10-K 1 k82556e10vk.txt ANNUAL REPORT FOR THE FISCAL YEAR ENDED 12/31/03 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) [X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2003 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from________________to________________ Commission file number 0-49771 Merchants Bancorp, Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its Charter.) Ohio 31-1467303 -------------------------------- ---------------------------------- (State or other jurisdiction of (IRS) Employer Identification No.) incorporation or organization) 100 North High Street, Hillsboro, Ohio 45133 ----------------------------------------- ------------------------------ (Address of principal executive offices) (ZIP Code) (937) 393-1993 -------------------------------------------------------------------------------- (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 Securities registered pursuant to Section 12(g) of the Act: Common Shares -------------------------------------------------------------------------------- (Title of class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. [X] 1 Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter. $63,000,000 Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 2,666,650 common shares DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) any annual report to security holders; (2) any proxy or information statement; and (3) any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980). Portions of the Company's Proxy Statement to shareholders in connection with the 2004 annual meeting of shareholders are incorporated by reference into Part III of this Report on Form 10-K. 2 PART I ITEM 1. BUSINESS General Merchants Bancorp, Inc. (the "Company") was incorporated under the laws of the State of Ohio on March 29, 1996 at the direction of the Board of Directors of the Merchants National Bank (the "Bank") for the purpose of becoming a bank holding company by acquiring all of the outstanding shares of the Bank. In December, 1996 the Company became the sole shareholder of the Bank. The principal office of the Company is located at 100 North High Street, Hillsboro, Ohio 45133. Hillsboro, situated in south central Ohio, is centrally located between the cities of Columbus, Cincinnati and Dayton, and is the county seat of Highland County. Highland County has a population of approximately 41,000. The company, through its banking affiliate, also conducts business in the neighboring counties of Madison and Fayette, which have populations of approximately 40,000 and 28,000 respectively. This tri-county area is primarily agricultural. Madison County is one of Ohio's principal producers of corn and soybeans, and Fayette County is a significant horsebreeding area. However, manufacturing also provides a significant source of employment in the area, accounting for approximately 30% of all jobs in the three counties. Area manufacturers produce a wide array of products, including textiles, electrical components and automotive parts. Some of the area's principal manufacturers include Hobart Corp., Johnson Controls, Inc., Showa Aluminum Corp., and Yamashita Rubber and Calmas, Inc. The Bank has operated in Hillsboro, Ohio as a national banking association since its charter was granted on December 26, 1879. The Company, through its banking affiliate, offers a broad range of banking services to the commercial, industrial and consumer market segments which it serves. The primary business of the Bank consists of accepting deposits through various consumer and commercial deposit products, and using such deposits to fund various loan products. The Bank's primary loan products (and the general terms for each) are as follows: (1) loans secured by residential real estate, including loans for the purchase of one to four family residences which are secured by 1st and 2nd mortgages (15 to 30 year terms with fixed and adjustable rate options) and home equity loans (10 year maturities tied to prime rate); (2) consumer loans, including new and used automobile loans (up to 60 months), loans for the purchase of mobile homes (10 to 15 year terms) and debt consolidation loans (exact terms depending upon available collateral); (3) agricultural loans, including loans for the purchase of real estate used in connection with agricultural purposes (15 to 30 year terms), operating loans (1 year terms) and loans for the purchase of equipment (5 to 7 year terms); and (4) commercial loans, including loans for the purchase of real estate used in connection with office or retail activities (15 to 20 year terms), loans for the purchase of equipment (7 to 10 year terms) and loans for the purchase of inventory (1 year terms). The primary risks inherent in any type of lending include interest rate risk and credit risk associated with the credit quality of individual borrowers. For further information regarding interest rate risk, see the section captioned "Market Risk Management" under "Management's Discussion and Analysis of Financial Condition and Results of Operations." Credit risk is generally offset both through the use of security and mortgage interests, and through the implementation of designated loan approval processes. Senior mortgages in real estate provide the greatest protection in the event of borrower default, while junior mortgages and security interests in depreciating assets provide somewhat less protection. Loans not secured by real or personal property present the greatest risk of loss upon default. All loans, whether secured or unsecured, are approved in accordance with a loan policy adopted by the Company's Board of Directors. While loan officers do have authority to make credit decisions outside of the parameters of the Board's loan policy, such loan officers must satisfy designated documentation 3 requirements when doing so. Credit risk is further mitigated both by restricting the types of loans and by establishing maximum amounts which can be approved by individual loan officers. Loans made beyond these individual limitations must be affirmatively approved by a committee comprised of loan officers. The Bank also engages in certain government guarantee programs, which help to reduce the risk inherent in certain types of loans. All of the Bank's deposit and lending services are available at its four full service offices. The remaining three offices of the Bank are engaged primarily in deposit-related services. The Company has no foreign operations, assets or investments. The Bank is a national banking association organized under the laws of the United States. The Bank is regulated by the Office of the Comptroller of the Currency ("OCC"), and its deposits are insured by the Federal Deposit Insurance Company ("FDIC") to the extent permitted by law and, as a subsidiary of the Company, is regulated by the Board of Governors of the Federal Reserve. As of December 31, 2003, the Company and its subsidiary had consolidated total assets of approximately $352 million, consolidated total deposits of approximately $270 million and consolidated total shareholders' equity of approximately $28.2 million. Employees As of December 31, 2003, the Bank had 88 full-time and 9 part-time employees. The Bank provides a number of benefits for its full-time employees, including health and life insurance, pension, profit sharing and 401(k) plans, workers' compensation, social security, paid vacations, and certain bank services. Competition The Bank's market consists of the following Ohio Counties: Fayette, Highland, and Madison. The commercial banking business in this market is very competitive. The Company and the Bank are in competition with other commercial banks operating in the primary market area. Some competitors of the Company and the Bank are substantially larger than the Bank. In addition to local bank competition, the Bank competes with larger commercial banks headquartered in metropolitan areas, savings banks, savings and loan associations, credit unions, finance companies and other financial institutions for loans and deposits. Pursuant to Deposit Market Share statistical information compiled by the Federal Deposit Insurance Corporation, there are approximately twenty (20) financial institutions operating in the Bank's market. As of June 30, 2003 (the most recent date for which the compiled statistical information is available) the Bank possessed the second largest market share with $262.4 million in total deposits, representing a market share of approximately 17.0%. Three other depositary institutions also possess over 10% of the market share in the Bank's market. The principal methods of competition within the financial services industry include improving customer service through the quality and range of services provided, improving efficiencies, and pricing services competitively. The Bank views its primary competitive advantages as being the provider of outstanding customer service and maintaining strong relationships with its core customer base. Rarely does the Bank offer the highest rates on deposit accounts or the lowest rates on loans. Fees and service charges are priced to meet the competition. The Bank believes that its distinguishing characteristics are knowing its customers, offering quality customer service and timely loan decisions and closings. By focusing on these key attributes, the Bank has built a loyal customer base, which also serves as its greatest source of new business by way of customer referrals. 4 SUPERVISION AND REGULATION General Merchants Bancorp, Inc. is a corporation organized under the laws of the State of Ohio. The business in which the Company and its subsidiary are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities. The supervision, regulation and examination to which the Company and its subsidiary are subject are intended primarily for the protection of depositors and the deposit insurance funds that insure the deposits of banks, rather than for the protection of shareholders. Several of the more significant regulatory provisions applicable to banks and bank holding companies to which the Company and its subsidiary are subject are discussed below, along with certain regulatory matters concerning the Company and its subsidiary. