10-K 1 rivr-20141231.htm FYE 12/31/2014
THE UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)
ý
 
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
   
of 1934 for the Fiscal Year Ended December 31, 2014
 
   
Or
 
 
Transition Report Pursuant to Section 13 or 15(d) of the Securities
   
Exchange Act of 1934 for the Transition Period from _______ to ______

000-21765
Commission File Number
 
RIVER VALLEY BANCORP
(Exact name of registrant as specified in its charter)
 
INDIANA
 
35-1984567
(State or other jurisdiction of incorporation or organization)
 
 
(IRS Employer Identification No.)
   
430 Clifty Drive, P.O. Box 1590, Madison, Indiana
47250-0590
(Address of principal executive offices)
 
(Zip Code)
 
(812) 273-4949
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock
 
The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes    No ý
 
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 ý
 
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  ý   No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes  ý   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.
 
ý
 
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.
 
Large Accelerated Filer
Accelerated Filer
Non-Accelerated Filer
(Do not check if a smaller reporting company)
 
Smaller Reporting Company ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
Yes No ý
 
As of June 30, 2014, the last day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant was $16,276,994 based on the closing sale price as reported on the NASDAQ Capital Market.
 
As of February 20, 2015, there were issued and outstanding 2,513,696 shares of the issuer’s Common Stock.
 
Documents Incorporated by Reference
Portions of the Proxy Statement for the 2015 Annual Meeting of Shareholders to be held on April 15, 2015 are incorporated in Part III.

RIVER VALLEY BANCORP
FORM 10-K
INDEX
FORWARD-LOOKING STATEMENTS
3
     
PART I
 
3
Item 1.
Business
3
Item 1A.
Risk Factors
26
Item 1B.
Unresolved Staff Comments
26
Item 2.
Properties
27
Item 3.
Legal Proceedings
28
Item 4.
Mine Safety Disclosures
28
Item 4.5.
Executive Officers of the Registrant
28
     
PART II
 
29
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
29
Item 6.
Selected Financial Data
31
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
32
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
48
Item 8.
Financial Statements and Supplementary Data
49
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
101
Item 9A.
Controls and Procedures
101
Item 9B.
Other Information
101
     
PART III
 
102
Item 10.
Directors, Executive Officers and Corporate Governance
102
Item 11.
Executive Compensation
102
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
102
Item 13.
Certain Relationships and Related Transactions, and Director Independence
102
Item 14.
Principal Accountant Fees and Services
103
     
PART IV
 
103
Item 15.
Exhibits and Financial Statement Schedules
103
     
SIGNATURES
104
     
EXHIBIT INDEX
105


2

FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (“Form 10-K”) contains statements which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-K and include statements regarding the intent, belief, outlook, estimates or expectations of River Valley Bancorp, its directors, or its officers primarily with respect to future events and the future financial performance of the Corporation. Readers of this Form 10-K are cautioned that any such forward-looking statements are not guarantees of future events or performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The accompanying information contained in this Form 10-K identifies important factors that could cause such differences. These factors include, but are not limited to, changes in interest rates; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; regulatory changes; or turmoil and governmental intervention in the financial services industry.
 
PART I
ITEM 1.  BUSINESS
BUSINESS
GENERAL
River Valley Bancorp (the “Holding Company” or “River Valley” and together with the “Bank,” the “Corporation”), an Indiana corporation, was formed in 1996 for the primary purpose of purchasing all of the issued and outstanding common stock of River Valley Financial Bank (formerly Madison First Federal Savings and Loan Association; hereinafter “River Valley Financial” or the “Bank”) in its conversion from mutual to stock form. The conversion offering was completed on December 20, 1996. On December 23, 1996, the Corporation utilized approximately $3.0 million of the net conversion proceeds to purchase 95.6% of the outstanding common shares of Citizens National Bank of Madison (“Citizens”), and on November 20, 1997, Citizens merged out of existence into River Valley Financial.
The activities of the Holding Company have been limited primarily to owning the stock of River Valley Financial, which was organized in 1875 under the laws of the United States of America and which continues today under charter from the State of Indiana. River Valley Financial, which provides banking services in a single significant business segment, conducts operations from its 14 full-service office locations in southeastern Indiana and northern Kentucky.
The Bank historically has concentrated its lending activities on the origination of loans secured by first mortgage liens for the purchase, construction, or refinancing of one-to-four family residential real property. One-to-four family residential mortgage loans continue to be a major focus of the Bank’s loan origination activities, representing 39.9% of the Bank’s total loan portfolio at December 31, 2014. The Bank is also focused on growing its commercial lending portfolio. The Bank identified loans totaling $423,000 as held for sale at December 31, 2014. The Bank also offers multi-family mortgage loans, nonresidential real estate loans, land loans, construction loans and consumer loans.
The Bank’s primary market areas have traditionally been Jefferson, Floyd and Clark Counties in southeastern Indiana and adjacent Carroll and Trimble Counties in Kentucky. In November 2012, the Corporation completed its acquisition of Dupont State Bank, an Indiana commercial bank wholly owned by Citizens Union Bancorp of Shelbyville, Inc. In conjunction with the acquisition, River Valley Financial merged with and into Dupont State Bank, which changed its name to River Valley Financial Bank, effecting the conversion of the Bank from a federally chartered thrift to a state chartered commercial bank. This acquisition expanded the Bank’s branch network to North Vernon, Seymour and Dupont, Indiana, adding a presence in Jackson and Jennings Counties, Indiana. After completing a branch acquisition in November 2013, the Bank opened another full service branch in Osgood, Indiana, in Ripley County. That branch was previously owned by Old National Bank of Evansville, Indiana. In 2014, the Corporation opened an additional full-service branch in Jeffersonville, Indiana, the Corporation’s third branch in Clark County, Indiana.
Until July 2011, the Holding Company and River Valley Financial were subject to regulation, supervision and examination by the Office of Thrift Supervision (“OTS”), but the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) eliminated the regulatory authority of the OTS and reallocated its functions. Thereafter, the Holding Company was subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve (“Federal Reserve”), and River Valley Financial was subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”).
3


As a result of the November 2012 conversion of the Bank to a state chartered bank, the Bank is subject to regulation, supervision and examination by the Indiana Department of Financial Institutions (“DFI”), instead of the OCC, and continues to be regulated by the FDIC. The Holding Company continues to be regulated by the Federal Reserve.
For ease of reference throughout this Annual Report on Form 10-K, references to the DFI are intended to include a reference to the OTS and/or the OCC, as the predecessors in thrift regulation and supervision, as the context and the time period requires.
Deposits in River Valley Financial are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Bank is also a member of the Federal Home Loan Bank (“FHLB”) system, and in particular the Federal Home Loan Bank of Indianapolis, which is one of twelve regional banks comprising the system.
The Corporation’s internet address is www.rvfbank.com. The Corporation makes available all filings with the Securities and Exchange Commission via its internet website.
 
LOAN PORTFOLIO DATA
The following table sets forth the composition of the Bank’s loan portfolio as of December 31, 2014, 2013, 2012, 2011 and 2010 by loan type as of the dates indicated, including a reconciliation of gross loans receivable after consideration of the allowance for loan losses, deferred loan origination costs and loans in process. Historical data in this table and others reporting loan portfolio data has been restated in some cases to conform to certain loan recategorizations employed as of December 31, 2014.
   
At December 31,
 
   
2014
   
2013
   
2012
   
2011
   
2010
 
   
Amount
   
Percent of Total
   
Amount
   
Percent of Total
   
Amount
   
Percent of Total
   
Amount
   
Percent
of Total
   
Amount
   
Percent of Total
 
   
(Dollars in thousands)
 
TYPE OF LOAN
                                       
Construction/Land
 
$
26,055
     
7.76
%
 
$
24,307
     
7.46
%
 
$
26,506
     
8.42
%
 
$
27,389
     
10.47
%
 
$
27,991
     
10.32
%
One-to-four family residential
   
133,904
     
39.91
     
137,298
     
42.11
     
137,402
     
43.65
     
111,198
     
42.50
     
117,616
     
43.38
 
Multi-family residential
   
20,936
     
6.24
     
16,408
     
5.03
     
19,988
     
6.35
     
18,582
     
7.10
     
14,997
     
5.53
 
Nonresidential
   
122,894
     
36.63
     
118,946
     
36.48
     
106,433
     
33.81
     
83,284
     
31.83
     
89,607
     
33.05
 
Commercial
   
27,861
     
8.30
     
24,741
     
7.59
     
19,549
     
6.21
     
17,349
     
6.63
     
16,413
     
6.05
 
Consumer
   
3,894
     
1.16
     
4,326
     
1.33
     
4,906
     
1.56
     
3,840
     
1.47
     
4,533
     
1.67
 
Gross loans receivable
   
335,544
     
100.00
%
   
326,026
     
100.00
%
   
314,784
     
100.00
%
   
261,642
     
100.00
%
   
271,157
     
100.00
%
                                                                                 
Add/(Deduct):
                                                                               
Deferred loan origination costs
   
513
     
.15
     
487
     
0.15
     
484
     
0.15
     
481
     
0.18
     
485
     
.2
 
Undisbursed portions of loans in process
   
(57
)
   
(.02
)
   
(5,775
)
   
(1.77
)
   
(6,186
)
   
(1.97
)
   
(5,024
)
   
(1.92
)
   
(2,388
)
   
(.9
)
Allowance for loan losses
   
(4,005
)
   
(1.19
)
   
(4,510
)
   
(1.38
)
   
(3,564
)
   
(1.13
)
   
(4,003
)
   
(1.53
)
   
(3,806
)
   
(1.4
)
Net loans receivable
 
 
$
331,995
     
98.94
%
 
$
316,228
     
97.00
%
 
$
305,518
     
97.05
%
 
$
253,096
     
96.73
%
 
$
265,448
     
97.9
%

 
The following table sets forth certain information at December 31, 2014, regarding the dollar amount of loans maturing in the Bank’s loan portfolio based on the contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. Management expects prepayments will cause actual maturities to be shorter.
   
Balance
   
Maturing
 
   
Outstanding at December 31, 2014
   
Within One Year
   
After One but Within Five Years
   
After Five Years
 
   
(In thousands)
 
Construction/Land
 
$
26,055
   
$
16,784
   
$
4,092
   
$
5,179
 
One-to-four family residential
   
133,904
     
2,370
     
4,855
     
126,679
 
Multi-family residential
   
20,936
     
694
     
1,312
     
18,930
 
Nonresidential
   
122,894
     
9,199
     
3,436
     
110,259
 
Commercial
   
27,861
     
12,023
     
6,940
     
8,898
 
Consumer
   
3,894
     
1,173
     
2,721
     
-
 
Total
 
$
335,544
   
$
42,243
   
$
23,356
   
$
269,945
 

4


The following table sets forth, as of December 31, 2014, the dollar amount of all loans due after one year that have fixed interest rates and floating or adjustable interest rates.
   
