Item 1. Business
Forward Looking Statements
This Annual Report (including information incorporated by reference) contains, and future oral and written statements of LaPorte Bancorp, Inc. (“LaPorte Bancorp” or the “Company”) and its management may contain, forward-looking statements as such term is defined in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of LaPorte Bancorp. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of LaPorte Bancorp’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and LaPorte Bancorp undertakes no obligation to update any statement in light of new information or future events. By identifying these forward-looking statements for you in this manner, we are alerting you to the possibility that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A
Item 1A. Risk Factors
The current economic crisis coupled with turmoil and uncertainty in the financial markets may adversely impact us and our ability to successfully execute our business plan.
The current economic crisis is adversely impacting the financial condition of the households and businesses comprising our loan customers. Such a deteriorating financial condition could arise from loss of employment or business revenue exacerbated by a reduction in the value of real estate collateralizing our customers’ loans. As a consequence, we may experience an increase in nonperforming loans which will negatively impact earnings through reduced collections of interest income coupled with possible increases in the provision for loan losses, charge offs and foreclosure costs. Our ability to originate new loans in accordance with our business plan goals and objectives may also be diminished as a result of these same factors.
Moreover, the general level of uncertainty and volatility in the marketplace has greatly diminished the sources of funding readily available to many large financial institutions. Consequently, such institutions are placing greater emphasis on their retail deposit channel to attract funding thereby placing upward pressure on retail deposit rates in the marketplace. As a result, despite the recent reduction in overall market interest rates, our cost of deposits may remain stable or increase while our yield on earning assets is reduced. This condition would reduce our net interest spread and margin and our earnings in future periods.
Finally, although the Federal government has initiated a number of programs designed to both stimulate the economy as well stabilize the real estate and banking sectors, it is unclear how effective they will be over the short- and long-term. Also, it is unclear what long-term effects these initiatives will have on our operations.
Changing interest rates may hurt our profits and asset values.
Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:
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the interest income we earn on our interest-earning assets, such as loans and securities; and
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the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.
Our liabilities generally have shorter maturities than our assets. This imbalance can create significant earnings volatility as market interest rates change. In periods of rising interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities, resulting in a decline in our net interest income. In periods of declining interest rates, our net interest income is generally positively affected although such positive effects may be reduced or eliminated by prepayments of loans and redemptions of callable securities. In addition, when long-term interest rates are not significantly higher than short-term rates thus creating a “flat” yield curve, the Company’s interest rate spread will decrease thus reducing net interest income. Finally, federal initiatives designed to reduce mortgage interest spreads may reduce our loan income without a corresponding reduction in funding costs, thus decreasing our spreads. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk.”
Changes in interest rates also affect the current market value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. As December 31, 2008, the fair value of our securities classified as available for sale totalled $101.5 million. Unrealized net gains on available-for-sale securities totalled $581,000 at December 31, 2008 and are
reported, net of tax, as a separate component of shareholder’s equity. However, a rise in interest rates could cause a decrease in the fair value of securities available for sale in future periods which would have an adverse effect on shareholder’s equity.
Depending on market conditions, we often place more emphasis on enhancing our net interest margin rather than matching the interest rate sensitivity of our assets and liabilities. In particular, we believe that the increased net interest income resulting from a mismatch in the maturity of our asset and liabilities portfolios can, during periods of stable or declining interest rates provide high enough returns to justify increased exposure to sudden and unexpected increases in interest rates. As a result, our results of operations and the economic value of our equity will remain vulnerable to increases in interest rates and to declines in the difference between long- and short-term rates. See “Managements Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk.”
We have increased our commercial real estate loan originations, which increases the risk in our loan portfolio.
In order to enhance the yield and shorten the term-to-maturity of our loan portfolio, we have expanded our commercial real estate lending during recent years. In addition, we acquired a significant portfolio of such loans in the City Savings Bank merger in 2007. Commercial real estate lending has increased as a percentage of our total loan portfolio from 18.5% at December 31, 2002 to 29.27% at December 31, 2008.
Given their larger balances and the complexity of the underlying collateral, commercial real estate loans generally expose a lender to greater credit risk than loans secured by owner occupied one- to four-family real estate. In addition, our commercial real estate loan portfolio is not as seasoned as the loan portfolios of some of our competitors. In light of the current dramatic weakness in the real estate market and economy, we may begin to experience higher levels of nonperforming loans and provisions for loan losses.
Slow growth in our market area has adversely affected and may continue to adversely affect our performance.
Economic and population growth within our market area has for several decades been below the national average. Management believes that these factors have adversely affected our profitability and our ability to increase our loans and deposits. Although our acquisition of City Savings Financial Corporation facilitated our entrance into the Michigan City and Chesterton, Indiana markets, which are growing more rapidly than Eastern LaPorte County, our operations remain subject to market conditions in Eastern LaPorte County.
Strong competition within our market area could hurt our profits and slow growth.
We face intense competition in making loans, attracting deposits and hiring and retaining experienced employees. This competition has made it more difficult for us to make new loans and attract deposits. Price competition for loans and deposits sometimes results in us charging lower interest rates on our loans and paying higher interest rates on our deposits, which reduces our net interest income. Competition also makes it more difficult and costly to attract and retain qualified employees. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area. For more information about our market area and the competition we face, see “Item 1. Business-Market Area” and “Item 1. Business-Competition.”
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the Federal Deposit Insurance Corporation, as insurer of our deposits, and by the Indiana Department of Financial Institutions as our primary regulator. LaPorte Savings Bank, MHC and LaPorte Bancorp are subject to regulation and supervision by the Office of Thrift Supervision. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the
insurance fund and the depositors and borrowers of The LaPorte Savings Bank rather than for holders of LaPorte Bancorp common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. In light of the current economic downturn and banking concerns, we expect that Congress and the regulatory agencies will implement new restrictions and reporting requirements on our activities and operations. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations including complains costs.
Stock price may be volatile due to limited trading volume.
LaPorte Bancorp, Inc.’s common stock is traded on the NASDAQ Capital Market System. However, the average daily trading volume in the Stock Company’s common stock has been relatively small, averaging less than approximately 5,633 shares per day during the month of December 2008. Our trading volume may be even lower in 2009 as we terminated our stock repurchase program effective February 27, 2009. As a result, trades involving a relatively small number of shares may have a significant effect on the market price of the common stock, and it may be difficult for investors to acquire or dispose of large blocks of stock without significantly affecting the market price.
Public stockholders own a minority of LaPorte Bancorp, Inc.’s common stock and will not be able to exercise voting control over most matters put to a vote of stockholders.
LaPorte Bancorp, Inc.’s holding company, LaPorte Savings Bank, MHC owns approximately 54.14% of its common stock, as of December 31, 2008. Directors and executive officers own or control approximately 2.89% of the common stock. The same directors and executive officers that manage LaPorte Bancorp, Inc., also manage LaPorte Savings Bank, MHC. Public stockholders who are not associated with the MHC or LaPorte Bancorp, Inc. own approximately 42.97% of the common stock. The Board of Directors of LaPorte Savings Bank, MHC will be able to exercise voting control over most matters put to a vote of stockholders because the MHC owns a majority of LaPorte Bancorp, Inc.’s common stock. For example, LaPorte Savings Bank, MHC may exercise its voting control to prevent a sale or merger transaction in which stockholders could receive a premium for their shares or to approve employee benefit plans.
We could potentially recognize goodwill impairment charges.
In connection with our acquisition of City Savings Financial, we recorded goodwill equaling $8.4 million. Pursuant to the provisions of SFAS No. 142, LaPorte Bancorp annually measures the fair value of its investment in The LaPorte Savings Bank to determine that such fair value equals or exceeds the carrying value of its investment, including goodwill. If the fair value of our investment in The LaPorte Savings Bank does not equal or exceed its carrying value, we will be required to record goodwill impairment charges which may adversely affect future earnings. The fair value of a banking franchise can fluctuate downward based on a number of factors that are beyond management’s control, (e.g. adverse trends in the general economy or interest rates). Based on the timing of the City Savings Financial acquisition in the fourth quarter of 2007, the first annual impairment review was performed in the fourth quarter of 2008. As a result of impairment testing performed as of September 30, 2008, no impairment charge was recorded by the Company. There can be no assurance that our banking franchise value will not decline in the future to a level necessitating goodwill impairment charges to operations that could be material to our results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
As of December 31, 2008, the net book value of our properties was $9.8 million. The following is a list of our offices:
The net book value of our furniture, fixtures and equipment (including computer software) at December 31, 2008 was $1.9 million.
Item 3.
Item 3. Legal Proceedings
The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of the fiscal year covered by this report, the Company did not submit any matters to the vote of security holders.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our shares of common stock are traded on the Nasdaq Capital Market under the symbol “LPSB”. The approximate number of holders of record of LaPorte Bancorp, Inc.’s common stock as of December 31, 2008 was 732. Certain shares of LaPorte Bancorp, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for LaPorte Bancorp, Inc.’s common stock for each quarter since trading commenced on October 15, 2007. The following information was provided by the Nasdaq Stock Market.