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and its subsidiary. Regulatory Agencies The Company, upon approval from the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), became a bank holding company on December 31, 1996, and continues to be subject to regulation under the Bank Holding Company Act of 1956 and to inspection, examination and supervision by the Federal Reserve Board. The Bank is a national banking association chartered under the laws of the United States of America. It is subject to regulation and examination primarily by the Office of the Comptroller of the Currency (the "OCC") and secondarily by the Federal Reserve Board and the FDIC. Holding Company Activities As a bank holding company incorporated and doing business within the State of Ohio, the Company is subject to regulation and supervision under the Bank Holding Act of 1956, as amended (the "Act"). The Company is required to file with the Federal Reserve Board on a quarterly basis information pursuant to the Act. The Federal Reserve Board may conduct examinations or inspections of the Company and its subsidiary. The Company is required to obtain prior approval from the Federal Reserve Board for the acquisition of more than five percent of the voting shares or substantially all of the assets of any bank or bank holding company. In addition, the Company is generally prohibited by the Act from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. The Company may, however, subject to the prior approval of the Federal Reserve Board, engage in, or acquire shares of companies engaged in activities which are deemed by the Federal Reserve Board by order or by regulation to be so closely related to banking or managing and controlling a bank as to be a proper activity. On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted into law. The GLB Act made sweeping changes with respect to the permissible financial services which various 5 types of financial institutions may now provide. The Glass-Steagall Act, which had generally prevented banks from affiliation with securities and insurance firms, was repealed. Pursuant to the GLB Act, bank holding companies may elect to become a "financial holding company," provided that all of the depository institution subsidiaries of the bank holding company are "well capitalized" and "well managed" under applicable regulatory standards. Under the GLB Act, a bank holding company that has elected to become a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Activities that are "financial in nature" include securities underwriting, dealing and market-making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board has determined to be closely related to banking. No Federal Reserve Board approval is required for the Company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. Prior Federal Reserve Board approval is required before the Company may acquire the beneficial ownership or control of more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. If any subsidiary bank of the Company ceases to be "well capitalized" or "well managed" under applicable regulatory standards, the Federal Reserve Board may, among other actions, order the Company to divest the subsidiary bank. Alternatively, the Company may elect to conform its activities to those permissible for a bank holding company that is not also a financial holding company. If any subsidiary bank of the Company receives a rating under the Community Reinvestment Act of 1977 of less than satisfactory, the Company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations. The Company has not elected to become a financial holding company and has no current intention of making such an election. Affiliate Transactions Various governmental requirements, including Sections 23A and 23B of the Federal Reserve Act, limit borrowings by holding companies and non-bank subsidiaries from affiliated insured depository institutions, and also limit various other transactions between holding companies and their non-bank subsidiaries, on the one hand, and their affiliated insured depository institutions on the other. Section 23A of the Federal Reserve Act also generally requires that an insured depository institution's loan to its non-bank affiliates be secured, and Section 23B of the Federal Reserve Act generally requires that an insured depository institution's transactions with its non-bank affiliates be on arms-length terms. Interstate Banking and Branching Under the Riegle-Neal Interstate Banking and Branching Efficiency Act ("Riegle-Neal"), subject to certain concentration limits and other requirements, bank holding companies such as the Company are permitted to acquire banks and bank holding companies located in any state. Any bank that is a subsidiary of a bank holding company is permitted to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of that bank holding company. Banks are permitted to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states and establishing de novo branch offices in other states, The ability of banks to acquire branch offices is contingent, however, on the host state having adopted legislation "opting in" to those provisions of Riegle-Neal. In addition, the ability of a bank to merge with a bank located in another state is contingent on the host state not having adopted legislation "opting out" of that provision of Riegle-Neal. The Company could from time to time use Riegle-Neal to acquire banks in additional states. 6 Control Acquisitions The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under the rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Company, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquiror that is a bank holding company) or more of any class of outstanding voting stock of a bank holding company, or otherwise obtaining control or a "controlling influence" over that bank holding company. Liability for Banking Subsidiaries Under the current Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to maintain resources adequate to support each subsidiary bank. This support may be required at times when the bank holding company may not have the resources to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a U.S. federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment. Any depository institution insured by the FDIC can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC in connection with (1) the "default" of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to both a commonly controlled FDIC-insured depository institution "in danger of default." The Company's subsidiary bank is an FDIC-insured depository institution. If a default occurred with respect to the Bank, any capital loans to the Bank from its parent holding company would be subordinate in right of payment to payment of the Bank's depositors and certain of its other obligations. Regulatory Capital Requirements The Company is required by the various regulatory authorities to maintain certain capital levels. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The required capital levels and the Company's capital position at December 31, 2003 are summarized in the table included in Note 13 to the consolidated financial statements. FDICIA The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), and the regulations promulgated under FDICIA, among other things, established five capital categories for insured depository institutions-well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized-and requires U.S. federal bank regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements based on these categories. Unless a bank is well capitalized, it is subject to restrictions on its ability to offer brokered deposits and on certain other aspects of its operations. An undercapitalized bank must develop a capital restoration plan and its parent bank holding company must guarantee the bank's compliance with the plan up to the lesser of 5% of the bank's or thrift's assets at the time it became undercapitalized and the amount needed to comply with the plan. As of December 31, 7 2003, the Company's banking subsidiary was well capitalized pursuant to these prompt corrective action guidelines. Dividend Restrictions The ability of the Company to obtain funds for the payment of dividends and for other cash requirements will be largely dependent on the amount of dividends which may be declared by its banking subsidiary. Various U.S. federal statutory provisions limit the amount of dividends the Company's banking subsidiaries can pay to the Company without regulatory approval. Dividend payments by national banks are limited to the lesser of (1) the level of undivided profits; (2) the amount in excess of which the bank ceases to be at least adequately capitalized; and (3) absent regulatory approval, an amount not in excess of net income for the current year combined with retained net income for the preceding two years. In addition, U.S. federal bank regulatory authorities have authority to prohibit the Company's banking subsidiary from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending upon the financial condition of the bank in question, could be deemed to constitute an unsafe or unsound practice. The ability of the Company's banking subsidiary to pay dividends in the future is currently, and could be further, influenced by bank regulatory policies and capital guidelines. Deposit Insurance Assessments The deposits of the Company's banking subsidiary are insured up to regulatory limits by the FDIC, and, accordingly, are subject to deposit insurance assessments to maintain the Bank Insurance Fund (the "BIF") and/or the Savings Association Insurance Fund (the "SAIF") administered by the FDIC. Depositor Preference Statute In the "liquidation or other resolution" of an institution by any receiver, U.S. federal legislation provides that deposits and certain claims for administrative expenses and employee compensation against the insured depository institution would be afforded a priority over general unsecured claims against that institution, including federal funds and letters of credit. Government Monetary Policy The earnings of the Company are affected primarily by general economic conditions, and to a lesser extent by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve. Its policies influence, to some degree, the volume of bank loans and deposits, and interest rates charged and paid thereon, and thus have an effect on the earnings of the Company's subsidiary Bank. Additional Regulation The Bank is also subject to federal regulation as to such matters as required reserves, limitation as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuance or retirement of their own securities, limitations upon the payment of dividends and other aspects of banking operations. In addition, the activities and operations of the Bank are subject to a number of additional detailed, complex and sometimes overlapping laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-in-Lending Act and 8 Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Truth in Savings Act, the Community Reinvestment Act, anti-redlining legislation and antitrust laws. Future Legislation Changes to the laws and regulations, both at the federal level and in the states where the Company and its subsidiary do business, can affect the operating environment of the Company and its subsidiary in substantial and unpredictable ways. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon the financial condition or results of operations of the Company or its subsidiary. ITEM 2. PROPERTIES. The Bank owns the real property used in its business as follows: Main Office: Greenfield Main 100 N. High Street 117 S. Washington Street Hillsboro, Ohio 45133 Greenfield, Ohio 45123 Hillsboro Branch Greenfield Branch 1478 N. High Street 102 Jefferson Street Hillsboro, Ohio 45133 Greenfield, Ohio 45123 Hillsboro Uptown Branch Washington Court House Branch 145 W. Beech Street 128 S. North Street Hillsboro, Ohio 45133 Washington Court House, Ohio 43160 London Branch 279 LaFayette Street London, Ohio 43140 All such properties are suitable for carrying on the general business of commercial banking. No such properties are subject to any material encumbrance. ITEM 3. LEGAL PROCEEDINGS. Currently, there are no legal proceedings of a material nature pending to which either the Company or the Bank is a party, or to which any of their property is the subject. Additionally, management of the Company is not aware of the contemplation of any proceedings the institution of which would have a material adverse impact upon the financial condition of the Company or the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There was no matter submitted during the fourth quarter of the fiscal year covered by this report to a vote of the Company's security holders. 9 PART II ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. a. Market Information There is no established public trading market for the Company's common stock and the shares of the Company are not listed on any exchange. Sale price information provided below on a quarterly basis for the two most recent fiscal years is based on information reported to the Company by individual buyers and sellers of the Company's stock, based on actual transactions of which information was obtained at the time of transfer. Not all sales transaction information during these periods was obtained.
