revise its lending policies in accordance with examiner recommendations, require greater financial information from borrowers, establish a loan review program, document Board review of the adequacy of loan losses, formulate a plan for improving the Bank's profitability, review staffing needs with particular emphasis on loan administration, strengthen certain internal controls and audit coverage and address other regulatory compliance issues raised in the most recent examination report by the FDIC and DFI. While the MOU is in effect, the Bank must maintain Tier 1 capital at or above 7% of assets.
F-(18)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
The Company's Board of Directors have adopted resolutions providing that the Company will not cause the Bank to pay dividends if its Tier 1 capital would be less than 7% thereafter, that the Company will not incur additional debt without prior Federal Reserve approval, and that the Company will not purchase any treasury stock. The resolutions remain in effect until the MOU is lifted.
The Company believes that it has taken all actions specified in the MOU and Board resolutions within the timeframes specified. The Company does not believe the MOU or Board resolutions will materially affect the operations of the Company or the Bank. A failure to comply with either the MOU or resolutions could lead to the initiation of formal enforcement action by the FDIC, DFI and the Federal Reserve.
Retained earnings at December 31, 2003, includes an allocation of income to bad debt deductions of approximately $11,883,000 for which no provision for federal income taxes has been made. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, including redemption of bank stock or excess dividends, or loss of "bank" status, federal income taxes may be imposed at the then applicable rates. The unrecorded deferred income tax liability on the above amount was approximately $4,000,000.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values are based on estimates using present value and other valuation techniques in instances where quoted market prices are not available. These techniques are significantly affected by the assumptions used, including discount rates and estimates of future cash flows. As such, the derived fair value estimates cannot be compared to independent markets and, further, may not be realizable in an immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent, and should not be construed to represent, the underlying value of the Company.
The following table presents the estimates of fair value of financial instruments:
F-(19)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
CASH AND CASH EQUIVALENTS, STOCK IN FHLB AND CASH VALUE OF LIFE INSURANCE: The carrying amounts reported in the consolidated balance sheets approximate those assets' fair values.
INVESTMENT SECURITIES: Fair values are based on quoted market prices.
LOANS: The fair values for loans are estimated using a discounted cash flow calculation that applies interest rates used to price new similar loans to a schedule of aggregated expected monthly maturities on loans.
INTEREST RECEIVABLE/PAYABLE: The fair value of accrued interest receivable/payable approximates carrying values.
DEPOSITS: The fair values of interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on deposits to a schedule of aggregated expected monthly maturities on deposits.
BORROWINGS: The fair value of borrowings is estimated using a discounted cash flow calculation, based on borrowing rates for periods comparable to the remaining terms to maturity of the borrowings.
DRAFTS PAYABLE: The fair value approximates carrying value.
17. PARENT COMPANY FINANCIAL INFORMATION
The following are condensed financial statements for the parent company, Ameriana Bancorp, only:
F-(20)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
F-(21)
Ameriana Bancorp Notes to Consolidated Financial Statements (table dollar amounts in thousands, except share data)
18. QUARTERLY DATA (UNAUDITED)
F-(22)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------------
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES - --------------------------------------------------------------------------------
As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company's principal executive officer and principal financial officer, of the effectiveness of the Company's disclosure controls and procedures. Based on this evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. It should be noted that the design of the Company's disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company's principal executive and financial officers have concluded that the Company's disclosure controls and procedures are, in fact, effective at a reasonable assurance level.
There have been no changes in the Company's internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company's last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------
For information concerning the directors of the Company, the identification of the Audit Committee and the audit committee financial expert, the information contained under the section captioned "Proposal I -- Election of Directors" in the Proxy Statement is incorporated herein by reference. For information concerning the executive officers of the Company, see "Item 1. Business -- Executive Officers" under Part I of the Annual Report, which is incorporated herein by reference.
For information concerning compliance with Section 16(a) of the Exchange Act, see the section titled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement, which is incorporated herein by reference.
The Company has adopted a Code of Ethics that applies to the Company's principal executive officer, principal accounting and financial officer and senior executive officers. The Code of Ethics is posted on the Company's Internet Web site at www.ameriana.com. The Company intends to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an amendment to or waiver from a provision of the Company's Code of Ethics by posting such information on its Internet Web site at www.ameriana.com.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - -------------------------------
The information contained under the section captioned "Proposal I -- Election of Directors -- Executive Compensation" in the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------------
(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Security Ownership" in the Proxy Statement.
(b) SECURITY OWNERSHIP OF MANAGEMENT
Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Security Ownership" in the Proxy Statement.
(c) CHANGES IN CONTROL
The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table sets forth certain information with respect to the Company's equity compensation plans as of December 31, 2003.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------
The information required by this item is incorporated herein by reference to the section captioned "Transactions with Management" in the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES - ------------------------------------------------
The information required by this item is incorporated herein by reference to the section captioned "Audit Fees" in the Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT ----------------------------------------------
(1) Financial Statements. The following consolidated financial statements are filed under Item 8 hereof:
Report of Independent Auditors Consolidated Balance Sheets at December 31, 2003 and Consolidated Statements of Operations for Each of the Three Years in the Period Ended December 31, 2003 Consolidated Statements of Shareholders' Equity for Each of the Three Years in the Period Ended December 31, 2003 Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended December 31, 2003 Notes to Consolidated Financial Statements
(2) Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations are either not required under the related instructions or are inapplicable, and therefore have been omitted.
(3) Exhibits. The following is a list of exhibits as part of this Report and is also the Exhibit Index.
------- * Management contract or compensation plan or arrangement.
(b) REPORTS ON FORM 8-K. During the fourth quarter of the fiscal year -------------------- covered by this Annual Report, the Company filed the following Current Report on Form 8-K: Financial Date of Report Item(s) Reported Statements Filed -------------- ---------------- ---------------- October 30, 2003 7, 12 N/A
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are --------- either filed as part of this Report or incorporated by reference herein.
(d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. --------------------------------------------------------------- There are no other financial statements and financial statement schedules required by Regulation S-X which are excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b)(1) which are required to be included herein.
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.
AMERIANA BANCORP
Date: March 26, 2004 By:/s/ Harry J. Bailey ------------------------------------ Harry J. Bailey President and Chief Executive Officer (Duly Authorized Representative)
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 in the capacities and on the dates indicated.
By: /s/ Harry J. Bailey March 26, 2004 ------------------------------------------------- Harry J. Bailey President, Chief Executive Officer and Director (Principal Executive Officer)
By: /s/ Bradley L. Smith March 26, 2004 ------------------------------------------------- Bradley L. Smith Senior Vice President - Treasurer (Principal Financial and Accounting Officer)
By: ------------------------------------------------- Paul W. Prior Chairman of the Board and Director
By: ------------------------------------------------- Donald C. Danielson Director
By: /s/ Charles M. Drackett, Jr. March 26, 2004 ------------------------------------------------- Charles M. Drackett, Jr. Director
By: -------------------------------------------------- R. Scott Hayes Director
By: /s/ Michael E. Kent March 26, 2004 ------------------------------------------------- Michael E. Kent Director
By: /s/ Ronald R. Pritzke March 26, 2004 -------------------------------------------------- Ronald R. Pritzke Director