-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PJlt0SnEzBz9xYFGyFVUtOTrvJfk52262o/nIcb4AbxeTbcF01nWsg/JGpqn2KUH WCx1VD5aeRBJ6shBdZdsag== 0000313337-09-000011.txt : 20090326 0000313337-09-000011.hdr.sgml : 20090326 20090326115810 ACCESSION NUMBER: 0000313337-09-000011 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20081231 FILED AS OF DATE: 20090326 DATE AS OF CHANGE: 20090326 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRI CITY BANKSHARES CORP CENTRAL INDEX KEY: 0000313337 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 391158740 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-09785 FILM NUMBER: 09705876 BUSINESS ADDRESS: STREET 1: 6400 S 27TH ST CITY: OAK CREEK STATE: WI ZIP: 53154 BUSINESS PHONE: 4147611610 MAIL ADDRESS: STREET 1: 6400 SOUTH 27TH STREET CITY: OAK CREEK STATE: WI ZIP: 53154 10-K 1 form10k2008.txt ANNUAL REPORT ON FORM 10K FOR 2008 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the fiscal year ended December 31, 2008 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 000-09785 TRI CITY BANKSHARES CORPORATION (Exact name of registrant as specified in its charter) Wisconsin 39-1158740 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 6400 South 27th Street Oak Creek, Wisconsin 53154 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (414) 761-1610 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: $1.00 par value common stock (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [ X ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [ X ] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ X ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ____ Accelerated filer ___ Non-accelerated filer [do not check if smaller reporting company] Smaller reporting Company _X Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] As of June 30, 2008, the aggregate market value of the shares held by non-affiliates was approximately $62,381,612. As of March 26, 2009, 8,904,915 shares of common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Document Incorporated in Annual report to shareholders for fiscal year ended December 31, 2008 Parts II and IV Proxy statement for annual meeting of shareholders to be held on June 10, 2009 Part III Form 10-K Table of Contents - -------------------------------------------------------------------------------- PART I PAGE # Item 1 Business 3 Item 1A Risk Factors 12 Item 1B Unresolved Staff Comments 17 Item 2 Properties 17 Item 3 Legal Proceedings 17 Item 4 Submission of Matters to a Vote of Security Holders 17 PART II Item 5 Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 18 Item 6 Selected Financial Data 18 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 7A Quantitative and Qualitative Disclosures About Market Risk 19 Item 8 Financial Statements and Supplementary Data 19 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 19 Item 9A(T) Controls and Procedures 19 Item 9B Other Information 21 PART III Item 10 Directors, Executive Officers and Corporate Governance 21 Item 11 Executive Compensation 21 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 21 Item 13 Certain Relationships and Related Transactions, and Director Independence 21 Item 14 Principal Accountant Fees and Services 21 PART IV Item 15 Exhibits and Financial Statement Schedules 22 Signatures 26 2 PART I Item 1. BUSINESS THE REGISTRANT Tri City Bankshares Corporation (the "Registrant"), a Wisconsin corporation, was organized in 1970 for the purpose of acquiring the outstanding shares of Tri City National Bank (the "Bank"). The Bank is a wholly owned subsidiary of the Registrant. At December 31, 2008, the Registrant had total assets of $792.9 million and total stockholders' equity of $108.9 million. THE BANK The Bank was chartered by the Wisconsin Banking Department (now the Wisconsin Department of Financial Institutions ("DFI")) in 1963 and converted to a national bank charter in 1969. The Bank is supervised by the Office of the Comptroller of the Currency ("OCC") and its deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank conducts business out of its main office located at 6400 South 27th Street, Oak Creek, Wisconsin. In addition, the Bank maintains 37 other offices in Wisconsin throughout Milwaukee, Ozaukee, Racine and Waukesha Counties. The Bank provides a full range of consumer and commercial banking services to individuals and businesses. The basic services offered include demand deposit accounts, money market deposit accounts, NOW accounts, time deposits, safe deposit services, direct deposits, notary services, money orders, night depository, travelers' checks, cashier's checks, savings bonds, secured and unsecured consumer, commercial, installment, real estate and mortgage loans. The Bank offers automated teller machine ("ATM") and debit cards. In addition, the Bank maintains an investment portfolio consisting primarily of U.S. government sponsored agency and state and political subdivision securities. As is the case with banking institutions generally, the Bank derives its revenues from interest on its loan and investment portfolios and fee income related to loans and deposits. The sale of alternative investment products provides additional fee income. The source of funds for the lending activities are deposits, repayment of loans, maturity of investment securities and short-term borrowing through correspondent banking relationships and the Federal Reserve Bank of Chicago. Principal expenses are the interest paid on deposits and borrowings, and operating and general administrative expenses. LENDING ACTIVITIES The Bank offers a range of lending services including secured and unsecured consumer, commercial, installment, real estate and mortgage loans to individuals, small businesses and other organizations that are located in or conduct a substantial portion of their business in the Bank's market area. The Bank's total loans as of December 31, 2008 were $599.6 million, or approximately 75.6% of total assets. Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan, and are further subject to competitive pressures, the cost and availability of funds and government policy. The Bank maintains a comprehensive loan policy that establishes guidelines with respect to all categories of lending activity. The policy establishes lending authority for each individual loan officer, the officer loan committee and the Board of Directors. All loans to directors and executive officers are approved by the Board of Directors with the interested director abstaining. The loans are concentrated in three major areas: real estate loans, commercial loans and consumer loans. The Bank's lending strategy is focused on the development and maintenance of a high quality loan portfolio. The Bank's real estate loans are collateralized by mortgages and consist primarily of loans to individuals for the purchase and improvement of real estate and for the purchase of residential lots and construction of single-family residential units. The Bank's residential real estate loans generally are repayable in monthly installments based on up to a thirty-year amortization schedule. Commercial loans include loans to individuals and small businesses, including loans for working capital, machinery and equipment purchases, premises and equipment acquisitions, purchase, improvement and investment in real estate and real estate development, and other business needs. Commercial lines of credit are typically for a one-year term. Other commercial loans with terms or 3 amortization schedules of longer than one year will normally carry interest rates that vary based on the term and will become payable in full, and are generally refinanced, in two to four years. Commercial loans typically entail a thorough analysis of the borrower, its industry, current and projected economic conditions and other factors. The Bank typically requires commercial borrowers to provide annual financial statements and requires appraisals or evaluations in connection with the loans collateralized by real estate. The Bank typically requires personal guarantees from principals involved with closely-held corporate borrowers. The Bank's consumer loan portfolio consists primarily of loans to individuals for various consumer purposes, payable on an installment basis. The loans are generally for terms of five years or less and are collateralized by liens on various personal assets of the borrower. DEPOSIT ACTIVITIES Deposits are the major source of the Bank's funds for lending and other investment activities. Generally, the Bank attempts to maintain the rates paid on its deposits at a competitive level. The Bank considers the majority of its regular savings, investor's choice, demand, NOW and money market deposit accounts (which comprised 78.9% of the Bank's total deposits at December 31, 2008) to be core deposits. Approximately 21.1% of the Bank's deposits at December 31, 2008 were certificates of deposit (CDs). CDs of $100,000 and over made up approximately 38.6% of the Bank's total CDs at December 31, 2008. The majority of the Bank's deposits are generated from Milwaukee, Ozaukee, Racine and Waukesha Counties. For additional information regarding the Bank's deposit accounts, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Interest Rate Sensitivity Management" and Note 10 of Notes to Consolidated Financial Statements, which are contained in the Registrant's 2008 Annual Report to Shareholders ("2008 Shareholder Report"), which discussion is incorporated by reference in Item 8 below. INVESTMENTS The Bank invests a portion of its assets in obligations of U.S. government-sponsored entities, (Federal Home Loan Mortgage Corporation and Federal National Mortgage Association), state, county and municipal obligations, collateralized mortgage obligations ("CMOs") and federal funds ("Fed Funds") sold. The investments are managed in relation to the loan demand and deposit growth and are generally used to provide for the investment of excess funds at reduced yields and risks relative to yields and risks of the loan portfolio, while providing liquidity to fund increases in loan demand or to offset fluctuations in deposits. For further information regarding the Registrant's investment portfolio, see Note 4 of Notes to Consolidated Financial Statements in the 2008 Shareholder Report, incorporated by reference in Item 8 below. SUPERVISION AND REGULATION The Registrant and the Bank are subject to extensive supervision and regulation by federal and state agencies. The following is a summary of the regulatory agencies, statutes and related regulations that have, or could have, a significant impact on the Registrant's business. This discussion is qualified in its entirety by reference to such regulations and statutes. BANK HOLDING COMPANY The Registrant is a legal entity separate and distinct from its subsidiaries and affiliated companies. As a registered bank holding company, the Registrant is subject to regulation under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Federal Reserve Board also has extensive enforcement authority over bank holding companies. In general, the Federal Reserve Board may initiate enforcement actions for violations of laws and regulations and unsafe or unsound practices. The Registrant is also required to file reports and other information with the Federal Reserve Board regarding its business operations and those of its subsidiaries. SUBSIDIARY BANK The Bank is subject to regulation and examination primarily by the Office of the Comptroller of the Currency ("OCC") and secondarily by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is subject to certain restrictions imposed by the Federal Reserve Act and Federal Reserve Board regulations regarding such matters as the maintenance of reserves against deposits, extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock 4 or other securities of the bank holding company or its subsidiaries and the taking of such stock or securities as collateral for loans to any borrower. NON-BANKING SUBSIDIARIES The Registrant's non-banking subsidiaries are also subject to regulation by the Federal Reserve Board and other applicable federal and state agencies. OTHER REGULATORY AGENCIES SECURITIES AND EXCHANGE COMMISSION ("SEC"). The Registrant is also under the jurisdiction of the SEC and certain states securities commissions for matters relating to the offering and sale of its securities. The Registrant is subject to disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as administered by the SEC. THE FDIC/DEPOSITORY INSURANCE. The FDIC is an independent federal agency which insures the deposits, up to prescribed statutory limits, of federally-insured banks and savings associations and safeguards the safety and soundness of the financial institution industry. The Bank's deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and subject to deposit insurance assessments to maintain the Deposit Insurance Fund. The FDIC uses a risk-based assessment system that imposes insurance premiums based upon a four-tier risk matrix based upon a bank's capital level and supervisory, or CAMELS, rating. Currently the Bank is in the best risk category and pays deposit assessments ranging from 12 to 14 cents per $100 of assessable deposits. On February 27, 2009, the FDIC adopted a final rule that changes the way its assessment system differentiates risk and changes assessment rates beginning April 1, 2009. For banks in the best risk category, the initial base rates will range from 12 to 16 cents per $100 of assessable deposits on an annual basis effective April 1, 2009. The FDIC also adopted an interim rule imposing an emergency special assessment of 20 cents per $100 of assessable deposits on all insured institutions on June 30, 2009, which will be collected on September 30, 2009. The interim rule also permits the FDIC to impose an emergency special assessment after June 30, 2009, of up to 10 cents per $100 of assessable deposits if necessary to maintain public confidence in federal deposit insurance. The interim rule is subject to a 30-day comment period. The FDIC may take further actions in the future that result in higher assessment rates that could have a material effect on earnings. The FDIC may terminate insurance coverage upon a finding that the insured institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition enacted or imposed by the institution's regulatory agency. BANK HOLDING COMPANY ACT In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The BHCA and other federal and state statutes regulate acquisitions of commercial banks. The BHCA requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than 5% of the voting shares of a commercial bank or its parent holding company. Under the Federal Bank Merger Act, the prior approval of the OCC is required for a national bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the applicant's performance record under the Community Reinvestment Act and fair housing laws and the effectiveness of the subject organizations in combating money laundering activities. In 1999, Congress enacted the Gramm-Leach-Bliley Act ("the Act"), which eliminated certain barriers to and restrictions on affiliations between banks and securities firms, insurance companies and other financial services organizations. Among other things, the Act repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the BHCA to permit bank holding companies that qualify as "financial holding companies" to engage in a broad list of "financial activities," and any non-financial activity that the Federal 5 Reserve Board, in consultation with the Secretary of the Treasury, determines is "complementary" to a financial activity and poses no substantial risk to the safety and soundness of depository institutions or the financial system. The Act treats various lending, insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities as financial in nature for this purpose. Under the Act, a bank holding company may become certified as a financial holding company by filing a notice with the Federal Reserve Board, together with a certification that the bank holding company meets certain criteria, including capital, management, and Community Reinvestment Act requirements. The Registrant has determined not to become certified as a financial holding company at this time. The Registrant may reconsider this determination in the future. CAPITAL ADEQUACY AND PROMPT CORRECTIVE ACTION The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among other things, identifies five capital categories for insured depository institutions and requires the respective federal regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. The federal regulatory agencies, including the Federal Reserve Board and the OCC, have adopted substantially similar regulatory capital guidelines and regulations consistent with the requirements of FDICIA, as well as established a system of prompt corrective action to resolve certain of the problems of undercapitalized institutions. This system is based on five capital level categories for insured depository institutions: "well-capitalized," "adequately capitalized," "under capitalized," "significantly under capitalized" and "critically under capitalized." Both the Registrant and the Bank are required to maintain sufficient capital to meet both a risk-based asset ratio test and leverage ratio test. From time to time, the regulatory agencies may require the Registrant and the Bank to maintain capital above these minimum levels should certain conditions exist, such as deterioration of their financial condition or growth in assets, either actual or expected. The Registrant and the Bank were deemed well capitalized as of both December 31, 2008 and 2007. Additional information regarding the Registrant's and the Bank's capital requirements and ratios can be found in Note 18 of the Notes to the Consolidated Financial Statements. COMMUNITY REINVESTMENT ACT The Community Reinvestment Act of 1977 ("CRA") requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and assigned ratings. As of December 31, 2008, the most recent performance evaluation by the OCC resulted in an overall rating of satisfactory. RECENT REGULATORY DEVELOPMENTS In response to global credit and liquidity issues involving a number of financial institutions, the United States government, particularly the United States Department of Treasury (the "U.S. Treasury") and the FDIC, have taken a variety of extraordinary measures designed to restore confidence in the financial markets and to strengthen financial institutions, including capital injections, guarantees of bank liabilities and the acquisition of illiquid assets from banks. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the "EESA") enacted by the U.S. Congress. Pursuant to the EESA, the U.S. Treasury was granted the authority to take a range of actions for the purpose of stabilizing and providing liquidity to the U.S. financial markets and has proposed several programs, including the purchase by the U.S. Treasury of certain troubled assets from financial institutions (the "Troubled Asset Relief Program" or "TARP") and the direct purchase by the U.S. Treasury of equity of healthy financial institutions (the "Capital Purchase Program" or "CPP") The EESA also temporarily raised the limit on federal deposit insurance coverage provided by the FDIC from $100,000 to $250,000 per depositor. Among other programs and actions taken by the U.S. regulatory agencies, the FDIC implemented the Temporary Liquidity Guarantee Program ("TLGP") to strengthen confidence and encourage liquidity in the banking system. The TLGP comprises the Debt Guaranty Program ("DGP") and the Transaction Account Guarantee Program ("TAGP"). The DGP guarantees all newly issued senior unsecured debt (e.g., promissory notes, unsubordinated unsecured notes and commercial paper) up to prescribed limits issued by participating entities beginning on October 14, 2008 and continuing through June 30, 2009. For eligible debt issued by that date, the FDIC will provide the 6 guarantee coverage until the earlier of the maturity date of the debt or June 30, 2012. The TAGP offers full guarantee for noninterest-bearing transaction accounts held at FDIC-insured depository institutions. The unlimited deposit coverage was voluntary for eligible institutions and was in addition to the $250,000 FDIC deposit insurance per account that was included as part of the EESA. The limits are presently scheduled to return to $100,000 on January 1, 2010. The TAGP coverage became effective on October 14, 2008 and will continue for participating institutions until December 31, 2009. CAPITAL PURCHASE PROGRAM After careful consideration by the Board of Directors of the Registrant, the Registrant elected not to participate in the CPP, although it believed that it was eligible to do so. TEMPORARY LIQUIDITY GUARANTEE PROGRAM Initially, the TLGP programs, the DGP and TAGP, were provided at no cost for the first 30 days. On November 3, 2008, the FDIC extended the opt-out period to December 5, 2008 to provide eligible institutions additional time to consider the terms before making a final decision regarding participation in the program. The Registrant elected not to "opt out" of the TAGP in order to provide unlimited FDIC coverage to the Bank's transaction account depositors. The Bank elected not to "opt out" of the DGP and, as a result, will continue participating in the DGP to the extent applicable. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the "ARRA") was signed into law. Section 7001 of the ARRA amended Section 111 of the EESA in its entirety. While the U.S. Treasury must promulgate regulations to implement the restrictions and standards set forth in Section 7001, the ARRA, among other things, significantly expands the executive compensation restrictions previously imposed by the EESA. Such restrictions apply to any entity that has received or will receive financial assistance provided under TARP, and shall generally continue to apply for as long as any obligation arising from financial assistance provided under TARP, including preferred stock issued under the CPP, remains outstanding. Since the Registrant elected not to participate in the CPP, Section 7001 of the ARRA does not apply to it. DIVIDEND RESTRICTIONS Current federal banking regulations impose restrictions on the Bank's ability to pay dividends to the Registrant. These restrictions include a limit on the amount of dividends that may be paid in a given year without prior approval of the OCC and a prohibition on paying dividends that would cause the Bank's total capital to be less than the required minimum levels under the risk-based capital requirements imposed by the OCC. The Bank's regulators may prohibit the payment of dividends at any time if the regulators determine the dividends represent unsafe and/or unsound banking practices or reduce the Bank's total capital below adequate levels. The Registrant's ability to pay dividends to its shareholders may also be restricted. Under current Federal Reserve Board policy, the Registrant is expected to act as a source of financial strength to, and commit resources to support, the Bank. Under this policy, the Federal Reserve Board may require the Registrant to contribute additional capital to the Bank, which could restrict the amount of cash available for dividends. Even when the legal ability exists, the Registrant or the Bank may decide to limit the payment of dividends in order to retain earnings for corporate use. CUSTOMER PRIVACY AND OTHER CONSUMER PROTECTIONS The Registrant is subject to regulations limiting the ability of financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated party. The Registrant is also subject to numerous federal and state laws aimed at protecting consumers, including the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Bank Secrecy Act, the Community Reinvestment Act and the Fair Credit Reporting Act. 7 USA PATRIOT ACT The Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA PATRIOT Act") and related regulations, among other things, require financial institutions to establish programs specifying procedures for obtaining identifying information from customers and establishing enhanced due diligence policies, procedures and controls designed to detect and report suspicious activity. The Bank has established policies and procedures that the Registrant believes comply with the requirements of the USA PATRIOT Act. MONETARY POLICY The Federal Reserve Board regulates money and credit conditions and interest rates in order to influence general economic conditions primarily through open market operations in U.S. government securities, changes in the discount rate on bank borrowings, and changes in the reserve requirements against depository institutions' deposits. These policies and regulations significantly affect the overall growth and distribution of loans, investments and deposits, as well as interest rates charged on loans and paid on deposits. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of financial institutions in the past and are expected to continue to have significant effects in the future. In view of the changing conditions in the economy, the money markets and the activities of monetary and fiscal authorities, the Registrant can make no definitive predictions as to future changes in interest rates, credit availability or deposit levels. INDUSTRY RESTRUCTURING For well over a decade, the banking industry has been undergoing a restructuring process that is anticipated to continue. The restructuring has been caused by product and technological innovations in the financial services industry, deregulation of interest rates, and increased competition from foreign and nontraditional banking competitors, and has been characterized principally by the gradual erosion of geographic barriers to intrastate and interstate banking and the gradual expansion of investment and lending authorities for bank institutions. COMPETITION The Bank's service area includes portions of Milwaukee, Ozaukee, Racine and Waukesha Counties. In Milwaukee County, the Bank competes with all the major banks and bank holding companies located in metropolitan Milwaukee, most of whom are far larger in terms of assets and deposits. Ozaukee County, with a population of approximately 87,000 residents, has eleven banks with thirty-five offices and five savings banks with eleven offices. Racine County, with a population of approximately 196,300 residents, has thirteen banks with fifty-eight offices and five savings banks with fourteen offices. Waukesha County, with a population of approximately 382,700 residents, has twenty-six banks with one hundred forty-five offices and thirteen savings banks with fifty-three offices. In addition to banks and savings banks, significant competition comes from credit unions, security and brokerage firms, mortgage companies, insurance companies and other providers of financial services in the area. EMPLOYEES As of December 31, 2008, the Registrant employed 329 full-time employees and 115 part-time employees. The employees are not represented by a collective bargaining unit. The Registrant considers relations with employees to be good. STATISTICAL PROFILE AND OTHER FINANCIAL DATA Statistical information relating to the Registrant and its subsidiaries on a consolidated basis, as required by Guide 3 of the Securities and Exchange Commission Guides for Preparation and Filing of Reports and Registration Statements and Reports, is set forth in the Management's Discussion and Analysis of Financial Position and Results of Operations ("MD&A") section of the 2008 Shareholder Report, as follows: (1) Average Balances and Interest Rates for each of the last three fiscal years; (2) Interest Income and Expense Volume and Rate Change for each of the last two years; 8 (3) Investment Securities Portfolio Maturity Distribution at December 31, 2008; (4) Investment Securities Portfolio for each of the last three years; (5) Loan Portfolio Composition for each of the last five years; (6) Summary of Loan Loss Experience for each of the last five years; and (7) Average Daily Balance of Deposits and Average Rate Paid on Deposits for each of the last three years. The following additional tables set forth certain statistical information relating to the Registrant and its subsidiaries on a consolidated basis. LOAN PORTFOLIO The following table presents information concerning the aggregate amount of nonperforming loans. Nonperforming loans are comprised of (a) loans accounted for on a nonaccrual basis and (b) loans contractually past due 90 days or more as to interest or principal payments, for which interest continues to be accrued. (Dollars in Thousands) December 31, 2008 2007 2006 2005 2004 ---- ---- ---- ---- ---- Nonaccrual loans $ 2,930 $ 2,024 $ -- $ 1,905 $ 275 Loans past due 90 days or more 5,684 3,703 3,417 1,005 1,688 ------- ------- ------- ------- ------ Total nonperforming loans $ 8,614 $ 5,727 $ 3,417 $ 2,910 $1,963 ======= ======= ======= ======= ====== Ratio of nonaccrual loans to total loans 0.49% 0.35% -% 0.36% 0.06% Ratio of nonperforming loans to total loans 1.44% 0.98% 0.64% 0.56% 0.42% Interest income of $60,501 was recognized during 2008 on loans that were accounted for on a nonaccrual basis. Additional interest income would have been recognized during 2008 under the original loan terms had these loans not been assigned nonaccrual status. The accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest. Management may continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balance and accrued interest. There were no loans at December 31, 2008 or 2007, 2006, 2005 or 2004 whose terms had been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower, and there are no current loans where, in the opinion of management, there are serious doubts as to the ability of the borrower to comply with present loan repayment terms. Loans defined as impaired by Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan," if any, are included in nonaccrual loans above. 9 RETURN ON EQUITY AND ASSETS AND SELECTED CAPITAL RATIOS The following table shows consolidated operating and capital ratios of the Registrant for each of the last three years: Year Ended December 31, ----------------------- 2008 2007 2006 Percentage of net income to: Average stockholders' equity 10.21% 9.49% 9.23% Average total assets 1.46% 1.36% 1.31% Percentage of dividends declared per common share to net income per common share 83.99% 88.54% 82.48% Percentage of average stockholders' equity to daily average total assets 14.33% 14.36% 14.16% SHORT-TERM BORROWINGS (Dollars in Thousands) Information relating to short-term borrowings follows: Federal Funds Purchased Other Short- and Securities Sold Under term Agreements to Repurchase Borrowings Balance at December 31: 2008 $ - $ 3,911 2007 $ 12,851 $ 2,171 2006 $ - $ 3,470 Weighted average interest rate at year end: 2008 -% 0.07% 2007 4.49% 4.13% 2006 -% 3.14% Maximum amount outstanding at any month's end 2008 $ 24,332 $ 3,911 2007 $ 38,083 $ 5,229 2006 $ 10,741 $ 3,470 Average amount outstanding during the year: 2008 $ 4,949 $ 1,488 2007 $ 12,489 $ 1,494 2006 $ 3,022 $ 1,342 Average interest rate during the year: 2008 1.96% 1.77% 2007 5.12% 4.84% 2006 5.40% 4.72% 10 Fed Funds purchased and securities sold under agreements to repurchase generally mature within one to four days of the transaction date. Other short-term borrowings generally mature within 90 days. AVAILABLE INFORMATION The Registrant maintains a website at www.tcnb.com. The Registrant makes available through its website, free of charge, copies of its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8K, and amendments to the reports, as soon as reasonably practicable after the Registrant electronically files those materials with, or furnishes them to, the Securities and Exchange Commission (the "SEC"). The Registrant's SEC reports can be accessed through the "About TCNB" link of its website. The Registrant's web address is included as an inactive textual reference only and the information thereon shall not be deemed to be incorporated by reference in this Report. Any reference to an SEC report available on the Registrant's website is qualified with reference to any later-dated SEC report, regardless of whether such later-dated SEC report is immediately available on the Registrant's website. 