2003 ------------------------------------------------------------------- First Quarter Second Quarter Third Quarter Fourth Quarter ------------- -------------- ------------- -------------- High Low High Low High Low High Low $25.00 $18.00 $23.00 $20.00 $25.00 $20.00 $22.50 $20.00
2002 ------------------------------------------------------------------- First Quarter Second Quarter Third Quarter Fourth Quarter ------------- -------------- ------------- -------------- High Low High Low High Low High Low $28.00 $26.50 $28.06 $20.00 $25.00 $21.00 $26.00 $20.00
--------------------------- At December 31, 2003, the Company had 2,945,000 shares of common stock outstanding. All of such shares are eligible for sale in the open market without restriction or registration under the Securities Act of 1933, as amended (the "Securities Act"), except for shares held by "affiliates" of the Company. Shares held by affiliates are subject to the resale limitations of Rule 144, as promulgated under the Securities Act. For purposes of Rule 144, "affiliates" are deemed to be all Directors, Executive Officers and ten percent beneficial owners of the Company. As of December 31, 2003, affiliates of the Company had beneficial ownership of an aggregate of 478,073 shares of the Company's common stock. The Company has one shareholder with beneficial ownership of more than ten percent of its outstanding shares, and such individual is also a Director of the Company. Rule 144 subjects affiliates to certain restrictions in connection with the resale of Company securities that do not apply to individuals currently holding outstanding shares of Company stock. Commencing ninety days after the effective date of this Registration Statement, affiliates of the Company may sell within any three-month period a number of shares that does not exceed the greater of one percent of the number of then outstanding shares of Company common stock, or the average weekly trading volume of the common stock in the over-the-counter market during the four calendar weeks preceding filing by the selling affiliate of the requisite notice of sale with the SEC on Form 144. Sales under Rule 144 are also subject to certain requirements as to the manner of sale, notice to the Securities and Exchange Commission, and the availability of current public information about the Company. On August 28, 2003 Merchants Bancorp entered into a stock redemption agreement with 3 shareholders of the Company. Collectively the three shareholders owned 351,350 common shares of the Company or 11.71% of outstanding shares. They desired to sell 333,350 of such shares(referred to herein 10 as the "shares") to the Company. The Company retained Austin Associates, LLC to determine a "fair value" and issued a "fairness opinion" to the Company dated July 30, 2003. The purchase was to be made in two separate settlements. The first settlement was for 55,000 shares and a total of $1,155,000 and occurred on September 5, 2003. The second settlement occurred on January 9, 2004 for the 278,350 remaining shares. The dollar value of the second settlement is $5,845,349.87 and is recorded in other liabilities on the December 31, 2003 financial statements. The total value of the transaction is $7,000,349.87. b. Holders The number of holders of record of the Company's common stock at December 31, 2003 was 786. c. Dividends Dividends are generally declared by the Board of Directors of the Company semiannually (June 30 and December 31, respectively). Dividends per share declared by the Company on its common stock during the years of 2003 and 2002 are as follows:
2003 2002 Month June $0.32 $0.28 December $0.32 $0.32 ----- ----- TOTALS $0.64 $0.60 ===== =====
The Company currently expects that comparable semiannual cash dividends will continue to be paid in the future. For information on regulatory restrictions to the Board's ability to declare and pay dividends, please refer to the following: (1) Supervision and Regulation - Dividend Restrictions and (2) Note 13 to the Company's Consolidated Financial Statements, Regulatory Matters. 11 The Company's Quarterly Financial Data for 2003 and 2002 follows:
Three months ended ------------------------------------- (in thousands, except per share data) March 31 June 30 Sept 30 Dec 31 ---------------------------------------------------------------------------------- 2003 Net interest income $3,459 $3,626 $3,570 $2,931 Provision for loan losses 404 262 1,785 456 Noninterest income 371 370 384 381 Noninterest expense 1,964 1,927 1,665 1,356 Net income $1,005 $1,223 $ 485 $1,078 Per common share: Basic and diluted earnings per share $ 0.34 $ 0.41 $ 0.16 $ 0.38 Dividends declared $ - $ 0.32 $ - $ 0.32 Selected ratios: Return on average assets, annualized 1.24% 1.44% .57% 1.26% Return on average common equity, annualized 12.01% 14.19% 5.93% 13.18% Net interest margin, annualized 4.53% 4.54% 4.44% 3.50% 2002 Net interest income $2,926 $3,296 $3,483 $3,267 Provision for loan losses 84 145 138 69 Noninterest income 352 379 400 378 Noninterest expense 1,735 1,797 1,887 1,691 Net income $ 995 $1,178 $1,255 $1,344 Per common share: Basic and diluted earnings per share $ 0.33 $ 0.39 $ 0.42 $ 0.45 Dividends declared $ - $ 0.2 $ - $ 0.32 Selected ratios: Return on average assets, annualized 1.31% 1.57% 1.63% 1.69% Return on average common equity, annualized 13.00% 14.97% 15.76% 16.22% Net interest margin, annualized 4.40% 4.71% 4.83% 4.52%
12 ITEM 6. SELECTED FINANCIAL DATA. The following table sets forth certain information derived from the consolidated financial information of the Company for each of the years as of December 31 (in thousands, except per share data). SELECTED FINANCIAL DATA
2003 2002 2001 2000 1999 -------- -------- -------- -------- -------- Interest and loan fee income $ 20,310 $ 20,866 $ 22,431 $ 21,603 $ 18,427 Interest expense 6,724 7,894 10,793 10,395 8,088 Net interest income 13,586 12,972 11,638 11,208 10,339 Provision for loan losses 2,907 436 177 177 130 Net interest income after provision for loan losses 10,679 12,536 11,461 11,031 10,209 Noninterest income 1,506 1,509 1,472 1,269 1,094 Noninterest expense 6,912 7,110 6,576 6,131 5,762 Income before income taxes 5,273 6,935 6,357 6,169 5,541 Income taxes 1,482 2,163 1,952 1,964 1,765 Net income 3,791 4,772 4,405 4,205 3,776 YEAR-END BALANCES Assets $352,421 $318,799 $304,896 $278,734 $246,923 Securities 33,085 40,012 38,221 37,753 40,661 Loans, net 286,192 246,164 221,767 220,460 184,963 Deposits 270,432 262,716 262,608 236,046 216,857 Short Term Borrowings 2,784 3,365 1,424 1,887 1,172 Federal Home Loan Bank advances 43,706 17,470 8,993 7,000 4,000 Shareholders' equity 28,227 33,508 30,232 27,114 23,579 AVERAGE BALANCES Assets $341,025 $308,488 $288,236 $265,957 $238,980 Securities 36,376 45,511 37,245 40,639 38,789 Loans 272,013 237,788 227,150 210,325 176,738 Deposits 268,069 253,869 246,919 231,047 205,329 Short-term borrowings 2,961 3,158 1,996 2,150 1,986 Federal Home Loan Bank advances 34,061 17,649 8,285 6,403 7,879 Shareholders' equity 32,878 32,384 29,357 25,523 23,148 SELECTED FINANCIAL RATIOS Net interest margin (tax equivalent) 4.38% 4.63% 4.37% 4.55% 4.66% Return on average assets 1.11% 1.55% 1.53% 1.58% 1.58% Return on average equity 11.53% 14.74% 15.00% 16.48% 16.31% Average equity to average assets 9.64% 10.50% 10.19% 9.60% 9.69% Dividend payout ratio 50.18% 37.72% 35.41% 32.10% 33.10% Ratio of nonperforming loans to total loans 0.51% 0.19% 0.17% 0.14% 0.13% Ratio of loan loss allowance to total loans 0.84% 0.85% 0.88% 0.86% 1.02% Ratio of loan loss allowance to nonperforming loans 166% 368% 512% 599% 781% Basic earnings per share(1) $ 1.27 $ 1.59 $ 1.47 $ 1.40 $ 1.26 Diluted earnings per share(1) $ 1.27 $ 1.59 $ 1.47 $ 1.40 $ 1.26 Dividends declared per share(1) $ 0.64 $ 0.60 $ 0.52 $ 0.45 $ 0.42
13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis comparing 2003 to prior years should be read in conjunction with the audited consolidated financial statements at December 31, 2003 and 2002 and for the three years ended December 31, 2003. In addition to the historical information contained herein with respect to the Company, the following discussion contains forward-looking statements that involve risks and uncertainties. Economic circumstances, the Company's operation and the Company's actual results could differ significantly from those discussed in the forward-looking statements. Forward-looking statements are typically identified by words or phrases such as "believe," "expect," "anticipate," "intend," "estimate," "may increase," "may fluctuate," and similar expressions or future or conditional verbs such as "will," "should," "would" and "could." These forward-looking statements involve risks and uncertainties including, but not limited to, economic conditions, portfolio growth, the credit performance of the portfolios, including bankruptcies, and seasonal factors; changes in general economic conditions including the performance of financial markets, the prices of crops, prevailing inflation and interest rates, and losses on lending activities; results of various investment activities; the effects of competitors' pricing policies, of changes in laws and regulations on competition and of demographic changes on target market populations' savings and financial planning needs; industry changes in information technology systems on which we are dependent; and the resolution of legal proceedings and related matters. In addition, the policies and regulations of the various regulatory authorities could affect the Company's results. These statements are representative only on the date hereof, and the Company undertakes no obligation to update any forward-looking statements made. Critical Accounting Policies Management believes that the determination of the allowance for loan losses represents a critical accounting policy. The Company maintains an allowance for loan losses to absorb probable loan losses inherent in the portfolio. The allowance for loan losses is maintained at a level management considers to be adequate to absorb probable loan losses inherent in the portfolio, based on evaluations of the collectibility and historical loss experience of loans. Credit losses are charged and recoveries are credited to the allowance. Provisions for loan losses are based on management's review of the historical loan loss experience and such factors which, in management's judgment, deserve consideration under existing economic conditions in estimating probable credit losses. The allowance is based on ongoing assessments of the probable estimated losses inherent in the loan portfolio. The Company's methodology for assessing the appropriate allowance level consists of several key elements, as described below. Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and available legal options. Included in the review of individual loans are those that are impaired as provided in Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as amended. Any specific reserves for impaired loans are measured based on the fair value of the underlying collateral. The Company evaluates the collectibility of both principal and interest when assessing the need for a specific reserve. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations. Homogenous loans, such as consumer installment and residential mortgage loans, are not individually reviewed for impairment by management. Reserves are established for each pool of loans based on the expected net charge-offs. Loss rates are based on the average five-year net charge-off history by loan category. 