(1) LaPorte Bancorp’s common stock began trading on the Nasdaq Capital Market on October 15, 2007.
The Board of Directors has the authority to declare cash dividends on shares of common stock, subject to statutory and regulatory requirements. However, no decision has been made with respect to the payment of cash dividends. In determining whether and in what amount to pay a cash dividend, the Board is expected to take into account a number of factors, including capital requirements, our consolidated financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurances can be given that any cash dividends will be paid or that, if paid, will not be reduced or eliminated in the future.
The available sources of funds for the payment of a cash dividend in the future are interest and principal payments with respect to LaPorte Bancorp, Inc.’s loan to the Employee Stock Ownership Plan, and dividends from LaPorte Savings Bank.
If LaPorte Bancorp pays dividends to its shareholders, it also will be required to pay dividends to LaPorte Savings Bank, MHC, unless LaPorte Savings Bank, MHC elects to waive the receipt of dividends. We anticipate that LaPorte Savings Bank, MHC will waive any dividends that LaPorte Bancorp may pay. Any decision to waive dividends will be subject to regulatory approval. As long as The LaPorte Savings Bank remains an Indiana chartered savings bank, (i) any dividends waived by LaPorte Savings Bank, MHC must be retained by LaPorte Bancorp or The LaPorte Savings Bank and segregated, earmarked, or otherwise identified on the books and records of LaPorte Bancorp or The LaPorte Savings Bank, (ii) such amounts must be taken into account in any valuation of the institution, and factored into the calculation used in establishing a fair and reasonable basis for exchanging shares in any subsequent conversion of LaPorte Savings Bank, MHC to stock form and (iii) such amounts shall not be available for payment to, or the value thereof transferred to, minority shareholders, by any means, including through dividend payments or at liquidation.
LaPorte Bancorp is generally not subject to regulatory restrictions on the payment of dividends. However, if we choose to participate in the Treasury’s CPP program, our ability to pay dividends to our stockholders will be restricted. See “Supervision and Regulation - Savings Bank Regulation - U.S. Treasury’s TARP Capital Purchase Program.
In addition, our ability to pay dividends largely depends upon dividends we receive from The LaPorte Savings Bank, which are subject to regulatory restrictions on dividends. Applicable regulations limit dividends and other distributions from The LaPorte Savings Bank to us. See Item 1 Business - Supervision and Regulation Dividend Limitations. In addition, The LaPorte Savings Bank may not make a distribution that would constitute a return of capital during the three-year term of the business plan submitted in connection with the offering. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized.
At December 31, 2008, there were no compensation plans under which equity securities of LaPorte Bancorp, Inc. were authorized for issuance other than the Employee Stock Ownership Plan.
The following table presents a summary of the Company’s share repurchases during the quarter ended December 31, 2008.
(1) On November 13, 2008, the Board of Directors authorized a stock repurchase program pursuant to which the Company would repurchase, in the open market and in privately negotiated transactions, up to 50,000 of its common shares. On November 26, 2008, the Board of Directors authorized a stock repurchase program pursuant to which the Company would repurchase, in the open market and in privately negotiated transactions, up to 60,000 of its common shares. On December 23, 2008, the Board of Directors authorized a stock repurchase program pursuant to which the Company would repurchase, in the open market and in privately negotiated transactions, up to 55,000 of its common shares. On February 26, 2009, the Board of Directors terminated this program after 37,500 shares had been repurchased at a weighted average cost of $5.41 per share.
Item 6.
Item 6. Selected Financial Data
The following information is derived from the audited consolidated financial statements of LaPorte Bancorp, Inc. For additional information, reference is made to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of LaPorte Bancorp, Inc. and related notes included elsewhere in this Annual Report.
(1) Represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period.
(2) Represents net interest income as a percent of average interest-earning assets for the period.
(3) Represents noninterest expense divided by the sum of net interest income and noninterest income. The efficiency ratio presented above includes other than temporary impairment losses on investments totaling $1,711, $228, $0, $0 and $1,486 for 2008 through 2004, respectively. The efficiency ratio excluding these losses would be 84.87%, 87.47%, 82.52%, 85.76% and 91.82% for 2008 through 2004.
(4) Represents capital ratios of The LaPorte Savings Bank.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Our results of operations depend mainly on our net interest income, which is the difference between the interest income earned on our loan and investment portfolios and interest expense paid on our deposits and borrowed funds. Results of operations are also affected by fee income from banking operations, provisions for loan losses, gains (losses) on sales and other than temporary impairment charges of loans and securities and other miscellaneous income. Our noninterest expenses consist primarily of salaries and employee benefits, occupancy and equipment, data processing, advertising, bank examination fees, amortization of intangibles, general administrative expenses, deposit insurance fees and income tax expense (benefit). Our results of operations are also significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations. See “Item 1A. Risk Factors.”
Critical Accounting Policies
We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies:
Securities. Securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available-for-sale when they might be sold before maturity. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss), net of tax, and as a separate component of shareholders’ equity. Other securities, such as Federal Home Loan Bank of Indianapolis stock, are carried at cost.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities and collateralized mortgage obligations where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) The LaPorte Savings Bank’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. 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. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.
A loan is impaired with specific allowance amounts allocated, if applicable, in accordance with SFAS. No. 114 when full payment under the loan terms is not expected. Loans included for analysis for potential impairment under SFAS No. 114 are all commercial and commercial real estate loans classified by The LaPorte Savings Bank as Substandard, Doubtful or Loss. Such loans are analyzed to determine if specific allowance allocations are required under either the fair value of collateral method, for all collateral dependent loans, or using the present value of estimated future cash flows method, using the loan’s existing interest rate as the discount factor. Other factors considered in the potential specific allowance allocation measurement are the timing and reliability of collateral appraisals or other collateral valuation sources, the confidence in The LaPorte Savings Bank’s lien on the collateral, historical losses on similar loans, and any other factors known to management at the time of the measurement that may affect the valuation. Based on management’s consideration of these factors for each individual loan that is reviewed for potential impairment, a specific allowance allocation is assigned to the loan, if applicable, and such allocations are periodically monitored and adjusted as appropriate
Non-specific general allowance amounts are allocated in accordance with SFAS No. 5. Loans included for analysis under SFAS No. 5 are all other loans not considered in the specific allowance allocation analysis under SFAS No. 114 described above. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly they are not separately identified for impairment disclosures. A minimum and maximum allowance allocation estimate is determined for each general loan category or loan pool based on the current three year historical average annual loss ratios as well as consideration of significant recent changes in annual historical loss ratios, classified loan trends by category, delinquency ratios and inherent risk factors attributable to current local and national economic conditions.
All of the allowance for loan losses is allocated under the specific and general allowance allocation methodologies described above. Management reviews its allowance allocation estimates and loan collateral values on at least a quarterly basis and adjusts the allowance for loan losses for changes in specific and general allowance allocations, as appropriate. Any differences between the estimated and actual observed loan losses are adjusted through increases or decreases to the allowance for loan losses on at least a quarterly basis and such losses are then factored into the revised historical average annual loss ratios for future quarterly allowance allocations.
The Bank is subject to periodic examinations by its federal and state regulatory examiners and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations. The process of assessing the adequacy of the allowance for loan losses is necessarily subjective. Further, and particularly in times of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management’s current estimates of incurred credit losses inherent within the loan portfolio. As such, there can be no assurance that future charge-offs will not exceed management’s current estimate of what constitutes a reasonable allowance for loan losses.
The Company acquired a group of loans through the acquisition of City Savings Financial Corporation on October 12, 2007. Purchased loans that showed evidence of credit deterioration since their origination were recorded at an allocated fair value, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, incurred losses are recognized by an increase in the allowance for loan losses. For further information about the accounting treatment of purchased loans subject to SOP 03-3, see Note 3 of the Notes to Consolidated Financial Statements included in Part IV hereof.
Income Taxes. Income tax expense (benefit) is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption had no effect on the Company’s consolidated financial condition or results of operations.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Valuation of Goodwill and Other Intangible Assets. We assess the carrying value of our goodwill at least annually in order to determine if this intangible asset is impaired. In reviewing the carrying value of our goodwill, we assess the recoverability of such assets by evaluating the fair value of the related business unit. If the carrying amount of goodwill exceeds its fair value, an impairment loss is recognized for the amount of the excess and the carrying value of goodwill is reduced accordingly. Any impairment would be required to be recorded during the period identified.
Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets, establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. At December 31, 2008, the Company had core deposit intangibles of $1.3 million subject to amortization and $8.4 million of goodwill, which is not subject to amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets arising from the acquisition of City Savings Financial in 2007. SFAS No. 142 requires an annual evaluation of goodwill for potential impairment using various estimates and assumptions. The Company became a publicly traded entity in October 2007 and due to the deteriorating financial environment that began at that time, the Company’s common stock has traded below book value since origination. The market price of the Company’s common stock at the close of business on December 31, 2008 was $5.25 per common share, compared to a book value of $9.91 per common share. Management believes the lower market price in relation to book value of the Company’s common stock is due to the overall decline in the financial industry sector and is not specific to the Company. Further, the Company engaged an independent third party specialist to perform an impairment test of its goodwill. The evaluation included three approaches:
1) income approach using a discounted cash flow analysis based on earnings capacity, 2) comparable sales transactions approach and 3) control premium price to book value ratios. Approaches 2 and 3 used median results from 50 bank sale transactions that occurred during 2007 and 2008. The selling banks ranged in size from $107 million to $976 million. The impairment test was performed as of September 30, 2008 and resulted in an implied fair value for the Company sufficiently above the book value of its common stock to support the carrying value of goodwill.
Based on the annual evaluation performed as of September 30, 2008 and completed in January 2009, management determined that the fair value of the reporting unit, which is defined as the Company as a whole, exceeded the carrying value of the goodwill, based on the opinion of the independent third party specialist that a control premium would be paid by a potential acquirer, such that the Company’s sale price per common share would exceed its book value per common share. Accordingly, no goodwill impairment was recognized in 2008. As the Company’s stock price per common share is currently less than its book value per common share, it is reasonably possible that management may conclude that goodwill, totaling $8.4 million at December 31, 2008, is impaired as a result of a future assessment. If our goodwill is determined to be impaired, the related charge to earnings could be material.
Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from a whole bank acquisition. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which range from 4 to 15 years. These intangible assets are also periodically evaluated for impairment. In the future, if these other intangible assets are determined to be impaired, our financial results could be materially impacted.
Business Strategy
Our business strategy is to enhance operations by:
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Increasing Commercial Real Estate Lending. In order to increase the yield of and reduce the term to repricing of our loan portfolio, we have increased our originations and, to a lesser extent, purchases of commercial real estate loans. However, we may limit the growth of such lending over the next several quarters until economic conditions begin to improve.
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Maintaining Our Status As An Independent Community Oriented Institution. We intend to use our customers’ connections and our knowledge of our local community to enhance our status as an independent community financial institution.
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Managed Growth. We believe that it can be helpful to increase our loans and deposits, if possible, in order to help cover the costs of operating in a highly competitive and regulated marketplace. Our acquisition of City Savings Financial was a part of this effort. In the future, we will continue, subject to market and economic conditions, to explore ways to grow our franchise both through internal growth and external acquisitions.
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Maintaining the Quality of our Loan Portfolio. Maintaining the quality of our loan portfolio is a key factor in managing our operations, particularly during a period of economic downturn. We will continue to use customary risk management techniques, such as independent internal and external loan reviews, portfolio credit analysis and field inspections of collateral in overseeing the performance of our loan portfolio.
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Managing Interest Rate Risk. We believe that it is difficult to achieve satisfactory levels of profitability in the financial services industry without assuming some level of interest rate risk. However, we believe that such risk must be carefully managed to avoid undue exposure to changes in interest rates. Accordingly, we seek to manage to the extent practical our interest rate risk.
We believe that these strategies will guide our investment of the net proceeds of the 2007 stock offering. We intend to continue to pursue our business strategy after the reorganization and the offering, subject to changes necessitated by future market conditions and other factors.
Comparison of Financial Condition At December 31, 2008 and December 31, 2007
General: Total assets increased $1.3 million, or 0.4%, to $368.6 million at December 31, 2008 from $367.3 million at December 31, 2007. The increase was primarily due to an increase in securities available-for-sale of $5.4 million, or 5.6%, offset by a decrease in cash and due from financial institutions of $4.3 million, or 43.4%. The continued competitive pressure on deposit interest rates contributed to an increase in Federal Home Loan Bank advances of $12.2 million and a decrease in total deposits of $11.5 million as of December 31, 2008.
Investment Securities: Securities available-for-sale increased $5.4 million, or 5.6%, to $101.5 million at December 31, 2008 from $96.0 million at December 31, 2007 funded primarily by a decrease in cash and due from financial institutions of $4.3 million and a decrease in net loans receivable of $571,000. During 2008, the Company recorded other-than-temporary impairment charges of $1.2 million related to the Freddie Mac preferred stock issues it held in the investment portfolio. At December 31, 2008 these securities are carried at $10,400. In 2008 the Company also recorded an other-than-temporary impairment charge of $480,000, or 100% of its carrying value, with respect to a Lehman Brothers Holdings bond it held. At December 31, 2008, the Company held $5.6 million in corporate debt securities, all of which are considered investment grade securities.
Net Loans: There was no material change in the balance of net loans at December 31, 2008 compared to December 31, 2007; however the Company did experience a change in composition of its loan portfolio.
Commercial business loans increased $2.0 million, or 11.7%, to $19.4 million at December 31, 2008 from $17.4 million at December 31, 2007. This increase is primarily attributable to an increase in loans to states and political subdivisions of $4.4 million
to $4.6 million at December 31, 2008 compared to $218,000 at December 31, 2007. These loans are primarily short term tax anticipation warrants issued by local schools and cities. This increase was partially offset by a decrease in commercial and industrial loans of $2.3 million.
One- to four-family residential loans decreased $8.7 million, or 9.3%, to $84.7 million at December 31, 2008 compared to $93.4 million at December 31, 2007. The Bank has continued to sell the majority of its fixed rate one- to four-family residential real estate loans originated, which along with repayment and refinance activity accounted for the decrease. Residential construction loans decreased $3.0 million, or 44.5%, to $3.7 million at December 31, 2008 compared to $6.7 million at December 31, 2007, primarily attributable to the slowdown in new home construction in the markets we serve.
Commercial real estate loans increased $5.7 million, or 9.7%, to $65.1 million at December 31, 2008 compared to $59.3 million at December 31, 2007 primarily attributable to an increase in loan demand in the new markets served as a result of the City Savings Financial Corporation acquisition on October 12, 2007. Commercial construction loans decreased $551,000, or 12.1%, to $4.0 million at December 31, 2008 from $4.6 million at December 31, 2007, primarily due to the lack of demand during the current economic challenges.
Consumer and home equity loans, including indirect automobile loans, decreased $6.1 million, or 17.2%, to $29.2 million at December 31, 2008 compared to $35.3 million at December 31, 2007. This decrease is primarily attributable to a decrease of $3.6 million in indirect automobile loans, attributable to the pricing changes management implemented over the last several years in order to decrease the Bank’s exposure in this type of lending. The indirect automobile loan portfolio was at $6.0 million at December 31, 2008 compared to $9.6 million at December 31, 2007, and management expects to see this portfolio continue to decline in the future. Home equity lines of credit and loans also decreased at December 31, 2008 by $1.4 million at December 31, 2008 compared to December 31, 2007 due to the lack of demand at this time. Management elected to change the loan to value requirements on home equity loans and lines of credit in the third quarter of 2008 to a maximum of 80% from a maximum of 90%, due to the current conditions in the housing market. The Bank has an interest rate floor on its outstanding variable rate home equity lines of credit of 4.00%.
The allowance for loan losses balance increased $715,000, or 39.8%, to $2.5 million at December 31, 2008 compared to $1.8 million at December 31, 2007, primarily attributable to the increase in nonperforming loans and a $326,000 increase in net charge-offs from $84,000 for 2007 to $410,000 for 2008. Total nonperforming loans increased $4.7 million, to $6.7 million at December 31, 2008 compared to $2.1 million at December 31, 2007. This increase in nonperforming loans is primarily attributable to one loan relationship totaling $3.3 million, acquired in the acquisition of City Savings Financial. Total nonperforming loans to total loans were 3.04% at December 31, 2008 compared to 0.94% at December 31, 2007. Total nonperforming assets to total assets at December 31, 2008 were 2.08% compared to 0.69% at December 31, 2007. Other real estate owned increased $467,000, or 102.9%, to $921,000 at December 31, 2008 compared to $454,000 at December 31, 2007. This increase is primarily attributable to loans acquired through the City Savings Financial acquisition that subsequently were taken into other real estate.
Mortgage servicing rights decreased $83,000, or 20.1%, to $329,000 at December 31, 2008 compared to $412,000 at December 31, 2007, primarily due to a valuation allowance of $42,000 established in the fourth quarter of 2008. This valuation allowance is a result of the increase in mortgage refinance activity as well as the overall cost of collection and foreclosure costs associated with the serviced loan portfolio built into the assumptions used in a third party valuation. Management expects that the value of its mortgage servicing rights may continue to decline based on the current housing market conditions and the potential acceleration of loan prepayments and potential increase in loan charge-offs.