Due After December 31, 2015
 
   
Fixed Rates
   
Variable Rates
   
Total
 
   
(In thousands)
 
Construction/Land
 
$
294
   
$
8,977
   
$
9,271
 
One-to-four family residential
   
11,181
     
120,353
     
131,534
 
Multi-family residential
   
2,048
     
18,194
     
20,242
 
Nonresidential
   
16,786
     
96,909
     
113,695
 
Commercial
   
14,428
     
1,410
     
15,838
 
Consumer
   
2,714
     
7
     
2,721
 
Total
 
$
47,451
   
$
245,850
   
$
293,301
 

Construction/Land Loans. The Bank offers mortgage loans for construction, land development and undeveloped land with respect to residential and nonresidential real estate and, in certain cases, to builders or developers on a speculative basis (i.e., before the builder/developer obtains a commitment from a buyer).
Generally, construction loans are written as twelve-month loans, either fixed or adjustable, with interest calculated on the amount disbursed under the loan and payable on a semi-annual or monthly basis. The Bank generally requires the ratio of the loan amount to the lesser of the current cost or appraised value of the property (the “Loan-to-Value Ratio”) to be 80% for its construction loans, although the Bank may permit an 85% Loan-to-Value Ratio for one-to-four family residential construction loans. Inspections are generally made prior to any disbursement under a construction loan, and the Bank does not typically charge commitment fees for its construction loans. The largest single construction loan at December 31, 2014 totaled $3.7 million and was for the construction of multi-family units in Louisville, Kentucky.
Land loans are generally written on terms and conditions similar to nonresidential real estate loans. Some of the Bank’s land loans are land development loans, meaning the proceeds of the loans are used for infrastructure improvements to the real estate such as streets and sewers. At December 31, 2014, the Bank’s largest single land loan, a development loan secured by residential building lots in Clark and Floyd Counties, Indiana, totaled $1.7 million.
At December 31, 2014, $26.1 million, or 7.8% of the Bank’s total loan portfolio, consisted of construction, land or land development loans. Of these loans, $2.1 million, or 0.7% of total loans, were included in the Bank’s non-performing assets. While providing the Bank with a comparable, and in some cases higher, yield than a conventional mortgage loan, construction and land loans involve a higher level of risk. Borrowers who are over budget may divert the loan funds to cover cost overruns rather than direct them toward the purpose for which such loans were made. In addition, these loans are more difficult to monitor than conventional mortgage loans. As such, a defaulting borrower could cause the Bank to take title to partially improved land that is unmarketable without further capital investment.
One-to-four Family Residential Loans. Residential loans consist primarily of one-to-four family residential loans. Approximately $133.9 million, or 39.9% of the Bank’s portfolio of loans, at December 31, 2014, consisted of one-to-four family residential loans, of which approximately 90.4% had adjustable rates.
The Bank currently offers adjustable rate one-to-four family residential mortgage loans (“ARMs”) which adjust annually and are indexed to the one-year U.S. Treasury securities yields adjusted to a constant maturity. Some of the Bank’s residential ARMs are originated at a discount or “teaser” rate which is generally 150 to 175 basis points below the “fully indexed” rate. These ARMs then adjust annually to maintain a margin above the applicable index, subject to maximum rate adjustments discussed below. The Bank’s ARMs have a current margin above such index of 3.0-3.5% for owner-occupied properties and 3.5-5.0% for non-owner-occupied properties. A substantial portion of the ARMs in the Bank’s portfolio at December 31, 2014 provide for maximum rate adjustments per year and over the life of the loan of 2% and 6%, respectively, although the Bank has originated residential ARMs which provide for maximum rate adjustments per year and over the life of the loan of 1% and 4%, respectively. The Bank’s ARMs generally provide for interest rate minimums equal to, or up to 1% below the origination rate. The Bank’s residential ARMs are amortized for terms up to 30 years.
Adjustable rate loans decrease the risk associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payments by the borrowers may rise to the extent permitted by the terms of the loan, thereby increasing the potential for default. Also, adjustable rate loans have features which restrict changes in interest rates on a short-term basis and over the life of the loan. At the same time, the market value of the underlying property may be adversely affected by higher interest rates.
5


The Bank currently offers fixed rate one-to-four family residential mortgage loans which provide for the payment of principal and interest over periods of 10 to 30 years. At December 31, 2014, approximately 9.6% of the Bank’s one-to-four family residential mortgage loans had fixed rates. The Bank currently underwrites a portion of its fixed rate residential mortgage loans for potential sale to the Federal Home Loan Mortgage Corporation (the “FHLMC”). The Bank retains all servicing rights on the residential mortgage loans sold to the FHLMC. At December 31, 2014, the Bank had approximately $96.7 million of fixed rate residential mortgage loans which were sold to the FHLMC and for which the Bank provides servicing. In conjunction with the acquisition of Dupont State Bank, the Bank also holds servicing rights for a portfolio of $12.7 million in Federal National Mortgage Association (“FNMA”) loans.
The Bank generally does not originate one-to-four family residential mortgage loans if the Loan-to-Value Ratio exceeds 95% and generally does not originate one-to-four family residential ARMs if the Loan-to-Value Ratio exceeds 90%. The Bank generally requires private mortgage insurance on all fixed rate conventional one-to-four family residential real estate mortgage loans with Loan-to-Value Ratios in excess of 80%. The cost of such insurance is factored into the annual percentage yield on such loans, and is not automatically eliminated when the principal balance is reduced over the term of the loan. During 2014, the Bank originated and retained $3.0 million of fixed rate one-to-four family residential mortgage loans. Typically, these loans would be sold into the secondary market, however, the majority of these loans were originated to existing customers and were retained, rather than sold, due to tightened lending standards in the secondary market.
Substantially all of the one-to-four family residential mortgage loans that the Bank originates include “due-on-sale” clauses, which give the Bank the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid.
At December 31, 2014, the Bank had outstanding approximately $17.4 million of home equity loans, with unused lines of credit totaling approximately $25.2 million. The Bank’s home equity lines of credit are adjustable rate lines of credit tied to the prime rate and are based on a 10- to 20-year maturity. The Bank generally allows a maximum 85% Loan-to-Value Ratio for its home equity loans (taking into account any other mortgages on the property). Payments on such home equity loans are equal to 1.5% of the outstanding principal balance per month, or on newer home equity loans, to the interest accrued at the end of the period.
The Bank also offers standard second mortgage loans, which are adjustable rate loans tied to the U.S. Treasury securities yields adjusted to a constant maturity with a current margin above such index of 3.5-4.0%. The Bank’s second mortgage loans have maximum rate adjustments per year and over the terms of the loans equal to 2% and 6%, respectively. The Bank’s second mortgage loans have terms of up to 30 years.
At December 31, 2014, $4.2 million of one-to-four family residential mortgage loans, or 1.3% of total loans, were included in the Bank’s non-performing assets.
Multi-family Residential Loans. At December 31, 2014, approximately $20.9 million, or 6.2% of the Bank’s total loan portfolio, consisted of mortgage loans secured by multi-family dwellings (those consisting of more than four units). The Bank writes multi-family residential loans on terms and conditions similar to its nonresidential real estate loans. The largest single multi-family residential loan in the Bank’s portfolio as of December 31, 2014 was $2.4 million. At December 31, 2014, $1.0 million of multi-family residential loans, or 0.3% of total loans, were included in the Bank’s non-performing assets.
Multi-family residential loans, like nonresidential real estate loans, involve a greater risk than residential loans. See “Nonresidential Real Estate Loans” below. Also, the loan-to-one borrower limitations restrict the ability of the Bank to make loans to developers of apartment complexes and other multi-family units.
Nonresidential Real Estate Loans. At December 31, 2014, $122.9 million, or 36.6% of the Bank’s total loan portfolio, consisted of nonresidential real estate loans and land used for agricultural production. Nonresidential real estate loans are primarily secured by real estate such as churches, farms and small business properties. The Bank generally originates nonresidential real estate as adjustable rate loans of varying rates with lock-in terms of up to 10 years indexed to the one-year U.S. Treasury securities yields adjusted to a constant maturity, written for maximum terms of 30 years. The Bank’s adjustable rate nonresidential real estate loans have maximum adjustments per year and over the life of the loan of 2% and 6%, respectively The Bank generally requires a Loan-to-Value Ratio of up to 80%, depending on the nature of the real estate collateral.
The Bank underwrites its nonresidential real estate loans on a case-by-case basis and, in addition to its normal underwriting criteria, evaluates the borrower’s ability to service the debt from the net operating income of the property. As of December 31, 2014, the Bank’s largest nonresidential real estate loan, for a large church in Jeffersonville, Indiana, was $4.2 million. The loan is a tax exempt loan, backed by economic development revenue refunding bonds, issued by the Town of Sellersburg, Indiana. Nonresidential real estate loans in the amount of $3.1 million, or 0.9% of total loans, were included in non-performing assets at December 31, 2014.
6


Loans secured by nonresidential real estate generally are larger than one-to-four family residential loans and involve a greater degree of risk. Nonresidential real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Payments on these loans depend to a large degree on results of operations and management of the properties and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of the loans may make them more difficult for management to monitor and evaluate.
Commercial Loans. At December 31, 2014, $27.9 million, or 8.3% of the Bank’s total loan portfolio, consisted of non-mortgage commercial loans. The Bank’s commercial loans are written on either a fixed rate or an adjustable rate basis with terms that vary depending on the type of security, if any. At December 31, 2014, approximately $26.9 million, or 96.4%, of the Bank’s commercial loans were secured by collateral, generally in the form of equipment, inventory, crops or, in some cases as an abundance of caution, real estate. The Bank’s adjustable rate commercial loans are generally indexed to the prime rate with varying margins and terms depending on the type of collateral securing the loans and the credit quality of the borrowers. At December 31, 2014, the largest single commercial loan was $3.0 million, an agricultural production loan for a large farming operation in Jefferson County, Indiana.  As of the same date, commercial loans totaling $255,000, or 0.1% of total loans, were included in non-performing assets.
Commercial loans tend to bear somewhat greater risk than residential mortgage loans, depending on the ability of the underlying enterprise to repay the loan. Further, they are frequently larger in amount than the Bank’s average residential mortgage loans.
Consumer Loans. The Bank’s consumer loans, consisting primarily of auto loans, home improvement loans, unsecured installment loans, loans secured by deposits and mobile home loans, aggregated approximately $3.9 million at December 31, 2014, or 1.2% of the Bank’s total loan portfolio. The Bank originates consumer loans to meet the needs of its customers and to assist in meeting its asset/liability management goals, although demand for these types of loans has steadily decreased over the past few years.  All of the Bank’s consumer loans, except loans secured by deposits, are fixed rate loans with terms that vary from six months (for unsecured installment loans) to 66 months (for home improvement loans and loans secured by new automobiles). At December 31, 2014, $2.7 million of the Bank’s $3.9 million consumer loans were secured by collateral.
The Bank’s loans secured by deposits are made in amounts up to 90% of the current account balance and accrue at a rate of 2% over the underlying passbook or certificate of deposit rate.
The Bank offers only direct automobile loans that provide the loan directly to a consumer.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. Further, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections depend upon the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At December 31, 2014, consumer loans amounting to $10,000 were included in non-performing assets.
Origination, Purchase and Sale of Loans. The Bank underwrites fixed rate residential mortgage loans for potential sale to the FHLMC on a servicing-retained basis. Loans originated for sale to the FHLMC in the secondary market are originated in accordance with the guidelines established by the FHLMC and are sold promptly after they are originated. The Bank receives a servicing fee of one-fourth of 1% of the principal balance of all loans serviced. At December 31, 2014, the Bank serviced $96.7 million in loans sold to the FHLMC. In conjunction with the acquisition of Dupont State Bank, the Bank acquired servicing rights for $17.6 million of FNMA loans, $12.7 million of which were being serviced by the Bank as of December 31, 2014.
The Bank focuses its loan origination activities primarily on Jefferson, Clark and Floyd Counties in Indiana and Trimble, Carroll, and Jefferson Counties in Kentucky, with some activity in the areas adjacent to these counties. With the acquisition of Dupont State Bank and the Osgood, Indiana branch, the Bank engages in loan origination activities in Jackson, Jennings and Ripley Counties in Indiana as well. At December 31, 2014, the Bank held loans totaling approximately $90.3 million that were secured by property located outside of its home state of Indiana, primarily in the adjacent states of Kentucky and Ohio. The Bank’s loan originations are generated from referrals from existing customers, real estate brokers and newspaper and periodical advertising. Loan applications are taken at any of the Bank’s 14 full-service offices.
The Bank’s loan approval processes are intended to assess the borrower’s ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan. To assess the borrower’s ability to repay, the Bank evaluates the employment and credit history and information on the historical and projected income and expenses of its borrowers.
7