14 Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the local economy, trends in the nature and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Company's internal credit review function. An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. Specific reserves on individual loans and historical loss rates are reviewed throughout the year and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience. The Company has not substantively changed any aspect of its overall approach in the determination of the allowance for loan losses since January 1, 2002. There have been no material changes in assumptions or estimation techniques as compared to prior years that impacted the determination of the current year allowance. Based on the procedures discussed above, management believes the allowance for loan losses was adequate to absorb estimated loan losses associated with the loan portfolio at December 31, 2003. See further information regarding the allowance for loan losses in Notes 1 and 4 of the Notes to the consolidated financial statements. New Accounting Pronouncements In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor Carriers and amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS 145 was effective for transactions occurring after May 15, 2002. Adoption of this standard did not have a material effect on the Corporation's consolidated financial statements. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management's commitment to an exit plan, which is generally before an actual liability has been incurred. This statement was effective for exit and disposal activities that were initiated after December 31, 2002 and has not had a material effect on the Corporation's consolidated financial statements. SFAS No. 147, Acquisitions of Certain Financial Institutions, was issued in October 2002. This statement clarifies that, if certain criteria are met, an acquisition of a less-than-whole financial institution (such as a branch acquisition) should be accounted for as a business combination. SFAS No. 147 states that, in such instances, the excess of the fair value of liabilities assumed over the value of tangible and identifiable intangible assets acquired represents goodwill. Prior to SFAS No. 147, such excesses were classified as an unidentifiable intangible asset subject to continuing amortization under SFAS No. 142. As a 15 result of SFAS No. 147, entities are required to reclassify and restate both the goodwill asset and amortization expense as of the date SFAS No. 142 was adopted. In addition, SFAS No. 147 amends SFAS No. 144 to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets. As a result, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that SFAS No. 144 requires for other long-lived assets that are held and used by a company. This Statement was effective October 1, 2002, and adoption did not have a material effect on the Corporation's consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Corporation does not have any outstanding stock options or stock option plans at December 31, 2003 and 2002. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain embedded derivatives, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement amends SFAS No. 133 to reflect the decisions made as part of the Derivatives Implementation group (DIG) and in other FASB projects or deliberations. SFAS No. 149 was effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. Adoption of this Standard did not have a material effect on the Corporation's Consolidated Financial Statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This Statement establishes standards for how an entity classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement requires that an issuer classify a financial instrument that is within its scope as a liability. Many of those instruments were previously classified as equity or in some cases presented between the liabilities section and the equity section of the statement of financial position. This statement was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of this Standard did not have a material effect on the Corporation's Consolidated Financial Statements. In December 2003, the FASB issued SFAS No. 132 (Revised 2003), Employers' Disclosure about Pension and Other Postretirement Benefits. This Statement expands upon the existing disclosure requirements as prescribed under the original SFAS No. 132 by requiring more details about pension plan assets, benefit obligations, cash flows, benefit costs and related information. SFAS No. 132 (Revised) also requires companies to disclose various elements of pension and postretirement benefit costs in interim period financial statements beginning after December 15, 2003. This Statement is effective for financial statements with fiscal years ending after December 15, 2003. The Corporation adopted this Standard and all its required disclosures. In November 2002, the FASB issued Interpretation No. 45, (FIN 45) Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability 16 for the fair value of the obligation undertaken in issuing the guarantee. The Interpretation expands on the accounting guidance of SFAS No. 5, Accounting for Contingencies, SFAS No. 57, Related Party Disclosures, and SFAS No. 107, Disclosures about Fair Value of Financial Instruments. It also incorporates without change the provisions of FASB Interpretation No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others, which is superseded. The initial recognition and measurement provisions of this Interpretation apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements in this Interpretation were effective for periods ending after December 15, 2002. Adoption of this Interpretation did not have a material effect on the Corporation's Consolidated Financial Statements. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. This Interpretation clarifies the application of ARB No. 51, Consolidated Financial Statements, for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. This Interpretation requires variable interest entities (VIE's) to be consolidated by the primary beneficiary which represents the enterprise that will absorb the majority of the VIE's expected losses if they occur, receive a majority of the VIE's residual returns if they occur, or both. Qualifying Special Purpose Entities (QSPE) are exempt from the consolidation requirements of FIN 46. This Interpretation was effective for VIE's created after January 31, 2003 and for VIE's in which an enterprise obtains an interest after that date. In December 2003, the FASB issued Staff Interpretation No. 46R (FIN 46R), Consolidation of Variable Interest Entities -- an interpretation of ARB 51 (revised December 2003), which replaces FIN 46. FIN 46R was primarily issued to clarify the required accounting for interests in VIE's. Additionally, this Interpretation exempts certain entities from its requirements and provides for special effective dates for enterprises that have fully or partially applied FIN 46 as of December 24, 2003. Application of FIN 46R is required in financial statements of public enterprises that have interests in structures that are commonly referred to as special-purpose entities, or SPE's, for periods ending after December 15, 2003. Application by public enterprises, other than small business issuers, for all other types of VIE's (i.e., non-SPE's) is required in financial statements for periods ending after March 15, 2004, with earlier adoption permitted. The Corporation does not have any variable interest entities. Management has determined that adoption of this Interpretation will not have a material impact on the Corporation's financial statements. I. RESULTS OF OPERATIONS Overview Net income for 2003 was $3.8 million, a decrease of 20.6% from 2002 net income of $4.8 million, which was an increase of 8.3% over 2001 net income of $4.4 million. Net income per share was $1.27 in 2003, compared to $1.59 in 2002, and $1.47 in 2001. The decrease in net income from 2002 is primarily due to additional accrual to the loan loss reserve for higher than normal credit losses in the agricultural loan area and one large credit loss in the commercial area. The credit loss is discussed further in the "Loans and Allowance for Loan Losses" section of this report. Net interest income before the provision for loan losses increased to $13.6 million in 2003, from $13.0 million in 2002 and $11.6 million in 2001, representing an increase of 4.7% and 11.5% in 2003 and 2002, respectively. The provision for loan losses was $2,907,000, $436,000, and $177,000 in 2003, 2002, and 2001 respectively. Noninterest income remained the same at $1.5 million in 2003, 2002 and 2001. Noninterest expense decreased 2.8% to $6.9 million for 2003, from $7.1 million in 2002, which was an increase of 8.1% from $6.6 million in 2001. 17 Selected Statistical Information The following tables set forth certain statistical information relating to the Company and its subsidiary on a consolidated basis and should be read together with the consolidated financial statements of the Company. CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND YIELDS/RATES The following table presents the daily average balance of each category of interest-earning assets and interest-bearing liabilities, and the interest earned or paid on such amounts (dollars in thousands). 18 CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME/EXPENSE AND YIELDS/RATES (IN THOUSANDS)
2003 2002 2001 ----------------------------- ---------------------------- ----------------------------- AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE --------- -------- ------ --------- -------- ------ --------- -------- ------ Interest-earning assets: Loans (1)(2)(3) $272,013 $ 18,455 6.78% $ 237,788 $ 18,520 7.79% $ 227,150 $ 20,033 8.82% Securities available for sale (3) 34,198 2,166 6.33% 43,420 2,648 6.10% 35,264 2,348 6.66% FHLB and FRB stock 2,178 89 4.09% 2,091 98 4.69% 1,981 132 6.66% Interest-bearing deposits 8 3 37.50% 1,553 27 1.74% 628 5 0.80% Federal funds sold 14,605 157 1.07% 6,748 92 1.36% 7,697 203 2.64% --------- -------- ----- --------- -------- ---- --------- -------- ---- Total interest-earning assets 323,002 20,870 6.46% 291,600 21,385 7.33% 272,720 22,721 8.33% --------- -------- ----- --------- -------- ---- --------- -------- ---- Noninterest-earning assets 20,535 18,950 17,483 Less: Allowance for loan losses (2,512) (2,062) (1,967) --------- --------- --------- Total assets $ 341,025 $ 308,488 $ 288,236 ========= ========= ========= Interest-bearing liabilities: Interest-bearing demand deposits $ 83,020 $ 1,299 1.56% $ 68,787 $ 1,379 2.00% $ 57,938 $ 1,636 2.82% Savings deposits 24,801 225 0.91% 20,759 348 1.68% 17,090 377 2.21% Time deposits > $100 29,909 794 2.65% 27,798 1,004 3.61% 31,690 1,689 5.33% Other time deposits 101,253 2,870 2.83% 107,565 4,169 3.88% 114,803 6,529 5.69% Securities sold under repo agreement. 2,961 90 3.04% 2,088 91 4.36% 1,494 85 5.69% Federal funds purchased 0 0 1,070 21 1.96% 502 31 6.18% Federal Home Loan Bank advances 34,061 1,447 4.25% 17,649 882 5.00% 8,285 446 5.38% --------- -------- ----- --------- -------- ---- --------- -------- ---- Total interest-bearing liabilities 276,005 6,725 2.44% 245,716 7,894 3.21% 231,802 10,793 4.66% --------- -------- ----- --------- -------- ---- --------- -------- ---- Noninterest-bearing liabilities: Demand deposits 29,086 28,960 25,398 Other liabilities 3,056 1,428 1,679 Shareholders' equity 32,878 32,384 29,357 --------- --------- --------- Total liabilities and shareholders' equity $ 341,025 $ 308,488 $ 288,236 ========= ========= ========= Net interest income $ 14,145 $ 13,491 $ 11,928 ======== ======== ======== Net interest spread (4) 4.02% 4.12% 3.68% ===== ==== ==== Net interest margin (5) 4.38% 4.63% 4.37% ===== ==== ====
(1) Nonaccrual loans are included in loan totals and do not have a significant impact on the information presented. Interest on nonaccrual loans is recorded when received. (2) Interest includes fees on loans of $398, $675, and $590, in 2003, 2002, and 2001, respectively. (3) Tax-exempt income on loans and securities is reported on a fully taxable equivalent basis using a 34% rate. (4) Net interest spread represents the difference between the average yield on interest-earning assets and the average rate on interest-bearing liabilities. (5) Net interest margin represents the net interest income as a percentage of average interest earning assets. 19 NET INTEREST DIFFERENTIAL The following table illustrates the summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the major components of interest-earning assets and interest-bearing liabilities on a fully taxable equivalent basis for the periods indicated (dollars in thousands).