11 Item 1A. RISK FACTORS ------------ CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING INFORMATION AND RISK FACTORS. The Registrant and its representatives may, from time to time, make written or verbal forward-looking statements. Those statements relate to developments, results, conditions or other events the Registrant expects or anticipates will occur in the future. The Registrant intends words such as "believes," "anticipates," "plans," "expects" and similar expressions to identify forward-looking statements. Without limiting the foregoing, those statements may relate to future economic or interest rate conditions, loan losses and allowances, loan and deposit growth, new branches and the competitive environment. Forward-looking statements are based on management's then current views and assumptions and, as a result, are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Any such forward-looking statements are qualified by the following important risk factors that could cause actual results to differ materially from those predicted by the forward-looking statements. An investment in the Registrant's common stock or other securities carries certain risks. Investors should carefully consider the risks described below and other risks, which may be disclosed from time to time in the Registrant's filings with the SEC before investing in the Registrant's securities. THE REGISTRANT AND THE BANK ARE AFFECTED BY CONDITIONS IN THE FINANCIAL MARKETS AND ECONOMIC CONDITIONS GENERALLY. The United States economy has been in a downward cycle since the end of 2007, which has been marked by reduced business activity across a wide range of industries and regions. Many businesses are experiencing serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. In addition, unemployment has increased significantly and continues to grow. The financial services industry and the securities markets generally have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the resulting impact on sub-prime mortgages but has since spread to all mortgage and real estate asset classes, as well as equity securities. The economic downturn has also resulted in the failure of a number of prominent financial institutions, resulting in further losses as a consequence of defaults on securities issued by them and defaults under contracts with such entities as counterparties. In addition, declining asset values, defaults on mortgages and consumer loans, the lack of market and investor confidence and other factors have all combined to cause rating agencies to lower credit ratings and to otherwise increase the cost and decrease the availability of liquidity. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining collateral values. In 2008, the U.S. government, the Federal Reserve, and other regulators have taken numerous steps to increase liquidity and to restore investor confidence, including investing in the equity of other banking organizations. In spite of this, asset values have continued to decline, and access to liquidity continues to be very limited. UNCERTAINTY IN THE FINANCIAL MARKETS COULD RESULT IN LOWER FAIR VALUES FOR INVESTMENT SECURITIES HELD BY REGISTRANT AND THE BANK. The upheaval in the financial markets over the past year has adversely impacted investor demand for all classes of securities and has resulted in volatility in the fair values of our investment securities. Significant prolonged reduction in investor demand could result in lower fair values for these securities and may result in recognition of an other-than-temporary impairment charge, which would have a direct adverse impact on results of operations. WE MAY BE ADVERSELY AFFECTED BY THE SOUNDNESS OF OTHER FINANCIAL INSTITUTIONS. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty. In addition, our credit risk may be heightened when the collateral we hold cannot be realized upon liquidation or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations. 12 FLUCTUATING INTEREST RATES IMPACT OUR RESULTS OF OPERATIONS AND OUR EQUITY. The results of operations for financial institutions may be materially and adversely affected by changes in prevailing economic conditions, including rapid changes in interest rates, changes in local market conditions, changes in the habits of the public, declines in real estate market values, increases in tax rates and other operating expenses, and the policies of regulatory authorities, including the monetary and fiscal policies of the Federal Reserve. Changes in the economic environment may influence the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. While the Bank has taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that such measures will be effective in avoiding undue interest rate risk. The Bank is unable to predict fluctuations of market interest rates, which are affected by many factors, including inflation, recession, a rise in unemployment, tightening money supply, and domestic and international disorder and instability in domestic and foreign financial markets. The Bank's profitability depends to a large extent upon its net interest income, which is the difference (or "spread") between interest income received on interest earning assets, such as loans and investments, and interest expense paid on interest-bearing liabilities, such as deposits and borrowings. The Bank's net interest spread and margin will be affected by general economic conditions and other factors that influence market interest rates and the Bank's ability to respond to changes in such rates. At any given time, the Bank's assets and liabilities will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates could have a positive or negative effect on the Bank's net income, capital and liquidity. The mismatch between maturities and interest rate sensitivities of balance sheet items (i.e., interest-earning assets and interest-bearing liabilities) results in interest rate risk, which risk will change as the level of interest rates changes. The Bank's liabilities consist primarily of deposits, which are either of a short-term maturity or have no stated maturity. These latter deposits consist of NOW accounts, demand accounts, savings accounts, and money market accounts. These accounts typically can react more quickly to changes in market interest rates than the Bank's assets because of the shorter maturity (or lack of maturity) and repricing characteristics of these deposits. Consequently, sharp increases or decreases in market interest rates may impact the Bank's earnings negatively or positively, respectively. To manage vulnerability to interest rate changes, the Bank's management monitors the Bank's interest rate risks. The Bank's officers have established investment policies and procedures, which ultimately are reported to the Board of Directors. Management and the Board of Directors generally meet quarterly and review the Bank's interest rate risk position, loan and securities repricing, current interest rates and programs for raising deposit-based maturity gaps, including retail and non-brokered deposits, and loan origination pipeline. The Bank's assets and liabilities maturing and repricing within one year generally result in a negative one-year gap, which occurs when the level of liabilities estimated to mature and reprice within one year are greater than the level of assets estimated to mature and reprice within that same time frame. If interest rates were to rise significantly, and for a prolonged period, the Bank's operating results could be adversely affected. Gap analysis attempts to estimate the Bank's earnings sensitivity based on many assumptions, including, but not limited to, the impact of contractual repricing and maturity characteristics for rate-sensitive assets and liabilities. Changes in interest rates will also affect the level of voluntary prepayments on the Bank's loans and the receipt of payments on the Bank's mortgage-backed securities, resulting in the receipt of proceeds that the Bank may have to reinvest at a lower rate than the loan or mortgage-backed security being prepaid. Finally, changes in interest rates can result in the flow of funds away from the banking institutions into investments in U.S. government and corporate securities, and other investment vehicles that, because of the absence of federal insurance premiums and reserve requirements, among other reasons, generally can pay higher rates of return than banking institutions. WE ARE VULNERABLE BECAUSE OF THE CONCENTRATION OF OUR BUSINESS IN A LIMITED GEOGRAPHIC AREA, AND BECAUSE OF OUR FOCUS ON PROVIDING CERTAIN TYPES OF LOAN PRODUCTS TO SMALL TO MEDIUM BUSINESS CUSTOMERS Most of the Bank's loans are to businesses and individuals in Wisconsin (and, more specifically, Milwaukee, Ozaukee, Racine and Waukesha Counties), and any general adverse change in the economic conditions prevailing in these areas could reduce the Bank's growth rate, impair its ability to collect loans or attract deposits, and generally have an adverse impact on the results of 13 operations and financial condition of the Bank. If these areas experience adverse economic, political or business conditions, the Bank would likely experience higher rates of loss and delinquency on its loans than if its loans were more geographically diverse. One of the primary focal points of the Bank's business strategy is serving the banking and financial services needs of small to medium-sized businesses in the Bank's geographic region. Small to medium-sized businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions deteriorate in the Milwaukee, Ozaukee, Racine and Waukesha County regions of Wisconsin, the businesses of the Bank's lending clients and their ability to repay outstanding loans may be negatively affected. As a consequence, the Bank's results of operations and financial condition may be adversely affected. The Bank offers fixed and adjustable interest rates on loans, with terms of up to 30 years. Although the majority of the residential mortgage loans that the Bank originates are fixed-rate mortgages, adjustable-rate mortgage ("ARM") loans increase the responsiveness of the Bank's loan portfolio to changes in market interest rates. However, because ARM loans are more responsive to changes in market interest rates than fixed-rate loans, ARM loans also increase the possibility of delinquencies in periods of high interest rates. The Bank also originates loans collateralized by mortgages on commercial real estate and multi-family residential real estate. Since these loans usually are larger than one-to-four family residential mortgage loans, they generally involve greater risks than one-to-four family residential mortgage loans. In addition, since customers' ability to repay these loans often is dependent on operating and managing those properties successfully, adverse conditions in the real estate market or the economy generally can impact repayment more severely than loans collateralized by one-to-four family residential properties. Moreover, the commercial real estate business is subject to downturns, overbuilding and local economic conditions. The Bank also makes construction loans for residences and commercial buildings, as well as on unimproved property. While these loans enable the Bank to increase the interest rate sensitivity of its loan portfolios and receive higher yields than those obtainable on permanent residential mortgage loans, the higher yields correspond to higher risk construction lending. These include risks associated generally with loans on the type of property collateralizing the loan. Moreover, commercial construction lending often involves disbursing substantial funds with repayment dependent largely on the success of the ultimate project instead of the borrower's or guarantor's ability to repay. Again, adverse conditions in the real estate market or the economy generally can impact repayment more severely than loans collateralized by one-to-four family residential properties. THE REGISTRANT AND THE BANK OPERATE IN A HIGHLY REGULATED ENVIRONMENT, WHICH COULD INCREASE OUR COST STRUCTURE OR HAVE ANOTHER NEGATIVE IMPACT ON OUR OPERATIONS. The Registrant and the Bank are subject to extensive state and federal government supervision, regulation and control. Existing state and federal banking laws subject the Registrant and the Bank to substantial limitations with respect to loans, purchase of securities, payment of dividends and many other aspects of the Bank's business. There can be no assurance that future legislation or government policy will not adversely affect the banking industry or the operations of the Bank, to the advantage of the Bank's non-bank competitors. In addition, economic and monetary policy of the Federal Reserve may increase the Bank's cost of doing business and affect its ability to attract deposits and make loans. The techniques used by the Federal Reserve include setting the reserve requirements of banks and establishing the discount rate on bank borrowings. The policies of the Federal Reserve have a direct effect on the amount of bank loans and deposits, and the interest rates charged and paid thereon. RECENT LEGISLATIVE AND REGULATORY ACTIONS TAKEN TO STABILIZE THE UNITED STATES BANKING SYSTEM AND ADDITIONAL ACTIONS BEING CONSIDERED MAY NOT SUCCEED OR MAY DISADVANTAGE US. In response to the recent financial market crisis, the United States government, specifically the Department of Treasury, Federal Reserve and FDIC, working in cooperation with foreign governments and other central banks, has taken a variety of extraordinary measures designed to restore confidence in the financial markets and to strengthen financial institutions, including measures available under the Emergency Economic Stability Act ("EESA"). The EESA followed, and has been followed by, numerous actions by the Federal Reserve, United States Congress, Department of Treasury, FDIC, SEC and others to address the current liquidity and credit crisis. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and 14 investment banks, the lowering of the Fed Funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the financial sector. The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. However, there can be no assurance as to the actual impact the EESA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced by some institutions, and they may not have the desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition, and results of operations could be materially adversely affected. The Treasury is currently developing additional programs to further alleviate the ongoing financial crisis. There can be no assurance that we will be able to participate in future programs. If we are unable to participate, it may have a material adverse effect on our competitive position, financial condition and results of operations. WE ARE SUBJECT TO INCREASES in FDIC insurance premiums and a one-time special ASSESSMENT BY THE FDIC. Effective January 1, 2007, the FDIC adopted a risk-based system for assessment of deposit insurance premiums under which all institutions are required to pay at least minimum annual premiums. In addition, in an effort to replenish the Deposit Insurance Fund in the wake of the recent increase in bank failures in the United States, the FDIC changed its rate structure in December 2008 to generally increase premiums effective for assessments in the first quarter of 2009. Further, in February 2009, the FDIC issued an interim rule to impose a special one-time 20 bps assessment against all financial institutions in the second quarter of 2009, payable in the third quarter of 2009. The system categorizes institutions into one of four risk categories depending on capitalization and supervisory rating criteria. Due to these changes to the FDIC rate structure, our FDIC insurance expense could increase significantly for 2009 and have a material adverse effect on our results of operation. IF WE HAVE SIGNIFICANT LOAN LOSSES, WE WOULD NEED TO FURTHER INCREASE OUR ALLOWANCE FOR LOAN LOSSES AND OUR EARNINGS WOULD DECREASE. The Bank's loan customers may not repay their loans according to their terms, and the collateral securing the repayment of these loans may be insufficient to assure repayment. The risk of nonpayment of loans is inherent in commercial banking, and such nonpayment, if it occurs, may have a material adverse effect on the Bank's results of operations and overall financial condition. The Bank's management attempts to minimize its credit exposure by carefully monitoring the concentration of its loans within specific industries and through prudent loan underwriting and approval procedures, including a determination of the creditworthiness of borrowers and the value of the assets serving as collateral for repayment of certain loans. However, there can be no assurance that such monitoring and procedures will reduce such lending risks. IF WE HAVE UNDERESTIMATED OUR ALLOWANCE FOR LOAN LOSSES, WE MAY HAVE TO TAKE ADDITIONAL CHARGES TO OUR INCOME TO RESTORE THE BALANCE IN ALLOWANCE. The Bank makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for loan losses based on a number of factors. The Bank's allowance for loan losses is established by management and is maintained at a level considered adequate by management to absorb loan losses that are probable and inherent in the Bank's portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond the Bank's control, and such losses may exceed current estimates. Although the Bank's management believes that the allowance for loan losses as of the end of each fiscal quarter is adequate to absorb probable and estimatible losses in its portfolio of loans, there can be no assurance that the allowance will prove sufficient to cover actual loan losses in the future. In addition, federal and state regulators periodically review the Bank's allowance for loan losses and may require the Bank to increase its provision for loan losses or recognize further loan charge-offs, based on judgments different than those of the Bank's management. Any increase in the Bank's allowance for loan losses or loan charge-offs as required by these regulatory agencies would have a negative effect on the operating results of the Bank. Non-performing loans at December 31, 2008 were $8.6 million, compared to $5.7 million at December 31, 2007. Management believes that the recent increase in 15 non-performing loans is a result of normal business fluctuations and the recent downturn in the real estate loan market and the US and local economies in general. No assurance can be given that non-performing loans will not increase in the future. WE ARE SUBJECT TO ENVIRONMENTAL LIABILITY RISK ASSOCIATED WITH COLLATERAL SECURING OUR REAL ESTATE LENDING. Because a significant portion of our loan portfolio is secured by real property, from time to time we may find it necessary to foreclose on and take title to properties securing such loans. In doing so, there is a risk that hazardous or toxic substances could be found on those properties. If such substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. We may also be required to incur substantial expenses that could materially reduce the affected property's value or limit our ability to use or sell the affected property. In addition, future environmental laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we are careful to perform environmental reviews on properties prior to loan closing, our reviews may not detect all environmental hazards. AN INCREASE IN THE COMPETITION IN MARKETS THE BANK SERVE COULD NEGATIVELY IMPACT OUR RESULTS. The financial services industry is highly competitive. The Bank faces intense competition from financial institutions in Milwaukee, Ozaukee, Racine and Waukesha Counties and surrounding markets, and from non-bank financial institutions, such as mutual funds, brokerage firms and insurance companies that are aggressively expanding into markets traditionally served by banks. Many of the Bank's non-bank competitors are not subject to the same degree of regulation as are imposed on bank holding companies, federally insured banks and Wisconsin-chartered state banks. As a result, such non-bank competitors may have advantages over the Bank in providing certain services. The Bank also competes indirectly with regional and national financial institutions, many of which have greater liquidity, lending limits, access to capital and market recognition and resources than the Bank. Expanded interstate banking may increase competition from out-of-state banking organizations and other financial institutions. As a relatively small bank, the Bank may lack the resources to compete effectively in the financial services market. THE BANK MAY NOT BE ABLE TO EFFECTIVELY IMPLEMENT NEW TECHNOLOGY, THAT COULD PUT IT AT A COMPETITIVE DISADVANTAGE AND NEGATIVELY IMPACT ITS RESULTS. The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Bank's future success will depend in part on its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience as well as create additional efficiencies in the Bank's operations. A number of the Bank's competitors may have substantially greater resources to invest in technological improvements. There can be no assurance that the Bank will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to its customers. UNAUTHORIZED DISCLOSURE OF SENSITIVE OR CONFIDENTIAL CUSTOMER INFORMATION, WHETHER THROUGH A BREACH OF THE BANK'S COMPUTER SYSTEM OR OTHERWISE, COULD SEVERELY HARM THE BANK'S BUSINESS. As part of the Bank's normal course of business, it collects, processes and retains sensitive and confidential customer information. Despite the security measures the Bank has in place, its facilities and systems, and those if its third party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors, or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information, whether by the Bank or its vendors, could severely damage its reputation, expose it to the risk of litigation and liability, disrupt its operations and harm its business. THE REGISTRANT'S SHAREHOLDERS MAY NOT BE ABLE TO LIQUIDATE THEIR HOLDINGS OF THE REGISTRANT'S COMMON STOCK WHEN DESIRED. Shares of the Registrant's stock are thinly traded. While the stock is quoted on the Over-the-Counter Bulletin Board, shareholders may be unable to resell their stock quickly or on favorable terms. 16 Item 1B. UNRESOLVED STAFF COMMENTS None. Item 2. PROPERTIES Tri City National Bank has thirty-seven locations in the Metropolitan Milwaukee area, including Oak Creek, Milwaukee, Brookfield, Menomonee Falls, West Allis, Hales Corners, Wauwatosa, Cedarburg, Sturtevant, South Milwaukee and Mount Pleasant. The Bank owns fourteen of its locations and leases twenty-three locations, including twenty-one full service banking centers located in grocery stores. Registrant believes that its bank locations are in buildings that are attractive, efficient and adequate for their operations, with sufficient space for parking and drive-in facilities. Item 3. LEGAL PROCEEDINGS The Registrant is not party to any material legal proceedings other than routine litigation arising in the ordinary course of conducting the Registrant's and the Bank's business. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 2008 to a vote of security holders. 17 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET PRICE FOR AND DIVIDENDS ON COMMON STOCK Information pertaining to the Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters specified in Item 201 of Regulation S-K and required under Item 5(a) of Form 10-K is incorporated herein by reference to Registrant's 2008 Annual Report to Stockholders under the caption entitled "Market for Corporation's Common Stock and Related Stockholder Matters" (Page 30). RECENT SALES OF UNREGISTERED SECURITIES During the three-year period ended December 31, 2008, the Registrant sold a total of approximately 284,895 unregistered shares of its common stock under its Dividend Reinvestment Plan ("DRIP") at a per-share price of $19.35 per share and aggregate consideration of approximately $5,513,000. All of these shares were sold to persons who were shareholders of the Registrant as of the respective dividend record dates who had elected to and participated in the DRIP from time to time. At the time the DRIP was terminated in January 2008 there were approximately 390 shareholders of the Registrant who were participants in the DRIP. The shares were issued in lieu of cash dividends that would otherwise have been paid to the participants. All the shares issued under the DRIP, in excess of the original 250,000 registered shares, were offered and sold without registration under the Securities Act of 1933 ("Securities Act") and no exemption from the registration requirements of the Securities Act may have been available to the Registrant in respect thereof. If these offerings were held to be in violation of the Securities Act of 1933, the Registrant could be required to repurchase the shares sold to purchasers in these offerings at the original purchase price, plus statutory interest from the date of purchase, less dividends received by purchasers on the shares, for a period of one year following the date of the violation. The Registrant believes that any liability that could arise out of its sale of securities without registration would not be material, although there can be no assurance to such effect. Although these shares were issued and sold without registration under the Securities Act of 1933, they were nevertheless validly issued under the Wisconsin Business Corporation Law and the Registrant's Articles of Incorporation and are issued and outstanding for all purposes with all rights (such as voting, dividend and liquidation rights) as all other issued and outstanding shares of the Registrant's common stock. Detailed historical information about the Registrant's sale of registered and unregistered shares pursuant to the DRIP from October 2002 through termination of the DRIP in January 2008 is included in Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities in Registrant's Annual Report on Form 10-K for the year ended December 31, 2007. Such information is incorporated herein by reference. ISSUER PURCHASES OF EQUITY SECURITIES The Registrant did not repurchase any shares of its common stock during the fourth quarter of 2008. Item 6. SELECTED FINANCIAL DATA The information required by Item 6 is incorporated herein by reference to Registrant's 2008 Annual Report to Stockholders under the caption entitled "Selected Financial Data" (Page 30) 18 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The information required by Item 7 is incorporated herein by reference to Registrant's 2008 Annual Report to Stockholders under the caption entitled "Management's Discussion and Analysis of Financial Condition and Results of Operation" (Pages 4 to 31). Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by Item 7A is incorporated herein by reference to Registrant's 2008 Annual Report to Stockholders under the caption entitled "Quantitative and Qualitative Disclosures About Market Risk" (Pages 24 to 27). Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by Item 8 is incorporated herein by reference to Registrant's 2008 Annual Report to Stockholders (Pages 32 to 61). Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None Item 9A(T). CONTROLS AND PROCEDURES The Registrant maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by it in the reports filed by it under the Securities Exchange Act of 1934, as amended, is recorded and processed, summarized and reported within the time periods specified in the SEC's rules and forms. At year end, the Registrant carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer of the Registrant, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer of the Registrant concluded that the Registrant's disclosure controls and procedures were effective as of the end of the period covered by this report. The Registrant's management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in 13a-15(f) and 15d-15(f) under the Exchange Act. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Registrant, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Registrant are being made only in accordance with authorizations of management and directors of the Registrant; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Registrant's assets that could have a material effect on interim or annual consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 19 The Registrant's management, with the participation of its CEO and the CFO, conducted an evaluation of the effectiveness of the Registrant's internal controls over financial reporting as of December 31, 2008 based on the framework and criteria established in Internal Controls - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, management concluded that the Registrant's internal control over financial reporting is effective as of December 31, 2008. This annual report on Form 10-K does not include an attestation of the Registrant's independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Registrant's independent registered public accounting firm pursuant to temporary rules of the SEC that permit the Registrant to provide only management's report in this annual report on Form 10-K. There have been no changes in the Registrant's internal control over financial reporting identified in connection with the evaluation discussed above that occurred during the Registrant's last fiscal quarter that have materially affected, or are reasonable likely to materially affect, the Registrant's internal control over financial reporting. 20 Item 9B. OTHER INFORMATION None. PART III Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by Item 10 is incorporated herein by reference to Registrant's definitive Proxy Statement for its annual meeting of stockholders on June 10, 2009 ("The 2009 Proxy Statement") under the captions entitled "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance". The Registrant has a Code of Ethics that applies to its principal executive officer, principal financial officer and principal accounting officer. Copies of our Code of Ethics are available upon request, free of charge, by contacting the Registrant at 6400 South 27th Street, Oak Creek, Wisconsin, 53154. Item 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference to the 2009 Proxy Statement under the caption entitled "Executive Compensation". Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by Item 12 is incorporated herein by reference to the 2009 Proxy Statement under the caption entitled "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information". Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by Item 13 is incorporated herein by reference to the 2009 Proxy Statement under the caption entitled "Loans and Other Transactions with Management". Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by Item 14 is incorporated herein by reference to the 2009 Proxy Statement under the caption entitled "Principal Accountant Fees and Services". 21 PART IV Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)(1) and (2) Financial statements and financial statement schedules ------------------------------------------------------------------ The response to this portion of Item 15 is submitted as a separate section of this report. (3) Listing of Exhibits Exhibit 3.1 - Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.2 to Registrant's current report on Form 8-K filed February 12, 2003). Exhibit 3.2 - By-Laws (incorporated herein by reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2000). Exhibit 10.1* - Summary of compensation arrangements with certain persons Exhibit 10.2* - Summary of director compensation Exhibit 10.3* - Description of consulting arrangements between Registrant and Mr. William J. Werry. Exhibit 10.4* - Summary of executive bonus arrangements Exhibit 13 - Annual Report to Stockholders for the year ended December 31, 2008. With the exception of the information incorporated by reference into Items 5, 6, 7, 7A,and 8 of this Form 10-K, the 2008 Annual Report to Stockholders is not deemed filed as part of this report. Exhibit 21 - Subsidiaries of Registrant. Exhibit 23 - Consent of Virchow, Krause & Company, LLP Exhibit 31.1 Certification of Chief Executive Officer pursuant to Rule 13a -14(a) or 15d-14(a) under the Securities and Exchange Act of 1934, as amended Exhibit 31.2 Certification of Chief Financial Officer pursuant to Rule 13a -14(a) or 15d-14(a) under the Securities and Exchange Act of 1934, as amended Exhibit 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 Exhibit 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 22 *A Management contract or compensation plan or arrangement (b) Exhibits See Item 15(a)(3) (c) Financial Statement Schedules See Item 15(a)(2) 23 PART IV ANNUAL REPORT ON FORM 10-K ITEM 15(a)(1), (2) and (b) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES CERTAIN EXHIBITS Year Ended December 31, 2008 TRI CITY BANKSHARES CORPORATION OAK CREEK, WISCONSIN 24 FORM 10-K-ITEM 15(a)(1) and (2) TRI CITY BANKSHARES CORPORATION LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES The following consolidated financial statements and report of independent registered public accounting firm of Tri City Bankshares Corporation, included in the annual report of the Registrant to its stockholders for the year ended December 31, 2008, are incorporated by reference in Item 8: Consolidated Balance Sheets-December 31, 2008 and 2007 Consolidated Statements of Income-Years ended December 31, 2008,2007 and 2006 Consolidated Statements of Stockholders' Equity-Years ended December 31, 2008, 2007 and 2006. Consolidated Statements of Cash Flows-Years ended December 31, 2008, 2007 and 2006. Notes to Consolidated Financial Statements-Years ended December 31, 2008, 2007 and 2006. Report of Independent Registered Public Accounting Firm Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are nonapplicable and, therefore, have been omitted. 