Under the Bank’s lending policy, a loan officer may approve mortgage loans up to $150,000, a Senior Loan Officer may approve mortgage loans up to $417,000 and the President may approve mortgage loans up to $500,000. All other mortgage loans must be approved by at least four members of the Bank’s Board of Directors. The lending policy further provides that loans secured by readily marketable collateral, such as stock, bonds and certificates of deposit, may be approved by a Loan Officer for up to $150,000, by a Senior Loan Officer for up to $300,000 and by the President up to $400,000. Loans secured by other non-real estate collateral may be approved by a Loan Officer for up to $50,000, by a Senior Loan Officer up to $100,000 and by the President up to $200,000. Finally, the lending policy provides that unsecured loans may be approved by a Loan Officer up to $15,000 or up to $25,000 by a Senior Loan Officer or up to $50,000 by the President. All other unsecured loans or loans secured by non-real estate collateral must be approved by at least four members of the Bank’s Board of Directors.
The Bank generally requires appraisals on all real property securing its loans and requires an attorney’s opinion or title insurance and a valid lien on the mortgaged real estate. Appraisals for all real property securing mortgage loans are performed by independent appraisers who are state-licensed. The Bank requires fire and extended coverage insurance in amounts at least equal to the principal amount of the loan and also requires flood insurance to protect the property securing the loan if the property is in a flood plain. The Bank also generally requires private mortgage insurance only on fixed rate residential mortgage loans with Loan-to-Value Ratios of greater than 80%. The Bank does not typically require escrow accounts for insurance premiums or taxes, however, in 2010, due to changes in Regulation Z relative to “high priced mortgages,” the Bank began requiring that certain borrowers escrow for both property taxes and hazard insurance. Under Regulation Z, a “high priced mortgage” is any first mortgage that is 1.5% over the index rate or any second mortgage that is 3.5% over the index rate.
The Bank’s underwriting standards for consumer and commercial loans are intended to protect against some of the risks inherent in making such loans. Borrower character, paying habits and financial strengths are important considerations.
The Bank occasionally purchases and sells participations in commercial loans, nonresidential real estate and multi-family loans to or from other financial institutions. At December 31, 2014, the Bank held $10.5 million in participation loans in its loan portfolio. The majority of the participations held by the Bank were acquired from Dupont State Bank, and represent relationships with financial institutions and borrowers located in southern Indiana and northern Kentucky. Participations originated by the Bank include: a commercial fitness operation in Floyd County, Indiana, funded through a joint effort of several financial institutions; a construction loan for multi-family units in Louisville, Kentucky, for which the Bank is the lead bank; and a participation in a loan backed by a tax increment bond, participating with four other local banks, funding commercial development in Clark County.
The following table shows loan disbursement and repayment activity for the Bank during the periods indicated.
   
Year Ended December 31,
 
   
2014
   
2013
   
2012
 
   
(In thousands)
 
Loans Disbursed:
           
Construction/Land
 
$
24,101
   
$
11,878
   
$
10,851
 
One-to-four family residential
   
42,102
     
57,103
     
57,741
 
Multi-family residential
   
6,558
     
5,577
     
4,017
 
Nonresidential
   
36,642
     
36,691
     
29,747
 
Commercial
   
26,699
     
26,840
     
18,037
 
Consumer and other
   
3,090
     
4,008
     
3,265
 
Total loans disbursed
   
139,192
     
142,097
     
123,658
 
Reductions:
                       
Sales
   
11,021
     
22,490
     
32,526
 
Principal loan repayments and other (1)
   
112,404
     
108,897
     
90,835
 
Total reductions
   
123,425
     
131,387
     
123,361
 
Fair value of loans acquired
   
-
     
-
     
52,125
 
Net increase
 
$
15,767
   
$
10,710
   
$
52,422
 

(1)
Other items consist of amortization of deferred loan origination costs, the provision for losses on loans, net charges to the allowance for loan losses, and restructured debt.
 
8


Origination and Other Fees. The Bank realizes income from loan origination fees, loan servicing fees, late charges, checking account service charges and fees for other miscellaneous services. Late charges are generally assessed if payment is not received within a specified number of days after it is due. The grace period depends on the individual loan documents.
 
NON-PERFORMING AND PROBLEM ASSETS
Mortgage loans are reviewed by the Bank on a regular basis and are placed on a nonaccrual status when management determines that the collectibility of the interest is less than probable or collection of any amount of principal is in doubt. Generally, when loans are placed on nonaccrual status, unpaid accrued interest is written off, and further income is recognized only to the extent received. The Bank delivers delinquency notices with respect to all mortgage loans contractually past due 10 days. When loans are 16 days in default, personal contact is made with the borrower to establish an acceptable repayment schedule. Management is authorized to commence foreclosure proceedings for any loan upon making a determination that it is prudent to do so.
Commercial and consumer loans are treated similarly. Interest income on consumer, commercial and other non-mortgage loans is accrued over the term of the loan except when serious doubt exists as to the collectibility of a loan, in which case accrual of interest is discontinued and the loan is written-off, or written down to the fair value of the collateral securing the loan. It is the Bank’s policy to recognize losses on these loans as soon as they become apparent.
Non-performing Assets. At December 31, 2014, $10.8 million, or 2.1% of consolidated total assets, were non-performing loans compared to $11.5 million, or 2.4% of consolidated total assets, at December 31, 2013. The balance of non-performing assets was real estate owned (“REO”), comprised of real estate taken during foreclosure proceedings, held at December 31, 2014, in the amount of $983,000, as compared to $155,000 at December 31, 2013. Of total REO held at December 31, 2014, $575,000 was for two large properties, one a 1-4 family residential property in Carrollton, Kentucky and the second a commercial property in Bloomington, Indiana.  Troubled debt restructured that is non-performing at the time of restructuring is required to be inclued as a non-performing asset until certain requirements for payment and borrower viability are met. Non-performing assets are also discussed in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation.
The following table sets forth the amounts and categories of the Bank’s non-performing assets (non-performing loans, non-performing troubled debt restructured, and foreclosed real estate) and troubled debt restructurings for the last five years. It is the policy of the Bank that all earned but uncollected interest on all past due loans is reviewed monthly to determine what portion of it should be classified as uncollectible for loans past due in excess of 90 days. Uncollectible interest is written off monthly.
   
At December 31,
 
   
2014
   
2013
   
2012
   
2011
   
2010
 
   
(In thousands)
 
Non-performing assets:
                   
Nonaccrual loans
 
$
10,745
   
$
11,514
   
$
10,850
   
$
9,863
   
$
10,381
 
Past due 90 days or more and accruing
   
28
     
1
     
-
     
-
     
-
 
Troubled debt restructured
   
2,368
     
3,898
     
3,860
     
6,939
     
6,747
 
Total non-performing loans and troubled debt restructured
   
13,141
     
15,413
     
14,710
     
16,802
     
17,128
 
Foreclosed real estate
   
983
     
155
     
1,610
     
2,487
     
400
 
Total non-performing assets
 
$
14,124
   
$
15,568
   
$
16,320
   
$
19,289
   
$
17,528
 
                                         
Total non-performing loans to net loans
   
3.24
%
   
3.64
%
   
3.55
%
   
3.90
%
   
3.91
%
Total non-performing loans, including troubled debt restructured, to net loans
   
3.96
%
   
4.87
%
   
4.81
%
   
6.64
%
   
6.45
%
Total non-performing loans to total assets
   
2.11
%
   
2.38
%
   
2.29
%
   
2.43
%
   
2.69
%
Total non-performing assets to total assets
   
2.77
%
   
3.22
%
   
3.45
%
   
4.74
%
   
4.53
%

The Corporation would have recorded interest income of $389,000 for the year ended December 31, 2014 if loans on nonaccrual status had been current in accordance with their original terms. Actual interest collected and recognized was $207,000 for the year ended December 31, 2014.
At December 31, 2014, the Bank held loans delinquent from 30 to 89 days totaling $1.7 million. As of that date, management was not aware of any other assets that would need to be disclosed as non-performing assets.
9


Delinquent Loans. The following table sets forth certain information at December 31, 2014, 2013, and 2012 relating to delinquencies in the Bank’s portfolio. Delinquent loans that are 90 days or more past due are considered non-performing assets. For the periods ended December 31, 2014 and 2013, delinquent purchased credit-impaired loans acquired in the Dupont State Bank acquisition with a fair value of $591,000 and $2.4 million, respectively, were excluded from the table below.

   
At December 31, 2014
 
At December 31, 2013
 
At December 31, 2012
 
   
30-89 Days
 
90 Days or More
 
30-89 Days
 
90 Days or More
 
30-89 Days
 
90 Days or More
 
   
Number of Loans
 
Principal Balance of Loans
 
Number of Loans
 
Principal Balance of Loans
 
Number of Loans
 
Principal Balance of Loans
 
Number of Loans
 
Principal Balance of Loans
 
Number of Loans
 
Principal Balance of Loans
 
Number of Loans
 
Principal Balance of Loans
 
(Dollars in thousands)
 
Construction/Land
 
-
 
$
-
 
2
 
$
187
 
2
 
$
207
 
1
 
$
71
 
1
 
$
63
 
2
 
$
556
 
One-to-four family residential
 
30
   
1,178
 
20
   
2,855
 
22
   
1,129
 
30
   
2,322
 
35
   
2,115
 
10
   
1,408
 
Multi-family residential
 
-
   
-
 
-
   
-
 
-
   
-
 
-
   
-
 
-
   
-
 
-
   
-
 
Nonresidential
 
5
   
458
 
8
   
1,745
 
5
   
665
 
8
   
940
 
6
   
276
 
5
   
753
 
Commercial
 
-
   
-
 
5
   
116
 
3
   
66
 
4
   
96
 
1
   
100
 
3
   
251
 
Consumer
 
9
   
35
 
3
   
10
 
11
   
111
 
3
   
7
 
9
   
36
 
1
   
2
 
Total
 
44
 
$
1,671
 
38
 
$
4,913
 
43
 
$
2,178
 
46
 
$
3,436
 
52
 
$
2,590
 
21
 
$
2,970
 
Delinquent loans to net loans
 
                 
1.98
%
               
1.78
%
               
1.82
%
 
Classified Assets. The Bank’s Asset Classification Policy provides for the classification of loans and other assets such as debt and equity securities of lesser quality as “special mention,” “substandard,” “doubtful,” or “loss” assets. An asset is treated as a “special mention” when the assets are currently protected but have credit weaknesses that warrant a higher degree of attention from management. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the Bank will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
An insured institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified substandard or doubtful, as well as for other problem loans. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.
The Bank regularly reviews its loan portfolio to determine whether any loans require classification in accordance with applicable regulation. Not all of the Bank’s classified assets constitute non-performing assets, although the balances of non-performing loans as a percent of total classified is higher than in prior years. Historically, management has been conservative in its listing of assets as classified, especially in comparison to peer classification of similar assets and to actual delinquency status. Whereas classified loans for the Bank historically have been a conservative list of loans warranting scrutiny, in 2014 and 2013 the classified list has become weighted heavily by loans and relationships in the lengthy process of foreclosure. The mating of the conservative approach in monitoring problem loans and loans lingering due to foreclosure has created a larger than historical balance of classified assets. As a result, the Bank remains somewhat higher than peer on balances of loans classified.
The classification of assets listing is evaluated quarterly by a committee comprised of lending personnel, the Bank’s Chief Executive Officer, Vice President – Finance, Loan Review personnel, Collection Officer, and Internal Auditor. Delinquency is evaluated weekly by a committee of loan officers, loan review personnel, the Executive Vice President of Loan Administration and the Chief Executive Officer. The lists for both meetings encompass entire relationships, rather than single problem loans. Changes to the list are only approved by the committee upon demonstrated sustained performance in accordance with the loan’s terms by the borrower.
10