Change Due Change Total Change Due Change Due Total to Due to Changes to to Changes Volume Rate 2003/2002 Volume Rate 2002/2001 ---------- ------- --------- ---------- ---------- --------- INTEREST INCOME ATTRIBUTABLE TO: Loans $ 2,666 $(2,731) $ (65) $ 938 (2,451) $(1,513) Securities available for sale (562) 80 (482) 543 (243) 300 FHLB and FRB Stock 4 (13) (9) 7 (4) (34) Interest-bearing deposits (27) 3 (24) 7 15 22 Federal funds sold 107 (42) 65 (25) (86) (111) ------- ------- ------- ------- ------ ------- Total interest income 2,188 (2,703) (515) 1,470 (2,806) (1,336) INTEREST EXPENSE ATTRIBUTABLE TO: Demand deposits 285 (365) (80) 306 (563) (257) Savings deposits 68 (191) (123) 81 (110) (29) Time deposits (161) (1,348) (1,509) (624) (2,421) (3,045) Securities sold under repo agreement 38 (39) (1) 34 (28) 6 Federal funds purchased (21) 0 (21) 35 (45) (10) Federal Home Loan Bank advances 832 (259) 573 511 (75) 436 ------- ------- ------- ------- ------ ------- Total interest expense 1,041 (2,202) (1,161) 343 (3,242) (2,899) Net interest income $ 1,147 $ (501) $ 646 $ 1,127 $ 436 $ 1,563 ======= ======= ======= ======= ======= =======
Results of Operations The Company reported net income of $3.8 million, $4.8 million, and $4.4 million for the years ended 2003, 2002, and 2001, respectively. During the same periods, basic and diluted earnings per share were $1.27, $1.59, and $1.47, respectively. The decrease in net income in 2003 is a result of a large provision made to loan loss provision due to higher than usual chargeoffs in 2003. The majority of the charge-offs was related to one commercial loan borrower. See the "Provision for Loan Loss" section for further discussion. Net interest income increased to $13.6 million in 2003 from $13.0 million in 2002 and $11.6 million in 2001. Noninterest income remained at $1.5 million in 2003, 2002 and 2001, while noninterest expense was $6.9 million, $7.1 million, and $6.6 million for the respective years. Return on average assets was 1.11%, 1.55%, and 1.53% in 2003, 2002, and 2001, respectively. Return on average equity was 11.53%, 14.74%, and 15.00%, for the respective years. Net Interest Income Net interest income increased to $13.6 million in 2003 from $13.0 million in 2002 and $11.6 million in 2001, representing an increase of 4.7% and 11.5% in 2003 and 2002, respectively. The Company's tax equivalent yield on average interest-earning assets decreased to 6.46% in 2003 from 20 7.33% in 2002, which was lower than the 8.33% yield in 2001. The decrease in yield is primarily a result of the Bank's declining Prime Rate, real estate contractual repricing to a lower rate, the prepayment of higher yielding loans and the origination of lower yielding loans. Additionally, to a lesser extent, the yield decrease is a result of a decrease in yields on the investment portfolio during the year. Because a large portion of commercial loans are tied to the Prime Rate, the unusual decline in interest rates negatively impacted our yield. The interest and fees on loans decreased 2.7% during 2003. The decrease in interest and fees was primarily due to the low interest rate environment. The Company's average interest-earning assets increased approximately $31.4 million or 10.8% in 2003 and $19.0 million or 6.9% in 2002. The higher growth rate in 2003 as compared to 2002 is primarily due to the bank offering a fixed rate 1-4 family loan that had not been offered in the past. Historically the bank sold fixed rate 1-4 family loans to independent parties. The bank has increased its fixed rate 1-4 family loans by approximately $26 million as of December 31, 2003 from December 31, 2002. The previously mentioned decline in interest rates also impacted the Company's interest expense. Falling interest rates caused interest expense to decrease 14.8% to $6.7 million in 2003 as compared to $7.9 million in 2002 while the average interest-bearing liabilities increased $30.3 million, or 12.3%, during 2003 as compared to $13.9 in 2002. The cost of funds decreased to 2.44% in 2003 from 3.21% in 2002. The average balance of certificates of deposit decreased $4.2 million, or 3.1%, in 2003 while other interest bearing deposits increased by $18.3 million. The fluctuation in cost of funds and certificate of deposit growth between each year can be largely attributed to the changing interest rate environment. The Company's tax equivalent net interest margin was 4.38% in 2003, 4.63% in 2002 and 4.37% in 2001. The decrease in net interest margin in 2003 was primarily due to the recording of lower yielding 1-4 family loans. The increase in 2002 from 2001 was primarily attributable to the Company's decreased cost of funds. The Company's securities portfolio experienced a decrease in average balances and an increase in yield during 2003. The average balance of the portfolio decreased $9.2 million (21.2%) as compared to 2002, and the tax equivalent yield increased to 6.33% in 2003 from 6.10% in 2002. The increase in yield is primarily due to the shift in the mix of the portfolio. The company did not replace the higher yielding mortgage back securities with a lower reinvestment rate. The portfolio now contains a proportionally larger percentage of higher yielding tax-exempt municipals. The Company's reinvestment rate was lower in 2003 than in 2002 and 2001. For further information, see the table titled "Consolidated Average Balance Sheets and Taxable Equivalent Income/Expense and Yields/Rates" in the Selected Statistical Information. Provision for Loan Losses The provision for loan losses was $2,907,000 in 2003, $436,000 in 2002 and $177,000 in 2001. The increase in the provision in 2003 was due to an increased number of charge-offs in the commercial and agricultural credit. Management increased the provision for loan losses to reflect the increased loan losses in 2003 and its current assessment of the loan portfolio characteristics during the year. Net charge-offs in 2003 were $2,580,000 compared to $290,000 in 2002 and $128,000 in 2001. The ratio of the allowance for loan losses as a percentage of total loans at December 31 was 0.84% in 2003, 0.85% in 2002, and .88% in 2001. For further information about the provision and management's methodology for estimating the allowance for loan losses, see "Allowance for Loan Losses" and "Critical Accounting Policies" within Management's Discussion and Analysis. 21 Noninterest Income Total noninterest income was $1.5 million in 2003, 2002, and 2001. As a percentage of average assets, noninterest income was 0.44%, 0.49%, and 0.51%, in 2003, 2002, and 2001, respectively. Service charges and fees have increased slightly over the last three years due to increased charges and growth in the number of deposit accounts. Noninterest Expense Total noninterest expense was $6.9 million in 2003, $7.1 million in 2002, and $6.6 million in 2001, representing a decrease of 2.8% in 2003 and 8.1% in 2002. As a percentage of average assets, noninterest expense was 2.02%, 2.30%, and 2.28% in 2003, 2002, and 2001, respectively. Salaries and benefits expense comprises the largest component of noninterest expense, with totals of $3.1 million in 2003, $3.5 million in 2002, and $3.3 million in 2001. As a percentage of assets, salaries and benefits expense was 0.94%, 1.14%, and 1.16%, in 2003, 2002, and 2001, respectively. The average number of full-time equivalent employees was 90 in 2003, 88 in 2002, and 86 in 2001. Included in salaries and benefits expense was net pension costs of approximately $254,000 in 2003 and $145,000 in 2002, which are based upon specific actuarial assumptions, including a long-term rate of return of 7.50%. Management believes the rate of return is a reasonable assumption of projected equity and bond indices long-term return projections as well as actual long-term historical plan returns realized. Management will continue to evaluate the actuarial assumptions, including the expected rate of return, annually, and will adjust the assumptions as necessary. The Company based its determination of pension expense on a market-related valuation of assets. Investment gains or losses are computed as the difference between the expected return calculated using the market-related value of assets and the actual return based on the market-related value of assets. The future value of assets will be impacted as previously deferred gains or losses are recognized. The discount rate that the Company utilizes for determining future pension obligations decreased to 6.00% in 2003 from 6.50% in 2002, based on management's evaluation of current yields