Goodwill and Other Intangible Assets: The Company’s goodwill totaled $8.4 million at December 31, 2008 and December 31, 2007. Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), Goodwill and Other Intangible Assets (as amended), requires goodwill to be tested for impairment on an annual basis, or more frequently if circumstances indicate that an asset might be impaired, by comparing the fair value of such goodwill to its recorded or carrying amount. If the carrying amount of the goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess. Based on the timing of the City Savings Financial acquisition in the fourth quarter of 2007, the first annual impairment review of the $8.4 million of goodwill previously recorded was performed in the fourth quarter of 2008. As a result of impairment testing performed, no impairment charge was recorded by the Company.
The fair value of goodwill was estimated using a number of measurement methods. These included the application of various metrics from bank sale transactions for institutions comparable to LaPorte Bancorp, Inc., including the application of market-derived multiples of tangible book value and earnings, as well as estimations of the present value of future cash flows. Based on this evaluation completed in January 2009, management determined that the fair value of the reporting unit, which is defined as the Company as a whole, exceeded the carrying value of the goodwill, based on the opinion of an independent third party specialist that a control premium would be paid by a potential acquirer, such that the sale price per common share of the Company would exceed its book value per common share. Accordingly, no goodwill impairment was recognized in 2008. As the Company’s stock price per common share is currently less than its book value per common share, it is reasonably possible that management may conclude that goodwill, totaling $8.4 million at December 31, 2008, is impaired as a result of a future assessment. If our goodwill is determined to be impaired, the related charge to earnings could be material.
Premises and Equipment: Net premises and equipment increased $800,000, or 7.3%, to $11.7 million at December 31, 2008 compared to $10.9 million at December 31, 2007, primarily attributable to the completion and opening of the Bank’s retail branch in Westville, Indiana.
Deposits: Total deposits decreased $11.5 million, or 4.7%, to $234.8 million at December 31, 2008 from $246.3 million at December 31, 2007, with the decrease primarily in certificate of deposits and IRAs and passbook savings. Management continued to decrease interest rates offered throughout 2008 on savings and other interest-bearing deposits in response to the overall decrease in market interest rates. Some of our competition has priced their deposits more aggressively in order to attract deposits. Management has elected to remain competitive, but has not offered what we consider to be excessive rates of interest on deposits when compared to other sources of funding, which has contributed to the decrease in deposits. If commercial loan demand continues to increase, this strategy may be altered in order to attract deposits.
Borrowed Funds: Federal Home Loan Bank of Indianapolis borrowings increased $12.2 million, or 18.4%, to $78.7 million at December 31, 2008 from $66.5 million at December 31, 2007. The increase is primarily attributable to replenishing our funding sources due to the decrease in deposits and the lower cost of funding for Federal Home Loan Bank advances when compared to deposits.
Total Shareholders’ Equity: Total shareholders’ equity decreased $563,000, or 1.2%, to $46.1 million at December 31, 2008 compared to $46.7 million at December 31, 2007 primarily attributable to a net loss of $400,000 for 2008 and purchases of $774,000 of treasury stock during the fourth quarter of 2008. These decreases were partially offset by a decrease of $607,000 in accumulated other comprehensive loss, net of tax from a loss of $224,000 at December 31, 2007 to income of $383,000 at December 31, 2008. The decrease in accumulated other comprehensive loss, net of tax, of $607,000 was primarily due to the decrease in interest rates during 2008 and its positive impact on the market values on securities held in the Company’s available for sale investment portfolio at December 31, 2008. In the last quarter of 2008, the Company participated in a stock buyback program in which it purchased $774,000 or 125,000 shares of its common stock, now held as treasury stock.
Comparison of Operating Results For The Years Ended December 31, 2008 and December 31, 2007
Net Income (Loss): Net income decreased $1.1 million, to a net loss of $400,000, for the year ended December 31, 2008, from net income of $717,000 for the year ended December 31, 2007. This decrease is primarily attributable to a $1.5 million increase in other-than-temporary impairment charges recorded in 2008 compared to 2007, a $1.1 million increase in the provision for loan losses for 2008 compared to 2007, a $1.7 million increase in noninterest expense for 2008 as compared to 2007, as well as a decrease in net gains on securities of $633,000 from the prior year. These reductions in earnings were partially offset by a $2.8 million increase in net interest income and a $810,000 decrease in tax expense for 2008 as compared to 2007. These changes are explained in the following discussion.
Net Interest Income: Net interest income increased $2.8 million to $9.9 million for the year ended December 31 2008 from $7.1 million for the year ended December 31, 2007. This increase is primarily attributable to the increase in average interest-earning assets
of $74.3 million for 2008 compared to 2007, primarily a result of the City Savings Financial acquisition in the fourth quarter of 2007. This increase was partially offset by the increase in average interest-bearing liabilities of $72.1 million for the year ended December 31, 2008 compared to the prior year. Net interest spread increased 35 basis points from 2.39% for 2007 to 2.74% for 2008, primarily due to the overall decline in interest rates as well as a decrease in the average cost of Federal Home Loan Bank of Indianapolis advances acquired from City Savings Financial compared to the Company’s existing long-term advances at the time of the acquisition. The yield on average interest-earning assets decreased 14 basis points from 6.14% for 2007 to 6.00% for 2008, primarily attributable to the decline in interest rates. Partially offsetting the effects of the decline in interest rates was an increase in the average loans to total average interest-earning assets ratio to 67.3% for the year ended December 31, 2008 compared to 62.1% for the prior year, primarily a result of the mix of the City Savings Bank interest-earning assets.
Interest and Dividend Income: Interest and dividend income increased $4.1 million, or 27.0%, to $19.4 million for the year ended December 31, 2008 from $15.2 million for the year ended December 31, 2007. This increase is primarily attributable to the acquisition of City Savings Financial.
Interest income on loans, including fees, increased $3.4 million, or 31.6%, for the year ended December 31, 2008 compared to the prior year, primarily due to the increase in average loans from the City Savings Financial acquisition in the fourth quarter of 2007. Offsetting this increase in income on loans is a decrease in the annualized average loan yield of 45 basis points from 7.00% for 2007 to 6.55% for 2008. This decrease was primarily the result of a decline in the prime rate over the prior year and its impact on the yield on variable rate loans as well as the pricing on new and renewed loans. This decrease was partially offset by additional income recorded in 2008 under SOP 03-3 for the accounting for a number of commercial and industrial loans and a home equity loan acquired through the acquisition of City Savings Financial that paid off during the year ended December 31, 2008. We recorded $59,000 in additional income on commercial and industrial loans and $91,000 in additional interest income on consumer and home equity loans that paid off during the year ended December 31, 2008, which increased the overall annualized average loan yield by 7 basis points for the year ended December 31, 2008.
Interest income from taxable securities increased $871,000, or 23.1%, to $4.6 million for the year ended December 31, 2008 compared to $3.8 million for the year ended December 31, 2007. This increase is primarily due to the increase in the average balance of taxable securities of $13.2 million for the year ended December 31, 2008 as compared to 2007 attributable to the City Savings Financial acquisition in the fourth quarter of 2007. The annualized average yield on taxable securities increased 26 basis points from 4.80% for 2007 to 5.06% for 2008, primarily due to the higher yielding securities acquired with City Savings Financial in the fourth quarter of 2007 as well as the affect of investment portfolio restructuring that occurred after the acquisition. This increase was partially offset by the elimination of the dividend on the Freddie Mac Preferred stock as well as the interest on Lehman Brothers Holdings Inc. bonds that were written down in 2008 due to other than temporary impairment. The annualized impact on interest income from this lost income is expected to be a reduction of approximately $128,000. We experienced a decrease in interest income from tax-exempt securities of $171,000, or 44.6%, primarily due to a decrease in the average balance of tax exempt securities of $3.9 million for the year ended December 31, 2008 as compared to 2007. The decrease was primarily due to the sale of a portion of tax-free municipal securities during 2008 that were reinvested into taxable securities during 2008, due to a change in the Company’s state tax planning objectives, given the tax effect of the City Savings Financial acquisition.
Dividend income of Federal Home Loan Bank of Indianapolis stock increased $68,000, or 48.2%, for the year ended December 31, 2008 compared to the prior year, primarily attributable to the increase in stock acquired in the City Savings Financial acquisition in the fourth quarter of 2007 as well as an increase of 27 basis points in the annualized average yield from 4.72% for 2007 to 4.99% for 2008. The Federal Home Loan Bank of Indianapolis decreased the dividend paid in the fourth quarter of 2008 to 4.75% from 5.25% in the previous quarter. The Federal Home Loan Bank of Indianapolis deferred the declaration of the fourth quarter dividend, normally paid in January 2009. The decision was deferred because of the need to finalize the review of the Federal Home Loan Bank of Indianapolis’ private label mortgage backed securities for other-than-temporary impairment. On February 20, 2009 the Federal Home Loan Bank of Indianapolis (FHLBI) did announce the declaration of the fourth quarter 2008 dividend. The dividend declared on the stock was 4.00%, a decrease from 4.75% for the previous quarter. In the February 20, 2009 letter to its members, the FHLBI indicated that they determined that none of its private-label mortgage backed securities were other-than-temporarily impaired as of December 31, 2008. Should the decision be made to suspend dividend payments on the Federal Home Loan Bank of
Indianapolis stock at some point in the future, it would have a negative impact on the Company’s earnings. Based on the most recent quarter’s dividend rate of 4.00%, dividend income would be decreased by approximately $168,000. Interest income from federal funds sold and other interest bearing deposits decreased $71,000, or 48.0%, for the year ended December 31, 2008 compared to the prior year, primarily due to a decrease in the annualized average yield of 300 basis points from 5.00% for 2007 to 2.00% for 2008.