At December 31, 2014, the Bank’s classified assets, were as follows:
   
At December 31, 2014
 
   
(In thousands)
 
Substandard assets
 
$
15,423
 
Doubtful assets
   
319
 
Loss assets
   
-
 
Total classified assets
 
$
15,742
 

Regulatory definition requires that total classified assets include classified loans, which at December 31, 2014 included $14.4 million classified as substandard and $319,000 classified as doubtful, and other real estate owned as a result of foreclosure or other legal proceedings of $983,000. Detail of classified loans by loan segment is provided in Footnote 6 to the Consolidated Financial Statements presented in Item 8 - Financial Statements and Supplementary Data in this Report on Form 10-K.
 
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained through the provision for loan losses, which is charged to earnings. The provision for loan losses is determined in conjunction with management’s review and evaluation of current economic conditions (including those of the Bank’s lending area), changes in the character and size of the loan portfolio, loan delinquencies (current status as well as past and anticipated trends) and adequacy of collateral securing loan delinquencies, historical and estimated net charge-offs and other pertinent information derived from a review of the loan portfolio. In management’s opinion, the Bank’s allowance for loan losses is adequate to absorb probable incurred losses from loans at December 31, 2014. However, there can be no assurance that regulators, when reviewing the Bank’s loan portfolio in the future, will not require increases in its allowances for loan losses or that changes in economic conditions will not adversely affect the Bank’s loan portfolio.
Summary of Loan Loss Experience. The following table analyzes changes in the allowance during the five years ended December 31, 2014. Additional detail about loan loss experience is presented in Footnote 6 to the Consolidated Financial Statements presented in Item 8 - Financial Statements and Supplementary Data in this Report on Form 10-K.

   
Year Ended December 31,
 
   
2014
   
2013
   
2012
   
2011
   
2010
 
   
(Dollars in thousands)
 
Balance at beginning of period
 
$
4,510
   
$
3,564
   
$
4,003
   
$
3,806
   
$
2,611
 
Charge-offs:
                                       
Construction/Land
   
(29
)
   
(99
)
   
(341
)
   
(824
)
   
(5
)
One-to-four family residential
   
(629
)
   
(245
)
   
(1,136
)
   
(604
)
   
(252
)
Multi-family residential
   
(517
)
   
-
     
-
     
(36
)
   
(8
)
Nonresidential
   
(100
)
   
(182
)
   
(366
)
   
(1,056
)
   
(1,425
)
Commercial
   
(4
)
   
(140
)
   
-
     
-
     
(405
)
Consumer and other
   
(146
)
   
(177
)
   
(89
)
   
(102
)
   
(130
)
Total charge-offs
   
(1,425
)
   
(843
)
   
(1,932
)
   
(2,622
)
   
(2,225
)
Recoveries
   
474
     
857
     
111
     
48
     
775
 
Net recoveries (charge-offs)
   
(951
)
   
14
     
(1,821
)
   
(2,574
)
   
(1,450
)
Provision for losses on loans
   
446
     
932
     
1,382
     
2,771
     
2,645
 
Balance end of period
 
$
4,005
   
$
4,510
   
$
3,564
   
$
4,003
   
$
3,806
 
Allowance for loan losses as a percent of total loans outstanding
   
1.19
%
   
1.41
%
   
1.15
%
   
1.56
%
   
1.41
%
Ratio of net charge-offs to average loans outstanding before net items (1)
   
.29
%
   
(0.01
)%
   
.69
%
   
.98
%
   
.53
%

_____________________
(1) Net items consist of deferred loan origination costs, undisbursed portions of loans in process and the allowance for loan losses.

11

Allocation of Allowance for Loan Losses. The following table presents an analysis of the allocation of the Bank’s allowance for loan losses at the dates indicated.
   
At December 31,
 
   
2014
   
2013
   
2012
   
2011
   
2010
 
   
Amount
 
Percent of loans in each category to total loans
   
Amount
 
Percent of loans in each category to total loans
   
Amount
   
Percent of loans in each category to total loans
   
Amount
 
Percent of loans in each category to total loans
   
Amount
 
Percent of loans in each category to total loans
 
   
(Dollars in thousands)
 
Balance at end of period applicable to:
                               
                                 
Construction/Land
 
$
740
 
7.8
%
 
$
676
 
7.5
%
 
$
648
   
8.4
%
 
$
1,016
 
10.5
%
 
$
1,011
 
10.3
%
One-to-four family   residential
   
1,977
 
39.9
     
1,749
 
42.1
     
1,423
   
43.7
     
1,986
 
42.5
     
746
 
43.4
 
Multi-family residential
   
28
 
6.2
     
404
 
5.0
     
281
   
6.3
     
65
 
7.1
     
138
 
5.5
 
Nonresidential
   
1,107
 
36.6
     
1,470
 
36.5
     
1,078
   
33.8
     
822
 
31.8
     
1,632
 
33.0
 
Commercial
   
151
 
8.3
     
189
 
7.6
     
133
   
6.2
     
70
 
6.6
     
157
 
6.1
 
Consumer and other
   
2
 
1.2
     
22
 
1.3
     
1
   
1.6
     
44
 
1.5
     
122
 
1.7
 
Total
 
$
4,005
 
100.0
%
 
$
4,510
 
100.0
%
 
$
3,564
   
100.0
%
 
$
4,003
 
100.0
%
 
$
3,806
 
100.0
%



INVESTMENTS AND MORTGAGE-BACKED SECURITIES
General. The Bank’s investment portfolio consists of U.S. government and agency obligations, corporate bonds, municipal securities, FHLB stock and mortgage-backed securities. At December 31, 2014, total investments in the portfolio had a combined carrying value of approximately $132.7 million, or 26.0%, of the consolidated total assets.
Investments reported in the financial statements of the Corporation are held both at the Bank level and at the Bank’s Nevada subsidiaries. All Corporation investments are available for sale, but the intent of the Corporation is to hold investments to maturity. Liquidity is met through a combination of deposit growth, borrowing from the Federal Home Loan Bank of Indianapolis, overnight borrowing of Fed funds, and if needed, sale of investments held at the Bank level. Securities held through the Nevada subsidiaries are held primarily for investment purposes. Securities held at the Bank level are held primarily for liquidity purposes. In 2014 and 2013, liquidity needs were met primarily through deposit growth, supplemented by some sale of agency investments. Sales of investments over the last twelve months have been made primarily to take advantage of gain positions on short-term investments, especially those expected to be called in the near future, while funds from maturing investments were reinvested primarily into high quality mortage-backed securities and long term municipals.
The portfolio increased by $8.2 million from December 31, 2013 to the same date in 2014, as $23.3 million in purchases of high quality mortgage and asset-backed securities, $11.9 million in purchases of municipal securities, and lesser amounts of agency and corporate purchases were offset by reductions in the form of maturities, calls, sales, and principal paydown, for a gross increase of $4.2 million in amortized cost. Also included in the portfolio increase, a $4.0 million swing in the fair value of the Corporation’s investment portfolio increased overall growth in the portfolio to $8.2 million. A $2.9 million loss on the portfolio at December 31, 2013 was replaced by a $1.1 million unrealized gain at December 31, 2014. The carrying value of the two trust preferred investments held by the Corporation, considered to be of higher risk than most investments, was $1.3 million at both December 31, 2013 and 2014.
12

Investments. The following table sets forth the amortized cost and the market value of the Bank’s investment portfolio, excluding mortgage-backed investments, at the dates indicated.
   
At December 31,
 
 
   
2014
   
2013
   
2012
 
   
Amortized Cost
   
Market Value
   
Amortized Cost
   
Market Value
   
Amortized Cost
   
Market Value
 
   
(In thousands)
 
Available for sale:
                       
U.S. Government and agency obligations
 
$
31,894
   
$
31,622
   
$
38,075
   
$
37,213
   
$
42,581
   
$
43,409
 
Municipal securities
   
40,710
     
42,200
     
37,709
     
37,122
     
29,331
     
31,162
 
Corporate
   
3,636
     
3,322
     
4,164
     
3,751
     
3,652
     
3,177
 
Total available for sale
   
76,240
     
77,144
     
79,948
     
78,086
     
75,564
     
77,748
 
FHLB stock
   
3,796
     
3,796
     
4,595
     
4,595
     
4,595
     
4,595
 
 
Total investments
 
 
$
80,036
   
$
80,940
   
$
84,543
   
$
82,681
   
$
80,159
   
$
82,343
 

The following table sets forth the amount of investment securities (excluding FHLB stock and mortgage-backed investments) which mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2014.
   
Amount at December 31, 2014 which matures
 
   
One Year or Less
   
After One Year through Five Years
   
After Five Years through Ten Years
   
After Ten Years
 
   
Amortized Cost
   
Average Yield
   
Amortized Cost
   
Average Yield
   
Amortized Cost
   
Average Yield
   
Amortized Cost
   
Average Yield
 
   
(Dollars in thousands)
 
U.S. Government and agency obligations
 
$
2,000
     
1.75
%
 
$
16,610
     
1.66
%
 
$
13,284
     
1.74
%
 
$
-
     
0.00
%
Municipal securities
   
9
     
0.97
     
1,615
     
3.86
     
9,266
     
3.67
     
29,820
     
3.40
 
Corporate
   
1,001
     
0.70
     
-
     
-
     
1,000
     
1.25
     
1,635
     
1.74
 

Yields on tax exempt obligations have been computed on a tax equivalent basis. These yields assume a 34% federal tax rate and a 69 basis points cost of funds which is used in determining the disallowance on the Corporation’s municipal income under the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”).
Mortgage-Backed Securities. The Bank maintains a portfolio of mortgage-backed pass-through securities in the form of FHLMC, FNMA and Government National Mortgage Association (“GNMA”) participation certificates. Mortgage-backed pass-through securities generally entitle the Bank to receive a portion of the cash flows from an identified pool of mortgages and gives the Bank an interest in that pool of mortgages. FHLMC, FNMA and GNMA securities are each guaranteed by its respective agency as to the payment of principal and interest.
Although mortgage-backed securities generally yield less than individual loans originated by the Bank, they present less credit risk. Because mortgage-backed securities have a lower yield relative to current market rates, retention of such investments could adversely affect the Bank’s earnings, particularly in a rising interest rate environment. The mortgage-backed securities portfolio is generally considered to have very low credit risk because the securities are guaranteed as to principal and interest repayment by the issuing agency.
In addition, the Bank has purchased adjustable rate mortgage-backed securities as part of its effort to reduce its interest rate risk. In a period of declining interest rates, the Bank is subject to prepayment risk on such adjustable rate mortgage-backed securities. The Bank attempts to mitigate this prepayment risk by purchasing mortgage-backed securities at or near par. If interest rates rise in general, the interest rates on the loans backing the mortgage-backed securities will also adjust upward, subject to the interest rate caps in the underlying mortgage loans. However, the Bank is still subject to interest rate risk on such securities if interest rates rise faster than the 1% to 2% maximum annual interest rate adjustments on the underlying loans.
At December 31, 2014, the Bank held mortgage-backed securities with a carrying value of approximately $51.7 million, all of which were classified as available for sale. These mortgage-backed securities may be used as collateral for borrowings and, through repayments, as a source of liquidity.
13

The following table sets forth the amortized cost and market value of the Bank’s mortgage-backed securities at the dates indicated.
   