on long-term yields on highly-rated bonds. Lowering the expected long-term rate of return on plan assets or the discount rate by .25% would not have had a significant impact on pension expense in 2003. II. FINANCIAL CONDITION Assets The Company's total assets increased to $352.4 million in 2003 from $318.8 million in 2002, representing an increase of 10.5%. Average total assets increased to $341.0 million in 2003 from $308.4 million in 2002, an increase of 10.5%. Average interest-earning assets increased to $323.0 in 2003 from $291.6 million in 2002, and remained at approximately 95% of total average assets. Securities available for sale The Company reported securities available for sale (at fair value) of $33.1 million and $40.0 million at 2003 and 2002, respectively, and average securities available for sale of $34.2 million in 2003 and $43.4 million in 2002. As a percentage of average assets, average securities were 10.03% in 2003, 22 14.0% in 2002 and 12.2% in 2001. As of December 31, 2003 and 2002, the Company did not classify any securities as trading or held to maturity. It is the general practice of management to hold securities until they are called or matured. But, by classifying securities in the available for sale category, management has the flexibility to sell the securities should the need arise. The available for sale portion of the portfolio includes mortgage-backed securities, U.S. Treasuries and municipals with an average life of 13 years, and average repricing term of 4 years, and an average tax-equivalent yield of 6.33% for the year ended December 31, 2003. Total available for sale securities consisted of the following: U.S. Treasuries and Agencies - 14%; fixed-rate mortgage-backed securities and CMO's - 24%; and fixed-rate tax-exempt municipal securities - 62%. INVESTMENT PORTFOLIO The amortized cost and fair values of securities available for sale as of December 31, 2003 and 2002 are presented in Note 2 to the consolidated financial statements. The amortized cost of securities as of December 31, 2003, 2002, and 2001, is presented below (dollars in thousands):
2003 2002 2001 ------- ------- ------- Securities available for sale: U.S. Treasury & agency obligations $ 4,532 $ 3,556 $ 2,515 Obligations of states and political subdivisions 19,749 19,476 8,588 Mortgage-backed securities 7,554 15,564 26,320 ------- ------- ------- Total securities available for sale 31,835 $38,596 $37,423 Federal Home Loan Bank stock 2,110 2,028 1,937 Federal Reserve Bank stock 120 120 120 ------- ------- ------- Total securities $34,065 $40,744 $39,480 ======= ======= =======
INVESTMENT PORTFOLIO MATURITIES The maturity distribution and weighted average interest rates of securities available for sale as of December 31, 2003, are as follows (dollars in thousands):
Less than 1 1 to 5 5 to 10 Year Years Years ------------------------------------------------------- Wtd Wtd Wtd Ave Ave Ave Amount Yield Amount Yield Amount Yield ------------------------------------------------------- Securities available for sale: U.S. Treasury and agency obligations $ 4,032 1.86% $ 0 -% $ 0- -% Obligations of states and political sub. 3,574 3.62% 3,617 5.53% 12,558 5.13% Mortgage-backed securities 123 1.93% 7,219 5.56% 83 3.13% ------- ---- ------- ---- ------- ---- Total securities available for sale $ 7,729 $10,836 $12,641 ======= ======= =======
Total Over 10 Amortized Years Cost Fair Value ------------------------------------------- Wtd Wtd Ave Ave Amount Yield Amount Yield Amount ------------------------------------------- Securities available for sale: U.S. Treasury and agency obligations $ 500 5.79% 4,532 2.30% $ 4,553 Obligations of states and political sub 0- -% 19,749 4.93% 20,700 Mortgage-backed securities 129 3.18% 7,554 5.44% 7,832 ----- ---- -------- ---- ------- Total securities available for sale $ 629 $ 31,835 $33,085 ===== ======== =======
23 The calculations of the weighted average interest rates for each maturity category are based on yield weighted by the respective costs of the securities. The weighted average rates on states and political subdivisions are computed on a taxable equivalent basis using a 34% tax rate. For purposes of the above presentation, maturities of U.S. Treasury and agency obligations and obligations of states and political subdivisions are based on average life or earliest call date; mortgage-backed securities are based on estimated maturities. Excluding those holdings of U.S. Treasury securities and other agencies of the U.S. Government, the Company did not hold any securities of any one issuer that exceeded 10% of the shareholders' equity of the Company at December 31, 2003. Loans The Company reported total loans of $288.6 million and $248.2 million at 2003 and 2002, respectively. As a percentage of average assets, average loans were 79.8% in 2003, and 77.1% in 2002. The table below shows the Company's loans outstanding at period-end by type of loan. The portfolio composition has remained relatively consistent during the three years ended December 31, 2003. Commercial and industrial loans totaled $25.1 million in 2003, representing a small decrease from $25.8 million in 2002, and $24.1 million in 2001. Residential real estate loans increased $32.0 million to $131.7 million in 2003 from $99.7 million in 2002 due to the Company's decision to hold 1-4 family fixed rate loans and increased demand by the Company's customers for home equity loans. For interest rate risk management purposes historically the company has made and held adjustable rate mortgages in its 1-4 family real estate portfolio. Commencing in 2000, the Company started originating and selling the majority of fixed-rate residential real estate loans, while holding the adjustable-rate loans in the portfolio. The Company recognizes a gain on sale of loans based on the premium received from the sale of loans to an independent party. The Company did not have any loans held for sale at December 31, 2003 and 2002. At December 31, 2003, the Company serviced approximately $956,000 of mortgage loans previously sold, for the benefit of others. The servicing asset and the related servicing fees generated from serviced loans are not material to the Company's financial statements. Commercial lending continues to be an important component of the company's loan portfolio, both real estate and industrial, because of the movement of the Company into new markets. The Company focused its commercial lending on small- to medium-sized companies in its market area, most of which are companies with long established track records. The Company expects to continue to grow in the real estate and commercial portfolios. At December 31, 2003, the Company serviced approximately $3.8 million of commercial loans previously sold, for the benefit of others. The Company will also continue to focus on agriculture lending and continue to use the Farm Service Agency (FSA) Guarantee Program which will guarantee up to 90% of the loan to qualified borrowers and therefore limits the Company's loss exposure while servicing the agricultural industry. Installment loans as a percentage of total loans outstanding has remained relatively consistent between 2003, 2002, and 2001. 24 LOAN PORTFOLIO The following table displays the loan portfolio composition at December 31 for each respective year (dollars in thousands).
% of % of % of % of % of 2003 Total 2002 Total 2001 Total 2000 Total 1999 Total ------------------------------------------------------------------------------------------ Commercial and industrial $ 25,158 8.7% $ 25,759 10.4% $ 24,126 10.8% $ 22,918 10.3% $ 19,479 10.4% Commercial real estate 60,833 21.1% 53,104 21.4% 41,917 18.7% 39,247 17.7% 33,784 18.1% Agricultural 40,362 14.0% 41,106 16.5% 34,313 15.3% 34,316 15.5% 30,511 16.3% Residential real estate 131,741 45.6% 99,728 40.2% 97,115 43.4% 99,242 44.6% 81,677 43.7% Installment 27,893 9.7% 27,122 10.9% 24,995 11.2% 24,681 11.1% 20,813 11.2% Other 2,781 0.9% 1,493 0.6% 1,267 0.6% 1,857 0.8% 499 0.3% -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total loans 288,768 100.0% $248,312 100.0% $223,733 100.0% $222,261 100.0% $186,763 100.0% Less: Net deferred loan origination fees/costs (144) (42) (6) 110 105 Allowance for loan losses (2,432) (2,106) (1,960) (1,911) (1,905) -------- -------- -------- -------- -------- Net loans $286,192 $246,164 $221,767 $220,460 $184,963 ======== ======== ======== ======== ========
The following tables show the Company's loan maturities and composition of fixed and adjustable rate loans at December 31, 2003 (in thousands).