25 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. TRI CITY BANKSHARES CORPORATION BY: /s/ Ronald K. Puetz. -------------------------------------------- Ronald K. Puetz, President, Chairman and CEO Date: 03/26/09 -------- Pursuant to the requirements of the Securities Exchange Act 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. Name Capacity Date /s/ Ronald K. Puetz President, Chairman, Chief 03/26/09 -------------------- Executive Officer and Director -------- Ronald K. Puetz (Principal Executive Officer) /s/ Scott A. Wilson Executive Vice President, 03/26/09 -------------------- Chief Financial Officer, -------- Scott A. Wilson Treasurer and Director /s/ Robert W. Orth Executive Vice President and 03/26/09 - --------------------- Director -------- Robert W. Orth /s/ Scott D. Gerardin Senior Vice President, 03/26/09 --------------------- General Counsel and Director -------- Scott D. Gerardin /s/ Thomas W. Vierthlaer Vice President and Comptroller 03/26/09 - ------------------------ (Principal Accounting Officer) -------- Thomas W. Vierthaler /s/ Frank J. Bauer Director 03/26/09 - ------------------------ -------- Frank J. Bauer /s/ William N. Beres Director 03/26/09 -------------------- -------- William N. Beres /s/ Sanford Fedderly Director 03/26/09 - -------------------- -------- Sanford Fedderly 26 /s/ William Gravitter Director 03/26/09 - --------------------- -------- William Gravitter /s/ Christ Krantz Director 03/26/09 - --------------------- -------- Christ Krantz /s/ Brian T. McGarry Director 03/26/09 -------------------- -------- Brian T. McGarry /s/ Agatha T. Ulrich Director 03/26/09 -------------------- -------- Agatha T. Ulrich /s/ David A. Ulrich, Jr. Director 03/26/09 ------------------------ -------- David A. Ulrich, Jr. /s/ William J. Werry Director 03/26/09 - --------------------- -------- William J. Werry 27 EX-32.2 2 exh3222008.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.2 SECTION 1350 CERTIFICATION I, Scott A. Wilson, Executive Vice-President, Chief Financial Officer and Treasurer of Tri City Bankshares Corporation (the "Corporation"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2003, 18 U.S.C. Section 1350, that to my knowledge: (1) the Corporation's Annual Report on Form 10-K for the year ended December 31, 2008 fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. Dated: March 26, 2009 /s/Scott A. Wilson --------------------------- Scott A. Wilson Executive Vice President/CFO & Treasurer This certification accompanies this Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2003 and shall not be deemed filed by Tri City Bankshares Corporation for purposes of the Securities Exchange Act of 1934. EX-32.1 3 exh3212008.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.1 SECTION 1350 CERTIFICATION I, Ronald K. Puetz, President, Chairman and Chief Executive Officer of Tri City Bankshares Corporation (the "Corporation"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2003, 18 U.S.C. Section 1350, that to my knowledge: (1) the Corporation's Annual Report on Form 10-K for the year ended December 31, 2008 fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. Dated: March 26, 2009 /s/Ronald K. Puetz ---------------------- Ronald K. Puetz President/Chairman/CEO This certification accompanies this Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2003 and shall not be deemed filed by Tri City Bankshares Corporation for purposes of the Securities Exchange Act of 1934. EX-23 4 exh232008.txt CONSENT OF VIRCHOW, KRAUSE & COMPANY, LLP 2 EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statements No. 33-56886 on Form S-3 of Tri City Bankshares Corporation of our report dated March 26, 2009, relating to the consolidated financial statements of Tri City Bankshares Corporation and subsidiaries as of December 31, 2008 and 2007, and for each of the three years in the period ended December 31, 2008, appearing in the Annual Report on Form 10-K of Tri City Bankshares Corporation for the year ended December 31, 2008. /s/ Virchow, Krause & Company, LLP Milwaukee, Wisconsin March 26, 2009 EX-31.1 5 exh3112008.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO RULE 13A-14(A) OR 15D-14(A 40 2 EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT AND RULE 13A-14(A) OR 15D-14(A) UNDER THE SECURITIES EXCHANGE ACT OF 1934 I, Ronald K. Puetz, certify that: I have reviewed this annual report on Form 10-K of Tri City Bankshares Corporation; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and Internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant's internal control over financial reporting; and The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 26, 2009 /s/Ronald K. Puetz ---------------------- Ronald K. Puetz President/Chairman/CEO EX-31.2 6 exh3122008.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO RULE 13A-14(A) OR 15D-14(A EXHIBIT 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT AND RULE 13A-14(A) OR 15D-14(A) UNDER THE SECURITIES EXCHANGE ACT OF 1934 I, Scott A. Wilson, certify that: I have reviewed this annual report on Form 10-K of Tri City Bankshares Corporation; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and Internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant's internal control over financial reporting; and The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 26, 2009 /s/Scott A Wilson -------------------------- Scott A. Wilson Executive Vice President/CFO EX-21 7 exh212008.txt SUBSIDIARIES OF THE REGISTRANT 6 EXHIBIT 21 SUBSIDIARIES OF REGISTRANT Name Percentage of Shares Owned Tri City National Bank 100.0% (National Banking Association) Tri City Capital Corporation 100.0%(1) (Nevada Corporation) Title Service of Southeast Wisconsin, Inc. 100.0%(1) (Wisconsin Corporation) (1) Owned by Tri City National Bank EX-10.1 8 exh1012008.txt SUMMARY OF COMPENSATION ARRANGEMENTS WITH CERTAIN PERSONS Exhibit 10.1 Summary of Compensation Arrangements with Certain Persons The Bank's executive officers do not have employment agreements with the Registrant. Their salaries as of February 28, 2009 were as follows: Tri City Tri City Tri City Name Bankshares National Bank Capital Corp. Total ---------- ------------- ------------ ---------- Ronald K. Puetz $ 40,000 $ 385,000 $ 1,500 $ 426,500 Robert W. Orth $ 20,000 $ 313,000 $ 1,000 $ 334,000 Scott A. Wilson $ 20,000 $ 283,000 $ 1,000 $ 304,000 Scott D. Gerardin $ 5,000 $ 162,000 $ 167,000 In addition, executive officers are eligible to participate in the Bank's bonus plan. EX-10.2 9 exh1022008.txt SUMMARY OF DIRECTOR COMPENSATION 2 Exhibit 10.2 Summary of Director Compensation Attached is Schedule B that details Board of Director and Committee Member compensation. Directors that are salaried officers of the corporation receive no director or committee compensation. Schedule B is approved annually by the Board of Directors. 1 Exhibit 10.2 Continued SCHEDULE B JANUARY 8, 2009 DIRECTORS' COMPENSATION: Non-salaried Directors $16,000 annual - ------------------------ retainer plus $1,500 per meeting attended of Tri City National Bank and $300 per meeting attended of Tri City Bankshares Corporation, payable quarterly EXECUTIVE COMMITTEE: Annual compensation, payable quarterly: - -------------------- Ronald K. Puetz Ronald K. Puetz - no compensation William Gravitter William Gravitter $17,900 Sanford Fedderly Sanford Fedderly $12,150 Christ Krantz Christ Krantz $ 5,600 Brian T. McGarry Brian T. McGarry $ 5,600 LOAN COMMITTEE: William Werry, Chairman Non-salaried Directors: Robert W. Orth Chairman $750 per meeting attended Sanford Fedderly Other members $500 per meeting attended William Gravitter Payable quarterly Christ Krantz Ronald K. Puetz Scott A. Wilson Brian T. McGarry AUDIT COMMITTEE: William N. Beres, Chairman Chairman $10,000 per annum, payable Sanford Fedderly quarterly Non-salaried members $250 per Christ Krantz meeting attended Payable quarterly CRA/COMPLIANCE COMMITTEE Scott A. Wilson, Chairman Non-salaried Directors: David A. Urlich, Jr. $250 per meeting attended, payable Scott D. Gerardin quarterly Georgia Franecki Joseph Porter Michael Koenen William Zick Mark Dandrea Kristen Gagliano EX-10.3 10 exh1032008.txt DESCRIPTION OF CONSULTING ARRANGEMENTS BETWEEN REGISTRANT AND MR. WILLIAM J. WE 9 Exhibit 10.3 Description of Consulting Arrangement Between Registrant and Mr. William J. Werry William J. Werry, a retired bank President, has been retained as an independent consultant advising the Chairman of the Registrant on a range of matters. His compensation is approved annually by the Board of Directors of Tri City National Bank. His current annual compensation for these services is $16,800, payable monthly, and is in addition to his compensation as a director. EX-10.4 11 exh1042008.txt SUMMARY OF EXECUTIVE BONUS ARRANGEMENTS 8 Exhibit 10.4 SUMMARY OF OFFICER BONUS ARRANGEMENTS DESCRIPTION The officers of the Registrant and the Bank are eligible for a bonus calculated as a percentage of each officer's base salary. Executive officers of the Registrant participate in the plan on the same basis as all other participating officers. The bonus is approved by the Board of Directors and the specific percentage award is determined based upon the Registrant's return on average assets for the twelve-month period ending on November 30. If the return on assets is less than one and one quarter percent (1.25%), no cash bonuses are paid under the plan. The threshold bonus is 2% of salary, and the maximum is 20% of salary. If the Registrant were to achieve a one and one half percent (1.50%) return on average assets, officers would receive a bonus of 10% of salary. OTHER PROVISIONS If an officer's employment is terminated for any reason before the bonus is paid, the officer forfeits all rights to the bonus. This bonus arrangement does not give any officer the right to be retained in the employment of the Registrant and does not affect the right of the Registrant to terminate, with or without cause, any officer's employment at any time. The Registrant has the right to withhold from any compensation payable to an officer, or to cause the officer (or the executor or administrator of his or her estate or his or her distributee) to make payment of any federal, state, local or foreign taxes required to be withheld with respect to any payment. The Board of Directors may amend, alter, suspend or discontinue the bonus arrangements as it shall at any time or from time to time determine in its sole discretion. EX-13 12 annrept2008.txt ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2008. Dear Shareholders: The banking landscape has changed dramatically over the last twelve months as the scope of the crisis in financial markets and the economy exceeded most predictions. In December 2008 the National Bureau of Economic Research reported that the United States had been in a recession since December 2007. With high unemployment, record numbers of foreclosures and numerous bank failures, this pronouncement came as no surprise. Despite the economic downturn, Tri City Bankshares Corporation had record earnings for a fourth consecutive year. Dividends were increased for a fifteenth consecutive year and the Corporation ended 2008 with an all-time high $792.9 million in total assets. These results were made possible by two basic strengths; equity significantly in excess of that which defines a bank as "well capitalized" and strategic reliance on the stability and low cost of core deposits. We will continue to build on our strengths. Our foremost objectives are managing credit risk and interest rate risk and maintaining our commitment to strong capital levels. These are not new initiatives, rather a continuation of the principles that have allowed your Corporation to weather a troubled economy. Our community bank business plan will remain a priority. Retail deposit acquisition provides core deposits. Those funds are deployed as small business and consumer loans allowing Tri City National Bank to completely serve the many communities we call home. Economic conditions in 2009 will provide challenges as well as opportunities for the Corporation. The Board of Directors, officers and staff will pursue those opportunities as we continually strive to protect and enhance your investment. Very truly yours, TRI CITY BANKSHARES, Inc. /s/Ronald K. Puetz Ronald K. Puetz Chairman of the Board, CEO Directors and Officers of the Corporation DIRECTORS Frank J. Bauer President of Frank Bauer Construction Company, Inc. William N. Beres Independent financial consultant since January, 2009. Former Chief Financial Officer of Wisvest LLC, and Vice President of Minergy LLC, wholly owned subsidiaries of Wisconsin Energy Corporation from January, 1999 through December, 2008. Sanford Fedderly Retired Registered Pharmacist Scott D. Gerardin Senior Vice President and General Counsel of Tri City Bankshares Corporation and Senior Vice President and General Counsel of Tri City National Bank William Gravitter Retired President of Hy-View Mobile Home Court, Inc. Christ Krantz Vice President of K.R.K., Inc., President of Krantz Realty, Inc. and Partner in Krantz Partnership Limited Brian T. McGarry Retired Vice President of Tri City National Bank and Director of NDC LLC Robert W. Orth Executive Vice President of the Corporation and President of Tri City National Bank Ronald K. Puetz Chairman of the Board, President and Chief Executive Officer of Tri City Bankshares Corporation and Chairman of the Board and Chief Executive Officer of Tri City National Bank and Treasurer of NDC LLC Agatha T. Ulrich Chairman and Director of NDC LLC, President and Director of the David A. and Agatha T. Ulrich Foundation, Inc. David A. Ulrich, Jr. Independent Investor, Retired Vice President and Director of Mega Marts, Inc., Retired Vice President and Director of NDC, Inc., Director of NDC LLC and Director of the David A. and Agatha T. Ulrich Foundation, Inc. William J. Werry Retired Unit President of Tri City National Bank Scott A. Wilson Executive Vice President CFO, Treasurer and Secretary of Tri City Bankshares Corporation, and Executive Vice President, Treasurer and Secretary of Tri City National Bank 2 Officers Ronald K. Puetz President, Chairman and Chief Executive Officer Robert W. Orth Executive Vice President Scott A. Wilson Executive Vice President, Chief Financial Officer and Treasurer Scott D. Gerardin Senior Vice President and General Counsel Thomas W. Vierthaler Vice President and Comptroller George E. Mikolajczak Vice President - Human Resources Gary J. Hafemann Vice President and Auditor 3 Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion provides Management's analysis of the audited consolidated financial statements of Tri City Bankshares Corporation (the "Corporation") and should be read in conjunction with those financial statements. This discussion focuses on significant factors that affected the Corporation's financial performance in 2008 with comparisons to 2007 and to 2006 where applicable. For all periods presented, the operations of Tri City National Bank (the "Bank") contributed substantially all of the Corporation's revenue and expense for the year. Included in the operations of the Bank are the activities of its wholly-owned subsidiaries, Tri City Capital Corporation, Inc. and Title Service of Southeast Wisconsin, Inc. OVERVIEW The year ended December 31, 2008 was one of the most challenging ever for financial institutions. The failure of numerous Wall Street investment banks, continued declines in the housing market, increasing unemployment and a credit crisis on Main Street as well as Wall Street resulted in unprecedented action prompting the U.S. Treasury to establish the $700 billion Troubled Asset Relief Program (TARP), the first substantive action under the Emergency Economic Stabilization Act approved by Congress. Despite the uncertainty and turmoil, the Corporation posted record after tax earnings of $11.0 million, an increase of $1.0 million (10.5%) over 2007 earnings. The results were partially due to the Bank's improved operating income and partially due to income from non-recurring events. Those events included a death benefit of $0.6 million on Bank Owned Life Insurance (BOLI) and gains of $0.1 million realized from the sale of VISA stock owned by the Bank. The increased earnings also occurred despite a $1.3 million charge to earnings for the Bank's Provision for Loan and Lease Losses (PLLL) for the year. The PLLL for 2008 increased by $0.8 million from $0.5 million in 2007. The Bank is not immune to the effects the weakening economy has had on its retail and commercial borrowers. FORWARD-LOOKING STATEMENTS This report contains statements that may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements other than historical facts contained or incorporated by reference in this report. These statements speak of the Corporation's plans, goals, beliefs or expectations, refer to estimates or use similar terms. Future filings by the Corporation with the Securities and Exchange Commission, and statements other than historical facts contained in written material, press releases and oral statements issued by, or on behalf of the Corporation, may also constitute forward-looking statements. Forward-looking statements are subject to significant risks and uncertainties. The Corporation's actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause actual results to differ from the results discussed in forward-looking statements include, but are not limited to the factors set forth in Item 1A of the Corporation's Annual Report on Form 10-K (the "2008 Form 10-K") for the year ended December 31, 2008, which item is incorporated herein by reference. All forward-looking statements contained in this report or that may be contained in future statements made for or on behalf of the Corporation are based upon information available at the time the statement is made and the Corporation assumes no obligation to update any forward-looking statement. CRITICAL ACCOUNTING POLICIES A number of accounting policies require the use of management's judgment. Management considers the most significant accounting policy to be the determination of the amount of the allowance for loan and lease losses. We evaluate our loan portfolio at least quarterly to determine the adequacy of the allowance for loan and lease losses ("ALLL"). Included in the review are five components: (1) historic review of losses and allowance coverage based on peak and average loss volume; (2) review of portfolio trends in volume and composition with attention to possible concentrations; (3) review of delinquency trends and loan performance compared to our peer group; (4) review of local and national economic conditions; and (5) qualitative review of non-performing loans identifying charge-offs, potential loss after collateral liquidation and credit weaknesses requiring above-normal supervision. As the allowance for loan and lease losses is an estimate, there is a risk that actual results will differ from expectations and additional losses, and a charge to earnings may result. 4 PERFORMANCE SUMMARY The Corporation's strong performance and record earnings came in a year with more financial turmoil than any in recent history. Many financial institutions have faltered and others, large and small, have failed. The Corporation and its Bank remain financially stable as a result of strong capital, strong funding from core deposits, a quality loan portfolio and the ability to rely on the strength of management and our dedicated employees. Meanwhile from Wall Street to Main Street shock waves were felt throughout 2008: o March - Bear Stearns is the first to succumb to the sub-prime lending crisis as it is sold in distressed condition to J.P. Morgan Chase. o July - The FDIC closes IndyMac Bank making it the fourth biggest bank failure in U.S. history. o September - The newly created Federal Housing Finance Agency places mortgage giants Fannie Mae and Freddie Mac in a conservatorship allowing the U.S. Treasury to support their obligations and operations. o September - Lehman Brothers, a prominent Wall Street securities firm, files for bankruptcy protection. o September - The Federal Reserve rescues American Insurance Group (AIG). o September - JP Morgan Chase takes over WaMu. Washington Mutual, the biggest savings bank in the county, is now also the largest bank ever to fail. o October - Congress approves Emergency Economic Stabilization Act in the amount of $700 billion. o October - Wachovia is acquired by Wells Fargo after its troubled mortgage portfolio and a stunning $5 billion worth of withdrawals in a single day make it the next likely big bank failure. o November - Citigroup receives a bailout in the form of additional capital and guarantees. o December - Madoff fraud allegedly bilks investors of $50 billion. o December - Federal Reserve Open Market Committee cuts rates to lowest ever with the unprecedented move to a range of 0.0% to 0.25% as the target rate for Federal Funds. o December - US Treasury gives automakers $17 billion in bailout loans from the TARP fund originally approved for the financial industry. In general, local banks have fared better than large national financial institutions, some of which were bailed out, failed or were sold in distressed condition. Although many Wisconsin banks posted reduced earnings or losses for 2008, a few saw increased earnings. The Corporation is in the latter group and is pleased to report record net income of $11.0 million for the year ended December 31, 2008, an increase of $1.0 million or 10.5% from the $10.0 million earned in 2007. Basic earnings per share for 2008 were $1.24, a 9.7% increase from 2007 basic earnings per share of $1.13. Return on average assets and return on average equity for 2008 were 1.46% and 10.12%, respectively, compared to 1.36% and 9.49%, respectively, for 2007. Cash dividends of $1.04 per share paid in 2008 increased by 4.0% over cash dividends of $1.00 per share paid in 2007. o 2008 net income increase of $1.0 million reflected income from two non-recurring events. The unexpected passing of Chairman Hank Karbiner resulted in a tax-free death benefit of $0.6 million from bank owned life insurance and pretax income of $0.1 million resulted from the gain on sale of VISA stock following the VISA initial public offering. Excluding these items, the Corporation would still have posted record net income of $10.3 million for 2008, an increase of $0.3 million (3.5%) over 2007. The $0.3 million increase excluding non-recurring items is notable given that the Bank's provision for loan losses increased $0.8 million (160%) to $1.3 million in 2008 from $0.5 million in 2007. o Taxable equivalent net interest income was $34.7 million for 2008, an increase of $1.6 million (4.8%) from 2007. Taxable equivalent interest income decreased $1.4 million while interest expense decreased $3.0 million as a result of declining rates and the opportunity to re-price the Bank's variable rate deposits faster than loans. Although interest yields on loans repriced at a slower pace than yields on deposits, they did reprice at lower rates throughout 2008, resulting in $3.8 million less interest income from loans. This decrease in interest income was partially offset by growth in commercial and real estate loans that added $2.7 million to interest income. The resulting $1.1 million net decrease in interest income from loans was the largest component of the $1.4 million decrease to total interest income with a reduction in interest income from Federal funds (Fed funds) sold accounting for the remainder. On the expense side, a decrease of $3.0 million in interest expense on deposits and short-term borrowings was primarily attributable to lower rates that reduced interest expense by $4.0 million that was partially offset by increased volume in time deposits and money market accounts resulting in $1.0 million additional interest expense. Average earning assets increased $23.7 million to $698.8 million while average interest bearing liabilities increased $22.0 million to $519.7 million. 5 o The net interest margin for 2008 was 4.97%, compared to 4.90% in 2007. The 7 basis point ("bp") increase is attributable to a 27 bp increase in interest rate spread (a decrease of 43 bp on the yield of earning assets offset by a 70 bp decrease on the yield of interest-bearing liabilities), partially offset by a 20 bp decrease from the contribution of net interest free funds. The Bank's net interest margin has remained in the upper third of its peer group throughout recent interest rate cycles. o Total loans were $599.6 million at December 31, 2008, an increase of $13.4 million from December 31, 2007, primarily due to commercial and residential real estate loan growth and a small increase in real estate construction loans outstanding. Total real estate loans grew $17.9 million (3.3%) and represented 93.7% of total loans at December 31, 2008, compared to 92.8% at December 31, 2007. Commercial loans declined $4.4 million (15.7%) and represented 3.9% of total loans at December 31, 2008, compared to 4.8% at December 31, 2007. Total deposits were $677.7 million at December 31, 2008, an increase of $11.9 million or 1.8% from December 31, 2007. The increase was fueled by a $26.7 million increase in time deposits which more than offset decreases in demand deposits, savings and transaction accounts. o Asset quality in the Bank has been negatively affected by the current economic crisis. However, non-performing assets and other real estate owned (OREO) are well below peer levels. Net charge offs were $1.1 million in 2008, an increase of $0.7 million from 2007, with the majority of the increase attributable to the real estate mortgage loan portfolio. Net charge offs were 0.19% of average loans in 2008 compared to 0.07% in 2007. The provision for loan losses charged to earnings was $1.3 million in 2008 compared to $0.5 million in 2007. The ratio of allowance for loan and lease losses to loans was 0.99% and 0.98% at December 31, 2008 and 2007, respectively. Nonperforming loans were $8.6 million, representing 1.4% of total loans at December 31, 2008, compared to $5.6 million (1.0%) of total loans at December 31, 2007. The Bank held only one property valued at $0.1 million in OREO at December 31, 2008 and this non-earning asset was liquidated in January 2009. o Non-interest income was $12.9 million for 2008, an increase of $1.6 million (14.4%) from 2007. The increase was primarily the result of ancillary fees paid by retail deposit account holders that increased $0.5 million (5.5%) from 2007 to 2008. Mortgage banking revenue also increased $0.2 million (125.8%) in 2008 due to increased refinance activity in secondary market mortgages. Other income increased $0.9 million (70.2%) primarily as a result of the aforementioned BOLI and VISA non-recurring events. o Non-interest expense was $29.2 million, up $1.2 million or 4.2% from 2007. Personnel expense increased $0.4 million (2.8%), occupancy expense increased $0.2 million (8.2%), computer services increased $0.3 million (13.5%) and other expenses increased $0.3 million (6.9%). o Income tax expense remained unchanged at $5.3 million for 2008 compared to 2007 despite higher income due to a significant increase in tax exempt investment security income and the tax-free nature of the BOLI death benefit. o As of December 31, 2008, the Bank's Tier 1 leverage ratio was 13.7%, the Tier 1 risk-based capital ratio was 17.3% and the total risk-based capital ratio was 18.3%. All ratios exceed minimum regulatory requirements for the Bank to be deemed "well capitalized". With the passage of TARP, financial institutions were able to improve their capital ratios by selling preferred stock to the US Treasury Department under the Treasury's Capital Purchase Program ("CPP"). Some financial institutions sought to achieve "well capitalized" status while other already "well capitalized" financial institutions sought to improve their ratios. With the Bank's leverage ratio of 13.7% exceeding the 5.0% "well capitalized" minimum by 8.7%, with its Tier 1 risk based ratio of 17.3% exceeding the 6.0% "well capitalized" minimum by 11.3% and with its total capital to risk weighted asset ratio of 18.3% exceeding the 10% "well capitalized" minimum by 8.3%, the Corporation chose not to participate in CPP and took no TARP money. INCOME STATEMENT ANALYSIS Table 1 provides average balances of interest-earning assets and interest-bearing liabilities, the interest income and expense resulting from each, and the calculated interest rates earned and paid. The table further shows net interest income, interest rate spread, and the net interest margin on a taxable equivalent basis for the years ended December 31, 2008, 2007 and 2006. 6 TABLE 1 AVERAGE BALANCES AND INTEREST RATES (Interest rates on a taxable equivalent basis) (Dollars in Thousands)
2008 2007 2006 ---- ---- ---- Yield Yield Yield Average or Average or Average or Balance Interest Cost Balance Interest Cost Balance Interest Cost ASSETS Interest Earning Assets: Loans $ 586,774 $ 38,828 6.62% $ 549,094 $ 39,894 7.27 % $ 515,074 $ 35,558 6.90 % Taxable Investment Securities 68,475 3,056 4.46% 88,062 3,617 4.11 % 96,782 3,744 3.87 % Non Taxable Investment 39,410 2,244 5.69% 29,427 1,673 5.69 % 32,653 1,763 5.40 % Securities Fed Funds Sold 4,171 86 2.06% 8,588 452 5.26 % 9,451 459 4.86 % ---------- --------- --------- --------- ---------- --------- Total Interest Earning Assets 698,830 44,214 6.33% 675,171 45,636 6.76 % 653,960 41,524 6.35 % Noninterest-Earning Assets: Other Assets 54,753 57,038 56,796 ---------- --------- ---------- TOTAL ASSETS $ 753,583 $ 732,209 $ 710,756 ========== ========= ========== LIABILITIES AND EQUITY Interest-Bearing Liabilities: Transaction Accounts $ 170,192 2,045 1.20% $ 180,013 4,105 2.28 % $ 157,293 3,313 2.11 % Money Market 77,411 1,438 1.86% 56,449 1,923 3.41 % 46,476 1,216 2.62 % Savings Deposits 132,643 850 0.64% 135,049 1,105 0.82 % 136,404 888 0.65 % Other Time Deposits 133,003 5,055 3.80% 112,222 4,741 4.22 % 125,681 4,946 3.94 % Short-Term Borrowings 6,437 129 2.00% 13,983 700 5.01 % 4,380 229 5.23 % ---------- --------- --------- --------- ---------- --------- Total Interest-Bearing Liabilities 519,686 9,517 1.83% 497,716 12,574 2.53 % 470,234 10,592 2.25 % --------- --------- --------- Noninterest Bearing Liabilities: Demand Deposits 125,217 128,100 137,152 Other 726 1,260 2,743 Stockholders' Equity 107,954 105,133 100,627 ---------- --------- ---------- Total Liabilities and Stockholders' Equity $ 753,583 $ 732,209 $ 710,756 ========== ========= ========== Net interest earnings and interest rate spread $ 34,697 4.50% $ 33,062 4.23 % $ 30,932 4.10% ========= ====== ========= ======= ========= ====== Net interest margin (FTE) 4.97% 4.90 % 4.73% ====== ======= ======