At December 31,
 
   
2014
   
2013
 
   
2012
 
   
Amortized Cost
   
Market Value
   
Amortized Cost
   
Market Value
   
Amortized Cost
   
Market Value
 
   
(In thousands)
 
Available for sale:
                       
Government-sponsored enterprise (GSE) residential mortgage-backed securities
 
$
19,894
   
$
20,240
   
$
19,393
   
$
18,913
   
$
13,595
   
$
13,851
 
Collateralized mortgage obligations
   
31,639
     
31,501
     
23,389
     
22,888
     
21,663
     
22,171
 
Total mortgage-backed securities
 
$
51,533
   
$
51,741
   
$
42,782
   
$
41,801
   
$
35,258
   
$
36,022
 

The following table sets forth the amount of mortgage-backed securities which mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2014.
 
Amount at December 31, 2014 which matures in
 
 
Less Than One Year
 
One Year to Five Years
 
Five to Ten Years
 
After Ten Years
 
 
Amortized Cost
 
Average Yield
 
Amortized Cost
 
Average Yield
 
Amortized Cost
 
Average Yield
 
Amortized Cost
 
Average Yield
 
 
(Dollars in thousands)
 
Government-sponsored enterprise (GSE) residential mortgage-backed securities
 
$
-
 
-
%
 
$
249
 
5.18
%
 
$
337
 
3.39
%
 
$
19,308
 
2.34
%
Collateralized mortgage obligations
   
-
 
-
     
1
 
8.50
     
12
 
2.12
     
31,626
 
2.16
 

The following table sets forth the changes in the Bank’s mortgage-backed securities portfolio at amortized cost for the years ended December 31, 2014, 2013, and 2012.
   
For the Year Ended December 31,
 
   
2014
   
2013
   
2012
 
   
(In thousands)
 
Beginning balance
 
$
42,782
   
$
35,258
   
$
33,565
 
Purchases
   
23,282
     
22,959
     
26,223
 
Sales proceeds
   
(8,853
)
   
(7,023
)
   
(13,706
)
Repayments
   
(5,482
)
   
(8,315
)
   
(11,197
)
Gain on sales
   
191
     
159
     
497
 
Premium and discount amortization, net
   
(387
)
   
(256
)
   
(124
)
Ending balance
 
$
51,533
   
$
42,782
   
$
35,258
 

SOURCES OF FUNDS
General. Deposits have traditionally been the Bank’s primary source of funds for use in lending and investment activities. In addition to deposits, the Bank derives funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings, income on earning assets, and borrowings. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions, and levels of competition. Borrowings from the FHLB of Indianapolis and other sources of wholesale funding may be used in the short term to compensate for reductions in deposits or deposit inflows at less than projected levels.
Deposits. Deposits are attracted through offering a broad selection of deposit instruments including fixed rate certificates of deposit, NOW, MMDAs and other transaction accounts, individual retirement accounts and savings accounts. The Bank actively solicits and advertises for deposits in Jefferson, Clark, Floyd, Jackson, Jennings and Ripley Counties in Indiana and in Trimble and Carroll Counties in Kentucky. Deposits will come from all of our market areas. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds remain on deposit and the interest rate. The Bank does not pay a fee for any deposits it receives.
14

Interest rates paid, maturity terms, service fees and withdrawal penalties are established by the Bank on a periodic basis. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by competitors, growth goals and applicable regulations. The Bank relies, in part, on customer service and long-standing relationships with customers to attract and retain its deposits, but also closely prices its deposits in relation to rates offered by its competitors.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. The Bank has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Historically, NOW and MMDAs have been relatively stable sources of deposits. Over the last few years, the Bank has experienced a continuation of the trend away from maturity deposits into transactional deposits, as customers, frustrated with low interest rates, placed their funds in more fluid products such as demand deposit accounts, both interest-bearing and noninterest-bearing.
The ability of the Bank to attract and maintain certificates of deposit, and the rates paid on these deposits, have been and will continue to be significantly affected by market conditions. Due primarily to the continued low interest rate environment for deposits, certificate of deposit balances decreased $23.4 million, or 17.1%, from $137.0 million as of December 31, 2013 to $113.6 million at December 31, 2014. As certificates of deposit repriced and new certificates were added, the lower interest rates paid caused a significant decline in the cost of deposits overall. Transactional, or “withdrawable,” deposits increased for the period by $25.5 million, or 9.9%, from $258.0 million as of December, 31, 2013 to $283.5 million at December 31, 2014.
The cost of deposits for the year ended December 31, 2014 was 0.56% as compared to 0.67% for the year ended December 31, 2013, a drop of 11 basis points, period to period. This change resulted in a weighted average rate for deposits of 0.49% at December 31, 2014, a decline of 9 basis points from 0.58% at December 31, 2013.
An analysis of the Corporation’s deposit accounts by type, maturity and rate at December 31, 2014 is as follows:
Type of Account
 
Minimum Opening Balance
   
Balance at
December 31, 2014
   
% of Deposits
   
Weighted Average Rate
 
   
(Dollars in thousands)
 
Withdrawable:
               
Noninterest bearing accounts
 
$
100
   
$
51,986
     
13.09
%
   
0.00
%
Savings accounts
   
50
     
58,700
     
14.78
     
0.08
 
MMDA
   
2,500
     
41,090
     
10.35
     
0.20
 
NOW accounts
   
1,000
     
131,696
     
33.17
     
0.45
 
Total withdrawable
           
283,472
     
71.39
     
0.25
 
Certificates (original terms):
                               
I.R.A.
   
2,500
     
11,506
     
2.90
     
1.32
 
3 months
   
2,500
     
119
     
0.03
     
0.10
 
6 months
   
2,500
     
571
     
0.14
     
0.15
 
9 months
   
2,500
     
-
     
-
     
-
 
12 months
   
2,500
     
56
     
0.01
     
0.46
 
15 months
   
2,500
     
16,603
     
4.18
     
0.31
 
18 months
   
2,500
     
4,372
     
1.10
     
0.47
 
24 months
   
2,500
     
4,255
     
1.07
     
0.52
 
30 months
   
2,500
     
437
     
0.11
     
0.61
 
36 months
   
2,500
     
3,555
     
0.90
     
0.82
 
41 months
   
2,500
     
-
     
-
     
-
 
48 months
   
2,500
     
4,003
     
1.01
     
1.28
 
60 months
   
2,500
     
14,672
     
3.69
     
1.96
 
10 year & misc
   
2,500
     
116
     
0.03
     
4.38
 
Jumbo certificates
   
2,500
     
53,346
     
13.44
     
1.01
 
Total certificates
           
113,611
     
28.61
     
1.02
 
Total deposits
         
$
397,083
     
100.00
%
   
0.49
%

15

The following table presents the average daily amount of deposits bearing interest and average rates paid on such deposits for the years indicated.

 
2014
 
2013
 
2012
 
 
(Dollars in thousands)
 
 
Amount
 
Rate %
 
Amount
 
Rate %
 
Amount
 
Rate %
 
Noninterest-bearing demand deposits
 
$
51,016
     
-
%
 
$
46,166
     
-
%
 
$
31,464
     
-
%
Savings accounts
   
100,256
     
0.13
     
97,601
     
0.19
     
80,287
     
0.36
 
NOW accounts
   
124,695
     
0.45
     
106,140
     
0.43
     
83,489
     
0.53
 
Certificates of deposit
   
125,249
     
1.02
     
141,617
     
1.18
     
122,316
     
1.59
 
Total deposits
 
$
401,216
     
0.49
%
 
$
391,524
     
0.59
%
 
$
317,556
     
0.84
%

 
The following table sets forth, by various interest rate categories, the composition of time deposits of the Bank at the dates indicated:
   
At December 31,
 
   
2014
   
2013
   
2012
 
   
(In thousands)
 
0.00 to 1.00%
 
$
69,806
   
$
83,970
   
$
82,418
 
1.01 to 2.00%
   
27,673
     
24,341
     
30,166
 
2.01 to 3.00%
   
15,477
     
25,891
     
32,044
 
3.01 to 4.00%
   
594
     
2,753
     
3,646
 
4.01 to 5.00%
   
5
     
5
     
1,094
 
5.01 to 6.00%
   
56
     
54
     
51
 
Total
 
$
113,611
   
$
137,014
   
$
149,419
 

 
The following table represents, by various interest rate categories, the amounts of time deposits maturing during each of the three years, and greater than three years, following December 31, 2014. Matured certificates, which have not been renewed as of December 31, 2014, have been allocated based upon certain rollover assumptions.
   
Amounts at December 31, 2014 Maturing In
 
   
One Year or Less
   
Two Years
   
Three Years
   
Greater Than Three Years
 
   
(In thousands)
 
0.00 to 1.00%
 
$
56,330
   
$
10,393
   
$
2,440
   
$
643
 
1.01 to 2.00%
   
940
     
2,959
     
9,841
     
13,933
 
2.01 to 3.00%
   
4,213
     
10,469
     
469
     
326
 
3.01 to 4.00%
   
562
     
-
     
-
     
32
 
4.01 to 5.00%
   
-
     
-
     
-
     
5
 
5.01 to 6.00%
   
-
     
-
     
56
     
-
 
Total
 
$
62,045
   
$
23,821
   
$
12,806
   
$
14,939
 


The following table indicates the amount of the Bank’s jumbo and other certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2014.
   
At December 31, 2014
 
Maturity Period
 
(In thousands)
 
Three months or less
 
$
6,973
 
Greater than 3 months through 6 months
   
5,403
 
Greater than 6 months through 12 months
   
19,709
 
Over 12 months
   
21,261
 
Total
 
$
53,346
 

16

The following table sets forth the dollar amount of the various types of deposits offered by the Bank at the dates indicated, and the amount of increase or decrease in such deposits as compared to the previous period.
   