Less than 1 Year 1 - 5 Years Over 5 Years Total ---------------------------------------------------------- Commercial real estate $ 9,819 $ 9,459 $ 41,555 $ 60,833 Commercial and industrial 8,351 9,766 7,048 25,158 Agricultural 10,175 6,639 23,548 40,362 Residential real estate 7,386 6,396 117,874 131,741 Installment 2,227 22,728 2,872 27,893 Other 875 1,180 726 2,781 ---------------------------------------------------------- Total $ 38,833 $ 56,168 $193,623 $288,624 ==========================================================
Predetermined Floating or Rates Adjustable Rates Total ---------------------------------------- Commercial real estate $ 13,119 $ 47,714 $ 60,833 Commercial and industrial 9,547 15,618 25,165 Agricultural 10,722 29,640 40,362 Residential real estate 37,927 93,729 131,656 Installment 27,398 429 27,827 Other 2,149 632 2,781 --------------------------------------- Total $100,862 $187,762 $288,624 =======================================
Allowance for Loan Losses Federal regulations and generally accepted accounting principles require that the Company establish prudent allowances for loan losses. The Company maintains an allowance for loan losses to absorb probable loan losses inherent in the portfolio, based on evaluations of the collectibility and 25 historical loss experience of loans. Loan losses are charged and recoveries are credited to the allowance. Provisions for loan losses are based on management's review of the historical loan loss experience and such factors which, in management's judgment, deserve consideration under existing economic conditions in estimating probable loan losses. The allowance is based on ongoing assessments of the probable estimated losses inherent in the loan portfolio. The Company's methodology for assessing the appropriate allowance level consists of several key elements, described below. Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and available legal options. Included in the review of individual loans are those that are impaired as provided in Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as amended. Any specific reserves for impaired loans are measured based on the fair value of the underlying collateral. The Company evaluates the collectibility of both principal and interest when assessing the need for a specific reserve. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations. Homogenous loans, such as consumer installment and residential mortgage loans, are not individually reviewed by management. Reserves are established for each pool of loans based on the expected net charge-offs. Loss rates are based on the average five-year net charge-off history by loan category. Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the local economy, trends in the nature and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Company's internal credit review function. Specific reserves on individual loans and historical loss rates are reviewed throughout the year and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience. A portion of the allowance is not allocated to any particular loan type and is maintained in recognition of the inherent inability to precisely determine the loss potential in any particular loan or pool of loans. Among the factors used by management in determining the unallocated portion of the allowance are current economic conditions, trends in the Company's loan portfolio delinquency, losses and recoveries, level of underperforming and nonperforming loans, and concentrations of loans in any one industry. The Company has not substantively changed any aspect of its overall approach in the determination of the allowance for loan losses during 2003. There have been no material changes in assumptions or estimation techniques as compared to prior years that impacted the determination of the current year allowance. Real estate acquired, or deemed acquired, by the Company as a result of foreclosure proceedings is classified as other real estate owned ("OREO") until it is sold. Interest accrual, if any, ceases no later than the date of acquisition of the real estate, and all costs incurred from such date in maintaining the property are expensed. OREO is recorded by the Company at the lower of cost or fair value less estimated costs of disposal, and any write-down resulting there from is charged to the allowance for loan 26 losses. When the foreclosed property is sold, the difference between proceeds received on OREO and the recorded value is recognized in current earnings. As discussed above, the allowance is maintained at a level necessary to absorb probable losses in the portfolio. Management's determination of the adequacy of the reserve is based on reviews of specific loans, loan loss experience, general economic conditions and other pertinent factors. If, as a result of charge-offs or increases in risk characteristics of the loan portfolio, the reserve is below the level considered by management to be adequate to absorb probable loan losses, the provision for loan losses is increased. The allowance for loan losses was 0.84% of total loans as of December 31, 2003, a decrease from 0.85% at the end of 2002. In 2003, the Company experienced net charge-offs of $2,580,000, or 0.95% of average loans, compared to net charge-offs of $290,000 (0.12%) in 2002 and $128,000 (0.06%) in 2001. The Company recorded a provision for loan losses of $2,907,000, $436,000 and $177,000 in 2003, 2002, and 2001, respectively. As a percentage of the provision for loan losses, net charge-offs were 88.7%, 66.5%, and 72.3% in 2003, 2002, and 2001, respectively. Management increased the provision for loan losses during the year 2003 to reflect the increased actual and probable loan losses in 2003, primarily related to a certain commercial borrower, which was identified by management on July 23, 2003. The Company assessed the collateral situation of the commercial borrower and believed the collateral to be inadequate. In July 2003, the Company made a provision of $1.5 million to the loan loss reserve to cover the estimated losses. In September 2003, the Company, once more specific information was obtained, charged off $1.5 million against the loan loss reserve relating to the credit loss. The Company made an additional provision for $80,000 in September 2003 for estimated additional losses associated with this credit. The remaining collateral will be liquidated over time to cover the remaining balance of the loans. The collateral to be liquidated includes 4 residential properties, a commercial property, chattels and rolling stock. The additional charge offs mentioned above were primarily within the agricultural portfolio. In 2002 drought conditions, reduced government program payments, and average to below-average grain prices affected the repayment opportunities for these certain borrowers. Management conducted a review of its agricultural lending approval process and made modifications where necessary to strengthen its underwriting process of agricultural operating loans. Management believes its review process has adequately identified problem loans within its portfolio on a timely basis. The amount of nonaccrual loans increased to $1,462,000 in 2003 from $476,000 in 2002. As a percentage of total loans, nonaccrual loans represented .51% in 2003 and .19% in 2002. The Company would have reported additional interest income of approximately $191,000, $79,000 and $49,000 in 2003, 2002 and 2001, respectively, if nonaccrual loans had been accruing interest. The increase in nonaccrual loans is largely due to a single commercial borrower whose nonaccrual borrowings total $888,000. These borrowings are secured with 4 residences, a commercial property, chattels, and rolling stock, all of which will be liquidated to repay these borrowings. Management will closely monitor the liquidation of collateral to assure adequate proceeds are available to fully repay the associated loans. Interest income from nonaccrual loans of approximately $4,000 has been included in net income in 2003 and $2,000 in 2002 and 2001. Nonaccrual loans at December 31, 2003 consisted of 14 relationships. Nonaccrual loans are expected to be resolved through payments or through liquidation of collateral in the normal course of business. Management estimates losses from these nonaccual loans to be approximately $6,000, which has been included in the allowance for loan losses. The category of accruing loans which are past due 90 days or more increased at December 31, 2003 to $1,441,000 as compared to $1,133,000 at December 31, 2002. As a percentage of total loans, loans past due 90 days and still accruing interest represented 0.51% in 2003 and 0.46% in 2002. 27 Management has analyzed these credits as to the borrower's current circumstances, value of the security pledged and the likely ultimate disposition of these loans. In management's opinion, appropriate specific reserves have been allocated to absorb any probable loss and these accounts are expected to be resolved through payments or liquidation of collateral in the normal course of business. The $1,441,000 of delinquent loans is represented by 38 accounts as follows: - 14 residential real estate accounts with outstanding balances of $719,000 of which $64,000 has been included as a specific reserve in the allowance for loan losses; - 7 commercial loan accounts with outstanding balances of $589,000 of which $76,000 has been specifically reserved; - 17 consumer installment loans with outstanding balances of $133,000 of which $12,000 has been specifically reserved; As a percentage of the allowance for loan losses, total nonaccrual loans and loans past due 90 days or more were 119.5% in 2003 and 76.4% in 2002. ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses for the years ended December 31 are as follows (in thousands).
2003 2002 2001 2000 1999 -------- -------- -------- -------- -------- Balance, beginning of period $ 2,106 $ 1,960 $ 1,911 $ 1,905 $ 1,911 Loans charged-off: Commercial and industrial 582 44 34 42 31 Commercial real estate 1,050 - - - - Agricultural 648 67 - - - Residential real estate 152 91 9 - 5 Installment 175 154 139 161 123 -------- -------- -------- -------- -------- Total charge-offs $ 2,607 356 182 203 159 Recoveries of loans previously charged-off: Commercial and industrial 8 22 3 5 1 Commercial real estate - - - - - Agricultural - - - - - Residential real estate 2 - 5 - - Installment 18 44 46 27 22 -------- -------- -------- -------- -------- Total recoveries 28 66 54 32 23 Net charge-offs 2,579 290 128 171 136 Provision for loan losses 2,907 436 177 177 130 -------- -------- -------- -------- -------- Balance, end of period $ 2,432 $ 2,106 $ 1,960 $ 1,911 $ 1,905 ======== ======== ======== ======== ======== Allowance to loans, end of year 0.84% 0.85% 0.88% 0.86% 1.02% Ratio of net charge-offs to average loans 0.95% 0.12% 0.06% 0.08% 0.08% outstanding Loan balance, end of year $288,624 $248,270 $223,727 $222,372 $186,868 Total average loans $272,013 $237,788 $227,150 $210,325 $176,738
28 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The following table indicates the portion of the loan loss reserve management has allocated to each loan type at December 31 (in thousands).
2003 2002 2001 2000 1999 ------ ------ ------ ------ ------ Commercial and industrial $521 $371 $315 $271 $197 Commercial real estate 445 276 648 603 743 Agricultural 482 676 274 255 295 Residential real estate 554 402 334 311 383 Installment 325 284 283 248 254 Other 12 - 10 16 5 Unallocated 93 97 96 207 28 ------ ------ ------ ------ ------ Balance, end of year $2,432 $2,106 $1,960 $1,911 $1,905 ====== ====== ====== ====== ======
NONPERFORMING ASSETS The following table represents the total of nonaccrual loans and loans 90 days past due and accruing interest at December 31 (in thousands).