NET INTEREST INCOME Interest income is the Corporation's primary source of revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing deposits and other borrowings, such as the Fed funds purchased through a correspondent bank. Net interest income is affected by increasing or decreasing interest rates, as well as by the mix and volume of both the interest-earning assets and interest-bearing liabilities. Additionally, the composition and characteristics of such assets and liabilities contribute to the sensitivity of the balance sheet to changes in interest rates. Examples of these characteristics include loans with floating rates tied to an index, such as the Bank's reference rate, and the contractual maturities of loans. Similarly, on the deposit side, the ratio of time deposits to deposits with no stated investment term impacts balance sheet sensitivity. An examination of the interest rate spread and net interest margin will explain changes in net interest income. Interest rate spread is the difference between 7 the yield on interest-earning assets and the rate paid for interest-bearing liabilities that fund those assets. Net interest margin is expressed as the percentage of net interest income to average interest-earning assets. Net interest margin exceeds interest rate spread because non-interest-bearing sources of funds, principally demand deposits and stockholders' equity, also support interest-earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt loans and securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis. Table 1 shows taxable equivalent net interest income of $34.7 million for 2008, an increase of $1.6 million (4.95%) from $33.1 million in 2007. The increase in taxable equivalent net interest income is the result of lower rates and the fact that the Bank has more variable rate liabilities than variable rate assets. The Federal Reserve ("Fed") aggressively cut the target rate on Fed funds seven times in 2008. The cumulative effect of the rate reductions was 4.0% and on December 17, 2008, the Fed took the unprecedented step of setting a range (0.0% to 0.25%) instead of a target rate. Each rate cut during the year reduced interest expense on variable rate deposits such as money market, transaction and savings accounts. Interest income on maturing notes and floating rate loans was also reduced. As rates declined, the Bank's interest expense declined faster than interest income. Interest expense on total interest bearing liabilities decreased $3.1 million to $9.5 million in 2008 from $12.6 million in 2007 while interest income on total interest earning assets decreased $1.4 million to $44.2 million from $45.6 million in 2007. The net effect of these variances is a year-to-year increase of $1.6 million in taxable equivalent net interest income. Growth in the commercial and residential real estate loan portfolios (resulting in a higher level of earning assets) partially offset reduced interest income resulting from rate changes that occurred as maturing loans re-priced at rates below the rate charged on the prior note. Another factor impacting interest income in 2008 occurred as numerous business loan customers requested rate reductions prior to the maturity of their loan based on competitive offers from other financial institutions. In some cases these requests were honored (reducing portfolio yield) while in other cases the business was allowed to refinance with another institution (reducing portfolio balances). In both cases the effect was a reduction in interest income. Interest income on loans decreased $1.1 million in 2008 to $38.8 million from $39.9 million in 2007. Interest income on taxable investment securities decreased $0.5 million in 2008 to $3.1 million from $3.6 million in 2007 despite an increased yield of 35 bp to 4.46% for 2008 from 4.11% in 2007. The decrease was the result of movement out of taxable securities and re-investment in tax-exempt securities. The transition allowed the Bank to take advantage of higher tax equivalent yields on municipal investments. Average balances of taxable investment securities decreased $19.5 million in 2008 to $68.5 million from $88.0 million in 2007. Tax-exempt investment securities increased $10 million in 2008 to $39.4 million from $29.4 million in 2007. Although tax equivalent yields were constant at 5.69% from 2007 to 2008, interest income on tax-exempt investments increased $0.5 million in 2008 to $2.2 million from $1.7 million in 2007 as a result of the $10.0 million increased average balance. Interest income on Fed funds sold by the Bank decreased $0.4 million to $0.1 million in 2008 from $0.5 million in 2007 as average balances decreased and the Fed's action reduced rates. Average Fed funds sold decreased $4.4 million to $4.2 million in 2008 from $8.6 million in 2007 as excess funds were used to support loan growth achieved in 2007-2008. Variable rate deposits and maturing time deposits all re-priced at lower rates as the year progressed. Overall funding yields on interest-bearing liabilities decreased 70 bp in 2008 to 1.83% from 2.53% in 2007. The decrease was significant in all five of the interest-bearing liability categories, as shown in Table 1. o Transaction account yields decreased 108 bp to 1.20% in 2008 from 2.28% in 2007. o Money market deposit yields decreased 155 bp to 1.86% in 2008 from 3.41% in 2007. o Savings deposit yields (including savings sweep accounts) decreased 18 bp to 0.64% in 2008 from 0.82% in 2007. o Time deposit yields decreased 42 bp to 3.80% in 2008 from 4.22% in 2007. o Short term rates on Fed funds borrowings decreased dramatically as a result of actions by the Fed already discussed. The effect was a reduction in the yield on Corporation's short term (Fed funds purchased) of 301 bp to 2.0% in 2008 from 5.01% in 2007. With the exception of time deposits, interest expense decreased on all deposit categories listed in Table 1 due to the reduced yields. The $21.0 million increase in the average balance on time deposits offset the 42 bp reduction in yield and resulted in a $0.4 million increase in interest expense to $5.1 million in 2008 from $4.7 million in 2007. 8 As a result of the changes to yields of interest earning assets and interest bearing liabilities the taxable equivalent net interest margin for 2008 was 4.97% compared to 4.90% for 2007. The 7 bp improvement is attributable to a 27 bp contribution from an improved interest rate spread (with a 43 bp decrease on the yields of earning assets more than offset by a 70 bp decrease on the rates paid on deposits and borrowed funds) less a 20 bp decreased contribution from net free funds. The increase marks the third consecutive year of margin improvement after three years of margin compression. However, the entire interest rate cycle should be viewed in the context of peer performance where the Corporation's net interest margin ranks in the top 10 percent of over 1,000 similarly sized banks as ranked by the Federal Financial Institutions Examination Council ("FFIEC") in its December 31, 2008 peer analysis, the Uniform Bank Performance Report ("UBPR"). Information in the UBPR is compiled by the FFIEC and while management believes such information to be accurate, the Corporation assumes no responsibility for any inaccuracies in such information. TABLE 2 INTEREST INCOME AND EXPENSE VOLUME AND RATE CHANGE (Dollars in Thousands) The following table sets forth, for the periods indicated, a summary of the changes in interest earned (on a fully taxable equivalent basis) and interest paid resulting from changes in volume and rates:
2008 Compared to 2007 2007 Compared to 2006 Increase (Decrease) Due to Increase (Decrease) Due to Volume Rate(1) Net Volume Rate(1) Net Interest earned on: Loans 2,738 (3,803) (1,065) 2,349 1,987 4,336 Taxable investment securities (805) 244 (561) (337) 210 (127) Nontaxable investment securities 568 3 571 (174) 84 (90) Fed funds sold (233) (133) (366) (42) 35 (7) ------- ------- ------- Total interest-earning assets $ 2,268 $(3,689) $(1,421) $ 1,796 $ 2,316 $ 4,112 ======= ======= ======= ======= ======= ======= Interest paid on: Transaction accounts (224) (1,835) (2,059) 479 313 792 Money market 714 (1,199) (485) 261 446 707 Savings deposits (20) (236) (256) (9) 226 217 Time deposits 878 (564) 314 (530) 325 (205) Short-term borrowings (378) (193) (571) 502 (31) 471 ------- ------- ------- ------- ------- ------- Total interest-bearing $ 970 $(4,027) $(3,057) $ 703 $ 1,279 $ 1,982 ======= ======= ======= ======= ======= ======= liabilities Increase in net interest income $ 1,636 $ 2,130 ======= =======
(1) The change in interest due to both rate and volume has been allocated to rate changes. Interest earned on total interest-earning assets indicates that changes due to volume caused taxable equivalent net interest income to increase by $2.3 million from 2007 to 2008 while changes due to rate caused a $3.7 million decrease for the same period, resulting in a net $1.4 million decrease from 2007 to 2008 in tax equivalent interest earned on total interest-earning assets. For interest paid on total interest-bearing liabilities, there was an increase of $1.0 million due to volume from 2007 to 2008, while changes due to rate decreased funding costs by $4.0 million, which resulted in a net decrease of $3.0 million interest paid on total interest-bearing liabilities. The net effect of the foregoing was an increase in net interest income of $1.6 million. A review of the changes to interest earned due to volume and rate for individual asset categories reveals an increase due to loan volume of $2.7 million and a decrease of $3.8 million due to rate, resulting in a net decrease of $1.1 million in interest earned on loans. Interest earned on taxable investment securities decreased $0.6 million and interest earned on tax-exempt investment securities increased $0.6 million, which reflects a shift during the year to tax-exempt investment securities in the portfolio and resulting in no net change from 2007 to 2008 in interest income in this asset group. The remainder of the variance in interest earned on interest earning assets is the result of a $0.4 million decrease due to both volume and rate on Fed funds sold. A review of the changes to interest paid on individual liability categories reveals decreased interest paid on all account types with the exception of time deposits. Lower rates on variable rate products was the most significant factor. o Lower rates reduced interest paid on transaction accounts $1.8 million accounting for nearly all of the $2.1 million decrease. 9 o Lower rates paid on money market accounts reduced interest paid $1.2 million, offset by a $0.7 million increase due to volume increases and resulting in a $0.5 million net decrease in interest paid on money market accounts. Money market average balances increased $21.0 million (37.1%) to $77.4 million in 2008 compared to $56.4 million in 2007 as a result of both a new investor money market account offered by the Bank and a general flight to safety that increased deposits at many FDIC insured institutions during 2008. o Net interest paid on savings deposits decreased $0.3 million almost entirely as a result of decreased interest rates. o With rates declining and the economic outlook negative, the Bank promoted time deposits for much of 2008 to maximize the advantage of core deposits. A $0.6 million decrease due to rates was more than offset by a $0.9 million increase due to volume resulting in a $0.3 million net increase to interest paid on time deposits. Average balances of time deposits increased $21 million (19%) to $133 million in 2008 compared to $112 million in 2007. o Interest paid on short-term borrowings decreased $0.4 million due to volume and decreased $0.2 million due to rate, resulting in reduced interest expense of $0.6 million for this liability category. TABLE 3 SELECTED AVERAGE BALANCES (Dollars in Thousands) Dollar Percent ASSETS 2008 2007 Change Change ---- ---- ------ ------ Loans: Commercial $ 401,523 $ 377,161 $ 24,362 6.5% Residential real estate 155,670 144,743 10,927 7.5% Consumer 29,581 27,190 2,391 8.8% --------- --------- -------- Total loans 586,774 549,094 37,680 6.9% Investment securities: Taxable 68,475 88,062 (19,587) (22.2)% Tax-exempt 39,410 29,427 9,983 33.9% Short-term investments 4,171 8,588 (4,417) (51.4)% --------- --------- -------- Securities and short-term investments 112,056 126,077 (14,021) (11.1)% --------- --------- -------- Total earning assets 698,830 675,171 23,659 3.5% Other assets 54,753 57,038 (2,285) (4.0)% --------- --------- -------- Total assets $ 753,583 $ 732,209 $ 21,374 2.9% ========= ========= ======== LIABILITIES & STOCKHOLDERS' EQUITY Interest-bearing deposits: Savings deposits $ 132,643 $ 135,049 $ (2,406) (1.8)% Transaction account deposits 170,192 180,013 (9,821) (5.5)% Money market deposits 77,411 56,449 20,962 37.1% Time deposits 133,003 112,222 20,781 18.5% --------- --------- -------- Total interest-bearing deposits 513,249 483,733 29,516 6.1% Short-term borrowings 6,437 13,983 (7,546) (54.0)% --------- --------- -------- Total interest-bearing liabilities 519,686 497,716 21,970 4.4% Noninterest-bearing demand deposits 125,217 128,100 (2,883) (2.3)% Accrued expenses and other liabilities 726 1,260 (534) (42.4)% Stockholders' equity 107,954 105,133 2,821 2.7% --------- --------- -------- Total liabilities and stockholders' equity $ 753,583 $ 732,209 $ 21,374 2.9% ========= ========= ======== 10 As shown in Table 3, average total earning assets were $698.8 million in 2008, an increase of $23.7 million (3.5%) from $675.2 million in 2007. The loan portfolio contributed $37.7 million of new earning assets, an increase of 6.9% to $586.8 million in 2008 from $549.1 million in 2007. The increase was driven by commercial and residential real estate loan growth. Commercial loans (primarily secured by real estate) increased $24.4 million (6.5%) to $401.5 million in 2008 from $377.2 million in 2007. Marketing for new business was very selective in 2008 with the Bank's attention to equity, cash flow and borrower character as critical as ever. Residential real estate loans increased $10.9 million (7.5%) to $155.7 million in 2008 from $144.7 million in 2007. Consumer loans increased $2.4 million (8.8%) to $29.6 million in 2008 from $27.2 million in 2007 as a result of Home Equity Line of Credit ("HELOC") promotions. Growth in both of these categories was achieved despite media reports that credit was tightening for consumers. While unqualified borrowers may see fewer credit options, creditworthy borrowers with sufficient equity and cash flow should be able to finance or refinance as needed. The Bank decreased its average investment securities and short term investments by a total of $14.0 million (11.1%) to $112.1 million in 2008 compared to $126.1 million for 2007. The Bank reduced the average balance of taxable investments $19.6 million (22.2%) to $68.5 million by shifting $10.0 million to tax-exempt investments offering higher tax-equivalent yields. The average balance of tax-exempt investments increased $10.0 million (33.9%) to $39.4 million as a result. The average balance of the Bank's short term investments, consisting of Fed funds sold overnight, decreased $4.4 million (51.4%) to $4.2 million in 2008 from $8.6 for 2007. Funds from this decrease of $14.0 million in securities and short term investments were deployed instead to higher yielding loans. Other assets were reduced $2.3 million (4.0%) to $54.7 million in 2008 from $57.0 million for 2007 as a result of normal depreciation of fixed assets and a decrease of $1.1 million to the Bank's investment in BOLI. Total average assets increased $21.4 million (2.9%) to $753.6 million in 2008 from $732.2 million in 2007. The increase in average earning assets in 2008 was supported by an increase of $29.5 million (6.1%) in average balances of total interest-bearing deposits to $513.2 million in 2008 compared to $483.7 million for 2007. Savings deposits decreased $2.4 million (1.8%) to $132.6 million in 2008 from $135.0 million in 2007. Transaction accounts decreased $9.8 million (5.5%) to $170.2 million in 2008 from $180.0 million in 2007. While some of these decreases were caused by normal account attrition, most of the decrease in the average balances of savings and transaction accounts was movement within the Bank to a newly offered product, an "Investor Money Market Deposit Account". As a result of balance shifting and new deposit inflow, average balances of money market deposits increased $21.0 million (37.1%) to $77.4 million in 2008 from $56.4 million for 2007. Time deposits increased $20.8 million (18.5%) to $133.0 million in 2008 from $112.2 million in 2007 as the Bank marketed more aggressively for these core deposits. Total interest-bearing liabilities increased $22.0 million (4.4%) to $519.7 million in 2008 from $497.7 million in 2007 as deposit growth was mitigated by a reduced need for short-term borrowings, which decreased $7.6 million (54.0%) to $6.4 million in 2008 from $14.0 million in 2007. The average balance of non-interest bearing demand accounts decreased $2.9 million (2.3%) to $125.2 million in 2008 from $128.1 million in 2007 due to normal attrition plus the fact that most consumers opening new accounts with the Bank choose interest-bearing checking accounts. Average stockholder equity increased $2.8 million (2.7%) to $107.9 million in 2008 from $105.1 million in 2007. The Corporation earned $11.0 million after tax, paid $9.3 million in dividends and received $0.4 million from dividends re-invested resulting in a net increase in stockholders' equity of $2.1 million. Total liabilities and stockholders' average balances increased $21.4 million or 2.9% to $753.6 million in 2008 from $732.2 million for 2007. PROVISION FOR LOAN AND LEASE LOSSES The provision for loan and lease losses (PLLL) represents the amount periodically added to the Bank's ALLL and charged to earnings in the relevant period. The PLLL for 2008 was $1.3 million, a substantial increase from $0.5 million for 2007 and $0.2 million in 2006. The Bank does no lease financing and the PLLL expense is entirely the result of loan losses. The Bank's loan portfolio has been negatively impacted by the economic downturn but overall asset quality, as discussed below, remains high relative to peers. The Federal Financial Institutions Examination Council ("FFIEC") publishes a peer analysis, the Uniform Bank Performance Report ("UBPR") quarterly. The standard measure of asset quality is a measure of non-performing assets (NPAs) as a percent of total loans where NPAs are defined as loans 90 or more days past due and loans that have been placed on a non-accrual status. The December 31, 2008 UBPR indicates that the average NPA/Total Loans ratio of 1.97% for institutions in UBPR Peer Group #3 (which comprises all insured commercial banks having assets between $300 million and $1 billion) is well above the Bank's 1.44% ratio. The UBPR is compiled by the FFIEC and while management believes the information in the UBPR to be accurate and complete, neither the Corporation nor the Bank assumes any responsibility for any inaccuracies in such information. As of December 31, 2008 the ALLL was $5.9 million compared to $5.8 million at December 31, 2007 and $5.7 million at year end 2006. Net loans charged off (total loans charged off less recoveries of prior loans charged off) for 2008 were $1.1 million compared to $0.4 million in 2007 and $0.2 million in 2006. Net loans charged off as a 11 percent of average loans were 0.19%, 0.07% and 0.04% for 2008, 2007 and 2006, respectively. The ratio of the ALLL to total loans was 0.99% at December 31, 2008, up minimally from 0.98% at December 31, 2007 and down from 1.07% at December 31, 2006. Nonperforming loans at December 31, 2008 were $8.6 million compared to $5.6 million at December 31, 2007 and $3.4 million at December 31, 2006. Table 4 summarizes the ALLL at the beginning and end of each of the last 5 years; changes in the ALLL losses arising from loans charged off and recoveries on loans previously charged-off, by loan category; additions to the allowance that have been charged to expense; and selected performance ratios.
TABLE 4 SUMMARY OF LOAN CHARGE OFFS, RECOVERIES AND PROVISIONS FOR LOAN LOSS (Dollars in Thousands) Year Ended December 31, 2008 2007 2006 2005 2004 - ------------------------ ---- ---- ---- ---- ---- Balance of allowance for loan and lease losses at beginning of period $ 5,758 $ 5,709 $ 5,666 $ 5,642 $ 5,289 ----------- ----------- ----------- --------- --------- Loans charged-off Commercial (491) (143) (102) (97) (7) Real Estate (586) (278) (26) (50) (22) Installment (152) (176) (165) (180) (194) ----------- ----------- ----------- --------- --------- Total loans charged-off (1,229) (597) () (327) (223) ----------- ----------- ----------- --------- --------- Recoveries of loans previously charged-off: Commercial 22 24 30 2 1 Real Estate 0 0 0 54 44 Installment 94 142 66 120 96 ----------- ----------- ----------- --------- --------- Total recoveries 116 166 176 141 ----------- ----------- ----------- --------- --------- Net loans charged-off (1,113) (431) (197) (151) (82) Additions to allowance charged to expense 1,300 480 240 175 435 ----------- ----------- ----------- --------- --------- Balance at end of period $ 5,945 $ 5,758 $ 5,709 $ 5,666 $ 5,642 =========== =========== =========== ========= ========= Ratio of net loans charged-off during the period to average loans outstanding 0.19% 0.07% 0.04% 0.03% 0.02% ============ ============ ============ ========== ========== Ratio of allowance at end of year to total loans 0.99% 0.98% 1.07% 1.10% 1.20% ============ ============ ============ ========== ==========
The PLLL results from the assessment of qualitative and quantitative factors to determine the required ALLL. Factors considered are the size of the portfolio, levels of nonperforming loans, historical losses, risk inherent in certain categories of loans, concentrations of loans to certain borrowers or certain industry segments, economic trends, collateral pledged, and other factors that could affect loan losses as discussed in Table 9. NON-INTEREST INCOME Total non-interest income was $12.9 million for 2008, an increase of $1.6 million (14.4%) from $11.3 million in 2007. The increase was partially due to revenue from service charges and fees on business and retail deposit accounts increasing $0.5 million (5.6%) to $9.6 million in 2008. These fees are driven by the number of accounts and the activity within those accounts. Business accounts receive an earnings credit to offset fees assessed for account activity. The credit is based on the Fed funds rate. Decreases to that rate during 2008 resulted in less credit to business account holders causing higher service fees for the Bank. Continued double digit growth of EZ Pay check card activity resulted in a significant increase in merchant discount paid to the Bank as card issuer. These two areas were responsible for the majority of the $0.5 million increase to service charges on deposits. Loan servicing income decreased 22% to $0.2 million for 2008. This income comprises fees generated by payment 12 collection, escrow collection and disbursement for loans serviced for the Federal Home Loan Mortgage Corporation (FHLMC). The increased amortization of Mortgage Servicing Rights (MSRs) due to refinancing was the principal reason for the loan servicing income decrease. Net gain on sale of loans increased $0.2 million (126%) to $0.4 million for 2008 as lower fixed rate mortgage opportunities accelerated refinance activity in the secondary mortgage market. Other non-interest income increased $0.9 million (70%) to $2.3 million for 2008. This increase was primarily due to two non-recurring events. The Bank received a death benefit of $0.6 million as the beneficiary of a BOLI policy and the Bank received a $0.1 million gain from the redemption of VISA stock following that company's initial public offering. TABLE 5 NON-INTEREST INCOME (In Thousands) Year Ended December 31, 2008 2007 2006 - ----------------------- ---- ---- ---- Service charges on deposits $ 9,575 $ 9,069 $ 8,223 Loan servicing income 179 231 198 Net gain on sale of loans 387 171 301 Increase in cash surrender value of life insurance 464 454 416 Other income 2,280 1,340 1,282 ------- ------- ------- Total non-interest income $12,885 $11,265 $10,420 ======= ======= ======= NON-INTEREST EXPENSE Total non-interest expense for 2008 was $29.2 million, an increase of $1.2 million (4.2%) over 2007. TABLE 6 NON-INTEREST EXPENSE (In Thousands) Year End December 31, 2008 2007 2006 - --------------------- ---- ---- ---- Salaries and employee benefits $16,241 $15,804 $14,577 Occupancy 2,931 2,708 2,419 Furniture and equipment 1,621 1,820 1,852 Computer services 2,642 2,327 2,176 Advertising and promotional 1,018 943 1,430 Regulatory agency assessments 267 246 213 Office supplies 718 650 585 Other expenses 3,764 3,519 3,172 ------- ------- ------- Total non-interest expense $29,202 $28,017 $26,424 ======= ======= ======= Salaries and employee benefits increased $0.4 million (2.8%) to $16.2 million for 2008. Occupancy expenses increased $0.2 million (8.2%) to $2.9 million for 2008 primarily as a result of increased rent and utility expenses. Equipment expenses decreased $0.2 million (10.9%) to $1.6 million for 2008 as a result of a settlement paid by the Village of Brown Deer for abandonment and relocation of the Bank's Bradley Road branch. Computer service expense increased $0.3 million (13.5%) to $2.6 million for 2008 due primarily to enhanced services for the Bank and additional new account volume. Advertising expense increased $0.1 million (8%) to $1.0 million in 2008 as the Bank continued to utilize direct mail as its primary marketing vehicle. Regulatory assessments and supply overhead remained relatively unchanged in 2008 from 2007. Other non-interest expenses increased $0.2 million (6.9%) to $3.8 million in 2008. Costs associated with higher volumes of new accounts such as postage and internet usage by new customers accounted for much of the increase. Additional loan collection expense due to increases in non-performing assets also contributed to the increase in other non-interest expenses. 13 INCOME TAXES Income tax expense was $5.3 million in both 2008 and 2007. The Corporation's effective tax rate (income tax expense divided by income before income taxes) was 32.4% in 2008, 34.6% in 2007 and 34.1% in 2006. The decrease in the effective tax rate for 2008 was due the increase in tax-exempt investment income and the tax-exempt BOLI death benefit received. BALANCE SHEET ANALYSIS Loans Total loans were $599.6 million at December 31, 2008, an increase of $13.4 million, or 2.3%, from $586.3 million at December 31, 2007. Loans originated by the Corporation's Bank are loans to small businesses and individuals in the communities served in the greater Milwaukee market. Although the legal lending limit of the Bank was $16.6 million as of December 31, 2008, the Bank's larger customers are borrowers with credit needs of $5 million and less and, in fact, most borrowers' credit relationships total less than $1 million. The following table presents information concerning the composition of the loans held for investment by the Bank at the dates indicated. Table 7
LOAN PORTFOLIO COMPOSITION (Dollars in Thousands) At December 31, 2008 2007 2006 2005 2004 ------------------ ------------------ ------------------ ------------------ ------------------ % of % of % of % of % of Amount Total Amount Total Amount Total Amount Total Amount Total Commercial $ 23,552 3.93% $ 27,927 4.76% $ 32,545 6.09% $ 26,463 5.12% $ 27,404 5.82% --------- ------ --------- ------- --------- ------- --------- ------- --------- ------- Real estate construction 47,726 7.96 44,042 7.51 42,180 7.89 60,178 11.65 44,502 9.44 Real estate mortgage: Single family 232,429 38.76 227,362 38.78 208,048 38.91 198,828 38.49 189,786 40.27 Multi-family 35,306 5.89 28,871 4.93 15,794 2.95 11,386 2.20 10,092 2.14 Commercial 246,660 41.13 243,923 41.61 221,080 41.35 201,349 38.98 174,223 36.97 --------- ------ --------- ------- --------- ------- --------- ------- --------- ------- Total real Estate 562,121 93.74 544,198 92.83 487,102 91.11 471,741 91.32 418,603 88.82 Installment 13,973 2.33 14,153 2.41 15,009 2.81 18,353 3.56 25,238 5.36 --------- ------ --------- ------- --------- ------- --------- ------- --------- ------- Total loans $ 599,646 100.00% $ 586,278 100.00% $ 534,656 100.00% $ 516,557 100.00% $ 471,245 100.00% ========= ======= ========= ======= ========= ======= ========= ======= ========= =======