Deposit Activity
 
 
   
Balance at
December 31,
2014
   
% of Deposits
   
Increase (Decrease) from 2013
   
Balance at
December 31,
2013
   
% of Deposits
   
Increase (Decrease) from 2012
   
Balance at
December 31,
2012
   
% of Deposits
 
   
(Dollars in thousands)
 
Withdrawable:
                               
Noninterest-bearing accounts
 
$
51,986
   
13.09
%
 
$
4,487
   
$
47,499
   
12.02
%
 
$
6,983
   
$
40,516
   
10.54
%
Savings accounts
   
58,700
   
14.78
     
2,337
     
56,363
   
14.27
     
5,463
     
50,900
   
13.25
 
MMDA
   
41,090
   
10.35
     
992
     
40,098
   
10.15
     
(1,884
)
   
41,982
   
10.93
 
NOW accounts
   
131,696
   
33.17
     
17,655
     
114,041
   
28.87
     
12,603
     
101,438
   
26.40
 
Total withdrawable
   
283,472
   
71.39
     
25,471
     
258,001
   
65.31
     
23,165
     
234,836
   
61.12
 
Certificates (original terms):
                                                         
I.R.A.
   
11,506
   
2.90
     
(842
)
   
12,348
   
3.13
     
(258
)
   
12,606
   
3.28
 
3 months
   
119
   
0.03
     
58
     
61
   
0.02
     
-
     
61
   
0.01
 
6 months
   
571
   
0.14
     
(17
)
   
588
   
0.15
     
19
     
569
   
0.15
 
9 months
   
-
   
0.00
     
-
     
-
   
-
     
-
     
-
   
0.00
 
12 months
   
56
   
0.01
     
(20
)
   
76
   
0.02
     
(1,564
)
   
1,640
   
0.43
 
15 months
   
16,603
   
4.18
     
(7,012
)
   
23,615
   
5.98
     
(6,501
)
   
30,116
   
7.84
 
18 months
   
4,372
   
1.10
     
1,916
     
2,456
   
0.62
     
(131
)
   
2,587
   
0.67
 
24 months
   
4,255
   
1.07
     
(1,745
)
   
6,000
   
1.52
     
(98
)
   
6,098
   
1.59
 
30 months
   
437
   
0.11
     
(245
)
   
682
   
0.17
     
(480
)
   
1,162
   
0.30
 
36 months
   
3,555
   
0.90
     
(836
)
   
4,391
   
1.11
     
(1,151
)
   
5,542
   
1.44
 
41 months
   
-
   
-
     
-
     
-
   
-
     
-
     
-
   
0.00
 
48 months
   
4,003
   
1.01
     
(1,918
)
   
5,921
   
1.50
     
257
     
5,664
   
1.47
 
60 months
   
14,672
   
3.69
     
(13
)
   
14,685
   
3.72
     
1,766
     
12,919
   
3.36
 
10 years
   
116
   
0.03
     
(16
)
   
132
   
0.03
     
132
     
-
   
-
 
Jumbo certificates
   
53,346
   
13.43
     
(12,713
)
   
66,059
   
16.72
     
(4,396
)
   
70,455
   
18.34
 
Total certificates
   
113,611
   
28.61
     
(23,403
)
   
137,014
   
34.69
     
(12,405
)
   
149,419
   
38.88
 
Total deposits
 
$
397,083
   
100.00
%
 
$
2,068
   
$
395,015
   
100.00
%
 
$
10,760
   
$
384,255
   
100.00
%

Borrowings. The Bank focuses on generating high quality loans and then seeks the best source of funding from deposits, investments, or borrowings. The Bank had $43.5 million in FHLB advances at December 31, 2014, compared to $42.5 million at December 31, 2013. The average rates for those borrowings decreased across the period, from 3.58% as of December 31, 2013 to 3.17% as of December 31, 2014, as the Corporation paid and replaced $25.0 million in advances, and purchased an additional $1.0 million. The Bank also developed a correspondent banking relationship with the Bankers Bank of Wisconsin during 2014, and as of December 31, 2014, the Bank held purchased funds totaling $4.2 million.  The Bank has a credit line of $5.0 million with the Bankers Bank of Wisconsin, and can also sell funds to that bank as an overnight investment opportunity. The Bank does not anticipate any difficulty in obtaining advances appropriate to meet its requirements in the future. No advances were prepaid during 2014, and correspondingly, no prepayment penalties were paid.
The following table presents certain information relating to the Corporation’s borrowings at or for the years ended December 31, 2014, 2013 and 2012.
   
At or for the Year Ended December 31,
 
   
2014
   
2013
   
2012
 
   
(Dollars in thousands)
 
FHLB Advances and Other Borrowed Money:
           
Outstanding at end of period
 
$
54,872
   
$
49,717
   
$
49,717
 
Average balance outstanding for period
   
46,434
     
52,134
     
63,175
 
Maximum amount outstanding at any month-end during the period
   
54,872
     
59,717
     
65,217
 
Weighted average interest rate during the period
   
3.17
%
   
3.58
%
   
3.67
%
Weighted average interest rate at end of period
   
2.71
%
   
3.23
%
   
3.78
%

17

SUBSIDIARIES
The Bank’s wholly-owned subsidiary, Madison 1st Service Corporation, which was incorporated under the laws of the State of Indiana on July 3, 1973, currently holds land (as discussed in Item 2 - Properties), but does not otherwise engage in significant business activities. The Bank established three subsidiaries in Nevada, including RVFB Investments, Inc., RVFB Holdings, Inc. and RVFB Portfolio, LLC, to hold and manage a significant portion of the Bank’s investment portfolio. Income from the Nevada investment subsidiaries increased from $1.8 million for the year ended December 31, 2013 to $2.2 million for the same period in 2014, an increase of 22.2%, due primarily to gains on the sale of available-for-sale securities. In December 2014, the Corporation established River Valley Risk Management, Inc., a wholly owned Nevada subsidiary, as a captive insurance company to provide insurance to the Corporation and its affiliates and to manage the Corporation’s insurance coverage.
 
FINANCING SUBSIDIARY
In 2003, the Corporation formed the “RIVR Statutory Trust I,” a statutory trust formed under Connecticut law, and filed a Certificate of Trust with the Secretary of the State of Connecticut. The sole purpose of the Trust was to issue and sell certain trust preferred securities representing undivided beneficial interests in the assets of the Trust and to invest the proceeds thereof in certain debentures of the Corporation.
 
EMPLOYEES
As of December 31, 2014, the Bank employed 121 persons on a full-time basis and 6 persons on a part-time basis. None of the employees is represented by a collective bargaining group. Management considers its employee relations to be good.
 
COMPETITION
The Bank originates most of its loans to and accepts most of its deposits from residents of Jefferson, Jackson, Jennings, Ripley, Floyd and Clark Counties, Indiana and Trimble and Carroll Counties, Kentucky. The Bank is subject to competition from various financial institutions, including state and national banks, state and federal savings associations, credit unions and certain non-banking consumer lenders that provide similar services in these counties. Some of these institutions have significantly larger resources available to them than does the Bank. In total, there are 34 banks and 6 credit unions located in the 8-county market area, including the Bank. The Bank also competes with money market funds and brokerage accounts with respect to deposit accounts and with insurance companies with respect to individual retirement accounts.
The primary factors influencing competition for deposits are interest rates, service and convenience of office locations. The Bank competes for loan originations primarily through the efficiency and quality of services it provides borrowers and through interest rates and loan fees charged. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions, current interest rate levels and other factors that are not readily predictable.
 
REGULATION AND SUPERVISION
GENERAL
The Bank is subject to examination, supervision and regulation by the Indiana Department of Financial Institutions (“DFI”), and the Federal Deposit Insurance Corporation (the “FDIC”). The Holding Company is a bank holding company and, with the creation of its insurance subsidiary, a financial holding company, subject to oversight by the Board of Governors of the Federal Reserve System (“Federal Reserve”).
This discussion will summarize the effect of existing and probable governmental regulations on the operations of the Holding Company and the Bank as a bank holding company and a state commercial bank, respectively.
 
BANK HOLDING COMPANY REGULATION
As a registered bank holding company for the Bank, the Holding Company is subject to the regulation and supervision of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (“BHCA”). Bank holding companies are required to file periodic reports with and are subject to periodic examination by the Federal Reserve.

Under the BHCA, without the prior approval of the Federal Reserve, the Holding Company may not acquire direct or indirect control of more than 5% of the voting stock or substantially all of the assets of any company, including a bank, and may not merge or consolidate with another bank holding company. In addition, the Holding Company is generally prohibited by the BHCA from engaging in any nonbanking business unless such business is determined by
18

the Federal Reserve to be so closely related to banking as to be a proper incident thereto. Under the BHCA, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.
Under the Dodd-Frank Act, a bank holding company is expected to serve as a source of financial and managerial strength to its subsidiary banks. Pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. This support may be required by the Federal Reserve at times when the Holding Company may not have the resources to provide it or, for other reasons, would not be inclined to provide it. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a bank holding company is required to provide limited guarantee of the compliance by any insured depository institution subsidiary that may become “undercapitalized” (as defined in the statute) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency.

GRAMM-LEACH-BLILEY ACT
Under the Gramm-Leach-Bliley Act (“Gramm-Leach”), bank holding companies are permitted to offer their customers virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. In order to engage in these new financial activities, a bank holding company must qualify and register with the Federal Reserve as a “financial holding company” by demonstrating that each of its bank subsidiaries is well capitalized, well managed and has at least a satisfactory rating under the Community Reinvestment Act. Gramm-Leach established a system of functional regulation, under which the federal banking agencies regulate the banking activities of financial holding companies, the U.S. Securities and Exchange Commission regulates their securities activities and state insurance regulators regulate their insurance activities. The Holding Company has filed an election to become a financial holding company under Gramm-Leach in connection with establishing its insurance company subsidiary.
Under Gramm-Leach, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of Gramm-Leach affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors. The Holding Company does not disclose any nonpublic information about any current or former customers to anyone except as permitted by law and subject to contractual confidentiality provisions which restrict the release and use of such information.

STATE COMMERCIAL BANK REGULATION
As an Indiana commercial bank, the Bank is subject to federal regulation and supervision by the FDIC and to state regulation and supervision by the DFI. The Bank’s deposit accounts are insured by the Deposit Insurance Fund (“DIF”), which is administered by the FDIC.
Both federal and Indiana law extensively regulate various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations.

STATE BANK ACTIVITIES
Under federal law, as implemented by regulations adopted by the FDIC, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by FDIC regulations, also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and could continue to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time frames set by the FDIC. It is not expected that these restrictions will have a material impact on the operations of the Bank.