Interest Expense: Interest expense increased $1.3 million, or 15.9%, to $9.4 million for 2008 compared to $8.1 million for 2007. This increase is primarily attributable to the increase of $72.1 million in average interest earning liabilities for 2008 compared to 2007 primarily due to the acquisition of City Savings Bank in the fourth quarter of 2007. This increase was partially offset by a decrease in the annualized average cost of interest bearing liabilities of 49 basis points, to 3.26% for 2008 from 3.75% for 2007. This decrease is due to the continued decrease in interest rates paid on interest-bearing deposits as well as the decrease in the average cost of Federal Home Loan Bank of Indianapolis advances and subordinated debentures for 2008 compared to 2007.
The annualized average cost of savings deposits decreased 26 basis points, to 0.25%, for 2008 compared to 0.51% for 2007, primarily due to management’s decision to decrease interest rates offered during 2008. In the third quarter of 2008 the interest rates being offered on savings deposits was lowered to 0.15%, which is not fully reflected in the 2008 annual results. The annualized average cost of money market and NOW accounts decreased 86 basis points from 1.98% for 2007 to 1.12% for 2008, primarily due to the decline in market interest rates during 2008. The annualized average cost of certificates of deposits and IRA time deposits for the year ended December 31, 2008 decreased 70 basis points to 3.94% for 2008 from 4.64% for 2007, primarily due to the overall decrease in interest rates offered for new or renewed deposits during 2008 compared to the interest rates on maturing deposits. Management does not expect to see a significant continued decrease on the annualized average cost of certificates of deposit and IRAs in the next year.
Interest expense on Federal Home Loan Bank of Indianapolis advances increased $872,000, or 37.1%, for 2008 compared to 2007, primarily due to the additional advances acquired in the City Savings Bank acquisition in the fourth quarter of 2007. The average balance on advances also increased for the year ended December 31, 2008 due to the lower cost of funding on these advances compared to deposits. Interest expense on subordinated debentures increased $237,000 for 2008 compared to 2007, primarily attributable to the City Savings Bank acquisition in the fourth quarter of 2007. The average cost of the subordinated debentures was 6.38% for 2008 compared to 8.35% for 2007. The interest rate adjusts quarterly at the rate of the three month libor plus 3.10%. The subordinated debentures bore an interest rate of 4.57% as of December 31, 2008 compared to 7.96% at December 31, 2007.
Provision for Loan Losses: The Bank recognizes a provision for loan losses, which is charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loan loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers’ ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. After an evaluation of these factors, management recognized a provision for loan losses of $1.1 million for 2008 compared to a $64,000 for 2007. Net charge-offs for the same periods were $410,000 and $84,000, respectively. The increase in the provision for loan losses was primarily due to an increase in nonperforming loans, most of which were acquired through the City Savings Financial acquisition, an increase in classified loans, growth in commercial loans as well as the overall increased national and local economic concerns and the $326,000 increase in net charge-offs for 2008 as compared to 2007.
The allowance for loan losses to total loans ratio increased to 1.13% at December 31, 2008 compared to 0.81% at December 31, 2007. The allowance for loan losses to nonperforming loans ratio was 37.21% at December 31, 2008 compared to 86.15% at December 31, 2007. Management’s assessment of losses that are probable and reasonably estimable at December 31, 2008 on the loans accounted for under SOP 03-3 were not included as part of the allowance for loan losses unless the loans further deteriorated since the acquisition date, but instead were accounted for under SOP 03-3. See Note 3 of the Notes to Consolidated Financial Statements for further information about the accounting treatment of purchased loans subject to SOP 03-3.
Noninterest Income: Noninterest income decreased $2.0 million, or 69.2%, to $879,000 for 2008 compared to $2.9 million for 2007. This decrease was primarily attributable to a $1.5 million increase in other-than-temporary impairment charges recorded in 2008 compared to 2007, as well as a decrease in net gains on securities of $633,000 from the prior year. During 2007, the Company sold the majority of its Fannie Mae and Freddie Mac preferred stock and recorded a gain of $896,000. The Company continued to hold $1.2 million in Freddie Mac preferred stock, for which we recorded approximately $1.2 million of other-than-temporary impairment charges during 2008. Additionally, in view of the bankruptcy filing of Lehman Brothers Holdings, the Company also recorded an other-than-temporary impairment charge of $480,000 during 2008 with respect to 100% of the Lehman debt securities it owned. Brokerage fee income decreased $71,000, or 33.2%, for 2008 compared to 2007 primarily due to the overall instability in the market and its negative impact on the volume of brokerage activity. Loan servicing fees decreased $69,000, or 69.7%, for 2008 compared to 2007, primarily attributable to a $42,000 valuation allowance provision taken against the Company’s mortgage servicing rights asset. Other income decreased $148,000, or 61.4%, for 2008 primarily due to a decrease in net gains on sales of other assets of $147,000. This decrease was partially a result of net losses of $67,000 on the sale of other real estate owned during 2008 compared to net losses of $48,000 during 2007.
Partially offsetting the decrease in noninterest income for 2008 as compared to 2007 was an increase of $170,000 in service charges on deposit accounts as well as a $61,000 increase in ATM and debit card fees, both of which are attributable to the increase in checking accounts as a result of the City Savings Financial acquisition in the fourth quarter of 2007. Earnings on life insurance increased $106,000 for 2008 compared to 2007 primarily due to the additional bank owned life insurance acquired in the City Savings Financial acquisition in the fourth quarter of 2007. Net gains on mortgage banking activities increased $98,000, or 41.7%, for 2008 compared to 2007 primarily attributable to an additional loan originator working in the new markets as a result of the acquisition, in addition to an increase in loan refinancing activity in the fourth quarter of 2008.
Noninterest Expense: Noninterest expense increased $1.7 million, or 19.1%, to $10.6 million for 2008 compared to $8.9 million for 2007, primarily due to the acquisition of City Savings Financial in the fourth quarter of 2007. Salaries and employee benefits increased $627,000, or 12.7%, primarily due to the additional employees brought on through the acquisition, as well as the addition of a Controller, Vice President of Commercial Lending, and a Commercial Lender in the Porter County market in late 2007. The Company did not accrue or award a management bonus for 2008 based on the current net income requirements of the bonus plan compared to a $114,000 bonus expense for 2007. Occupancy and equipment expense increased $326,000, or 20.1%, for 2008 compared to 2007, primarily due to the addition of three branch locations acquired through City Savings Financial in the fourth quarter of 2007, as well as the new Westville branch that opened in June of 2008. Increased real estate tax expense accounted for $95,000 of the increase as well as an increase in depreciation expense of $77,000, an increase in utilities and telephone of $64,000, and an increase in building maintenance and services of $79,000, all of which are primarily attributable to the increase in branch locations.
Data processing expense decreased $156,000, or 28.1%, for 2008 compared to 2007, primarily due to $167,000 in initial conversion costs from our providers of technology during the third quarter of 2007 related to the conversion costs with the acquisition, as well as operating efficiencies gained as a result of the acquisition and the consolidation to one core processor.
Advertising expense increased $65,000, or 48.2%, for 2008 compared to 2007, primarily attributable to the new markets served and the opening of the Westville branch.
Bank examination fees increased $150,000, or 37.6%, of which $88,000 of this increase was in the first quarter of 2008 due to additional costs attributable to our first external audit and annual SEC reporting as a public company, including a review of our purchase accounting entries for the acquisition of City Savings Financial in the fourth quarter of 2007. Internal audit fees also increased by approximately $74,000 attributable to the implementation of internal control assessment requirements under SOX Section 404 during 2008.
The amortization of intangibles expense increased $306,000 for 2008 compared to 2007, as a result of a full year of amortization expense for 2008 compared to one quarter’s amortization expense for 2007 as a result of the acquisition of City Savings Financial in the fourth quarter of 2007.
Other expenses increased $386,000 for 2008 as compared to 2007, primarily due to an increase in collection and OREO related expenses of $165,000 in 2008 as compared to 2007 as well as an increase in legal expense of $100,000 in 2008 as compared to 2007. The increase in legal expense is a result of our first annual Form 10-K review and our first annual shareholders’ meeting, as well as an increase in legal work associated with loan foreclosure and collection activity.