As Table 7 indicates, commercial loans were $23.6 million at December 31, 2008, down $4.4 million (15.7%) from December 31, 2007 and comprised 3.9% of the total loan portfolio compared to $27.9 million comprising of 4.8% of the loan portfolio at December 31, 2007. Historically commercial and industrial (C&I) lending has been a smaller part of the Bank's portfolio and a sluggish 2008 economy reduced this segment even further. Balances decreased as businesses reduced the outstanding balances on lines of credit and made little, if any, investment in new equipment. C&I loans are collateralized by general business assets such as accounts receivable, inventory and equipment and have no real estate component. Real estate construction loans increased $3.7 million, or 8.4% to $47.7 million, representing 8.0% of the total loan portfolio at December 31, 2008, compared to $44.0 million (7.5%) of the total loan portfolio at December 31, 2007 and $42.2 million (7.9%) at December 31, 2006. This category includes loans to individuals for construction of owner-occupied single family residences and loans to developers that provide financing for the acquisition or development of commercial real estate and residential subdivisions. Loans to real estate developers comprise most of the dollars outstanding in real estate construction loans. The soft real estate market and increased inventories of residential real estate lots decreased demand for development loans beginning in 2006. Despite a $3.7 million increase in 2008 resulting in $47.7 million outstanding, the balances remain well below 2005 totals when volume in this category peaked at $60.2 million or 11.7% of outstanding loans. Real estate construction loans are made to developers who are well known to the Bank, have prior successful project 14 experience and are well capitalized. Loans are made to customers in the Bank's Southeastern Wisconsin market who have experience and knowledge of the local economy. Although these developers have curtailed their inventory from the robust market of 2003-2005, the increase in 2008 is because some local builders are simply out of lot inventory, despite the slow economy. Real estate construction loans of this type are generally larger in size and involve greater risks than residential mortgage loans because payments depend on the success of the project or the successful management of the property. The Bank will generally make credit extensions to borrowers with adequate outside liquidity to support the project in the event the actual performance is less than projected. Although business also slowed for developers with which the Bank does business, we believe, generally, that they personally or their companies have the ability to service the development debt. Residential real estate loans (single family and 2-4 family dwellings) increased $5.1 million or 2.2% to $232.4 million and comprised 38.8% of the Bank's total loan portfolio at December 31, 2008 compared to $227.4 million (38.8%) at December 31, 2007 and $208.0 million (38.9%) at December 31, 2006. These loans to area residents, the second largest component of the portfolio, represent the lowest risk with individual loans averaging approximately $94,000 and no single loan exceeding $1 million. They provide a foundation for the sale of all other retail banking products and have always been a staple of the portfolio. Loans in this category are generally originated with maturities of one, two or three years to provide a re-pricing opportunity to the Bank when rates change. Amortization periods offered to customers are 20-25 years depending on equity and loan-to-value ratios. Customers seeking long term rate locks choose the secondary market products offered by the Bank where rates can be fixed for 15, 20 or 30 years. These loans are then sold and as a result do not impact the portfolio yields nor are they a factor in interest rate risk. Multi-family real estate loans increased $6.4 million (22.3%) to $35.3 million, representing 5.9% of the total loan portfolio at December 31, 2008 compared to $28.9 million (4.9%) at December 31, 2007 and $15.8 million (3.0%) at December 31, 2006. The loans in this category are collateralized by properties with more than four family dwelling units. The Bank remains conservative in requiring equity sufficient to sustain reasonable debt service coverage in the event of interest rate pressure. Loans in this category typically have maturities of 3, 4 or 5 years and are amortized over 15-20 years. Commercial real estate loans (non-residential real estate loans) increased $2.7 million (1.1%) to $246.7 million at December 31, 2008, compared to $243.9 million at December 31, 2007 and $221.1 million at December 31, 2006. The modest growth in 2008 is the result of a weak economy and fewer new transaction opportunities. This category of loans makes up the largest component of the total loan portfolio at 41.1%, slightly greater than single family mortgage loans at 38.8% of the total loan portfolio as of December 31, 2008. Commercial real estate loans comprised 41.6% and 41.4% of the Bank's loan portfolio at December 31, 2007 and 2006 respectively. The Bank's commercial real estate lending efforts are focused on owner occupied, improved property such as office buildings, warehouses, small manufacturing operations and retail facilities located in its market areas. The Bank's $16.6 million legal lending limit would permit it to compete for activity in the middle market, but management prefers to seek small businesses as its target borrowers. Loans to such businesses are approved based on the creditworthiness, economic feasibility and cash flow abilities of the borrower. As displayed in Table 4, the loan loss experience of the Corporation has historically been favorable in this market segment. Total real estate loans increased $17.9 million (3.3%) to $562.1 million at December 31, 2008 compared to $544.2 at December 31, 2007. Real estate loans account for 93.7% of the Bank's total loan portfolio and, as previously discussed, are a key driver of the Bank's earning assets. Total real estate loans comprised 92.8% and 91.1% of the Bank's total loan portfolio at December 31, 2007 and 2006 respectively Installment loans declined $0.2 million, or 1.3%, to $14.0 million at December 31, 2008 compared to $14.2 million at December 31, 2007 and compared to $15.0 million at December 31, 2006. Regular retail and consumer lending is no longer a growth area. Auto loan volume decreased as sales of new cars dwindled in 2008. As a result, the automobile industry is offering even more incentive pricing and special financing than in normal economic times. The Bank's promotion of HELOCs successfully begun in 2007, continued in 2008. This product is offered with a maximum 80% loan-to-value ratio and is no longer at a competitive disadvantage because the era of low equity and no equity HELOCs ended as the subprime lending crisis emerged. However, these loans do not always increase the installment portfolio as many become part of the single family real estate loan portfolio when a HELOC is secured by a first real estate mortgage or the equivalent. This occurs frequently as the Bank cross-sells HELOCs to its first mortgage customers and vice-versa. 15 To ensure credit quality, overall credit management of portfolio loans in the Bank requires sound loan underwriting and administration, systematic monitoring of existing loans, effective loan review, early identification of problem loans, an adequate allowance for loan and lease losses and valid non-accrual and charge off policies. As the economy weakened in 2008, loan underwriting was strengthened at the Bank by reducing delegated authority for lenders in the branch locations to insure appropriate standards would be met on every credit request. Credit standards and availability were not tightened as criteria such as cash flow, equity and character were already strict. The Bank has continued to improve its credit risk management process. The fundamental control is a detailed underwriting process that includes weekly credit review meetings to allow quick approvals and senior lender review. Periodic review of borrowers' loans and relationships occur as dictated by the type of credit. Single family amortizing real estate loans may only be reviewed every three years at note maturity, whereas a commercial facility is reviewed at least annually. The Bank's loan operation center occupies an upgraded facility in the lower level of the West Allis branch, which is centrally located for the suburban and metropolitan offices and provides support to lenders and loan customers. Loan Operations controls documentation, preparation, servicing and exception tracking. Remote distribution (print-back) of prepared documents to the subsidiary bank's branch locations via its wide area telecommunications network debuted in late 2007 and made a very positive contribution to loan efficiency in 2008. Document preparation remains a centralized function, but electronic distribution eliminates the need for courier delivery of loan papers to the loan offices. The downturn of the economy in 2008 necessitated a change in collection practices for the Bank. Increases in past dues, collection efforts, foreclosures and repossessions dictated a move to centralize all collection-related activity. A senior vice president at the corporate offices is now involved daily with debtors, attorneys, bankruptcy trustees, repossession companies, real estate agents and buyers of assets being liquidated. Loan losses and recoveries have been previously discussed in Table 4, but it is worth noting that at December 31, 2008, the Bank had no repossessed business assets, autos or trucks, boats or recreational vehicles in its possession and had only one piece of foreclosed property valued at $109,500, that was sold in January 2009. The current centralized structure is the reason collection, repossession and liquidation has become more efficient. 16 Loan maturity distribution and interest rate sensitivity are displayed in Table 8. The table displays the maturity distribution by loan classification. Since C&I lending of $23.6 million and installment loans of $14.0 million account for 3.9% and 2.3% of the total selected loans respectively, the majority of the Bank's portfolio is collateralized by real estate. None of the aforementioned C&I or installment lending matures after five years, with most maturing in three years or less given the Bank's preference for one, two and three year notes. Although not displayed in Table 8, $555.1 million (92.6%) of the total $599.6 million loan portfolio is re-pricable within a three year period as a result of the Bank's use of one, two and three year notes as its primary borrowing agreement. Real estate construction loans are typically floating rate loans with one year notes as evidenced by the fact that $33.0 million (69%) of loans in this class have maturities within one year. Other real estate mortgage loans are predominantly (99%) notes with maturities of five years or less. $206.8 million (40%) of this loan class is re-pricable in one year or less, with an additional $301.3 (59%) million maturing in more than one year but less than five years. The remaining $6.3 million (1%) of other real estate mortgage loans mature after five years, however, $5.3 million (85%) of this total has a floating or variable rate structure that allows the Bank to re-price the loan after one year through five years. TABLE 8 Maturities for Selected Loan Categories (Dollars in Thousands) After Within One year After One Through Five December 31, 2008: Year Five years Years Total - ----------------- ------ ---------- ------ ----- Selected loan maturities: Commercial $ 12,313 $ 11,239 $ -- $ 23,552 Real estate construction 32,981 14,745 -- 47,726 Other real estate mortgage 206,796 301,328 6,271 514,395 Installment and other loans 7,756 6,217 -- 13,973 -------- --------- -------- --------- Total selected loans $ 259,846 $ 333,529 $ 6,271 $ 599,646 ========= ========= ======== ========= Sensitivity of loans due after one year to changes in interest rates: Loans to fixed interest rates $ 330,678 $ 943 Loans at floating/variable interest rates 2,851 5,328 --------- -------- Total selected loans $ 333,529 $ 6,271 ========= ======== 17 ALLOWANCE FOR LOAN AND LEASE LOSSES The loan portfolio is the primary asset subject to credit risk. Credit risk is controlled and monitored through the use of lending standards, management's close review and underwriting of potential borrowers and on-going review of loan payment performance. Management of credit risk and minimization of loan losses is a high priority of senior management. Active asset quality administration, including early problem loan identification and timely resolution, aids in the management of credit risk and minimization of loan losses. Table 9 summarizes the ALLL balances at the beginning and end of each year, changes in the ALLL arising from loans charged off and recoveries on loans previously charged-off, additions to the allowance that have been charged to expense and selected performance ratios. TABLE 9
SUMMARY OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in Thousands) Year ended December 31, 2008 2007 2006 2005 2004 - ----------------------- ---- ---- ---- ---- ---- Balance of allowance for loan and lease losses at beginning of period $ 5,758 $ 5,709 $ 5,666 $ 5,642 $ 5,289 ---------- ----------- --------- ----------- ---------- Total loans charged-off (1,229) (597) (293) (327) (223) Total recoveries 116 166 96 176 141 ---------- ----------- --------- ----------- ---------- Net loans charged-off (1,113) (431) (197) (151) (82) Additions to allowance charged to expense 1,300 480 240 175 435 ---------- ------------ --------- ----------- ---------- Balance of allowance for loan and lease losses at end of period $ 5,945 $ 5,758 $ 5,709 $ 5,666 $ 5,642 ========== =========== ========= =========== ========== Total Loans $ 599,646 $ 586,278 $ 534,656 $ 516,556 $ 471,245 Total non-performing loans $ 8,613 $ 5,612 $ 3,417 $ 2,910 $ 1,963 Ratio of allowance for loan and lease losses to total non-performing loans 0.7 1.0 1.7 1.9 2.8 Ratio of net loans charged-off during the period to average loans outstanding 0.19% 0.07% 0.04% 0.03% 0.02% Ratio of allowance at end of year to total loans 0.99% 0.98% 1.07% 1.10% 1.20%
The ALLL represents management's estimate of an amount adequate to provide for probable and inherent credit losses in the loan portfolio. To assess the adequacy of the ALLL, management uses significant judgment focusing on specific allocations applied to loans that are identified for evaluation on an individual loan basis. In addition, loans are analyzed on a group basis using risk characteristics that are common to groups of similar loans. The factors that are considered include asset quality trends, trends in loan volume, terms and documentation, the impact of changes to lending policies, procedures or practices, the experience, ability and depth of management and staff, economic trends, industry conditions and concentrations of credit. At December 31, 2008 the ALLL was $5.9 million, compared to $5.8 million at December 31, 2007 and $5.7 million at December 31, 2006. As of December 31, 2008, the ratio of the ALLL to total loans was 0.99% and covered 0.7 times nonperforming loans, compared to a ratio of 0.98% covering 1.0 times non-performing loans at December 31, 2007 and a ratio of 1.07% covering 1.7 times of non-performing loans at December 31, 2006. Non performing loans were $8.6 million (1.4%) of total loans as of December 31, 2008 compared to $5.6 million (1.0%) at December 31, 2007 and $3.4 million (0.6%) at December 31, 2006. Net charge offs were $1.1 million, $0.4 million and $0.2 million for 2008, 2007, and 2006 respectively. Loans charged off are subject to continuous review and specific efforts are taken to achieve maximum recovery of principal, accrued interest and related expenses. 18 TABLE 10
ALLOWANCE FOR LOAN AND LEASE LOSS COMPONENTS (Dollars in Thousands) December 31, 2008 December 31, 2007 December 31, 2006 ----------------- ----------------- ----------------- % of Loans % of Loans % of Loans In each In each In each Amount Category Amount Category Amount Category ------ -------- ------ -------- ------ -------- Commercial, industrial, agricultural $ 242,400 3.9% $ 467,060 4.8% $ 562,682 6.1% Real Estate Construction 1,267,555 8.0% 836,502 7.5% 893,973 7.9% Real estate-commercial mortgage 2,231,165 41.1% 2,756,306 46.5% 2,542,770 44.3% Real estate - residential mortgage 2,134,181 44.6% 1,627,296 38.8% 1,587,549 38.9% Installment loans to individuals 69,861 2.4% 70,763 2.4% 1,222,423 2.8% ------------ ------------ ------------ ------------ ------------ ------------ Total $ 5,945,162 100.0% $ 5,757,927 100.0% $ 5,709,397 100.0% ============ ============ ============ ============ ============ ============
Table 10 summarizes the components of the ALLL at December 31, 2008, 2007 and 2006. The balances applicable to the five loan categories listed are also representative of the components at December 31, 2005 and 2004. The Bank's loans have historically been predominantly collateralized by real estate as shown in Table 7. The ALLL considers specific loans, changes in the size and character of the loan portfolio, changes in the levels of impaired and non-performing loans, historical losses in each category, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing economic conditions, and the fair value of underlying collateral as well as changes to the fair value of underlying collateral in the recessionary environment of 2008. Because assumptions and conditions used to estimate the ALLL are subject to change, the components shown in Table 10 above are not necessarily indicative of the trend of future loan losses in any particular loan category. For example, continued deterioration of commercial real estate values could impact future losses of that loan type. The total ALLL is available to absorb losses from any segment of the portfolio. At December 31, 2008, as can be seen in Table 10 above, $0.2 million of the ALLL was allocated to potential losses on commercial, industrial or agricultural loans as a result of management's analysis of C&I loans that comprise 3.9% of total loans in the Bank's portfolio. This allocation represents a decrease of $0.3 million from $0.5 million at December 31, 2007 when the C&I category represented 4.8% of total loans. At December 31, 2008, $1.3 million of the ALLL was allocated to potential losses on real estate construction financing, an increase of $0.5 million from $0.8 million at December 31, 2007. Real estate construction financing represents 8.0% of total loans at December 31, 2008 compared to 7.5% of total loans at December 31, 2007. Although loans in the real estate construction financing category as a per cent of total loans increased minimally, the allocation to this category increased 62.5% as a result of the slowdown in new home sales and the impact on residential developers. This loan type presents greater risk in the portfolio and will continue to present such risk until the economy rebounds. At December 31, 2008, $2.2 million of the ALLL was allocated to potential losses from commercial real estate loans, a decrease of $0.6 million from $2.8 million at December 31, 2007. Commercial property in the market served by the Bank has not been as depressed as in other parts of the U.S. and management believes that the portfolio held by the Bank is stable enough to warrant this decrease. In addition, commercial real estate mortgage loans represented 41.1% of total loans at December 31, 2008 down from 46.5% at December 31, 2007. At December 31, 2008, $2.1 million of the ALLL was allocated to potential losses on residential real estate loans that comprise 44.6% of total loans in the Bank's portfolio. This allocation represents an increase of $0.5 million from $1.6 million at December 31, 2007 when residential real estate mortgage loans represented 38.8% of total loans. As the economic slowdown persisted in 2008 management identified home mortgages requiring an additional allocation. The Bank works with borrowers where ever possible to restructure and avoid foreclosure. At December 31, 2008 the allocation for installment loans to individuals was $0.1 million of the total ALLL, unchanged from 2007. Installment loans represented 2.4% of total loans at the Bank, also unchanged from 2007. Although significant growth in total loans continued during 2008, underwriting standards for portfolio loans were maintained. Historical levels of loan losses are regarded by management as being favorable to our peers in the industry. This can be attributed to the fact that over 93% of our loan portfolio is collateralized by real estate. More importantly, loans collateralized by real estate had borrower equity based on realistic appraisals and cash down payments at purchase. Equity offers two advantages when a borrower is past due. First, it 19 makes a decision to abandon the property much more difficult for the property owner. Second, even with real estate values down, real estate secured loans at the Bank generally still carry a loan balance less than the current fair market value of the property. Credit administration remains a high priority, with management monitoring the Corporation's loan portfolio to identify potential loan loss situations and to address any weaknesses promptly. Management believes the ALLL to be adequate at December 31, 2008. INVESTMENT SECURITIES PORTFOLIO The investment securities portfolio is intended to provide the Bank with liquidity, flexibility in asset/liability management, a source of stable income, and is structured to have minimum credit exposure to the Corporation. It is the practice of the Corporation to hold securities to maturity. Table 11 INVESTMENT SECURITIES PORTFOLIO (Dollars in Thousands)
At December 31, 2008 2007 2006 - --------------- ---- ---- ---- Investment securities Amortized Percentage Amortized Percentage Amortized Percentage held-to-maturity Cost of Total Cost of Total Cost of Total - ---------------- ---- -------- ---- -------- ---- -------- Obligations of: States and political subdivisions (tax-exempt) $ 40,524 38.0% $ 34,126 30.9% $ 24,190 20.4% States and political subdivisions (taxable) 3,040 2.9% 6,088 5.5% 3,499 3.0% U.S. government sponsored entities 60,890 57.1% 70,337 63.6% 90,624 76.6% Corporate entities 2,197 2.0% - 0.0% - 0.0% --------- --------- --------- Total investment securities $ 106,651 100.0% $ 110,551 100.0% $ 118,313 100.0% ========= ========= ========= Fair value of investment securities $ 108,275 $ 111,160 $ 116,997 Total assets at year end $ 792,933 $ 790,027 $ 772,248 Average earning assets $ 698,830 $ 675,171 $ 653,960
The total investment securities portfolio decreased $3.9 million (3.5%) to $106.7 million at December 31, 2008 compared to $110.6 million at December 31, 2007 and $118.3 million at December 31, 2006. At December 31, 2008 the total carrying value of investment securities represented 13.4% of total assets, compared to 14.0% at December 31, 2007 and 15.3% at December 31, 2006. States and political subdivisions (tax-exempt) investment securities increased $6.4 million (18.7%) to $40.5 million at December 31, 2008 compared to $34.1 million at December 31, 2007 and $24.2 million at December 31, 2006. States and political subdivisions (taxable) investment securities decreased $3.0 million (50.1%) to $3.0 million at December 31, 2008 compared to $6.1 million at year end 2007 and $3.5 million at December 31, 2006. The shift in the investment mix to tax-exempt municipal securities from U.S. government sponsored entities is the result of the Bank taking advantage of better tax equivalent yields. Municipal Investments (tax-exempt and taxable) represent 40.9% of total investment securities at December 31, 2008 compared to 36.4% and 23.4% respectively at December 31, 2007 and 2006. Management maintains overall quality as well as addresses its asset/liability management concerns by limiting purchases to rated investments of high quality or, on a limited basis, to well known local non-rated issues. Diversity in the portfolio is maintained by limiting the amount of investment to any single debtor in the municipal category. At December 31, 2008, the Bank's securities portfolio did not contain any obligations of any single issuer that were payable by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 3.1% of stockholders' equity. Investments in securities of U.S. government sponsored entities (GSEs) decreased $9.4 million (13.4%) to $60.9 million at December 31, 2008 compared to $70.3 million at year end 2007 and $90.6 million at year end 2006. Investments include three GSEs; the Federal Home Loan Bank, the Federal National Mortgage 20 Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac). Investments in GSE securities represented 57.1% of total investment securities at December 31, 2008 compared to 63.6% and 76.6% respectively in 2007 and 2006. This three-year downward trend is due to investment yield opportunities in tax-exempt municipal investment securities and is not the result of a risk-based decision. The implicit guarantee of GSEs by the Federal government was affirmed when Fannie Mae and Freddie Mac were placed under the conservatorship of the Federal Housing Finance Agency (FHFA) in September 2008. Although stockholders in both entities suffered losses as share prices dropped to pennies, bond holders did not as the operation of these mortgage entities continued. Neither the Corporation, nor the Bank held any stock issued by either Fannie Mae or Freddie Mac. The conservatorship has allowed the Treasury to support the obligations and operations of both Freddie Mac and Fannie Mae. The Bank continues to utilize Freddie Mac for the sale of fixed rate mortgages that are originated by the Bank and continues its relationship with Freddie Mac as a servicer of those mortgages. This philosophy has been successful as borrowers prefer to deal with their local banker for issues concerning payments, tax escrows, or refinancing related to their home mortgages. The following table sets forth the maturities of investment securities at December 31, 2008, the weighted average yields of such securities (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security) and the tax-equivalent adjustment used in calculating the yields. TABLE 12 INVESTMENT SECURITIES PORTFOLIO MATURITY DISTRIBUTION (Dollars in Thousands)
Maturity ------------------------------------------------------------------- After One After Five Within One Year Within Five Years Within Ten Years Amount Yield Amount Yield Amount Yield Obligations of: ------ ----- ------ ----- ------ ----- States and political subdivisions (tax-exempt) $ 6,900 6.22 % $ 22,858 5.70% $ 10,767 5.02% States and political subdivisions (taxable) 2,605 5.30% 435 5.64% - - U.S. government sponsored entities - - 30,975 4.51% 29,914 4.15% Corporate entities 2,197 7.87% - - - - ---------- --------- ---------- $ 11,702 $ 54,268 $ 40,681 =========== =========== ========== Tax equivalent adjustment for calculation of yield $ 171 $ 443 $ 180
Note: The weighted average yields on tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a tax rate of 34%. Investment securities are generally purchased with maturities of three to five years. As indicated in Table 12, $11.7 million (11.0%) of total investment securities mature within one year. Most of the remainder of the investment portfolio, $54.3 million (50.9%) matures after one year and within five years. An additional $40.7 million (38.1%) has a maturity extending beyond 5 years, most with maturities after five years and within seven years. Expected maturities will differ from contractual maturities, as borrowers may have the right to call or repay obligations with or without call or prepayment penalties. With historic lows on short term rates, the Corporation expects borrowers with call options to exercise those calls during 2009. Over half ($49 million) of the $94.9 million investment securities maturing after one year have such call features. DEPOSITS Deposits are the Bank's largest source of funds. The Bank competes in the metropolitan Milwaukee market with other financial institutions such as banks, thrifts and credit unions, as well as non-bank institutions, for retail and commercial deposits. The Corporation continues to market its checking accounts and had continued success in 2008 with completely free checking (non-interest bearing), several options for interest bearing checking and Investor Checking, a tiered product. The interest bearing checking options offered are desirable to the Bank as low cost core deposit growth. Depositors earn interest, but the yields paid on these products are low compared to other funding costs. In 2008 the Bank also offered a new "Investor Money Market" account with tiered rate offerings. The new account offering was timely as the effect of a poor economy caused many investors to seek the safety of an insured account. The Bank experienced good growth in this area as discussed below. 21 TABLE 13 AVERAGE DAILY BALANCE OF DEPOSITS AND AVERAGE RATE PAID ON DEPOSITS (Dollars in Thousands)
Year ended December 31, 2008 2007 2006 - ---------------------- ------------------ ------------------ ------------------- Amount Rate Amount Rate Amount Rate ------ ---- ------ ---- ------ ---- Noninterest-bearing demand deposits $ 125,217 $ 128,100 $ 137,152 Transaction Accounts 170,192 1.20% 180,013 2.28% 157,293 2.11% Money Market Accounts 77,411 1.94 56,449 3.53 46,476 2.79 Savings 132,643 0.65 135,049 0.82 136,404 0.66 Time deposits (excludingtime certificates of deposit of $100,000 or more) 77,693 4.92 71,013 4.90 77,166 4.43 Time deposits ($100,000 or more) 55,310 2.22 41,209 3.06 48,515 3.14 --------- --------- ---------- $ 638,466 $ 611,833 $ 603,006 ========= ========= =========
For the year ended December 31, 2008 average daily deposits were $638.5 million, an increase of $26.6 million (4.4%) over December 31, 2007. Average non-interest bearing demand deposits decreased $2.9 million (2.3%) to $125.2 million at December 31, 2008 from $128.1 million at December 31, 2007. Personal checking account average balances decreased $4.2 million accounting for the decline. This decline is primarily due to normal attrition and to a lesser extent conversion of long-time non-interest bearing demand deposits to interest bearing checking accounts. These accounts pay an interest rate of 0.25% and are very desirable core deposits, whether new or converted. Transaction accounts consist of interest bearing checking held by individuals, municipalities, non-profit organizations and sole owner businesses. Interest bearing personal checking deposits increased $9.1 million (20.8%) to $53.0 million at December 31, 2008 as a result of marketing efforts to attract retail depositors. This increase was offset by decreases in municipal NOW accounts and Investor checking accounts. The most significant decrease was $12.9 million from Investor checking accounts. The majority of these funds did not leave the Corporation however, as depositors who were eligible for the higher tiers and yields offered in the new Investor Money Market account transferred funds within the Bank. The resulting net decrease for all transaction accounts was $9.8 million (5.5%) to $170.2 million at December 31, 2008. The blended rate for all transaction accounts (interest bearing checking products) in 2008 was 1.20% a decrease of 108 bp from 2.28% in 2007 and 2.11% in 2006. The average daily balance of money market deposit accounts increased $21.0 million (37.1%) to $77.4 million at December 31, 2008 compared to $56.4 million at December 31, 2007 and $46.4 million at December 31, 2006. The increase in money market accounts is due both to a new product offering and a return to the safety of insured savings deposits by many investors given the uncertainty in the market in 2008. Funds transferred from Investor checking accounted for $12.9 million of the increase. The other $8.1 million of the increase was new deposits to the Bank. The yield on money market deposits decreased 159 bp to 1.94% for 2008 from 3.53% in 2007 and 2.79% in 2006. The average daily balance of savings accounts decreased $2.4 million (1.8%) to $132.6 million for the year ended December 31, 2008 from $135.0 million and $136.4 million in 2007 and 2006 respectively. The yield on basic savings was 0.40% in 2008 and 0.50% in both 2007 and 2006. Savings sweep accounts for businesses increased the blended savings yields to 0.65%, 0.82% and 0.66% for 2008, 2007 and 2006, respectively. The sweep rates are tied to the Fed funds rate and vary as that index moves. The average daily balance of time deposits increased by $20.8 million (18.5%) to $133.0 million at December 31, 2008 from $112.2 million at December 31, 2007 and $125.7 million at December 31, 2006. Within that total, time deposits $100,000 or more increased $14.1 million (34.2%) to $55.3 million from $41.2 million and $48.5 million at December 31, 2007 and 2006 respectively. Time deposits less than $100,000 increased $6.7 million (9.4%) to $77.7 million from $71.0 million and $77.2 million respectively at December 31, 2007 and 2006. The yield on time deposits $100,000 or more was 2.22% in 2008, down slightly from 3.06% in 2007, and 3.14% in 2006. The average yields are lower on the larger certificates of deposit (CDs) than on time deposits less than $100,000. A total of $15.0 million (27%) of time deposits in amounts $100,000 or more mature in three months or less, an additional $7.9 million (14%) mature between 3 and 6 months, and an additional $16.4 million (30%) mature between 6 and 12 months making the total maturing in one year or less $39.3 million (71%) of time deposits in amounts of $100,000 or more as shown in Table 14. As a result, these investments earn a 22 lower yield (being on the short end of a normal yield curve) and because they mature faster, renew at lower rates given the declining rate environment of 2008. The growth in both large- and small-balance time deposits comes from local depositors and increases in 2008 are the result of a decision by management to attract additional core deposits during the year. The Bank promoted certificate of deposit "specials" and was pleased to achieve the growth shown in Table 13. The yield on time deposits excluding time deposits of $100,000 or more increased to 4.92% in 2008 up from 4.90% in 2007 and 4.43% in 2006. Certificate of deposits less than $100,000 have a more even maturity distribution from short term to 60 months, which is the longest investment term offered by the Bank. Therefore these depositors earn higher rates as deposits are spread evenly throughout the yield curve and do not re-price at lower rates as quickly. The Bank has no brokered certificates of deposit and does not participate in any CDars programs. Certificate of deposits of $100,000 or more are drawn from the Bank's market and from its customers. Core deposits are crucial to the success of a financial institution and the Corporation considers these deposits in amounts of $100,000 or more to be core deposits. Table 14 MATURITY DISTRIBUTION DEPOSITS IN AMOUNTS OF $100,000 AND OVER (Dollars in Thousands) December 31, 2008: Three months or less $ 14,959 After 3 through 6 months 7,928 After 6 through 12 months 16,437 After 1 year through 2 years 10,402 After 2 years through 3 years 922 After 3 years through 4 years 2,932 After 4 years through 6 years 1,730 ---------- $ 55,310 ========== OTHER FUNDING SOURCES The Bank meets daily funding needs through other short-term borrowings; principally its Fed funds facilities with two correspondent banks and two secured facilities; treasury, tax and loan (TT&L) with the U.S. Treasury and a short-term borrowing facility from the Federal Reserve Bank of Chicago. The Bank had no Fed funds purchased at December 31, 2008 compared to $12.9 million at December 31, 2007 and zero at December 31, 2006. TT&L borrowings totaled $3.9 million, $2.2 million and $3.5 million at December 31, 2008, 2007 and 2006, respectively. The Fed funds purchased facility is a non-collateralized overnight borrowing. The TT&L notes are demand notes representing secured borrowings from the U.S. Treasury, collateralized by qualifying securities. The funds are placed with the Bank at the discretion of the U.S. Treasury and may be called at any time. LIQUIDITY The objective of liquidity management is to ensure that the Corporation and its Bank have the ability to generate sufficient cash or cash equivalents in a timely and cost efficient manner so as to meet the commitments as they come due. Funds are available from a number of sources, primarily from core deposits and loan and security repayments and/or maturities. If needed, additional liquidity can be obtained from the sale of portfolio securities or loans, lines of credit with major banks and the Bank's ability to acquire deposits. It has been management's practice not to sell portfolio loans or securities prior to maturity. The use of its credit facilities has been the principal source of liquidity when needed. At December 31, 2008, the Bank has a combined $45 million approved Fed funds purchased facility with two correspondent banks and has the ability to borrow an additional $32.3 million under a short-term facility at the Federal Reserve Bank of Chicago. Management has avoided the use of brokered deposits, however the Bank has, through its normal day-to-day activity, developed deposit relationships with a number of local government entities and has pledged securities and loans to these depositors to meet their collateral requirements. The Bank continues to attract deposits by offering competitive deposit rates and by offering a high level of service with extended hours, seven days per week banking and thirty-eight locations in the Milwaukee metropolitan area. 23 OFF-BALANCE SHEET ARRANGEMENTS The Bank utilizes certain derivative financial instruments to meet the ongoing credit needs of its customers and in order to manage the market exposure of its residential loans held for sale and its commitments to extend credit for residential loans. Derivative financial instruments include commitments to extend credit and forward loan sale commitments. The Bank does not use interest rate contracts (e.g. swaps, caps or floors) or other derivatives to manage interest rate risk and has none of these instruments outstanding. The Bank, through its normal operations, does have loan commitments and standby letters of credit outstanding as of December 31, 2008 in the amount of $69.9 million and $4.5 million, respectively. These items are further explained in Note 16 of Notes to Consolidated Financial Statements. TABLE 15
CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD AT DECEMBER 31, 2008 (In Thousands) Less Than One to Three to More than Contractual Obligations Total One Year Three Years Five Years Five Years - ----------------------- ----- --------- ----------- ---------- ---------- Certificates of Deposit and $ 143,190 $ 110,433 $ 25,548 $ 5,574 $ 1,635 Other Time Deposits Short-Term Debt Obligations 3,911 3,911 - - - Minimum Operating Lease Obligations 1,745 817 849 63 16 --------- --------- ----------- ---------- ---------- Total $ 148,846 $ 115,161 $ 26,397 $ 5,637 $ 1,651 ========= ========= =========== ========== ==========
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk arises from exposure to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk. Market risk in the form of interest rate risk is measured and managed through the asset/liability management system. The Bank uses financial modeling techniques that measure the sensitivity of future earnings due to changing rate environments. Policies approved by the Board of Directors limit exposure of earnings at risk. General interest rate movements are used to develop sensitivity models and monitor earnings at risk. These limits are based on the Bank's exposure to a 100 bp and 200 bp immediate and sustained parallel rate move, either upward or downward. The Bank's primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of the Bank's transactions are denominated in United States dollars, with no specific foreign exchange exposure. 24 INTEREST RATE RISK Financial institutions derive their income primarily from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and pays on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed to lower profit margins (or losses) if it cannot adapt to interest rate changes. Interest Rate Risk ("IRR") is the exposure of an organization's financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and stockholder value. However, excessive levels of IRR could pose a significant threat to the Bank's earnings and capital base. Accordingly, effective risk management that maintains IRR at prudent levels is essential to the Bank's safety and soundness. When assessing IRR, the Bank seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain IRR at prudent levels with consistency and continuity. Evaluating the quantitative level of IRR exposure requires the Bank to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity and, where appropriate, asset quality. Financial institutions are also subject to prepayment risk in falling rate environments. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refinance its obligations at new, lower rates. Prepayments of assets carrying higher rates reduce the Bank's interest income and overall asset yields. Certain portions of an institution's liabilities may be short-term or due on demand, while most of its assets may be invested in long-term loans or investments. Accordingly, the Bank seeks to have in place sources of cash to meet short-term demands. These funds can be obtained by increasing deposits, borrowing or selling assets. Also, short-term borrowings provide additional sources of liquidity for the Bank. Several ways an institution can manage IRR include: selling existing assets or repaying certain liabilities and matching repricing periods for new assets and liabilities by shortening terms of new loans or investments. The Bank has employed all these strategies in varying degrees. An institution might also invest in more complex financial instruments intended to hedge or otherwise change IRR. Interest rate swaps, futures contracts, options on futures and other such derivative financial instruments are often used for this purpose. The Bank has never purchased any of these types of derivative financial instruments. In order to measure earnings sensitivity to changing rates, the Bank uses two different measurement tools: static gap analysis, and simulation of earnings. The static gap analysis starts with contractual repricing information for assets and liabilities. These items are then combined with repricing estimations for administered rate (interest-bearing demand deposits, savings, and money market accounts) and non-rate related products (demand deposit accounts, other assets, and other liabilities) to create a baseline repricing balance sheet. In addition to the contractual information, residential mortgage whole loan products are adjusted based on industry estimates of prepayment speeds that capture the expected prepayment of principal above the contractual amount. At the end of 2008, the Bank's balance sheet was liability sensitive to interest rate movements for principal amounts maturing in one year. Asset sensitive means that assets will reprice faster than liabilities. In a rising rate environment, an asset sensitive bank will generally benefit. Liability sensitive means interest bearing deposits will reprice faster than assets. In a rising rate environment a liability sensitive bank will generally not benefit. 25 TABLE 16 TRI CITY BANKSHARES CORPORATION QUANTITATIVE DISCLOSURES OF MARKET RISK (Dollars in Thousands)
December 31, 2008 Principal Amount Maturing in: Fair Value --------------------------------------------------------------------------------------- 2009 2010 2011 2012 2013 Thereafter Total 12/31/08 --------- --------- --------- --------- --------- ---------- --------- --------- Rate-sensitive assets: Fixed interest rate loans $ 168,957 $ 136,434 $ 146,977 $ 13,725 $ 16,216 $ 7,868 $ 490,177 $ 494,394 Average interest rate 6.71% 6.97% 6.38% 6.29% 6.06% 5.89% 6.64% Variable interest rate loans $ 73,118 $ 17,050 $ 11,827 $ 425 $ 1,988 $ 5,061 $ 109,469 $ 110,411 Average interest rate 3.41% 3.19% 3.88% 5.70% 6.18% 6.72% 3.64% Fixed interest rate securities $ 11,702 $ 4,392 $ 10,831 $ 15,026 $ 24,019 $ 40,681 $ 106,651 $ 108,275 Average interest rate 6.40% 5.65% 5.63% 5.77% 4.16% 4.38% 4.93% Other interest bearing assets $ 11,457 $ 11,457 $ 11,457 Average interest rate 2.06% 2.06% Rate-sensitive liabilities: Savings and interest-bearing Checking $ 408,932 $ 408,932 $ 408,932 Average interest rate 1.16% 1.16% Time deposits $ 110,433 $ 21,952 $ 3,596 $ 3,944 $ 3,265 $ - $ 143,190 $ 144,084 Average interest rate 3.23% 3.62% 4.12% 4.45% 3.48% -% 3.35% Variable interest rate Borrowings $ 3,911 $ 3,911 $ 3,911 Average interest rate 2.00% 2.00% December 31, 2007 Principal Amount Maturing in: Fair Value --------------------------------------------------------------------------------------- 2008 2009 2010 2011 2012 Thereafter Total 12/31/07 --------- --------- --------- --------- --------- ---------- --------- --------- Rate-sensitive assets: Fixed interest rate loans $ 174,323 $ 119,233 $ 150,402 $ 15,955 $ 9,689 $ 5,607 $ 475,209 $ 477,305 Average interest rate 6.82% 7.29% 7.15% 6.95% 7.07% 6.59% 7.05% Variable interest rate loans $ 78,579 $ 11,893 $ 11,771 $ 1,806 $ 382 $ 6,636 $ 111,067 $ 111,557 Average interest rate 7.10% 7.25% 7.15% 6.78% 6.54% 7.10% 7.12% Fixed interest rate securities $ 56,410 $ 25,918 $ 3,934 $ 8,814 $ 14,243 $ 1,232 $ 110,551 $ 111,160 Average interest rate 3.94% 4.98% 5.80% 5.60% 5.81% 5.48% 4.64% Other interest bearing assets $ - $ - $ - Average interest rate -% -% Rate-sensitive liabilities: Savings and interest-bearing Checking $411,900 $ 411,900 $ 411,900 Average interest rate 1.95% 1.95% Time deposits $ 82,093 $ 14,897 $ 10,068 $ 5,338 $ 4,123 $ - $ 116,519 $ 116,699 Average interest rate 4.41% 4.30% 4.52% 4.50% 4.49% -% 4.41% Variable interest rate Borrowings $15,022 $ 15,022 $ 15,022 Average interest rate 5.01% 5.01%
As indicated in Table 16, the majority of the Bank's earning assets mature within the next three years. Fixed interest rate loans in the amount of $169.0 million, $136.4 million and $147.0 million mature respectively in 2009, 2010 and 2011. These fixed-rate loans total $452.4 million (92.3%) of all fixed-rate loans at December 31, 2008. The maturity distribution indicates very little change from December 31, 2007. At that date fixed rate loans maturing in three years or less were $444.0 million (93.4%) of all fixed rate loans. The Bank's traditional vehicle for lending remains residential real estate loans and commercial real estate loans held in its portfolio with a note with maturity of one to three years. The average interest rate on total fixed rate loans decreased 41 bp to 6.64% for 2008 from 7.05% in 2007 as notes matured and renewed at lower rates. The Bank also offers lines of credit to businesses and HELOCs to consumers. These loans typically have floating rates indexed to the Bank's reference rate or in the case of HELOCs to the prime rate as published by the Wall Street Journal. Total variable interest rate loans decreased $1.6 million (1.4%) to $109.5 million at December 31, 2008 from $111.1 million at December 31, 2007. The maturity distribution of variable interest rate loans is not the measure of interest rate risk as interest rates are adjusted daily for most commercial lines and HELOCs when the associated index changes. The average interest rate on variable rate loans decreased dramatically to 3.64% as of December 31, 2008 compared to 7.12% as of December 31, 2007 as the 4.0% reduction in the Fed funds target reduced rates, affecting both types of variable interest rate loans in the Bank's portfolio. 26 The maturity distribution of fixed interest rate securities showed considerable movement from 2007 to 2008. As of December 31, 2007 $56.4 million in fixed rate investment securities were scheduled to mature in 2008 and $25.9 million were scheduled to mature in 2009. Many of these securities were called resulting in only $11.7 million that remain scheduled to mature in 2009. As the securities maturing in 2008 and those called securities were re-invested management extended the maturities. On December 31, 2007, $1.2 million (1.1%) of a total of $110.5 million fixed rate securities had maturities greater than five years (after 2012). On December 31, 2008, $40.7 million (38.1%) of a total of $106.7 million fixed rate securities had maturities greater than five years (after 2013). Investments beyond 2013 mature primarily in 2014 and 2015 and provide additional yield. The average interest rate on total fixed rate investment securities increased 29 bp to 4.93% at December 31, 2008 from 4.64% at year end 2007. At December 31, 2008, other interest-bearing assets (overnight funds invested as Fed funds sold to a correspondent bank) were $11.5 million with an average interest rate of 2.06% while the Bank had no other interest-bearing assets at December 31, 2007. Rate sensitive liabilities create funding which is predominantly short term with $408.9 million in savings and interest bearing checking accounts that have no stated maturity and are considered to be floating rate funds. Historically, the Bank has relied on core deposit growth in these areas because funding costs for both products are the lowest of the various interest bearing products offered by financial institutions. The average interest rate on savings and interest-bearing checking decreased 79 bp to 1.16% at December 31, 2008 from 1.95% at December 31, 2007. Time deposit balances maturing in one year or less increased $28.3 million (34.5%) to $110.4 million at December 31, 2008 compared to $82.1 at December 31, 2007. Time deposit balances maturing in 2010 through 2013 decreased $1.7 million (4.8%) at December 31, 2008. In total time deposits increased $26.7 million (22.9%) to $143.2 million at December 31, 2008 compared to $116.5 million at December 31, 2007 as a result of the aforementioned promotional efforts in the Bank. The average interest rate of time deposits decreased 106 bp to 3.35% at December 31, 2008 from 4.41% at December 31, 2007. The Corporation's funding acquisition and deployment strategy, management reporting and board approved limits target a cumulative ratio of 1.0 for Rate Sensitive Assets vs. Rate Sensitive Liabilities (RSA/RSL) at one year. The Bank RSA/RSL ratio is 0.89 at December 31, 2008 (where a cumulative ratio of 1.0 is balanced and neither asset nor liability sensitive after one year). The liability sensitive difference of 0.11 means that $45.8 million more interest bearing liabilities will be rate adjusted than earning assets at that point. As of December 31, 2008, the 12 month weighted liability gap is $103.4 million, an increase of $12.8 million from a $90.5 million weighted liability gap at December 31, 2007. The weighted gap indicates the excess average balance of liabilities (in the case of a liability sensitive company) subject to re-pricing earlier than assets. The ratio and analysis includes assumptions that closely follow the Bank's techniques for managing risk; lagged interest rate adjustments, administered rate products, rate adjustment of cash flow from amortization and prepayment of loans through reinvestment, and the reinvestment of maturing assets and liabilities. Along with the static gap analysis, determining the sensitivity of short-term future earnings to a hypothetical plus or minus 100 bp and 200 bp parallel rate shock can be accomplished through the use of simulation modeling. In addition to the assumptions used to create the static gap, simulation of earnings includes the modeling of the balance sheet as an ongoing entity. The model projects net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the net interest income amount calculated using flat rates. This difference represents the Corporation's earnings sensitivity to a plus or minus 100 and 200 bp parallel rate shock. These results are based solely on the modeled changes in market rates, and do not reflect the earnings sensitivity that may arise from other factors such as the shape of the yield curve and changes in spread between key market rates. These actions also do not include any action management may take to mitigate potential income variances. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies. CAPITAL The adequacy of the Corporation's capital is regularly reviewed to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. The assessment of overall capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings stability, changing competitive forces, economic condition in markets served, and strength of management. 27 TABLE 17 CAPITAL (Dollars and Share Numbers in Thousands) Year ended December 31, 2008 2007 2006 - -------------------------------------------- --------- --------- --------- Total stockholders' equity $ 108,936 $ 106,767 $ 104,033 Tier 1 capital 108,936 106,767 104,033 Total capital 114,881 112,525 109,742 Book value per common share 12.23 12.02 11.82 Cash dividends per common share 1.04 1.00 0.88 Dividend reinvestment price at end of period -- 19.35 19.35 Low reinvestment price for the period 19.35 19.35 19.35 High reinvestment price for the period 19.35 19.35 19.35 Total equity/assets 13.74% 13.51% 13.51% Tier 1 leverage ratio 14.26 14.26 14.46 Tier 1 risk-based capital ratio 18.02 17.98 17.99 Total risk-based capital ratio 19.00 18.95 18.98 Shares outstanding (period end) 8,905 8,884 8,802 Basic shares outstanding (average) 8,903 8,848 8,735 Diluted shares outstanding (average) 8,903 8,848 8,735 Total stockholders' equity at December 31, 2008 increased $2.1 million to $108.9 million, or $12.23 book value per common share compared with $106.8 million, or $12.02 book value per common share at December 31, 2007 and $104.0 million, or $11.82 book value per common share at December 31, 2006. The increase in stockholders' equity was the result of retained earnings for 2008 and stockholder participation in the Corporation's dividend reinvestment program in January 2008, with offsetting decreases from the payment of cash dividends. The Corporation's dividend reinvestment program was terminated after the dividend paid in January 2008. Stockholders' equity to assets at December 31, 2008 was 13.74%, up from 13.51% at both December 31, 2007 and 2006. Cash dividends paid in 2008 were $1.04 per share compared with $1.00 per share in 2007, an increase of 4.0%. Cash dividends paid in 2007 were $1.00 per share compared with $0.88 per share in 2006, an increase of 13.6%. As of December 31, 2008 and 2007, the Corporation's Tier 1 leverage ratios were 14.26% for both years compared to 14.46% at December 31, 2006. Tier 1 risk-based capital ratios were 18.02%, 17.98% and 17.99% respectively, and total risk-based capital (Tier 1 and Tier 2) ratios were 19.0%, 18.95% and 18.98%, respectively for year end 2008, 2007 and 2006. All ratios are significantly in excess of minimum regulatory requirements. A bank is "well capitalized" with a minimum Tier 1 leverage ratio of 5.0%, a minimum Tier 1 risk based capital ratio of 6.0% and a minimum total risk based capital ratio of 10.0%. As of December 31, 2008, the Bank's Tier 1 leverage ratio was 13.7%, the Tier 1 risk-based capital ratio was 17.3% and the total risk-based capital ratio was 18.3%. All ratios exceed minimum regulatory requirements for the Bank to be deemed "well capitalized". With the passage of TARP, financial institutions were able to improve their capital ratios by selling preferred stock to the US Treasury Department under the Treasury's Capital Purchase Program ("CPP"). Some financial institutions sought to achieve "well capitalized" status while other already "well capitalized" financial institutions sought to improve their ratios. With the Bank's leverage ratio of 13.7% exceeding the 5.0% "well capitalized" minimum by 8.7%, with its Tier 1 risk based ratio of 17.3% exceeding the 6.0% "well capitalized" minimum by 11.3% and with its total capital to risk weighted asset ratio of 18.3% exceeding the 10% "well capitalized" minimum by 8.3% the Board determined that the Corporation had no need to and elected not to participate in CPP. Earnings continue to be stable and provide sufficient capital retention for anticipated growth. Management believes that the Corporation has a strong capital position and is positioned to take advantage of opportunities for profitable geographic and product expansion, and to provide depositor and investor confidence. Management actively reviews capital strategies for the Corporation and each of its subsidiaries in light of perceived business risks, future growth opportunities, industry standards, and regulatory requirements. Results of Operations 28 2007 COMPARED TO 2006 The Corporation posted net income of $10.0 million for the year ended December 31, 2007, an increase of $0.7 million, or 7.5% from $9.3 million earned in 2006. Basic earnings per share for 2007 were $1.13, a 6.6% increase from 2006 basic earnings per share of $1.06. Return on average assets and return on average equity for 2007 were 1.36% and 9.49%, respectively, compared to 1.31% and 9.23%, respectively, for 2006. Cash dividends of $1.00 per share paid in 2007 increased by 13.6% over cash dividends of $0.88 per share paid in 2006. Taxable equivalent net interest income was $33.1 million for 2007, $2.1 million or 6.9% higher than 2006. Taxable equivalent interest income increased $4.1 million while interest expense increased $2.0 million. The increase in taxable equivalent interest income was partially attributable to volume variances with balance sheet growth in commercial and real estate loans adding $2.3 million to interest income. Favorable rate changes also contributed $2.0 million to increased interest income. Re-pricing the subsidiary bank's maturing loans and increasing yields on loans with floating rates are the two most common reasons for favorable rate changes in an increasing rate environment. These increases were partially offset by a net decrease of $0.2 million in interest earned on investment securities. On the expense side, the increase of $2.0 million in interest paid on deposits and short-term borrowings was primarily attributable to rate with increased yields accounting for $1.3 million and increased deposit balance volume accounting for the remaining $0.7 million. Average earning assets increased $21.2 million to $675.2 million while average interest bearing liabilities increased $27.5 million to $497.7 million. Net interest margin for 2007 was 4.90%, compared to 4.73% in 2006. The 17 bp increase is attributable to a 13 bp increase in interest rate spread and a 4 bp higher contribution from net interest free funds. Total loans were $586.3 million at December 31, 2007, an increase of $51.6 million (9.7%) from December 31, 2006, primarily due to commercial and residential real estate loan growth and a small increase in real estate construction loans outstanding. Total real estate loans grew $57.1 million (11.7%) and represented 92.8% of total loans at December 31, 2007, compared to 91.1% at December 31, 2006. Commercial loans in the portfolio declined $4.6 million (14.2%) representing 4.76% of total loans at December 31, 2007, compared to 6.09% at December 31, 2006. Total deposits were $665.8 million at December 31, 2007, an increase of $4.4 million (0.7%) from December 31, 2006. The increase in deposits for the year was the net effect of a $13.0 million increase primarily in municipal deposits and retail transaction deposit accounts offset by a decrease of $8.6 million in time deposits. Net charge offs were $0.4 million, an increase of $0.2 million from 2006, with the majority of the increase attributable to the real estate mortgage loan portfolio. Net charge offs were 0.07% of average loans compared to 0.04% in 2006. The provision for loan losses increased accordingly to $0.5 million compared to $0.2 million in 2006. More than 90% of the Bank's loan portfolio is collateralized by local real estate and all loans were originated by the Bank's lenders, and were not brokered or purchased transactions. Non-interest income was $11.3 million for 2007, $0.8 million or 8.1% higher than 2006. This increase was the result of an increase in ancillary fees paid by retail deposit account holders. Mortgage banking revenue decreased $0.1 million (19.4%) to $0.4 million in 2007 due to the sluggish real estate market and the resulting decline in the volume of secondary market mortgage transactions. Non-interest expense was $28.0 million, up $1.6 million, or 6.0% from 2006. Increased personnel expense was the largest contributor, adding $1.2 million due to higher staffing levels, new branch locations and additional staffing commitment within the in-store banking group. Income tax expense increased to $5.3 million, up $0.5 million, or 10.0% from 2006. The increase reflected the 8.3% improvement in pre-tax earnings for the year. 29 Tri City Bankshares Corporation Selected Financial Data
2008 2007 2006 2005 2004 ---- ---- ---- ---- ---- Total interest income $ 43,451,436 $ 45,067,344 $ 40,923,621 $ 36,026,287 $ 31,874,924 Total interest expense 9,517,508 12,574,378 10,592,023 7,630,910 4,892,165 Net interest income 33,933,928 32,492,966 30,331,598 28,395,377 26,982,759 Provision for loan losses 1,300,000 480,000 240,000 175,000 435,000 Net interest income after provision for loan losses 32,633,928 32,012,966 30,091,598 28,220,377 26,547,759 Income before income taxes 16,316,874 15,260,616 14,087,241 13,205,607 12,061,172 Provision for income tax 5,292,500 5,284,000 4,803,500 4,257,000 3,673,000 Net income 11,024,374 9,976,616 9,283,741 8,948,607 8,388,172 Basic earnings per share 1.24 1.13 1.06 1.05 1.01 Cash dividends declared per share 1.04 1.00 .88 .78 .70 Average daily balances: (amounts in thousands) Total assets $ 753,583 $ 732,209 $ 710,756 $ 698,776 $ 664,548 Total net loans 580,906 543,338 509,365 489,687 438,453 Held to maturity investment securities 107,885 117,489 129,435 146,829 161,971 Total deposits 638,466 611,833 603,006 575,724 560,084 Total stockholders' equity 107,954 105,133 100,627 95,093 88,344
Tri City Bankshares Corporation Market for Corporation's Common Stock And Related Stockholder Matters The Corporation's stock is traded on the Over-the-Counter Bulletin Board ("OTCBB") under the trading symbol "TRCY". Trading in the Corporation's stock is limited and sporadic and the Corporation believes that no established trading market for the Corporation's stock exists. OTCBB quotations reflect interdealer prices, without retail markup, markdown or commission and may not necessarily reflect actual transactions. The following table sets forth the high and low OTCBB bid quotations for the Corporation's stock for the past two years. OTCBB Quotations FISCAL QUARTER ENDED HIGH LOW March 31, 2007 $ 20.50 19.25 June 30, 2007 20.20 18.90 September 30, 2007 20.25 19.00 December 31, 2007 20.50 19.50 March 31, 2008 20.00 18.50 June 30, 2008 19.75 16.50 September 30, 2008 18.10 13.25 December 31, 2008 17.50 12.00 As of December 31, 2008, the number of holders of record of the Corporation's common stock was 621. Pursuant to the Corporation's Dividend Reinvestment Plan, which was terminated after the payment of the January, 2008 dividend, the Board of Directors had been required to establish the "Fair Market Value" of the Corporation's stock on a quarterly basis based on factors set forth in the Dividend Reinvestment Plan. The Board established $19.35 per share as the Fair Market Value for the first quarter of 2008 The Corporation declared four quarterly cash dividends in 2008 in the amount of $0.26 per share. These dividends were declared on January 8, April 9, July 9 and October 8, payable on January 28, April 25, July 25 and October 24, respectively. Quarterly dividends of $0.25 per share were paid each of the four quarters of 2007. 30 The Corporation is not party to any loan agreement, indenture or other agreement that restricts its ability to pay dividends; however, the Wisconsin Business Corporation Law authorizes directors to declare and pay cash dividends only out of the Corporation's unreserved and unrestricted earned surplus. See Note 18 of the notes to consolidated financial statements for restrictions imposed by regulatory agencies upon the subsidiary bank's ability to transfer funds to the parent corporation. STOCK PERFORMANCE GRAPH The following graph shows the cumulative total stockholder return on the Corporation's Common Stock over the last five fiscal years compared to the returns of the Standard & Poor's 500 Stock Index and S&P500 Banks Index compiled by Standard & Poor's and consisting of 20 regional banks, assuming that $100 is invested on December 31, 2003 with dividends reinvested. FIVE YEAR STOCK PERFORMANCE PERIOD S&P 500 COMMERCIAL TRI CITY (FISCAL YEAR COVERED) S&P 500 BANKS BANKSHARES 2003 100.00 100.00 100.00 2004 110.88 114.92 104.74 2005 116.32 116.67 101.08 2006 134.69 134.87 108.61 2007 142.09 104.27 110.33 2008 89.51 66.04 84.75 Trading in the Corporation's stock is limited and sporadic and the Corporation believes that no established trading market for the Corporation's stock exists. 31 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders Tri City Bankshares Corporation We have audited the accompanying consolidated balance sheets of Tri City Bankshares Corporation and subsidiaries (the "Corporation") as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years ended December 31, 2008, 2007 and 2006. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of its internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Corporation's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tri City Bankshares Corporation and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and cash flows for the years ended December 31, 2008, 2007 and 2006, in conformity with U. S. generally accepted accounting principles. s/ VIRCHOW, KRAUSE & COMPANY, LLP Milwaukee, Wisconsin March 26, 2009 32 TRI CITY BANKSHARES CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 2008 and 2007 - -------------------------------------------------------------------------------- ASSETS
2008 2007 ------------- ------------- Cash and due from banks $ 41,504,793 $ 60,079,747 Federal funds sold 11,457,040 - ------------- ------------- Cash and cash equivalents 52,961,833 60,079,747 Held to maturity securities, fair value of $108,274,692 and $111,160,170 as of 2008 and 2007, respectively 106,650,798 110,550,652 Loans, less allowance for loan and lease losses of $5,945,162 and $5,757,927 as of 2008 and 2007, respectively 593,700,921 580,520,538 Premises and equipment - net 21,104,762 20,053,314 Cash surrender value of life insurance 11,047,591 11,622,695 Mortgage servicing rights - net 590,224 658,717 Accrued interest receivable and other assets 6,876,815 6,541,335 ------------- ------------- TOTAL ASSETS $ 792,932,944 $ 790,026,998 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY COMMITMENTS AND CONTINGENCIES LIABILITIES Deposits Demand $ 125,556,485 $ 137,384,198 Savings and NOW 408,931,613 411,900,132 Other time 143,190,064 116,519,450 ------------- ------------- Total Deposits 677,678,162 665,803,780 Federal funds purchased - 12,851,264 Other borrowings 3,911,054 2,170,571 Accrued interest payable and other liabilities 2,407,462 2,434,058 -------------- ------------- TOTAL LIABILITIES 683,996,678 683,259,673 ------------- ------------- STOCKHOLDERS' EQUITY Cumulative preferred stock, $1 par value, 200,000 shares authorized, no shares issued - - Common stock, $1 par value, 15,000,000 shares authorized, 8,904,915 and 8,884,045 shares issued and outstanding as of 2008 and 2007, respectively 8,904,915 8,884,045 Additional paid-in capital 26,543,470 26,160,505 Retained earnings 73,487,881 71,722,775 ------------- ------------- TOTAL STOCKHOLDERS' EQUITY 108,936,266 106,767,325 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 792,932,944 $ 790,026,998 ============= =============
See accompanying notes to consolidated financial statements. 33 TRI CITY BANKSHARES CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2008, 2007 and 2006 - --------------------------------------------------------------------------------