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FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB system, which consists of 12 regional banks. The Federal Housing Finance Board (“FHFB”), an independent agency, controls the FHLB system, including the FHLB of Indianapolis. The FHLB system provides a central credit facility primarily for member financial institutions. At December 31, 2014, the Bank’s investment in stock of the FHLB of Indianapolis was $3.8 million. For the fiscal year ended December 31, 2014, the FHLB of Indianapolis paid approximately $193,000 in cash dividends to the Bank. Annualized, this income would have a rate of 4.22%. The rate paid during the period ended December 31, 2014 was higher than the 3.50% paid for the period ended December 31, 2013, primarily due to improvement in the financial condition of the FHLB of Indianapolis in the last few years. All 12 FHLBs are required to provide funds to establish affordable housing programs through direct loans or interest subsidies on advances to members to be used for lending at subsidized interest rates for low-and moderate-income, owner-occupied housing projects, affordable rental housing, and certain other community projects. These contributions and obligations could adversely affect the value of FHLB stock in the future. A reduction in the value of such stock may result in a corresponding reduction in the Bank’s capital.
The FHLB of Indianapolis serves as a reserve or central bank for its member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes advances to members in accordance with policies and procedures established by the FHLB and the Board of Directors of the FHLB of Indianapolis. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Indianapolis and the purpose of the borrowing.
All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. Eligible collateral includes first mortgage loans not more than 90 days delinquent or securities evidencing interests therein, securities (including mortgage-backed securities) issued, insured or guaranteed by the federal government or any agency thereof, cash or FHLB deposits, certain small business and agricultural loans of smaller institutions and real estate with readily ascertainable value in which a perfected security interest may be obtained. Other forms of collateral may be accepted as additional security or, under certain circumstances, to renew outstanding advances. All long-term advances are required to provide funds for residential home financing, and the FHLB has established standards of community service that members must meet to maintain access to long-term advances.
At December 31, 2014, the Bank had $43.5 million in such borrowings, with an additional $48.5 million available, previously approved by the Board of Directors.
FEDERAL RESERVE SYSTEM
The Federal Reserve requires all depository institutions to maintain noninterest bearing reserves at specified levels against their transaction accounts, which are primarily checking and NOW accounts, and non-personal time deposits. The effect of these reserve requirements is to increase the Bank’s cost of funds. At December 31, 2014, the Bank was in compliance with its reserve requirements.
INSURANCE OF DEPOSITS
Deposits in the Bank are insured by the Deposit Insurance Fund of the FDIC up to a maximum amount, which is generally $250,000 per depositor, subject to aggregation rules. The Dodd-Frank Act extended unlimited insurance on noninterest bearing accounts through December 31, 2012. Under this program, traditional noninterest demand deposit (or checking) accounts that allow for an unlimited number of transfers and withdrawals at any time, whether held for a business, individual, or other type of depositor, were covered. Because this program expired on December 31, 2012, there is no longer unlimited insurance coverage for noninterest bearing transaction accounts. Deposits held in noninterest bearing transaction accounts are now aggregated with interest bearing deposits the owner may hold in the same ownership category, and the combined total is insured up to $250,000.
The Bank is subject to deposit insurance assessments by the FDIC pursuant to its regulations establishing a risk-related deposit insurance assessment system, based upon the institution’s capital levels and risk profile. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk-weighted categories based on supervisory evaluations, regulatory capital levels, and certain other factors, with less risky institutions paying lower assessments. An institution’s initial assessment rate depends upon the category to which it is assigned. There are also adjustments to a bank’s initial assessment rates based on levels of long-term unsecured debt, secured liabilities in excess of 25% of domestic deposits and, for certain institutions, brokered deposit levels. Pursuant to FDIC rules adopted under the Dodd-Frank Act, effective April 1, 2011, initial assessments ranged from 5 to 35 basis points of the institution’s total assets minus tangible equity. The Bank’s assessment rate reflected in its invoices for the 2014 quarters was 8.77 basis points for each $100 of average consolidated assets less average tangible equity. No institution may pay a dividend if it is in default of the federal deposit insurance assessment.
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The Bank is also subject to assessment for the Financing Corporation (FICO) to service the interest on its bond obligations. The amount assessed on individual institutions, including the Bank, by FICO is in addition to the amount paid for deposit insurance according to the risk-related assessment rate schedule. These assessments will continue until the FICO bonds are repaid between 2017 and 2019. During 2014, the FICO assessment rate was 0.62 basis points for each $100 of the same assessment bases applicable to the FDIC assessment. For the first quarter of 2015, the FICO assessment rate is 0.60 basis points. The Bank expensed deposit insurance assessments (including the FICO assessments) of $440,000 during the year ended December 31, 2014. Future increases in deposit insurance premiums or changes in risk classification would increase the Bank’s deposit related costs.
On December 30, 2009, banks were required to pay the fourth quarter FDIC assessment and to prepay estimated insurance assessments for the years 2010 through 2012 on that date. The prepayment did not affect the Bank’s earnings on that date. The Bank paid an aggregate of $1.9 million in premiums on December 30, 2009, $1.6 million of which constituted prepaid premiums. During 2013, the remaining balance of this prepayment, $703,000, was refunded to the Bank from the FDIC.
Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion, and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. In December 2010, the FDIC adopted a final rule setting the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits.
On October 19, 2010, the FDIC proposed a comprehensive long-range plan for deposit insurance fund management with the goals of maintaining a positive fund balance, even during periods of large fund losses, and maintaining steady, predictable assessment rates throughout economic and credit cycles. The FDIC determined not to increase assessments in 2011 by 3 basis points, as previously proposed, but to keep the current rate schedule in effect. In addition, the FDIC proposed adopting a lower assessment rate schedule when the designated reserve ratio reaches 1.15% so that the average rate over time should be about 8.5 basis points. In lieu of dividends, the FDIC proposed adopting lower rate schedules when the reserve ratio reaches 2% and 2.5%, so that the average rates will decline about 25 percent and 50 percent, respectively.
Under the Dodd-Frank Act, the assessment base for deposit insurance premiums was changed from adjusted domestic deposits to average consolidated total assets minus average tangible equity, affecting assessments for the last two quarters of 2011, as well as future assessments. Tangible equity for this purpose means Tier 1 capital. Since this is a larger base than adjusted domestic deposits, assessment rates have been lower for the Bank as a result of these changes, which were first reflected in invoices due September 30, 2011. The FDIC rule to implement the revised assessment requirements includes rate schedules scaled to the increase in the assessment base, including schedules that will go into effect when the reserve ratio reaches 1.15%, 2% and 2.5%. The FDIC staff has projected that the new rate schedules will be approximately revenue neutral.
The schedule reduces the initial base assessment rate in each of the four risk-based pricing categories.
· For small Risk Category I banks, the rates range from 5-9 basis points.
· The rates for small institutions in Risk Categories II, III and IV are 14, 23 and 35 basis points, respectively.
· For large institutions and large, highly complex institutions, the rate schedule ranges from 5 to 35 basis points.
There are also adjustments made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.
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CAPITAL REQUIREMENTS
The Federal Reserve and the FDIC have issued substantially similar risk-based and leverage capital guidelines that are applicable to the Bank. These guidelines require a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities such as standby letters of credit) of 8%. At least half of the total required capital must be “Tier 1 capital,” consisting principally of common stockholders’ equity, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain goodwill items. The remainder (“Tier 2 capital”) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, cumulative perpetual preferred stock, and a limited amount of the allowance for loan losses.
In addition to the risk-based capital guidelines, the Bank is subject to a Tier 1 leverage capital ratio which requires a minimum level of Tier 1 capital to adjusted average assets of 3% in the case of financial institutions that have the highest regulatory examination ratings and are not contemplating significant growth or expansion. All other institutions are expected to maintain a ratio of at least 1% to 2% above the stated minimum. Pursuant to the regulations, banks must maintain capital levels commensurate with the level of risk, including the volume and severity of problem loans, to which they are exposed.
See Footnote 16 to the Consolidated Financial Statements, which shows that, at December 31, 2014, the capital of the Bank exceeded all regulatory capital requirements. At December 31, 2014, the Bank was categorized as “well capitalized.”
The Dodd-Frank Act required the Federal Reserve to set minimum capital levels for bank holding companies that would be as stringent as those required for insured depository subsidiaries. Bank holding companies with less than $500 million in assets were made exempt from these capital requirements. The legislation also established a floor for capital of insured depository institutions and directed the federal banking regulators to implement new leverage and capital requirements that would take into account off-balance sheet activities and risks, including risks related to securitized products and derivatives.
As a result of these mandates, on July 2, 2013, the Federal Reserve approved final rules that substantially amended the regulatory risk-based capital rules applicable to the Holding Company and the Bank. These new risk-based capital and leverage ratios will be phased in from 2015 to 2019. Effective in December 2014, however, Congress passed a law increasing the $500 million threshold so that, in general, bank holding companies and savings and loan holding companies with less than $1 billion in total consolidated assets will not be subject to the new regulatory capital requirements (but these requirements will apply to their depository institution subsidiaries). Legislation proposed by the Federal Reserve is pending to implement this law. See “New Capital Rules” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Effect of Current Events.
The Corporation is evaluating the impact of the pending changes in the capital requirements, but believes that based on current capital composition and levels, the Bank would be in compliance with the requirements if they were presently in effect.
PROMPT CORRECTIVE REGULATORY ACTION
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. At December 31, 2014, the Bank was categorized as “well capitalized,” meaning that its total risk-based capital ratio exceeded 10%, its Tier I risk-based capital ratio exceeded 6%, its leverage ratio exceeded 5%, and it was not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure.
The FDIC may order institutions which have insufficient capital to take corrective actions, including, among other things, submitting a capital restoration plan, limiting asset growth, placing restrictions on activities, requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired, restricting transactions with affiliates and prohibiting the payment of principal or interest on subordinated debt. Institutions deemed by the FDIC to be “critically undercapitalized” would be subject to the appointment of a receiver or conservator.
DIVIDEND LIMITATIONS
The Holding Company is a legal entity separate and distinct from the Bank. The primary source of the Holding Company’s cash flow, including cash flow to pay dividends on the Holding Company’s common stock, is the payment of dividends to the Holding Company by the Bank. Under Indiana law, the Bank may pay dividends of so
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much of its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the DFI for the payment of a dividend if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income” means net income as calculated for call report purposes, less all dividends declared for the applicable period.
The FDIC has the authority to prohibit the Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank. In addition, under Federal Reserve supervisory policy, a bank holding company generally should not maintain its existing rate of cash dividends on common shares unless (i) the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization’s capital needs, assets, quality, and overall financial condition. The Federal Reserve issued a letter dated February 24, 2009, to bank holding companies providing that it expects banks holding companies to consult with it in advance of declaring dividends that could raise safety and soundness concerns (i.e., such as when the dividend is not supported by earnings or involves a material increase in the dividend rate) and in advance of repurchasing shares of common or preferred stock.
LOANS TO ONE BORROWER
Under Indiana law, the Bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily marketable collateral, including certain debt and equity securities but not including real estate. At December 31, 2014, the Bank did not have any loans or extensions of credit to a single or related group of borrowers in excess of its lending limits.
MORTGAGE REFORM AND ANTI-PREDATORY LENDING
Title XIV of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act, includes a series of amendments to the Truth In Lending Act with respect to mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and prepayments. With respect to mortgage loan originator compensation, except in limited circumstances, an originator is prohibited from receiving compensation that varies based on the terms of the loan (other than the principal amount). The amendments to the Truth In Lending Act also prohibit a creditor from making a residential mortgage loan unless it determines, based on verified and documented information of the consumer’s financial resources, that the consumer has a reasonable ability to repay the loan. The amendments also prohibit certain prepayment penalties and require creditors offering a consumer a mortgage loan with prepayment penalty to offer the consumer the option of a mortgage loan without such a penalty. In addition, the Dodd-Frank Act expands the definition of a “high-cost mortgage” under the Truth In Lending Act, and imposes new requirements on high-cost mortgages and new disclosure, reporting and notice requirements for residential mortgage loans, as well as new requirements with respect to escrows and appraisal practices.
ACQUISITIONS OR DISPOSITIONS AND BRANCHING
Branching by the Bank requires the approval of the DFI. Under current law, Indiana chartered banks may establish branches throughout the state and in other states, subject to certain limitations. Congress authorized interstate branching, with certain limitations, beginning in 1997. Indiana law authorizes an Indiana bank to establish one or more branches in states other than Indiana through interstate merger transactions and to establish one or more interstate branches through de novo branching or the acquisition of a branch. The Dodd-Frank Act permits the establishment of de novo branches in states where such branches could be opened by a state bank chartered by that state. The consent of the state is no longer required.
FINANCIAL SYSTEM REFORM - THE DODD-FRANK ACT AND THE CFPB
The Dodd-Frank Act, which became law in 2010, significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act included provisions affecting large and small financial institutions alike, including several provisions that have profoundly affected how community banks, thrifts, and small bank and thrift holding companies, such as the Corporation, are regulated. Among other things, these provisions abolished the Office of Thrift Supervision (the “OTS”) and transferred its functions to the other federal banking agencies, relaxed rules regarding interstate branching, allowed financial institutions to pay interest on business checking accounts, changed the scope of federal deposit insurance coverage, imposed new capital requirements on bank and thrift holding companies, and imposed limits on debit card interchange fees charged by large banks (commonly known as the Durbin Amendment).
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The Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. In July 2011, many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies transferred to the CFBP. The CFBP has a large budget and staff, and has the authority to implement regulations under federal consumer protection laws and enforce those laws against financial institutions. The CFPB has examination and primary enforcement authority over depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by the federal banking regulators for consumer compliance purposes. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with offering consumer financial products. Additionally, this bureau is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities. Moreover, the Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay, and will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB.
The CFPB has indicated that mortgage lending is an area of supervisory focus and that it will concentrate its examination and rulemaking efforts on the variety of mortgage-related topics required under the Dodd-Frank Act, including minimum standards for the origination of residential mortgages. The CFPB has published several final regulations impacting the mortgage industry, including rules related to ability-to-repay, mortgage servicing, escrow accounts, and mortgage loan originator compensation. The ability-to-repay rule makes lenders liable if they fail to assess ability to repay under a prescribed test, but also creates a safe harbor for so called “qualified mortgages.” Failure to comply with the ability-to-repay rule may result in possible CFPB enforcement action and special statutory damages plus actual, class action, and attorneys’ fees damages, all of which a borrower may claim in defense of a foreclosure action at any time. The Corporation’s management is assessing the impact of these requirements on its mortgage lending business.
The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of the Corporation in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is expected to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act and the CFPB, is unpredictable at this time. The Corporation’s management continues to actively monitor the implementation of the Dodd-Frank Act and the regulations promulgated thereunder and assess its probable impact on the business, financial condition, and results of operations of the Corporation. However, the ultimate effect of the Dodd-Frank Act and the CFPB on the financial services industry in general, and the Corporation in particular, remains uncertain.
INTERCHANGE FEES FOR DEBIT CARDS
Under the Dodd-Frank Act, interchange fees for debit card transactions must be reasonable and proportional to the issuer’s incremental cost incurred with respect to the transaction plus certain fraud related costs. Although institutions with total assets of less than $10 billion are exempt from this requirement, competitive pressures may require smaller depository institutions to reduce fees with respect to these debit card transactions.
TRANSACTIONS WITH AFFILIATES
Under Indiana law, the Bank is subject to Sections 22(h), 23A and 23B of the Federal Reserve Act, which restrict financial transactions between banks and affiliated companies, such as the Holding Company. The statute limits credit transactions between a bank and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank’s extension of credit to an affiliate.
FEDERAL SECURITIES LAW
The shares of common stock of the Holding Company have been registered with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act (the “1934 Act”). The Holding Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the 1934 Act and the rules of the SEC thereunder. If the Holding Company has fewer than 300 shareholders, it may deregister its shares under the 1934 Act and cease to be subject to the foregoing requirements.
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Shares of common stock held by persons who are affiliates of the Holding Company may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the Securities Act of 1933. If the Holding Company meets the current public information requirements under Rule 144, each affiliate of the Holding Company who complies with the other conditions of Rule 144 (including those that require the affiliate’s sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Holding Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.
Under the Dodd-Frank Act, beginning in 2013, the Holding Company was required to provide its shareholders an opportunity to vote on the executive compensation payable to its named executive officers and on golden parachute payments made in connection with mergers or acquisitions. The first such “say-on-pay” vote was held at the Holding Company’s annual meeting in April 2013, and the shareholders voted in favor of the compensation. This vote, and all others like it, will be non-binding and advisory. Also beginning in 2013, the Holding Company was required to permit its shareholders to determine on an advisory basis at least once every six years whether such say-on-pay votes should be held every one, two, or three years. At the annual meeting held in April 2013, the shareholders followed the recommendation of the Board of Directors and voted in favor of holding future say-on-pay advisory votes on an annual basis. Accordingly, the shareholders held a say-on-pay advisory vote in 2014 and will vote on say-on-pay each year until the next advisory vote on the frequency of say-on-pay votes, which is required to occur no later than the 2019 annual meeting of shareholders.
SARBANES-OXLEY ACT OF 2002
On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) became law. The Sarbanes-Oxley Act’s stated goals include enhancing corporate responsibility, increasing penalties for accounting and auditing improprieties at publicly traded companies and protecting investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC under the Exchange Act.
Among other things, the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board as an independent body subject to SEC supervision with responsibility for setting auditing, quality control and ethical standards for auditors of public companies. The Sarbanes-Oxley Act also requires public companies to make faster and more extensive financial disclosures, requires the chief executive officer and chief financial officer of public companies to provide signed certifications as to the accuracy and completeness of financial information filed with the SEC, and provides enhanced criminal and civil penalties for violations of the federal securities laws.
The Sarbanes-Oxley Act also addresses functions and responsibilities of audit committees of public companies. The statute makes the audit committee directly responsible for the appointment, compensation and oversight of the work of the Corporation’s outside auditor, and requires the auditor to report directly to the audit committee. The Sarbanes-Oxley Act authorizes each audit committee to engage independent counsel and other advisors, and requires a public company to provide the appropriate funding, as determined by its audit committee, to pay the Corporation’s auditors and any advisors that its audit committee retains. The Sarbanes-Oxley Act also requires public companies to include an internal control report and assessment by management. As a small reporting company, the Corporation is not subject to the additional obligation to have an auditor attestation to the effectiveness of its controls included in its annual report.
Although the Corporation will continue to incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on the Corporation’s results of operations or financial condition.
COMMUNITY REINVESTMENT ACT MATTERS
Federal law requires that ratings of depository institutions under the Community Reinvestment Act of 1977 (“CRA”) be disclosed. The disclosure includes both a four-unit descriptive rating (specifically, outstanding, satisfactory, needs to improve, and substantial noncompliance) and a written evaluation of an institution’s performance. Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLB. The standards take into account a member’s performance under the CRA and its record of lending to first-time home buyers. As of the date of its most recent regulatory examination, the Bank was rated “satisfactory” with respect to its CRA compliance.
USA PATRIOT ACT OF 2001
In 2001, the USA PATRIOT Act of 2001 (the “PATRIOT Act”) became law. The PATRIOT Act, among other things, strengthens the ability of U.S. law enforcement to combat terrorism on a variety of fronts. The PATRIOT Act
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contains sweeping anti-money laundering and financial transparency laws and requires financial institutions to implement additional policies and procedures to address the following matters, among others: money laundering, suspicious activities and currency transaction reporting, and currency crimes. Many of the provisions in the PATRIOT Act were to have expired December 31, 2005, but the U.S. Congress made permanent all but two of the provisions that had been set to expire and provided that the remaining two provisions, which relate to surveillance and the production of business records under the Foreign Intelligence Surveillance Act, expire in June 2015. These provisions have not materially affected our operations.
OTHER FUTURE LEGISLATION AND CHANGE IN REGULATIONS
Various other legislation, including proposals to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced. This legislation may change banking statutes and the operating environment of the Holding Company and the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot accurately predict whether any of this potential legislation will ultimately be enacted, and, if enacted, the ultimate effect that it, or implementing regulations, would have upon the financial condition or results of operations of the Holding Company or the Bank.
 