Correspondent bank charges increased $38,000 for 2008 compared to 2007 primarily attributable to an increase in the Bank’s Federal Reserve monthly charges as a result of the increase in processed items due to the acquisition of City Savings Financial in the fourth quarter of 2007.
FDIC insurance expense, included in other expenses, increased $28,000, or 87.6%, for 2008 compared to 2007, primarily attributable to the increase in deposits due to the acquisition of City Savings Financial in the fourth quarter of 2007. Since June 2007, our FDIC assessment has been reduced by a special credit. This credit was substantially exhausted by year end 2008. In addition, the premium rates set by the FDIC for 2009 have substantially increased over prior year rates. Management estimates this could result in an increase of approximately $312,000 in FDIC insurance expense in 2009 compared to 2008. On March 2, 2009 the FDIC adopted an interim rule setting a special assessment of 20 basis points for June 30, 2009, to be collected September 30, 2009. Management estimates this additional increase to be approximately $490,000 in FDIC insurance expense in 2009. Later, the FDIC reduced this special assessment to 10 basis points, subject to congressional action. Management estimates that a special assessment of 10 basis points would result in a cost of $245,000 for 2009. The Company’s other insurance expenses increased $34,000 for 2008 compared to 2007, attributable to an increase in property and casualty insurance premiums as well as an increase in the coverage limits attributable to the acquisition of City Savings Financial in the fourth quarter of 2007. Other miscellaneous services expense decreased $31,000 for 2008 compared to 2007, primarily attributable to $47,000 in recruitment expenses paid in 2007. These recruitment fees were attributable to the hiring of the Vice President of Commercial Lending and a new Commercial Lender for the Porter County market.
Income Taxes: Income tax expense decreased $810,000, or 302.2%, to a tax benefit of $542,000 for 2008 compared to an income tax expense of $268,000 for 2007. This substantial decrease is primarily due to the decrease in income before taxes of $1.9 million. The income tax expense recorded for 2007 also reflected an additional $183,000 of expense to increase the valuation allowance for deferred tax assets for the portion of the net state deferred tax asset that management feels is not realizable as a result of the additional state net operating loss carry forward brought over from City Savings Financial. The total additional income tax expense related to the adjustment of the valuation allowance for the net state deferred tax asset was $71,000 for 2008, compared to $495,000 for 2007. The resulting effective income tax rate was a (57.5%) benefit for 2008 and a 27.2% expense for 2007.
Comparison of Operating Results For The Years Ended December 31, 2007 and December 31, 2006
Net Income: Net income decreased $400,000 or 35.8% to $717,000 for 2007 from $1.1 million for 2006, primarily attributed to $658,000 in noninterest expenses related to the reorganization, stock offering and acquisition of City Savings Financial Corporation in the fourth quarter of 2007. All indirect costs related to the acquisition were expensed as they were incurred. In addition, an other-than-temporary securities impairment loss of $228,000 was recorded in the fourth quarter of 2007. The increase in non-interest expenses was partially offset by an increase in net interest income of $469,000 as well as an increase in net gains on securities of $918,000.
Net Interest Income: Net interest income increased $469,000 or 7.1% to $7.1 million for 2007 from $6.6 million for 2006, primarily attributable to the increase in net interest earning assets acquired from City Savings Financial in the fourth quarter of 2007. Although the net interest rate spread decreased by five basis points in 2007, the net interest margin remained stable at 2.86% for 2007 as compared to 2.85% for 2006. The yield on average interest-earning assets increased 32 basis points, offset by an increase in the cost on average interest-bearing liabilities of 37 basis points. The increase in the cost of funds was the result of the increased competitive pressure to raise our interest rates on interest-bearing checking accounts and certificates of deposit early in 2007 as well as the cost on the subordinated debt issue acquired from City Savings Financial in the fourth quarter of 2007.
Interest and Dividend Income: Interest and dividend income increased $1.7 million or 12.2% to $15.2 million for 2007 from $13.6 million for 2006. The increase was primarily attributable to the increase in the average yield on both loans and investments for 2007 compared to 2006, as well as the increase in total loans and investments due to the City Savings Financial acquisition in the fourth quarter of 2007.
The average yield on taxable securities increased 21 basis points to 4.80% for 2007 compared to 4.59% for 2006. The average yield on loans increased 34 basis points to 7.00% for 2007 as compared to 6.66% for 2006. This increase was attributable to a higher yield on our one- to four-family residential real estate loans as well as the increase in the yield on our indirect auto loan portfolio. The average yield on one- to four-family real estate loans increased 34 basis points, primarily because of new originations at higher rates as well as the acquisition of the City Savings Bank higher yielding one-to four-family residential loans in the fourth quarter of 2007. The yield on our indirect portfolio increased by 42 basis points for 2007 compared to 2006 due to management’s decision to change its pricing structure in 2006, due to credit risk involved, realizing that the balance on the portfolio would be decreasing over time.
Other interest income decreased $104,000 for 2007 due to a decrease of $2.2 million in average federal funds sold and other interest bearing deposits compared to 2006.
Interest Expense: Interest expense increased $1.2 million or 17.1% to $8.1 million for 2007 from $6.9 million for 2006. This increase was attributable to the increase in interest-bearing deposits and borrowings acquired from City Savings Financial in the fourth quarter of 2007, as well as an increase in the average cost of interest bearing liabilities of 37 basis points. The average balance on total interest bearing deposits and borrowings increased $11.3 million for 2007 compared to 2006.
The average cost of interest-bearing deposits increased 40 basis points for 2007 compared to 2006 due to the continued competitive pressure on interest rates paid for deposits earlier in 2007. This trend had begun to abate as interest rates declined significantly in the last six months of 2007. The average balance on total interest bearing deposits increased $12.1 million due to the acquisition of City Savings Financial in the last quarter of 2007.
In the second half of 2006, management elected to tier and increase the rates paid on NOW and money market accounts in order to compete with other banks in the marketplace. This resulted in an increase in the average cost of NOW and money market deposits of 72 basis points for 2007 compared to 2006. As interest rates started to decline significantly in the second half of 2007, management significantly lowered the interest rates on these accounts.
Interest expense on borrowings increased $146,000 or 6.3% to $2.5 million for 2007 from $2.3 million for 2006. This increase was largely attributable to the interest cost on the subordinated debt acquired from City Savings Financial in the fourth quarter of 2007. The average cost of the subordinated debt was 8.35% for 2007. As mentioned previously, the preferred debt adjusts quarterly at the rate of the 3 month labor plus 3.10%. The preferred debt bore an annual rate of 7.96% as of December 31, 2007.
Provision for Loan Losses: Our allowance for loan loss is the estimated amount considered necessary to reflect probable incurred losses in the loan portfolio at the balance sheet date. Our analysis of the appropriate allowance includes a review of identifiable problem loans for which a specific allowance is required as well as general allowance allocations for the remainder of the loan portfolio. The Company acquired a group of troubled loans through the acquisition of City Savings Financial on October 12, 2007. Acquired loans that showed evidence of credit deterioration since their origination were recorded at an allocated fair value, such that there was no carryover of the seller’s allowance for loan losses. After acquisition, incurred losses were recognized by an increase in the allowance for loan losses. For further information about the accounting treatment of purchased loans subject to SOP 03-3, see Note 3 of the Notes to Consolidated Financial Statements included in Part IV hereof.
A provision for loan losses of $64,000 was recorded for 2007 compared to a provision of $143,000 for 2006. Net loan charge offs for 2007 were $84,000 compared to the provision for loan losses of $64,000. Total nonperforming loans increased $1.2 million or
149.2% to $2.1 at December 31, 2007 from $837,000 at December 31, 2006 of which $707,000 were loans acquired from City Savings Bank in the fourth quarter of 2007 that were accounted for under SOP 03-3. See Note 3 of the Notes to Consolidated Financial Statements included in Part IV hereof. Total nonperforming loans to total loans increased from 0.61% at December 31, 2006 to 0.94% at December 31, 2007. The allowance for loan losses to nonperforming loans decreased to 86.2% at December 31, 2007 from 124.4% at December 31, 2006. The allowance for loan losses to total loans increased to 0.81% at December 31, 2007 compared to 0.76% at December 31, 2006.
Noninterest Income: Noninterest income increased $901,000 or 46.1% to $2.9 million for 2007 from $2.0 million for 2006. The increase was primarily due to the increase in net gains on securities of $918,000 as well as an increase in trust and brokerage fees of $96,000 and an increase in earnings on life insurance of $50,000.