2008 2007 2006 ------------- ------------- ------------- INTEREST INCOME Loans $ 38,828,304 $ 39,893,667 $ 35,557,534 Investment securities Taxable 3,036,762 3,597,836 3,724,360 Tax exempt 1,480,986 1,104,444 1,163,425 Federal funds sold 86,058 452,071 458,976 Other 19,326 19,326 19,326 ------------- ------------- ------------- Total Interest Income 43,451,436 45,067,344 40,923,621 ------------- ------------- ------------- INTEREST EXPENSE Deposits 9,388,654 11,873,895 10,363,386 Federal funds purchased 107,464 627,389 173,905 Other borrowings 21,390 73,094 54,732 ------------- ------------- ------------- Total Interest Expense 9,517,508 12,574,378 10,592,023 ------------- ------------- ------------- Net Interest Income before Provision for Loan Losses 33,933,928 32,492,966 30,331,598 Provision for loan losses 1,300,000 480,000 240,000 ------------- ------------- ------------- Net Interest Income after Provision for Loan Losses 32,633,928 32,012,966 30,091,598 ------------- ------------- ------------- NONINTEREST INCOME Service charges on deposits 9,574,566 9,069,226 8,222,625 Loan servicing income 179,381 230,881 197,558 Net gain on sale of loans 387,036 171,402 301,515 Increase in cash surrender value of life insurance 464,465 453,755 415,934 Other income 2,279,620 1,339,678 1,282,538 ------------- ------------- ------------- Total Noninterest Income 12,885,068 11,264,942 10,420,170 ------------- ------------- ------------- NONINTEREST EXPENSES Salaries and employee benefits 16,240,596 15,803,452 14,577,454 Net occupancy costs 2,930,770 2,707,894 2,419,437 Furniture and equipment expenses 1,621,313 1,819,604 1,851,745 Computer services 2,642,398 2,327,097 2,176,339 Advertising and promotional 1,018,367 943,358 1,429,781 Regulatory agency assessments 266,943 246,237 212,913 Office supplies 718,208 650,236 584,596 Other expenses 3,763,527 3,519,414 3,172,262 ------------- ------------- ------------- Total Noninterest Expenses 29,202,122 28,017,292 26,424,527 ------------- ------------- ------------- Income before income taxes 16,316,874 15,260,616 14,087,241 Less: Applicable income taxes 5,292,500 5,284,000 4,803,500 ------------- ------------- ------------- NET INCOME $ 11,024,374 $ 9,976,616 $ 9,283,741 ============= ============= ============= Basic earnings per share $ 1.24 $ 1.13 $ 1.06 ============= ============= ============= Dividends per share $ 1.04 $ 1.00 $ 0.88 ============= ============= ============= Weighted average shares outstanding 8,903,317 8,847,973 8,734,997 ============= ============= =============
See accompanying notes to consolidated financial statements. 34 TRI CITY BANKSHARES CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2008, 2007 and 2006 - --------------------------------------------------------------------------------
Additional Retained Common Stock Paid-In Capital Earnings Total ------------ --------------- ------------ -------------- BALANCES - January 1, 2006 $ 8,615,527 $ 21,233,200 $ 68,952,531 $ 98,801,258 Net income - - 9,283,741 9,283,741 Cash dividends - $0.88 per share - - (7,656,919) (7,656,919) Common stock issued under dividend reinvestment plan - 181,984 shares 181,984 3,339,408 - 3,521,392 Common stock fractional shares redeemed 2 35 - 37 Common stock issued under employee stock plan - 4,300 shares 4,300 78,905 - 83,205 ----------- ------------ ------------- -------------- BALANCES - December 31, 2006 8,801,813 24,651,548 70,579,353 104,032,714 Net income - - 9,976,616 9,976,616 Cash dividends - $1.00 per share - - (8,833,194) (8,833,194) Common stock issued under dividend reinvestment plan - 82,230 shares 82,230 1,508,913 - 1,591,143 Common stock fractional shares issued 2 44 - 46 ----------- ------------ ------------- -------------- BALANCES - December 31, 2007 8,884,045 26,160,505 71,722,775 106,767,325 Net income - - 11,024,374 11,024,374 Cash dividends - $1.04 per share - - (9,259,268) (9,259,268) Common stock issued under dividend reinvestment plan - 20,685 shares 20,685 379,558 - 400,243 Common stock fractional shares issued 185 3,407 - 3,592 ----------- ------------ ------------- -------------- BALANCES - December 31, 2008 $ 8,904,915 $ 26,543,470 $ 73,487,881 $ 108,936,266 =========== ============ ============= ==============
See accompanying notes to consolidated financial statements. 35 TRI CITY BANKSHARES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2008, 2007 and 2006 - --------------------------------------------------------------------------------
2008 2007 2006 -------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 11,024,374 $ 9,976,616 $ 9,283,741 Adjustments to reconcile net income to net cash flows provided by operating activities: Depreciation 2,186,194 2,041,732 2,170,182 Amortization of servicing rights, premiums and discounts 400,495 335,290 370,106 Gain on sale of loans (387,036) (171,402) (301,515) Provision for loan losses 1,300,000 480,000 240,000 Benefit for deferred income taxes (241,000) (202,000) (360,000) Proceeds from sales of loans held for sale 26,784,889 15,661,095 21,287,975 Originations of loans held for sale (26,604,607) (15,489,693) (20,986,460) Increase in cash surrender value of life insurance (464,465) (453,755) (415,934) (Gain) loss on sale of other real estate owned (58,573) 50,000 25,449 (Gain) loss on disposal of premises and equipment (165,244) - 10,147 Gain on death benefits of insurance policy (606,585) - - Net change in: Accrued interest receivable and other assets 15,073 (194,051) (1,125,758) Accrued interest payable and other liabilities (26,596) (680,737) 425,425 ------------- ------------- ------------- Net Cash Flows Provided by Operating Activities 13,156,919 11,353,095 10,623,358 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Activity in held to maturity securities: Maturities, prepayments and calls 88,851,957 38,180,084 35,972,750 Purchases (85,077,351) (30,519,754) (16,470,749) Net increase in loans (15,288,163) (52,053,838) (18,295,256) Purchases of premises and equipment - net (3,155,980) (1,923,381) (1,462,012) Proceeds from sale of other real estate owned 756,800 175,000 104,051 Proceeds of life insurance death benefit 1,646,154 - - Proceeds from sales of premises and equipment 83,582 - 4,651 ------------- ------------- ------------- Net Cash Flows Used in Investing Activities (12,183,001) (46,141,889) (146,565) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 11,874,382 4,375,539 22,136,793 Net change in federal funds purchased (12,851,264) 12,851,264 - Net change in other borrowings 1,740,483 (1,299,449) 1,037,857 Dividends paid (9,259,268) (8,833,194) (7,656,919) Common stock issued - net 403,835 1,591,189 3,604,634 ------------- ------------- ------------- Net Cash Flows Provided by(Used) in Financing Activities (8,091,832) 8,685,349 19,122,365 ------------- ------------- ------------- NET CHANGE IN CASH AND CASH EQUIVALENTS (7,117,914) (26,103,445) 29,599,158 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 60,079,747 86,183,192 56,584,034 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS - END OF YEAR $ 52,961,833 $ 60,079,747 $ 86,183,192 ============= ============= ============= SUPPLEMENTAL CASH FLOW DISCLOSURES Cash paid for interest $ 9,538,753 $ 12,605,994 $ 10,508,287 Cash paid for income taxes 5,665,125 5,345,100 5,701,600 Loans receivable transferred to other real estate owned 807,780 225,000 - Mortgage servicing rights resulting from sales of loans 206,754 113,983 164,028
See accompanying notes to consolidated financial statements. 36 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007 and 2006 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies - -------------------------------------------------------------------------------- CONSOLIDATION The consolidated financial statements of Tri City Bankshares Corporation (the "Corporation") include the accounts of its wholly owned subsidiary, Tri City National Bank (the "Bank"). Tri City National Bank includes the accounts of its wholly owned subsidiaries, Tri City Capital Corporation, a Nevada investment subsidiary, and Title Service of Southeast Wisconsin, Inc., a title company subsidiary. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. NATURE OF BANKING ACTIVITIES The consolidated income of the Corporation is principally from the income of its wholly owned subsidiary. The Bank grants commercial, residential and consumer loans and accepts deposits primarily in the metropolitan Milwaukee, Wisconsin area. The Corporation and the Bank are subject to competition from other financial institutions and nonfinancial institutions providing financial products. Additionally, the Corporation and the Bank are subject to the regulations of certain regulatory agencies and undergo periodic examination by those regulatory agencies. USE OF ESTIMATES In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease losses. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash and balances due from banks and federal funds sold, all of which mature within ninety days. The Bank maintains amounts due from banks which, at times, may exceed federally insured limits. The Bank has not experienced any losses in such accounts. HELD TO MATURITY SECURITIES Securities classified as held to maturity are those securities the Bank has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. Interest and dividends are included in interest income from the related securities as earned. These securities are carried at cost, adjusted for amortization of premium and accretion of discount, computed by the effective interest method over their contractual lives. The sale of a security within three months of its maturity date or after collection of at least 85 percent of the principal outstanding at the time the security was acquired is considered a maturity for purposes of classification and disclosure. Realized gains and losses are computed on a specific identification basis and declines in value determined to be other than temporary are included in gains (losses) on sale of securities. Purchase premiums and discounts are recognized in interest income using the effective interest method over the terms of the securities. 37 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies (cont.) - -------------------------------------------------------------------------------- LOANS Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the amount of unpaid principal, reduced by an allowance for loan and lease losses and any deferred fees or costs in originating loans. Interest income is accrued and credited to income on a daily basis based on the unpaid principal balance. Loan origination fees, net of certain direct loan origination costs, are deferred and recognized as an adjustment of the loan yield using an effective interest method. The accrual of interest income on impaired loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower's ability to meet payment of interest or principal when they become due. Management may elect to continue the accrual of interest when the estimated fair value of collateral is sufficient to cover the principal balance and accrued interest. When interest accrual is discontinued, all unpaid accrued interest is reversed. Cash collections on impaired loans are credited to the loan receivable balance and no interest income is recognized on those loans until the principal balance is current. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current and future payments are reasonably assured. LOANS HELD FOR SALE Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. All sales are made without recourse. The Bank also services loans that have been sold with servicing retained by the Bank. Such loans are not included in the accompanying consolidated balance sheets. There were no loans held for sale at December 31, 2008 or 2007. ALLOWANCE FOR LOAN AND LEASE LOSSES The allowance for loan and lease losses is composed of specific and general valuation allowances. The Bank establishes specific valuation allowances on loans considered impaired. A loan is considered impaired (and a specific valuation allowance established for an amount equal to the impairment) when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan's original effective interest rate, or the fair value of the underlying collateral. General valuation allowances are based on an evaluation of the various risk components that are inherent in the credit portfolio. The risk components that are evaluated include past loan loss experience; the level of nonperforming and classified assets; current economic conditions; volume, growth and composition of the loan portfolio; adverse situations that may affect the borrower's ability to repay; the estimated value of any underlying collateral; peer group comparisons; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and reduced by charge-offs, net of recoveries. Management may transfer reserves between specific and general valuation allowances as considered necessary. The adequacy of the allowance for loan and lease losses is reviewed and approved by the Bank's Board of Directors. The allowance reflects management's best estimate of the probable and inherent losses on loans, and is based on a risk model developed and implemented by management and approved by the Bank's Board of Directors. In addition, various regulatory agencies periodically review the allowance for loan and lease losses. These agencies may suggest additions to the allowance for loan and lease losses based on their judgments of collectibility based on information available to them at the time of their examination. 38 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007 and 2006 39 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies (cont.) - -------------------------------------------------------------------------------- TRANSFERS OF FINANCIAL ASSETS Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. MORTGAGE SERVICING RIGHTS Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets. Capitalized mortgage servicing rights are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based on discounted cash flows using market based assumptions such as prepayment speeds, interest rates, and other factors which are subject to change over time. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. PREMISES AND EQUIPMENT Depreciable assets are stated at cost less accumulated depreciation. Provisions for depreciation are computed on straight-line methods over the estimated useful lives of the assets, which range from 3 to 10 years for furniture and equipment and 15 to 40 years for buildings and leasehold improvements. Repairs and maintenance costs are expensed as incurred. EMPLOYEE BENEFIT PLAN The Bank has established a defined contribution 401(k) profit-sharing plan for qualified employees. The Bank's policy is to fund contributions as accrued. OTHER REAL ESTATE OWNED Other real estate owned, acquired through partial or total satisfaction of loans is carried at the lower of cost or fair value less cost to sell. At the date of acquisition, losses are charged to the allowance for loan and lease losses. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses. FEDERAL RESERVE BANK STOCK The Bank's investment in Federal Reserve Bank stock meets the minimum amount required by current regulations and is carried at cost, which approximates fair value. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS In the ordinary course of business the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. 39 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007 and 2006 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies (cont.) - -------------------------------------------------------------------------------- DERIVATIVE FINANCIAL INSTRUMENTS The Bank utilizes derivative financial instruments to meet the ongoing credit needs of its customers and in order to manage the market exposure of its residential loans held for sale and its commitments to extend credit for residential loans. Derivative financial instruments include commitments to extend credit. The Bank does not use interest rate contracts (e.g. swaps, caps, floors) or other derivatives to manage interest rate risk and has none of these instruments outstanding. ADVERTISING COSTS All advertising costs incurred by the Bank are expensed in the period in which they are incurred. INCOME TAXES The Corporation files a consolidated federal income tax return and individual state income tax returns. Income tax expense is recorded based on the liability method. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The differences relate principally to the allowance for loan and lease losses, mortgage servicing rights, deferred loan fees, and premises and equipment. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. EARNINGS PER SHARE Basic earnings per share are computed based upon the weighted average number of common shares outstanding during each year. The Corporation had no potentially dilutive shares outstanding during each of the three years in the period ended December 31, 2008. INTERIM FINANCIAL DATA The interim financial data (see Note 21) is unaudited; however, in management's opinion, the interim data includes all adjustments, consisting only of normal, recurring adjustments necessary for a fair presentation of results for the interim periods. SEGMENT REPORTING The Bank has determined that it has one reportable segment - community banking. The Bank offers a range of financial products and services to external customers, including: accepting deposits and originating residential, consumer and commercial loans. Revenues for each of these products and services are disclosed in the consolidated statements of income. 40 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies (cont.) - -------------------------------------------------------------------------------- FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standard ("SFAS") No. 157 "Fair Value Measurements" gives guidance for using fair value to measure assets and liabilities and expands disclosures about the use of fair value. SFAS 157 emphasizes that fair value measurement is a market-based measurement, focusing on the exit price of assets and liabilities in a market in which participants are buyers and sellers in the principal (or most advantageous) market. SFAS 157 established a three-tiered fair value hierarchy based on the level of observable inputs used in the measurement of fair value (e.g., Level 1 representing quoted prices for identical assets or liabilities in an active market, Level 2 representing quoted prices for similar assets or liabilities and Level 3 representing estimated values based on significant unobservable inputs). The Corporation adopted SFAS 157 on January 1, 2008. Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About Fair Value of Financial Instruments", requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation. The following methods and assumptions were used by the Bank in estimating the fair value of its financial instruments: CARRYING AMOUNTS APPROXIMATE FAIR VALUES FOR THE FOLLOWING INSTRUMENTS Cash and due from banks Federal funds sold Non marketable equity securities Variable rate loans that reprice frequently where no significant change in credit risk has occurred Cash surrender value of life insurance Accrued interest receivable Demand deposits Variable rate money market accounts Variable rate certificates of deposit Federal funds purchased Short term borrowings Accrued interest payable QUOTED MARKET PRICES Where available, or if not available, based on quoted market prices of comparable instruments for the following instrument: Held to maturity securities DISCOUNTED CASH FLOWS Using interest rates currently being offered on instruments with similar terms and with similar credit quality: 41 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies (cont.) - -------------------------------------------------------------------------------- FAIR VALUE OF FINANCIAL INSTRUMENTS (CONT.) All loans except variable rate loans described above Mortgage servicing rights - using current market assumptions for prepayments, servicing costs and other factors Fixed rate certificates of deposit QUOTED FEES CURRENTLY BEING CHARGED FOR SIMILAR INSTRUMENTS Taking into account the remaining terms of the agreements and the counterparties' credit standing: Off-balance-sheet instruments Letters of credit Lending commitments Since the majority of the Bank's off-balance-sheet instruments consist of nonfee-producing, variable rate commitments, the Bank has determined these do not have a distinguishable fair value. RECLASSIFICATIONS Certain 2007 and 2006 amounts have been reclassified to conform with the 2008 presentation. The reclassifications have no effect on previously reported net income, basic earnings per share, and stockholders' equity. RECENT ACCOUNTING PRONOUNCEMENTS In February 2007, the FASB issued SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities". SFAS No. 159 permits entities to choose to measure financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The decision to elect the fair value option may be applied instrument by instrument, is irrevocable and is applied to the entire instrument and not to only specified risks, specific cash flows or portions of that instrument. An entity is restricted in choosing the dates to elect the fair value option for an eligible item. The Corporation adopted SFAS No. 159 on January 1, 2008. The adoption of this standard had no effect on the Corporation's consolidated financial statements. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS No. 160"). SFAS No. 160 amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements" ("ARB No. 51"), to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The Corporation will be required to adopt SFAS No. 160 on January 1, 2009. Management has determined that this statement will have no impact on the Corporation's consolidated financial statements. In March 2008, the FASB issued SFAS 161 "Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133. SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities and thereby improves on the transparency of financial reporting. In adopting SFAS 161, entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial positions, financial performance and cash flows. Because this pronouncement affects only disclosures, this pronouncement will not have an impact on the Bank's consolidated financial statements. The adoption of SFAS 161 is effective for the fiscal year beginning after October 1, 2009, with early adoption permitted. 42 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 1 - Summary of Significant Accounting Policies (cont.) - -------------------------------------------------------------------------------- During May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). This statement identifies the sources of accounting principles and the framework for selecting the principles that are presented in conformity with generally accepted accounting principles in the United States of America. This statement became effective during November 2008. The adoption of SFAS 162 did not have any effect on the Association's results of operations, financial position or cash flows. - -------------------------------------------------------------------------------- NOTE 2 - Fair Value of Financial Instruments - -------------------------------------------------------------------------------- On January 1, 2008, the Corporation adopted SFAS No. 157, which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value. As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Corporation utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Corporation is able to classify fair value balances based on the observability of those inputs. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy defined by SFAS No. 157 are as follows: Level 1 - Fair value is based upon quoted prices (unadjusted) for identical assets or liabilities in active markets in which the Corporation can participate. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as listed equities and U.S. government treasury securities. Level 2 - Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. Level 3 - Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value. At each balance sheet date, the Corporation performs an analysis of all instruments subject to SFAS No. 157 and includes in Level 3 all of those whose fair value is based on significant unobservable inputs. ASSETS Loans held for investment. The Bank does not record loans held for investment at fair value on a recurring basis. However, from time to time, a particular loan may be considered impaired and an allowance for loan and lease losses established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, "Accounting by Creditors for Impairment of a Loan." The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value 43 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 2 - Fair Value of Financial Instruments - (cont.) - -------------------------------------------------------------------------------- of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2008, substantially all of the impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as a nonrecurring Level 2 valuation. Repossessed assets. Loans on which the underlying collateral has been repossessed are adjusted to fair value upon transfer to repossessed assets. Subsequently, repossessed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the repossessed asset as a nonrecurring Level 2 valuation. Mortgage Servicing Rights. The Bank does not record Mortgage Servicing Rights (MSR's) at fair value on a recurring basis. However, from time to time, MSR's may be considered impaired and an allowance for losses established. MSR's for which it is probable that payment of principal will not be made in accordance with the MSR agreement are considered impaired. The fair value of MSR's is estimated using the Office of Thrift Supervision selected asset price tables for servicing cost and servicing fees applied to the Bank's portfolio of serviced loans. If the MSR's fair value is less than the MSR's amortized value, then MSR's are considered impaired. At December 31, 2008, MSR's were evaluated based on their fair value. In accordance with SFAS 157, impaired MSR's where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired MSR as a nonrecurring Level 2 valuation. The Bank as of December 31, 2008 does not carry any assets that are measured at fair value on a recurring basis or use significant unobservable inputs. ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS The Bank has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These include assets that are measured at the lower of cost or market and had a fair value below cost at the end of the period as summarized below. Balance at 12/31/08 Level 1 Level 2 Level 3 ------------ ------- ------- ------- Loans held for investment $ 12,277,424 $ - $ 12,277,424 $ - Repossessed assets 109,553 - 109,553 - ------------ -------- ------------ -------- Totals $ 12,386,977 $ - $ 12,386,977 $ - ============ ======== ============ ======== 44 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 2 - Fair Value of Financial Instruments - (cont.) - -------------------------------------------------------------------------------- The estimated fair values of financial instruments at December 31, 2008 and 2007 are as follows:
2008 2007 ----------------------------------- ----------------------------------- Estimated Fair Estimated Fair Carrying Amount Value Carrying Amount Value FINANCIAL ASSETS Cash and due from banks $ 41,504,793 $ 41,504,793 $ 60,079,747 $ 60,079,747 ================ ================ ================ ================ Federal funds sold $ 11,457,040 $ 11,457,040 $ - $ - ================ ================ ================ ================ Held to maturity securities $ 106,650,798 $ 108,274,692 $ 110,550,652 $ 111,160,170 ================ ================ ================ ================ Non marketable equity securities $ 322,100 $ 322,100 $ 322,100 $ 322,100 ================ ================ ================ ================ Loans - net $ 593,700,921 $ 598,859,959 $ 580,520,538 $ 584,213,046 ================ ================ ================ ================ Cash surrender value of life insurance $ 11,047,591 $ 11,047,591 $ 11,622,695 $ 11,622,695 ================ ================ ================ ================ Mortgage servicing rights $ 590,224 $ 735,048 $ 658,717 $ 925,763 ================ ================ ================ ================ Accrued interest receivable $ 3,776,247 $ 3,776,247 $ 3,800,662 $ 3,800,662 ================ ================ ================ ================ FINANCIAL LIABILITIES Deposits $ 677,678,162 $ 678,571,780 $ 665,803,780 $ 665,983,043 ================ ================ ================ ================ Federal funds purchased $ - $ - $ 12,851,264 $ 12,851,264 ================ ================ ================ ================ Other borrowings $ 3,911,054 $ 3,911,054 $ 2,170,571 $ 2,170,571 ================ ================ ================ ================ Accrued interest payable $ 573,982 $ 573,982 $ 595,227 $ 595,227 ================ ================ ================ ================
The estimated fair value of fee income on letters of credit at December 31, 2008 and 2007 is insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at December 31, 2008 and 2007. The Bank assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, fair values of the Bank's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Bank. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Bank's overall interest rate risk. 45 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 3 - Cash and Due From Banks - -------------------------------------------------------------------------------- The Bank is required to maintain vault cash and reserve balances with Federal Reserve Banks based upon a percentage of deposits. These requirements approximated $8,281,000 and $8,889,000 at December 31, 2008 and 2007, respectively. - -------------------------------------------------------------------------------- NOTE 4 - Held to Maturity Securities - -------------------------------------------------------------------------------- Amortized costs and fair values of held to maturity securities as of December 31, 2008 and 2007 are summarized as follows:
2008 -------------------------------------------------------------------------- Obligations of: Amortized Cost Unrealized Gains Unrealized Losses Fair Value ---------------- ---------------- ---------------- ---------------- States and political subdivisions $ 43,564,260 $ 476,736 $ (88,503) $ 43,952,493 U.S. government sponsored entities 63,086,538 1,346,181 (110,520) 64,322,199 ---------------- ---------------- ---------------- ---------------- Totals $ 106,650,798 $ 1,822,917 $ (199,023) $ 108,274,692 ================ ================ ================ ================ 2007 -------------------------------------------------------------------------- Obligations of: Amortized Cost Unrealized Gains Unrealized Losses Fair Value ---------------- ---------------- ---------------- ---------------- States and political subdivisions $ 40,214,124 $ 182,420 $ (14,569) $ 40,381,975 U.S. government sponsored entities 70,336,528 536,966 (95,299) 70,778,195 ---------------- ---------------- ---------------- ---------------- Totals $ 110,550,652 $ 719,386 $ (109,868) $ 111,160,170 ================ ================ ================ ================
Obligations of U.S. government sponsored entities consist of securities issued by the Federal Home Loan Mortgage Corporation and Federal National Mortgage Association. The amortized cost and fair value of held to maturity securities at December 31, 2008, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers or issuers may have the right to call or prepay obligations with or without call or prepayment penalties. 2008 ------------------------------- Amortized Cost Fair Value -------------- -------------- Due in one year or less $ 11,701,572 $ 11,615,284 Due after one year less than 5 years 54,267,616 55,591,183 Due after 5 years less than 10 years 40,681,610 41,068,225 -------------- -------------- Totals $ 106,650,798 $ 108,274,692 ============== ============== Held to maturity securities with an amortized cost of $74,175,143 and $38,165,894 at December 31, 2008 and 2007, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. 46 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 4 - Held to Maturity Securities (cont.) - -------------------------------------------------------------------------------- The following tables summarize the portion of the Bank's held to maturity securities portfolio which has gross unrealized losses, reflecting the length of time that individual securities have been in a continuous unrealized loss position at December 31, 2008 and 2007.