TAXATION
FEDERAL TAXATION
For federal income tax purposes, the Corporation has been reporting its income and expenses on the accrual method of accounting. The Holding Company and the Bank file a consolidated federal income tax return for each fiscal year ending December 31. The Corporation’s federal income tax returns have not been audited in recent years.
STATE TAXATION
The Corporation is subject to Indiana’s Financial Institutions Tax (“IFIT”), which is imposed at a flat rate of 8.5% on apportioned “adjusted gross income.” “Adjusted gross income,” for purposes of IFIT, begins with taxable income as defined by Section 63 of the Code and, thus, incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications. Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes. The Corporation’s state income tax returns have not been audited in recent years.
The Corporation is subject to Kentucky’s Bank Franchise Tax (“KBFT”), which is imposed at a flat rate of 1.1% on apportioned “net capital.” For purposes of the KBFT, “net capital” is determined by (1) adding together the Corporation’s paid-in capital stock, surplus, undivided profits, capital reserves, net unrealized gains or losses on certain securities, and cumulative foreign currency translation adjustments and (2) deducting from the total an amount equal to the same percentage of the total as the book value of U.S. obligations and Kentucky obligations bears to the book value of the total assets of the Corporation. “Kentucky obligations” are all obligations of the state, counties, municipalities, taxing districts, and school districts that are exempt from taxation under Kentucky law. Other applicable state taxes include generally applicable sales and use taxes as well as Kentucky bank deposit and local deposit taxes which are generally imposed on the Corporation with respect to the deposits of Kentucky resident individuals at rates of .001% and .025%, respectively.
ITEM 1A.  RISK FACTORS
Not applicable for Smaller Reporting Companies.
ITEM 1B.  UNRESOLVED STAFF COMMENTS
Not applicable.
26



ITEM 2.  PROPERTIES
The following table provides certain information with respect to the Bank’s offices as of December 31, 2014.
Description and Address
Owned or Leased
 
Year Opened
   
Total Deposits
(in thousands)
   
Net Book Value of Property, Furniture & Fixtures
(in thousands)
   
Approximate Square Footage
 
 
Locations in Madison, Indiana
                 
Downtown Office:
                 
233 East Main Street
Owned
 
1952
   
$
66,742
   
$
278
   
9,110
 
Drive-Through Branch:
                           
401 East Main Street
Owned
 
1984
     
-
     
203
   
420
 
Hilltop Location:
                           
430 Clifty Drive
Owned
 
1983
     
159,811
     
2,233
   
18,696
 
Wal-Mart Banking Center:
                           
567 Ivy Tech Drive
Leased
 
1995
     
7,437
     
56
   
517
 
                             
Location in Charlestown, Indiana
                           
1025 Highway 62
Leased/Land
 
2002
     
7,521
     
448
   
1,500
 
                             
Location in Dupont, Indiana
                           
10525 N West Front Street
Owned
 
1910
     
8,316
     
133
   
2,332
 
                               
Location in Floyds Knobs, Indiana
                             
3660 Paoli Pike
Leased
 
2008
     
12,127
     
266
   
3,000
 
                               
Location in Hanover, Indiana
                             
10 Medical Plaza Drive
Owned
 
1995
     
14,132
     
316
   
1,344
 
                               
Location in Jeffersonville, Indiana
                             
1475 Veterans Parkway, Suite 105
Leased
 
2014
     
111
     
516
   
2,603
 
                               
Location in New Albany, Indiana
                             
2675 Charlestown Road
Owned
 
2010
     
26,197
     
496
   
6,000
 
                               
Location in North Vernon, Indiana
                             
Branch:
220 N State Street
Leased
 
2003
     
42,003
     
49
   
3,168
 
Operations Building:
                             
216 N State Street
Leased
 
2007
     
-
     
4
   
7,560
 
                               
Location in Osgood, Indiana