In the first quarter of 2007, management elected to sell a majority of the Fannie Mae and Freddie Mac preferred stock issues it had previously written down in 2004 due to an other than temporary impairment classification. The market value on these securities substantially recovered in early 2007 and management elected to sell the majority of these securities and realize a gross gain of $896,000. A majority of the proceeds from this sale were reinvested in fixed rate mortgage backed securities. Management did elect to continue to hold two of the preferred stock issues. At December 31, 2007 these securities further declined in market value resulting in an other-than-temporary impairment charge of $228,000 in the fourth quarter of 2007. The investments were carried at $1.2 million, or 1.3% of the total investment portfolio at December 31, 2007.
Brokerage and trust fees increased due to steady growth in both areas attributable to a continued emphasis on cross-selling and business development efforts.
Income on life insurance increased $50,000 in 2007 due to the life insurance policies acquired from City Savings Financial in the fourth quarter of 2007.
Noninterest Expense: Noninterest expense increased $1.8 million or 25.7% to $8.9 million for 2007 from $7.1 million for 2006, primarily due to nonrecurring costs associated with the reorganization, stock offering and acquisition of City Savings Financial in the fourth quarter of 2007, as well as ongoing increased costs due to public company reporting requirements and the amortization of the core deposit and other intangibles beginning in the fourth quarter of 2007.
Salaries and wages increased $634,000 or 14.7% for 2007 due to the 25 additional employees added from the City Savings Financial acquisition in the fourth quarter of 2007, as well as the addition of two key positions to staff in 2007. The Bank added a Controller and a Vice President of Commercial/Consumer Lending during the first six months of 2007. In addition, management elected to create a new position to oversee all of the credit and underwriting functions for commercial lending. This position was filled by the Executive Vice President of Commercial Lending at that time and as a result created the need to hire a new head of commercial lending. This position was filled in August 2007. Also contributing to this increase in salaries and wages was the creation and expense of the employee stock ownership plan. The ESOP expense for 2007 was $70,000.
Occupancy expense increased $227,000 or 16.3% to $1.6 million for 2007 from $1.4 million for 2006. The increase was primarily due to nonrecurring expenses related to the acquisition of City Savings Financial in the fourth quarter of 2007. Costs associated with converting the City Savings ATM’s, wiring and other building costs at the new branches, as well as furniture and fixtures expense amounted to $95,000 for 2007. In addition to these costs, all other occupancy expenses increased due to the addition of three additional City Savings branch locations during the fourth quarter of 2007.
Data processing expenses increased $256,000 or 85.6% to $555,000 for 2007 from $299,000 for 2006. The Bank incurred $141,000 in expenses attributable to the core conversion of City Savings Bank, as well as $26,000 for the ATM conversion in preparation for the acquisition. In addition to the acquisition costs, annual data processing maintenance costs increased in 2007 compared to 2006 due to the addition of new software products and costs associated with upgrading the Bank’s online banking product in 2007.
Advertising costs increased $35,000 or 35.0% to $135,000 for 2007 from $100,000 for 2006, primarily due to $26,000 in signage and advertising costs associated with the acquisition.
Bank examination expense increased $177,000 or 79.2% to $399,000 for 2007 from $222,000 for 2006, primarily attributable to the increase in external audit fees due to the change in public company status. There were also $25,000 in nonrecurring expenses attributable to fees paid to the regulatory agencies in conjunction with the reorganization.
Amortization of intangibles and other expenses increased $495,000 or 65.1% to $1.3 million for 2007 from $760,000 for 2006, of which $173,000, was attributable to the acquisition of City Savings Financial in the fourth quarter of 2007. These expenses included $84,000 for legal and consulting, $48,000 for recruitment fees, and approximately $30,000 for general supplies associated with the initial acquisition. Amortization of the core deposit and customer relationship intangibles was $130,000 for 2007, which we did not have in 2006. Other miscellaneous services increased $14,000 due to a temporary consulting engagement to assist with conversion activities as well as $7,000 for ESOP annual administration. We also experienced an increase in postage of $27,000 in 2007 due to the additional mailings in conjunction with the acquisition. Donations increased $15,000 in 2007, and FDIC insurance premium expense increased $9,000, both which were due to the acquisition.
Income Tax Expense: Income tax expense was $268,000 for 2007, an increase of $25,000 or 10.3%, compared to $243,000 for 2006, principally due to a substantial increase in the valuation allowance for deferred tax assets for the portion of the net state deferred tax asset that management feels is not realizable. An addition to the valuation allowance of $183,000 was taken at the end of 2007 as a result of the additional state net operating loss carry forward brought over from City Savings Financial. The resulting effective tax rate was 27.21% for 2007 compared to 17.87% for 2006. The effective tax rate increased due to the increase in the state tax valuation reserve. The effective tax rate is below the expected federal income tax rate of 34% due to tax-exempt securities and life insurance income.
Interest Rate Margin Analysis
The following tables set forth average balance sheets, average yields and costs, and certain other information at the date and for the periods indicated. No tax-equivalent yield adjustments were made. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred loan fees, discounts and premiums that are amortized or accreted to interest income or expense.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Management of Interest Rate Risk
Our asset/liability management strategy attempts to manage the impact of changes in interest rates on net interest income, our primary source of earnings.
Historically, we have relied on funding longer term higher interest-earning assets with shorter term lower interest-bearing deposits to earn a favorable net interest rate spread. As a result, we have been vulnerable to adverse changes in interest rates. Over the past several years, management has implemented an asset/liability strategy to manage, subject to our profitability goals, our interest rate risk. Among the techniques we are currently using to manage interest rate risk are: (i) selling on the secondary market the majority of our originations of long-term fixed-rate one- to four-family residential mortgage loans; (ii) subject to market conditions and consumer demand, originating residential adjustable rate mortgages for our portfolio; (iii) expanding, subject to market conditions, our commercial real estate loans as they generally reprice more quickly than residential mortgage loans; and (iv) reducing the amount of long term, fixed rate mortgage-backed and CMO securities, which are vulnerable to a decreasing interest rate environment and will extend in duration. We have also used structured rates with redemption features to improve yield and may consider interest rate swaps and other hedging instruments although we have not done so recently.
While this strategy has helped manage our interest rate exposure, it does pose risks. For instance, the prepayment options embedded in adjustable rate one- to four-family residential loans and the mortgage-backed securities and CMOs, which allow for early repayment at the borrower’s discretion may result in prepayment before the loan reaches the fully indexed rate. Conversely, in a falling interest rate environment, borrowers may refinance their loans and redeemable securities may be called. In addition, commercial real estate lending generally present higher credit risks than residential one- to four-family lending.
Our Board of Directors is responsible for the review and oversight of management’s asset/liability strategies. Our Asset/Liability Committee is charged with developing and implementing an asset/liability management plan. This committee meets monthly to review pricing and liquidity needs and assess our interest rate risk. We currently utilize a third party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates. In addition, on a monthly basis, the committee reviews our current liquidity position, investment activity, deposit and loan repricing and terms, and Federal Home Loan Bank and other borrowing strategies.
Depending on market conditions, we often place more emphasis on enhancing net interest margin rather than matching the interest rate sensitivity of our assets and liabilities. In particular, we believe that the increased net interest income resulting from a mismatch in the maturity of our asset and liabilities portfolios can, during periods of stable interest rates, provide high enough returns to justify increased exposure to sudden and unexpected increases in interest rates. As a result of this philosophy, our results of operations and the economic value of our equity will remain vulnerable to increases in interest rates and to declines in the difference between long- and short-term interest rates.
Quantitative Analysis. The table below sets forth, as of December 31, 2008, the estimated changes in the economic value of equity that would result from the designated changes in the United States Treasury yield curve over a 12 month non-parallel ramp. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
(1) Assumes changes in interest rates over a 12 month non-parallel ramp.
(2) EVE or Economic Value of Equity at Risk measures the Bank’s exposure to equity due to changes in a forecast interest rate environment.
(3) EVE Ratio represents Economic Value of Equity divided by the economic value of assets which should translate into built in stability for future earnings.
The table above indicates that at December 31, 2008, in the event of a 100 basis point decrease in interest rates over a 12 month non-parallel ramp, we would experience a 4.56% decrease in net portfolio value. In the event of a 100 basis point increase in interest rates over a 12 month non-parallel ramp, the economic value would remain relatively stable with a.96% decrease in net portfolio value,
As a result of the current interest rate environment, the table above reflects a greater exposure to declining interest rates in the event of a 200 and 300 basis point movement in interest rates over a 12 month non-parallel ramp. This is primarily due to the significant decline in the intrinsic value normally attributable to NOW, savings and non-interest bearing demand deposits in the analysis. The intrinsic value is normally derived from the value of funding the balance sheet through these types of low cost deposits versus wholesale funding. At December 31, 2008 the cost of wholesale funding was actually below the cost of these types deposits, creating this decline in economic value. The Company has, and will continue to, take advantage of wholesale funding where prudent, however we believe that the utilization of NOW, savings and non-interest bearing demand deposits is the best long-term funding strategy for the Bank.