2008 ------------------------------------------------------------------------------------------------- Continuous unrealized Continuous unrealized losses existing for less than losses existing for greater 12 Months than 12 months Total ------------------------------------------------------------------------------------------------- Unrealized Unrealized Unrealized Fair Value Losses Fair Value Losses Fair Value Losses ------------ ------------ ------------ ------------ ------------ ------------ Obligations of: States and political $ 2,086,699 $ 110,520 $ - $ - $ 2,086,699 $ 110,520 subdivisions U.S. government 5,646,364 88,503 - - 5,646,364 88,503 ------------ ------------ ------------ ------------ ------------ ------------ sponsored entities Totals $ 7,733,063 $ 199,023 $ - $ - $ 7,733,063 $ 199,023 ============ ============ ============ ============ ============ ============ 2007 ------------------------------------------------------------------------------------------------- Continuous unrealized Continuous unrealized losses existing for less than losses existing for greater 12 Months than 12 months Total ------------------------------------------------------------------------------------------------- Unrealized Unrealized Unrealized Fair Value Losses Fair Value Losses Fair Value Losses ------------ ------------ ------------ ------------ ------------ ------------ Obligations of: States and political subdivisions $ 6,297,975 $ 14,569 $ - $ - $ 6,297,975 $ 14,569 U.S. government sponsored entities 51,451,859 95,299 - - 51,451,859 95,299 ------------ ------------ ------------ ------------ ------------ ------------ Totals $ 57,749,834 $ 109,868 $ - $ - $ 57,749,834 $ 109,868 ============ ============ ============ ============ ============ ============
Management does not believe any individual unrealized losses as of December 31, 2008 and 2007 represents losses other than temporary impairment. The Bank held no investment securities at December 31, 2008 that had unrealized losses existing for greater than 12 months. The Bank held seventeen securities at December 31, 2008 that had unrealized losses existing or less than 12 months. The securities consisted of sixteen obligations of states and political subdivisions and one obligation of other U.S. government agencies/corporations. The Bank held no investment securities at December 31, 2007 that had unrealized losses existing for greater than 12 months. The Bank held nineteen securities at December 31, 2007 that had unrealized losses existing for less than 12 months. The securities consisted of eight obligations of states and political subdivisions and eleven obligations of U.S. government agencies/corporations. Management believes the temporary impairment in fair value was caused by market fluctuations in interest rates and a reduction in liquidity and not by a deterioration in credit quality. Since securities are held to maturity, management does not believe that the Bank will experience any losses on these investments. 47 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 5 - Loans - -------------------------------------------------------------------------------- Major classification of loans are as follows at December 31: 2008 2007 ------------- ------------- Commercial $ 23,551,986 $ 27,926,616 Real estate Construction 47,726,345 44,042,342 Commercial 281,965,820 272,795,259 Residential 232,429,710 227,361,616 Installment and consumer 13,972,222 14,152,632 ------------- ------------- 599,646,083 586,278,465 Less: Allowance for loan and lease losses (5,945,162) (5,757,927) ------------- ------------- Net Loans $ 593,700,921 $ 580,520,538 ============= ============= Commercial loans and commercial real estate loans are evaluated for the adequacy of repayment sources at the time of approval and are regularly reviewed for any possible deterioration in the ability of the borrower to repay the loan. The Bank evaluates the credit risk of each commercial customer on an individual basis and, where deemed appropriate, collateral is obtained. Collateral varies by the type of loan and individual loan customer and consists of general business assets such as equipment, receivables and inventory. The Bank's access to collateral is dependent upon the type of collateral obtained. Policies have been established that set standards for the maximum commercial real estate loan amount by type of property, loan terms, pricing structures, loan-to-value limits by property type, as well as policies and procedures for granting exceptions to established underwriting standards. The Bank's residential real estate lending policies require all loans to have viable repayment sources. Residential real estate loans are evaluated for the adequacy of these repayment sources at the time of approval, using such factors as credit scores, debt-to-income ratios and collateral values. Home equity loans and lines of credit are generally governed by the same lending policies. Origination activities for construction real estate loans are similar to those described above for commercial, real estate and residential real estate lending. Impaired loans of approximately $2.8 million and $0.9 million at December 31, 2008 and 2007, respectively, have been included in the consolidated financial statements. The average recorded amount of impaired loans during 2008 and 2007 was approximately $1.9 million and $1.0 million, respectively. The total allowance for loan and lease losses related to these loans was approximately $0.6 million and $0.5 million at December 31, 2008 and 2007, respectively. There was $19,360 paid interest income recognized on impaired loans in 2008 and $21,510 in 2007. Nonaccrual loans totaled approximately $2.9 million and $2.0 million at December 31, 2008 and 2007, respectively. Loans, greater than 90 days past due and accruing interest, totaled approximately $5.7 million and $3.7 million at December 31, 2008 and 2007, respectively. 48 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 5 - Loans (cont.) - -------------------------------------------------------------------------------- Certain directors and executive officers of the Corporation, and their related interests, had loans outstanding in the aggregate amounts of $2.4 million and $5.1 million at December 31, 2008 and 2007, respectively. During 2008 and 2007, $0.5 million and $0.4 million of new loans were made and repayments totaled $3.2 million and $1.0 million, respectively. Management believes these loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons and did not involve more than normal risks of collectibility or present other unfavorable features. Residential and commercial real estate loans approximating $97.4 million and $112.3 million at December 31, 2008 and 2007, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. - -------------------------------------------------------------------------------- NOTE 6 - Allowance for Loan and Lease Losses - -------------------------------------------------------------------------------- The allowance for loan and lease losses reflected in the accompanying consolidated financial statements represents the allowance available to absorb loan losses that are probable and inherent in the portfolio. An analysis of changes in the allowance is presented in the following tabulation as of December 31: 2008 2007 2006 --------------------------------------- Balance at Beginning of Year $ 5,757,927 $ 5,709,397 $ 5,665,519 Charge-offs (1,229,349) (597,733) (292,607) Recoveries 116,584 166,263 96,485 Provision charged to operations 1,300,000 480,000 240,000 ----------- ----------- ----------- Balance at End of Year $ 5,945,162 $ 5,757,927 $ 5,709,397 =========== =========== =========== - -------------------------------------------------------------------------------- NOTE 7 - Mortgage Servicing Rights - -------------------------------------------------------------------------------- The unpaid principal balance of mortgage loans serviced for others, which is not included in the accompanying consolidated balance sheets, was $180,098,745, $181,663,470 and $187,409,555 at December 31, 2008, 2007 and 2006, respectively. For these sold loans, the Bank has recorded mortgage servicing rights, as shown below. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were $729,768, $534,275 and $668,540 at December 31, 2008, 2007 and 2006, respectively. The following is an analysis of the mortgage servicing rights activity for the years ended December 31: 2008 2007 2006 Unamortized cost of mortgage ----------- ----------- ----------- servicing rights Balance at beginning of year $ 658,717 $ 778,458 $ 887,885 Additions of mortgage servicing rights 206,754 113,983 164,028 Amortization (275,247) (233,724) (273,455) ----------- ----------- ----------- Balance at End of Year $ 590,224 $ 658,717 $ 778,458 =========== =========== =========== 49 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 7 - Mortgage Servicing Rights (cont.) - -------------------------------------------------------------------------------- The carrying value of mortgage servicing rights is determined in accordance with SFAS No. 140 and SFAS No. 156. SFAS No. 140 permits capitalized mortgage servicing rights to be amortized in proportion to and over the period of estimated net servicing income and to be assessed for impairment. The Bank relies on industry data to estimate the initial fair value of MSRs to be capitalized as a percentage of the principal balance of the loans sold. The Bank adjusts the carrying value monthly for reductions due to actual prepayments including defaults. The Bank assesses its MSR's for impairment each reporting period using the most recent statistical data published by the Office of Thrift Supervision (OTS tables). At December 31, 2008 and 2007, the weighted average coupon rates of mortgage loans underlying the MSRs was 5.41% and 5.40%, respectively, and the weighted average remaining maturity of the mortgage loans underlying the MSRs was 189 months and 190 months, respectively. The Bank utilized comparable industry information provided by the OTS in estimating the fair value of MSRs at December 31, 2008 and 2007. The estimated fair values of the MSR's was $735,048 and $925,763 at December 31, 2008 and 2007, respectively. As the carrying value of the Bank's MSR's was less than the estimated fair value at December 31, 2008 and 2007, no impairment existed. The carrying value of MSRs was $590,224, or 0.33% of loans serviced at December 31, 2008 compared with $658,717, or 0.36% of loans serviced at December 31, 2007. The projections of amortization expense shown below for mortgage servicing rights are based on existing asset balances and the existing interest rate environment at December 31, 2008. Future amortization may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions. Estimated future amortization by year is as follows: 2009 $ 137,893 2010 149,727 2011 105,064 2012 77,788 2013 53,602 Thereafter 66,150 ---------- $ 590,224 ========== - -------------------------------------------------------------------------------- NOTE 8 - Premises and Equipment - -------------------------------------------------------------------------------- Premises and equipment are stated at cost less accumulated depreciation at December 31 and are summarized as follows: 2008 2007 ------------- ------------- Land $ 6,061,354 $ 5,835,162 Buildings and leasehold improvements 28,582,615 26,757,240 Furniture and equipment 12,606,107 13,011,600 ------------- ------------- Total - at cost 47,250,076 45,604,002 Less: Accumulated depreciation (26,145,314) (25,550,688) ------------- ------------- Net Premises and Equipment $ 21,104,762 $ 20,053,314 ============= ============= Depreciation expense amounted to $2,186,194, $2,041,732 and $2,170,182 in 2008, 2007 and 2006, respectively. 50 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 9 - Accrued Interest Receivable and Other Assets - -------------------------------------------------------------------------------- A summary of accrued interest receivable and other assets at December 31 is as follows: 2008 2007 ------------- ------------- Accrued interest receivable $ 3,776,247 $ 3,800,662 Federal Reserve Stock 322,100 322,100 Prepaid expenses and other assets 2,778,468 2,418,573 ------------- ------------- Total $ 6,876,815 $ 6,541,335 ============= ============= - -------------------------------------------------------------------------------- NOTE 10 - Deposits - -------------------------------------------------------------------------------- The aggregate amount of time deposits, each with a minimum denomination of $100,000, was $55,309,505 and $41,208,913 at December 31, 2008 and 2007, respectively. Scheduled maturities of time deposits was as follows: 2008 2007 ---------------------------- Due within one year $ 110,433,320 $ 82,093,157 After one year but within two years 21,952,105 14,896,933 After two years but within three years 3,595,739 10,068,162 After three years but within four years 3,943,670 5,338,260 After four years but within five years 3,265,230 4,122,938 ------------- ------------- Totals $ 143,190,064 $ 116,519,450 ============= ============= Interest expense on deposits was as follows: 2008 2007 2006 ----------- ------------ ------------ Interest-bearing checking accounts $ 2,045,224 $ 4,104,554 $ 3,313,077 Money market accounts 1,438,207 1,922,830 1,215,610 Savings accounts 849,867 1,105,231 888,246 Time deposit accounts 5,055,356 4,741,280 4,946,453 ----------- ------------ ------------ Totals $ 9,388,654 $ 11,873,895 $ 10,363,386 =========== ============ ============ The Bank has one customer with a deposit balance in excess of 5% of total deposits, amounting to approximately $36,348,234 and $55,234,736 at December 31, 2008 and 2007, respectively. - -------------------------------------------------------------------------------- NOTE 11 -Federal Funds Purchased and Securities Sold Under Repurchase Agreements - -------------------------------------------------------------------------------- The Bank has the ability to borrow (purchase) federal funds of up to $45,000,000 under a revolving line-of-credit. Such borrowings bear interest at the lender bank's announced daily federal funds rate and mature daily. There was $0 and $12,851,264 in federal funds purchased outstanding at December 31, 2008 and 2007, respectively. 51 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 11 - Federal Funds Purchased and Securities Sold Under Repurchase Agreements (cont.) - -------------------------------------------------------------------------------- The Bank may also borrow through securities sold under repurchase agreements (reverse repurchase agreements). Reverse repurchase agreements, which are classified as secured borrowings, generally mature within one to four days from the transaction date. They are reflected at the amount of cash received in connection with the transaction. The Bank had no borrowings outstanding under the reverse repurchase agreements at December 31, 2008 and 2007, respectively. The Bank pledged U.S. government sponsored entity securities and municipal obligations whose carrying values were $34,342,932 and $31,190,866 at December 31, 2008 and 2007, respectively, as collateral under a master repurchase agreement. In addition, at December 31, 2008, the Bank could also pledge up to $6,808,089 of additional securities as collateral under the existing agreements if needed to obtain additional borrowings. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. The Bank may also borrow through the Federal Reserve Bank Discount Window short term funds up to the amount of $32,580,000 secured by $32,857,286 in U.S. government sponsored entity securities or qualified Municipal securities as of December 31, 2008. This facility was not available in 2007 - -------------------------------------------------------------------------------- NOTE 12 - Other Borrowings - -------------------------------------------------------------------------------- Other borrowings consist of accounts due to the Federal Reserve Bank under a $6,000,000 treasury, tax and loan depository agreement. Such borrowings bear interest at the lender bank's announced daily federal funds rate and mature on demand. Treasury, tax and loan account balances were $3,911,054 and $2,170,571 at December 31, 2008 and 2007, respectively. Such accounts generally are repaid within one to 120 days from the transaction date and are collateralized by a pledge of investment securities with a carrying value of $6,974,925 and $6,975,028 at December 31, 2008 and 2007, respectively. 52 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 13 - Income Taxes - -------------------------------------------------------------------------------- The provision for income taxes included in the accompanying consolidated financial statements consists of the following components for the year ending December 31: 2008 2007 2006 Current Taxes ----------- ----------- ----------- Federal $ 4,456,500 $ 4,644,000 $ 4,332,000 State 938,000 842,000 831,500 ----------- ----------- ----------- Total Current Provision 5,394,500 5,486,000 5,163,500 ----------- ----------- ----------- Deferred Income Taxes (Benefit) Federal (46,000) (213,000) (311,000) State (56,000) 11,000 (49,000) ----------- ----------- ----------- Total Deferred Provision (102,000) (202,000) (360,000) ------------ ----------- ----------- Total Provision for Income Taxes $ 5,292,500 $ 5,284,000 $ 4,803,500 ============ =========== =========== The net deferred income tax assets in the accompanying consolidated balance sheets include the following amounts of deferred income tax assets and liabilities at December 31: 2008 2007 Deferred Income Tax Assets ----------- ----------- Allowance for loan and lease losses $ 2,339,000 $ 2,279,000 Excess servicing gains 2,000 3,000 Reserve for health plan 318,000 340,000 Depreciation 244,000 221,000 Non-accrual interest - 84,000 Loss carryforwards 51,000 34,000 Other 118,000 25,000 ----------- ----------- Deferred Tax Assets before valuation allowance 3,072,000 2,986,000 Valuation allowance (93,000) (79,000) ----------- ----------- Net Deferred Income Tax Assets 2,979,000 2,907,000 ----------- ----------- Deferred Income Tax Liabilities Deferred loan fees (188,000) (189,000) Mortgage servicing rights (232,000) (261,000) ----------- ----------- Total Deferred Income Tax Liabilities (420,000) (450,000) ----------- ----------- Net Deferred Income Tax Assets $ 2,559,000 $ 2,457,000 =========== =========== 53 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 13 - Income Taxes (cont.) - -------------------------------------------------------------------------------- The Corporation has state net business loss carryforwards of approximately $915,000 and $665,000 as of December 31, 2008 and 2007, respectively. The net business loss carryforwards expire in varying amounts between 2016 and 2023. Realization of the net deferred income tax asset over time is dependent upon the existence of taxable income in carryback periods or the Corporation generating sufficient taxable income in future periods. In determining that realization of the net deferred income tax asset recorded was more likely than not, the Corporation gave consideration to a number of factors including its recent earnings history, its expectations for earnings in the future, and where applicable, the expiration dates associated with tax carryforwards. A valuation allowance has been established against state deferred income tax assets for those entities which have state net business loss carryforwards in which management believes that it is more likely than not that the state deferred income tax assets will not be realized. A reconciliation of statutory federal income taxes based upon income before taxes to the provision for federal and state income taxes is as follows:
2008 2007 2006 ------------------------------------------------------------------------- % of Pretax % of Pretax % of Pretax Amount Income Amount Income Amount Income ------------------------------------------------------------------------- Reconciliation of statutory to effective rates Federal income taxes at statutory rate $ 5,650,412 34.63% $ 5,249,034 34.40% $ 4,830,515 34.29% Adjustments for Tax exempt interest on municipal obligations (512,711) (3.14) (345,146) (2.26) (365,243) (2.59) Increase in taxes resulting from state income taxes, net of federal tax benefit 577,224 3.54 559,603 3.66 514,180 3.65 Life insurance death benefits (160,841) (0.99) Increase in cash surrender value of life insurance (210,060) (1.29) (156,074) (1.02) (142,624) (1.01) Other - net (51,524) (0.31) (23,417) (0.15) (33,328) (0.24) ----------- ------ ----------- ------ ----------- ------ Income Tax Provision $ 5,292,500 32.44% $ 5,284,000 34.63% $ 4,803,500 34.10% =========== ====== =========== ====== =========== ======
FIN No. 48 was adopted by the Corporation on January 1, 2007. The adoption of this standard had no effect on the Corporation's consolidated financial statements. As of the December 31, 2008 and as of December 31, 2007, the Corporation had no uncertain tax positions. The Corporation's policy is to record interest and penalties related to income tax liabilities in income tax expense. The Corporation, along with its subsidiaries, files U.S. Federal and Wisconsin income tax returns. The Corporation's federal tax returns for 2004 and prior, and its 2003 and prior year Wisconsin tax returns, are no longer subject to examination by tax authorities. 54 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 14 - Employee Benefit Plans - -------------------------------------------------------------------------------- The Bank has a contributory defined-contribution 401(k) retirement plan. This plan covers substantially all employees who have attained the age of 21 and completed one year of service. Participants may contribute a portion of their compensation (up to IRS limits) to the plan. The Bank may make regular and matching contributions to the plan each year. In 2008, 2007 and 2006, the Bank provided a dollar-for-dollar match of employee contributions up to 5% of their compensation. Participants direct the investment of their contributions into one or more investment options. The Bank recorded contributions expense of $436,704, $383,094, and $382,214 in 2008, 2007 and 2006, respectively. In December 2003, the Corporation adopted a Stock Purchase Plan to aid the Corporation in obtaining and retaining key management personnel by providing them with an opportunity to acquire an ownership interest in the Corporation by purchasing the Corporation's common stock. The Stock Purchase Plan was terminated in October 2006 by the Board of Directors. Eligibility to participate in the plan was restricted to directors, officers at a position of vice president or above, and certain officers with ten or more years of continuous service. Participants could subscribe to purchase shares annually during January of each year, subject to limitations as defined in the plan, at a price per share equivalent to the most recently established fair market value determined under the Corporation's Automatic Dividend Reinvestment Plan. Common shares subscribed and issued under the plan were 4,300 in January of 2006. The Bank purchased paid-up life insurance as owner and beneficiary on certain officers and executives to provide the Bank with funds in the event of the death of such individuals and to help recover the cost of employee benefits. Included in the consolidated financial statements is $11,047,591 and $11,622,695 of related cash surrender value as of December 31, 2008 and 2007, respectively. - -------------------------------------------------------------------------------- NOTE 15 - Operating Leases - -------------------------------------------------------------------------------- The Bank leases various banking facilities under operating lease agreements from various companies. Three of these facilities are leased from companies held by a director and major shareholder of the Corporation. All of the agreements include renewal options and one agreement requires the Bank to pay insurance, real estate taxes and maintenance costs associated with the lease. Rental amounts are subject to annual escalation based upon increases in the Consumer Price Index. Aggregate rental expense under the leases amounted to $841,437, $822,204 and $749,712 in 2008, 2007 and 2006, respectively, including $290,536, $275,411 and $265,448, respectively, on facilities leased from companies held by a director and major shareholder of the Corporation. At December 31, 2008, the future minimum lease payments for each of the five succeeding years and in the aggregate are as follows: 2009 $ 816,687 2010 637,692 2011 211,216 2012 47,367 2013 16,072 Thereafter 16,072 ----------- $ 1,745,106 =========== Office space at certain facilities is leased to outside parties. Rental income included in net occupancy costs was $1,131,064, $1,129,329 and $1,153,283 for the years ended December 31, 2008, 2007 and 2006, respectively. 55 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 16 - Commitments and Contingencies - -------------------------------------------------------------------------------- The Corporation and Bank are party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, financial guarantees and standby letters of credit. They involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized on the consolidated balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and issuing letters of credit as they do for on-balance-sheet instruments. A summary of the contract or notional amount of the Bank's exposure to off-balance-sheet risk as of December 31, 2008 and 2007 is as follows: 2008 2007 Financial instruments whose contract ------------ ------------ amounts represent credit risk: Commitments to extend credit $ 69,875,084 $ 81,495,823 Standby letters of credit $ 4,539,110 $ 3,825,192 Forward commitment to sell mortgage loans $ 4,036,900 $ 588,600 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. The Bank also enters into forward commitments to sell mortgage loans to a secondary market agency. - -------------------------------------------------------------------------------- NOTE 17 - Stockholders' Equity - -------------------------------------------------------------------------------- CUMULATIVE PREFERRED STOCK The Corporation's articles of incorporation authorize the issuance of up to 200,000 shares of $1 par value cumulative preferred stock. The Board of Directors is authorized to divide the stock into series and fix and determine the relative rights and preferences of each series. No shares have been issued. RETAINED EARNINGS The principal source of income and funds of the Corporation are dividends from the Bank. Dividends declared by the Bank that exceed the retained net income for the most current year plus retained net income for the preceding two years must be approved by federal regulatory agencies. Under this formula, dividends of approximately $10,775,218 may be paid without prior regulatory approval. Maintenance of adequate capital at the Bank effectively restricts potential dividends to an amount less than $10,775,218. 56 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 17 - Stockholders' Equity (cont.) - -------------------------------------------------------------------------------- Under Federal Reserve regulations, the Bank is limited as to the amount it may lend to its affiliates, including the Corporation. Such loans are required to be collateralized by investments defined in the regulations. In addition, the maximum amount available for transfer from the Bank to the Corporation in the form of loans is limited to 10% of the Bank's stockholders' equity in the case of any one affiliate or 20% in the case of all affiliates. - -------------------------------------------------------------------------------- NOTE 18 - Regulatory Capital Requirements - -------------------------------------------------------------------------------- The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Corporation's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table that follows) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier 1 capital (as defined) to average assets (as defined). As of December 31, 2008 and 2007 the Corporation and the Bank met all capital adequacy requirements to which they are subject. As of December 31, 2008, the most recent notification from the regulatory agencies categorized the subsidiary Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since these notifications that management believes have changed the institution's category. Listed below is a comparison of the Corporation's and the Bank's actual capital amounts with the minimum requirements for well capitalized and adequately capitalized banks, as defined by the federal regulatory agencies' Prompt Corrective Action Rules, as of December 31, 2008 and 2007. 57 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 18 - Regulatory Capital Requirements (cont.) - --------------------------------------------------------------------------------
To Be Well Capitalized For Capital Adequacy Under Prompt Corrective Actual Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 2008 Total capital (to risk weighted assets) Tri City Bankshares Corporation $ 114,881,000 19.0% $ 48,362,000 8.0% N/A N/A Tri City National Bank $ 110,278,000 18.3% $ 48,282,000 8.0% $ 60,353,000 10.0% Tier 1 capital (to risk weighted assets) Tri City Bankshares Corporation $ 108,936,000 18.0% $ 24,181,000 4.0% N/A N/A Tri City National Bank $ 104,392,000 17.3% $ 24,141,000 4.0% $ 36,212,000 6.0% Tier 1 capital (to average assets) Tri City Bankshares Corporation $ 108,936,000 14.3% $ 30,548,000 4.0% N/A N/A Tri City National Bank $ 104,392,000 13.7% $ 30,540,000 4.0% $ 38,176,000 5.0% As of December 31, 2007 Total capital (to risk weighted assets) Tri City Bankshares Corporation $ 112,525,000 19.0% $ 47,503,000 8.0% N/A N/A Tri City National Bank $ 107,938,000 18.2% $ 47,484,000 8.0% $ 59,355,000 10.0% Tier 1 capital (to risk weighted assets) Tri City Bankshares Corporation $ 106,767,000 18.0% $ 23,752,000 4.0% N/A N/A Tri City National Bank $ 102,180,000 17.2% $ 23,742,000 4.0% $ 35,613,000 6.0% Tier 1 capital (to average assets) Tri City Bankshares Corporation $ 106,767,000 14.3% $ 29,943,000 4.0% N/A N/A Tri City National Bank $ 102,180,000 13.7% $ 29,935,000 4.0% $ 37,419,000 5.0%
- -------------------------------------------------------------------------------- NOTE 19 - Concentration of Credit Risk - -------------------------------------------------------------------------------- Practically all of the Bank's loans, commitments, and commercial and standby letters of credit have been granted to customers in the Bank's market area. Although the Bank has a diversified loan portfolio, the ability of its debtors to honor its contracts is dependent on the economic conditions of the counties surrounding the Bank. The concentration of credit by type of loan is set forth in Note 5. 58 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 20 - Tri City Bankshares Corporation (Parent Company Only) Financial Information - -------------------------------------------------------------------------------- CONDENSED BALANCE SHEETS
December 31, ------------------------------ 2008 2007 ASSETS ------------- ------------- Cash on deposit with subsidiary Bank $ 3,652,534 $ 3,633,163 Premises and equipment - net 1,341,576 1,425,747 Investment in subsidiary Bank 103,259,853 100,991,027 Other assets - net 682,303 717,388 ------------- ------------- TOTAL ASSETS $ 108,936,266 $ 106,767,325 ============= ============= STOCKHOLDERS' EQUITY Cumulative preferred stock, $1 par value, 200,000 shares authorized, no shares issued $ - $ - Common stock, $1 par value, 15,000,000 shares authorized, 8,904,915 and 8,884,045 shares issued and outstanding as of 2008 and 2007, respectively 8,904,915 8,884,045 Additional paid-in capital 26,543,470 26,160,505 Retained earnings 73,487,881 71,722,775 ------------- ------------- TOTAL STOCKHOLDERS' EQUITY $ 108,936,266 $ 106,767,325 ============= =============
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, ------------------------------------------ 2008 2007 2006 ------------------------------------------ INCOME Dividends from subsidiary Bank $ 8,890,000 $ 7,280,000 $ 3,416,000 Interest income from subsidiary Bank 102,088 200,941 199,723 Management fees from subsidiary Bank 572,400 553,945 546,736 ------------ ----------- ----------- Total Income 9,564,488 8,034,886 4,162,459 EXPENSES Administrative and general - net 850,943 822,457 792,688 ------------ ----------- ----------- Income before income taxes and equity in undistributed earnings of subsidiary Bank 8,713,545 7,212,429 3,369,771 Less: Applicable income taxes (benefit) (42,000) (5,000) 3,000 ------------ ----------- ----------- Income before equity in undistributed earnings of subsidiary 8,755,545 7,217,429 3,366,771 Equity in undistributed earnings of subsidiary Bank 2,268,829 2,759,187 5,916,970 ------------ ----------- ----------- NET INCOME $ 11,024,374 $ 9,976,616 $ 9,283,741 ============ =========== ===========
59 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007, and 2006 - -------------------------------------------------------------------------------- NOTE 20 - Tri City Bankshares Corporation (Parent Company Only) Financial Information (cont.) - -------------------------------------------------------------------------------- CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------------------------ 2008 2007 2006 ------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 11,024,374 $ 9,976,616 $ 9,283,741 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation 90,871 91,791 94,332 Equity in undistributed income of subsidiary Bank (2,268,829) (2,759,187) (5,916,970) Other 35,085 (11,926) 18,407 ------------ ------------ ----------- Net Cash Flows Provided by Operating Activities 8,881,501 7,297,294 3,479,510 ------------ ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of premises and equipment - net (6,697) (18,460) (77,186) ------------ ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid (9,259,268) (8,833,194) (7,656,919) Common stock issued - net 403,835 1,591,189 3,604,634 ------------ ------------ ----------- Net Cash Flows Used in Financing Activities (8,855,433) (7,242,005) (4,052,285) ------------ ------------ ----------- Net Change in Cash 19,371 36,829 (649,961) CASH - BEGINNING OF YEAR 3,633,163 3,596,334 4,246,295 ------------ ------------ ----------- CASH - END OF YEAR $ 3,652,534 $ 3,633,163 $ 3,596,334 ============ ============ ===========
60 TRI CITY BANKSHARES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008, 2007and 2006 - -------------------------------------------------------------------------------- NOTE 21 - Quarterly Results of Operations (Unaudited) - -------------------------------------------------------------------------------- The following is a summary of the quarterly results of operations for the years ended December 31, 2008 and 2007: (In thousands, except per share data) Three Months Ended -------------------------------------------- 2008 December 31 September 30 June 30 March 31 -------- -------- -------- -------- Interest income $ 10,617 $ 10,678 $ 10,798 $ 11,358 Interest expense (2,070) (2,204) (2,242) (3,001) -------- -------- -------- -------- Net interest income 8,547 8,474 8,556 8,357 Provision for loan losses (715) (200) (200) (185) Noninterest income 3,203 3,104 3,064 3,514 Noninterest expense (7,085) (7,312) (7,364) (7,441) -------- -------- -------- -------- Income before income taxes 3,950 4,066 4,056 4,245 Income taxes (1,328) (1,357) (1,388) (1,220) -------- -------- -------- -------- Net Income $ 2,622 $ 2,709 $ 2,668 $ 3,025 ======== ======== ======== ======== Basic earnings per share $ 0.30 $ 0.30 $ 0.30 $ 0.34 2007 Interest income $ 11,632 $ 11,465 $ 11,105 $ 10,865 Interest expense (3,328) (3,161) (2,963) (3,122) -------- -------- -------- -------- Net interest income 8,304 8,304 8,142 7,743 Provision for loan losses (235) (125) (60) (60) Noninterest income 2,929 2,908 2,858 2,570 Noninterest expense (7,177) (7,052) (7,002) (6,786) -------- -------- -------- -------- Income before income taxes 3,821 4,035 3,938 3,467 Income taxes (1,306) (1,415) (1,376) (1,187) -------- -------- -------- -------- Net Income $ 2,515 $ 2,620 $ 2,562 $ 2,280 ======== ======== ======== ======== Basic earnings per share $ 0.29 $ 0.29 $ 0.29 $ 0.26 61 Form 10-K Shareholders interested in obtaining a copy of the Corporation's Annual Report to the Securities and Exchange Commission as filed on Form 10-K may do so at no cost by writing to: Office of the Secretary Tri City Bankshares Corporation 6400 South 27th Street Oak Creek, Wisconsin 53154 -----END PRIVACY-ENHANCED MESSAGE-----