The Company is also continuing to take steps to address its exposure to rising interest rates. For instance management is considering the use of an interest rate swap to address the exposure on its $5.0 million floating rate trust preferred debenture in the future. We are also continuing to sell a majority of the fixed rate one-to-four family residential real estate loans originated and continuing to originate the majority of commercial real estate loans at a variable rate with interest rate floors attached.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in the economic portfolio value of equity require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in interest rates. In this regard, the economic value of equity table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that particular changes in interest rates occur at different times and in different amounts in response to a designed change in the yield curve for U.S. Treasuries. Furthermore, although the economic value of equity table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income. Finally, the above table does not take into account the changes in the credit risk of our assets which can occur in connection with change in interest rates.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet both our short- and long-term liquidity needs. We adjust our liquidity levels to fund deposit outflows, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.
Our primary sources of liquidity are deposits, amortization and prepayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations, as well as access to Federal Home Loan Bank advances and other borrowings. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. We set the interest rates on our deposits to maintain a desired level of total deposits.
A portion of our liquidity consists of cash and cash equivalents and borrowings, which are a product of our operating, investing and financing activities. At December 31, 2008, $5.6 million of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the maturities of securities, principal repayments of mortgage-backed securities and increases in deposit accounts. Short-term investment securities (maturing in one year or less) totaled $520,000 at December 31, 2008, not including scheduled or pre-payments from mortgage backed securities and CMO’s. As of December 31, 2008, we had $78.7 million in borrowings outstanding from the Federal Home Loan Bank of Indianapolis and we have access to additional Federal Home Loan Bank advances of up to approximately $3.0 million. As of December 31, 2008, we had $650,000 in borrowings from the Federal Reserve Bank discount window and access to additional borrowings of up to approximately $4.8 million. The market value of unpledged available for sale securities which could be pledged for additional borrowing purposes was $57.3 million at December 31, 2008.
At December 31, 2008, we had $38.2 million in loan commitments outstanding, of which $15.6 million was committed to originate unused home equity lines of credit, $2.5 million was committed to originate commercial lines of credit, $3.4 million was committed to originate unused commercial standby letters of credit, $7.2 was committed to unused overdraft lines of credit and $9.5 million was committed to originate commercial real estate and one- to four-family residential loans. Certificates of deposit and IRAs due within one year of December 31, 2008 totaled $57.2 million, or 44.8% of certificates of deposit and IRAs. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit, IRAs and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2009. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
As reported in the Consolidated Statements of Cash Flows, our cash flows are classified for financial reporting purposes as operating, investing or financing cash flows. Net cash provided by operating activities was $3.6 million and $445,000 for years ended December 31, 2008 and December 31, 2007, respectively. Net cash used in investing activities was $8.6 million during the year ended December 31, 2008 and net cash provided by investing activities was $9.5 million during the year ended December 31, 2007. Investment securities cash flows had the most significant effect, as net cash from sales and maturities amounted to $44.1 million and $32.8 million and net cash utilized in purchases amounted to $50.0 million and $33.7 million during the years ended December 31, 2008 and December 31, 2007, respectively. During 2008 we used $774,000 to purchase treasury stock. Net cash provided by financing activities was $631,000 for the year ended December 31, 2008. Deposit and borrowing cash flows have comprised most of our financing activities in 2008 and 2007. In 2007, we also received $9.9 million in proceeds from issuing stock in our initial public offering, which resulted in net cash used of $21.0 million during the year ended December 31, 2007. The net effect of our operating, investing and financing activities was to reduce our cash and cash equivalents from $9.9 million at the beginning of fiscal year 2007 to $5.6 million at December 31, 2008.
We also have obligations under our post retirement plans as described in Notes 9 and 12 of the Notes to Consolidated Financial Statements. The post retirement benefit plans will require future payments to eligible plan participants. We contributed $111,000 to our 401(k) plan in 2008 and $94,000 in 2007. In addition, as part of the reorganization and offering, the employee stock ownership plan trust borrowed funds from LaPorte Bancorp and used those funds to purchase shares to be allocated to participants in our ESOP.
Off-Balance-Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transaction involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit and standby letters of credit. For information about our loan commitments, letters of credit and unused lines of credit, see Note 16 of the Notes to Consolidated Financial Statements.
For the years ended December 31, 2008 and 2007, we did not engage in any off-balance-sheet transactions other than loan origination commitments, unused lines of credit and standby letters of credit in the normal course of our lending activities. During 2007, we did acquire several additional letters of credit and a substantial increase in unused lines of credit through the City Savings Financial acquisition, however, this increase is in proportion to the commercial loan portfolio acquired.
Recent Accounting Pronouncements
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“FAS 157”). This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard was effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (“FSP”) 157-2, Effective Date of FASB Statement No. 157. This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The impact of adoption on January 1, 2008 was not material to the Company’s consolidated financial condition or results of operations. In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. This FSP clarifies the application of FAS 157 in a market that is not active. The impact of adoption was not material to the Company’s consolidated financial condition or results of operations.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard was effective for the Company on January 1, 2008. The Company elected the fair value option prospectively on January 1, 2008 for loans held for sale. The Company did not elect the fair value option for any other financial assets or financial liabilities as of January 1, 2008.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability is based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. The issue was effective for fiscal years beginning after December 15, 2007. The impact of the adoption of this standard on January 1, 2008, resulted in a $55 decrease to deferred tax assets and retained earnings.
In November 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 109 (SAB No. 109), Written Loan Commitments Recorded at Fair Value through Earnings superseding SAB No. 105, Application of Accounting Principles to Loan Commitments, which stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB No. 109 supersedes SAB No. 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB No. 105 also indicated that internally-developed
intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB No. 109 retains that view. SAB No. 109 became effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The adoption of this standard on January 1, 2008 did not have a material effect on the Company’s consolidated financial condition or results of operations.
In December 2007, the FASB issued Statement No. 141 (revised 2007), Business Combinations (“FAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. FAS No. 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The impact of adoption of this standard is dependent on future business combinations.
In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133. FAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 for derivative instruments and hedging activities. FAS No. 161 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. FAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this standard is not expected to have a material effect on the Company’s consolidated results of operations or financial condition.
Impact of Inflation and Changing Prices
The financial statements and related notes of LaPorte Bancorp, Inc. have been prepared in accordance with United States generally accepted accounting principles (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For information regarding market risk see Item 7 - “Management’s Discussion and Analysis of Financial Conditions and Results of Operation.”
Item 8.
Item 8. Financial Statements and Supplementary Data
The information regarding financial statements is incorporated herein by reference to LaPorte Bancorp’s 2008 Annual Report to Stockholders in the Financial Statements and the Notes thereto.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of disclosure controls and procedures
The Company has adopted disclosure controls and procedures designed to facilitate financial reporting. The Company’s disclosure controls currently consist of communications among the Company’s Chief Executive Officer, the Company’s Chief Financial Officer and each department head to identify any transactions, events, trends, risks or contingencies which may be material to its operations. These disclosure controls also contain certain elements of the Company’s internal controls adopted in connection with applicable accounting and regulatory guidelines. In addition, the Company’s Chief Executive Officer, Chief Financial Officer, Audit Committee and independent registered public accounting firm meet on a quarterly basis to discuss disclosure matters. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report and found them to be effective.
(b) Management’s Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, and management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008 based upon the criteria set forth in a report entitled Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment, the Company’s management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2008.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
(c) Changes in internal controls
There were no significant changes made in our internal control over financial reporting during the Company’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not Applicable
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The “Proposal I-Election of Directors” section of the Company’s definitive proxy statement for the Company’s 2009 Annual Meeting of Stockholders (the “2009 Proxy Statement”) is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The “Proposal I-Election of Directors” section of the Company’s 2009 Proxy Statement is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The “Proposal I-Election of Directors” section of the Company’s 2009 Proxy Statement is incorporated herein by reference.
The Company does not have any equity compensation program that was not approved by stockholders, other than its employee stock ownership plan.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The “Transactions with Certain Related Persons” section of the Company’s 2009 Proxy Statement is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The “Proposal III-Ratification of Appointment of Independent Registered Public Accounting Firm” Section of the Company’s 2009 Proxy Statement is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)(1) Financial Statements
The following are filed as a part of this report by means of incorporation by reference to LaPorte Bancorp’s 2008 Annual Report to Stockholders:
(A) Report of Independent Registered Public Accounting Firm
(B) Consolidated Balance Sheets-at December 31, 2008, 2007 and 2006
(C) Consolidated Statements of Income-Years ended December 31, 2008, 2007 and 2006
(D) Consolidated Statements of Changes In Shareholders’ Equity-Years ended December 31, 2008, 2007 and 2006
(E) Consolidated Statements of Cash Flows-Years ended December 31, 2008, 2007 and 2006
(F) Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
(1) Incorporated by reference to the Registration Statement on Form S-1 of LaPorte Bancorp, Inc. (file no. 333-143526), originally filed with the Securities and Exchange Commission on June 5, 2007.
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.
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.