2003 2002 2001 2000 1999 ------ ------ ----- ---- ---- Loans accounted for on nonaccrual basis $1,462 $ 476 $ 383 $319 $244 Accruing loans which are past due 90 days or more 1,441 1,133 1,649 668 442 Restructured loans - - - - - ------ ------ ------ ---- ---- Total $2,903 $1,705 $2,032 $987 $686 ====== ====== ====== ==== ====
Deposits Deposits have traditionally been the primary source of the Company's funds for use in lending and other investment activities. In addition to deposits, the Company derives funds from interest payments and principal repayments on loans and income on earning assets. Loan payments are a relatively stable source of funds, while deposit inflows and outflows fluctuate more in response to general interest rates and money market conditions. Deposits are attracted principally from within the Company's market area through the offering of numerous deposit instruments, including checking accounts, regular passbook savings accounts, NOW accounts, money market deposit accounts, term certificate accounts and individual retirement accounts ("IRAs"). Interest rates paid, maturity terms, service fees and withdrawal penalties for the various types of accounts are established periodically by the Company's management based on the Company's liquidity requirements, growth goals and market trends. 29 The table below presents a summary of period end deposit balances. The composition of deposit categories has remained relatively consistent as a percentage of total deposits throughout the three-year period ended December 31, 2003. As a percentage of total deposits, interest-bearing demand accounts have remained constant at 24% in 2003 and 2002, while certificates of deposits (less than $100,000) have decreased to 37% in 2003 from 40% in 2002. This shift was caused by the lower rate environment in 2003 and a slightly less aggressive marketing strategy. Savings and money market accounts have only a 1% increase from 2002 as a percentage of deposits. Certificates of deposit $100,000 and over are primarily short-term public funds. Balances of such large certificates fluctuate depending on the Company's pricing strategy and funding needs at any particular time and were comparable as a percentage of total deposits in 2003 and 2002. Interest rates, maturity terms, service fees, and withdrawal penalties for the various types of accounts are established periodically by management based on the Company's liquidity requirements, growth goals and market trends. The amount of deposits currently from outside the Company's market area is not significant. DEPOSIT COMPOSITION The following table indicates the total deposits by type at December 31 (dollars in thousands):
Percent Percent Percent 2003 of 2002 of 2001 of Amount Total Amount Total Amount Total -------- ------- -------- ------- ------ -------- Noninterest-bearing demand deposits $ 31,693 12% $ 30,195 12% $ 31,220 12% Interest-bearing demand deposits 64,645 24% 63,755 24% 59,012 22% Money market deposits 19,426 7% 16,150 6% 8,618 3% Savings 24,384 9% 21,852 9% 18,350 7% Time deposits greater than $100 29,799 11% 27,296 10% 30,618 12% Other time deposits 100,485 37% 103,468 40% 114,790 44% -------- --- -------- --- -------- --- Total $270,432 100% $262,716 100% $262,608 100% ======== === ======== === ======== ===
The following table indicates the average amount of and the average rate paid on deposit categories which exceeded 10% of average total deposits at December 31 (in thousands):
2003 2002 2001 Amount Rate Amount Rate Amount Rate -------- ----- -------- ----- -------- ------ Noninterest-bearing demand deposits $ 29,086 $ 28,960 $ 25,398 - Interest-bearing demand deposits 83,020 1.56% 2.00% 57,938 2.82% including money market deposits 68,787 Time deposits greater than $100 29,909 2.65% 27,798 3.61% 31,690 5.33% Other time deposits 101,253 2.83% 107,565 3.88% 114,803 5.69% -------- ---- -------- ---- -------- ---- $243,268 $233,110 $229,829 ======== ==== ======== ==== ======== ====
30 MATURITIES OF TIME DEPOSITS GREATER THAN $100,000 The following table indicates the amount of the Company's time deposits greater than $100,000 by time remaining until maturity as of December 31, 2003(dollars in thousands): Three months or less $ 3,325 Over three through 6 months 6,617 Over six through 12 months 9,901 Over 12 through 60 months 9,956 ------- Total $29,799 =======
Other Borrowings Periodically, the Company will borrow long term money from the Federal Home Loan Bank (FHLB) as a way to provide funding for loan demand. At December 31, 2003, the Company had outstanding $43.7 million of total borrowings from the FHLB with a weighted average cost of 4.11%. Borrowings of $7 million consist of three fixed-rate notes with maturities in 2008 and 2010. At the option of the FHLB, these notes can be converted at certain dates to instruments that adjust quarterly at the three-month LIBOR rate. The note amount and nearest optional conversion dates at December 31, 2003, are $3 million in March 2004; $1 million in April 2004; and $3 million in March 2004 if the three month LIBOR reaches 8%. The Company borrowed a $500,000 amortizing note to match against a loan to earn a 2.55% spread. Additionally, the Company utilized a borrowing of $10 million, due in 2012, with a rate that can adjust quarterly if the three-month LIBOR reaches 7.75%. With the funds, the Company purchased $10 million in securities classified as available for sale with an average yield of 5% and call features ranging from 2011 to 2013, resulting in a net spread of 2.7% on the borrowing. The Company began keeping fixed rate 1-4 family mortgages in-house. To fund these loans the Company borrowed long term money from the FHLB to lock in a spread and match the amortization with the average life of the loan. The Company borrowed funds with a maturities ranging from 10 to 20 years with all of them having a 10% annual principal prepayment rate. The average life of these loans is approximately 5 years. The average rate on the borrowings is 3.54%. The balance on these borrowings is $26.6 million as of December 31, 2003. Capital The declaration and payment of dividends by the Company are subject to the discretion of the Board of Directors and to the earnings and financial condition of the Company and applicable laws and regulations. The dividend payout ratio was increased to 50.1% in 2003 from 37.7% in 2002. At December 31, 2003 consolidated Tier 1 risk based capital was 10.57%, and total risk-based capital was 11.39%. The minimum Tier 1 and total risk-based capital ratios required by the Board of Governors of the Federal Reserve are 4% and 8%, respectively. 31 Liquidity Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as company cash needs, are met. The Company manages liquidity on both the asset and liability sides of the balance sheet. Community bank liquidity management currently involves the challenge of attracting deposits while maintaining positive loan growth at a reasonable interest rate spread. The loan to deposit ratio at December 31, 2003, was 106.7%, compared to 94.5% in 2002. Loans to total assets were 81.9% at the end of 2003, compared to 77.9% in 2002. The securities portfolio is available for sale and consists of securities that are readily marketable. Approximately 70% of the available for sale portfolio is pledged to secure public deposits, short-term and long-term borrowings and for other purposes as required by law. The balance of the available for sale securities could be sold if necessary for liquidity purposes. Also, a stable deposit base, consisting of 89% core deposits, makes the Company less susceptible to large fluctuations in funding needs. The Company also has both short- and long-term borrowings capacity available through FHLB with unused available credit of approximately $11.9 million as of December 31, 2003. The Company has the ability to obtain deposits in the brokered certificate of deposit market to help provide liquidity to fund loan growth, if necessary. Generally, the Company uses short-term borrowings to fund overnight and short-term funding needs in the Company's balance sheet. Longer-term borrowings have been primarily used to fund mortgage-loan originations. This has occurred when FHLB longer-term rates are a more economical source of funding than traditional deposit gathering activities. Additionally, the Company occasionally uses FHLB borrowings to fund larger commercial loans. Impact of Inflation, Changing Prices and Local Economic Conditions The majority of the Company's assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in non-monetary assets, such as fixed assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and on the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of general inflation. Management believes the most significant impact on financial and operating results is the Company's ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest sensitive assets and liabilities in order to protect against the effects of wide interest rate fluctuations. The Company's success is dependent on the general economic conditions of the communities we serve. Unlike larger banks that are more geographically diversified, we provide financial and banking services primarily in south central Ohio. The economies of our markets are dependent to a significant extent on the agricultural industry. The economic conditions in these areas have a significant impact on loan demand, the ability of borrowers to repay these loans, and the value of the collateral securing these loans. A significant decline in general economic conditions, and in particular the agricultural industry, could affect these local economic conditions and could negatively impact the financial results of our banking operations. Factors influencing general conditions include inflation, recession, unemployment, and other factors beyond our control. 32 Contractual Obligations and Commercial Commitments The Company has certain obligations and commitments to make future payments under contracts. At December 31, 2003, the aggregate contractual obligations and commercial commitments are:
Payments Due by Period Contractual Obligations Less than 1-3 3-5 After 5 ($ in thousands) Total One Year Years Years Years ----------------------------------------------------------------------------------------------------------- Total Deposits $ 270,432 $ 225,076 45,114 230 12 FHLB Borrowings 43,706 3,792 6,263 4,817 11,658 Repurchase Agreements 2,784 2,784 Stock Redemption Commitment 5,845 5,845 --------- --------- -------- ------- -------- Total $ 322,767 $ 237,497 $ 51,377 $ 5,047 $ 11,670
Other Commercial Commitments
Amount of Unused Commitments - Expirations by Period Less than 1-3 3-5 After 5 (in thousands) Total One Year Years Years Years ---------------------------- ------- --------- ------ ------ -------- Commitments to Extend Credit $24,508 $8,706 $2,445 $2,678 $10,669 ------- ------ ------ ------ ------- Total $24,508 $8,706 $2,445 $2,678 $10,669
The company's off balance sheet arrangement consist primarily of business and consumer lines of credit. These arrangements arise in the normal course of business. Management considers the company's liquidity to meet the funding requirements of the arrangements as they occur in the normal course of business. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. III. MARKET RISK MANAGEMENT Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to variations in interest rates, exchange rates, equity price risk and commodity prices. The Company does not maintain a trading account for any class of financial instrument, and is not currently subject to currency exchange rate risk, equity price risk or commodity price risk. The Company's market risk is composed primarily of interest rate risk. The major source of the Company's interest rate risk is the difference in the maturity and repricing characteristics between the Company's core banking assets and liabilities - loans and deposits. This difference, or mismatch, poses a risk to net interest income. Most significantly, the Company's core banking assets and liabilities are mismatched with respect to repricing frequency, maturity and/or index. Most of the Company's commercial loans, for example, reprice rapidly in response to changes in short-term interest. In contrast, many of the Company's consumer deposits reprice slowly, if at all, in response to changes in market interest rates. 33 The Company's Senior Management is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by senior management are approved by the Company's Board of Directors. The primary goal of the asset/liability management function is to maximize net interest income within the interest rate risk limits set by approved guidelines. Techniques used include both interest rate gap management and simulation modeling that measures the effect of rate changes on net interest income and market value of equity under different rate scenarios. The interest rate gap analysis schedule quantifies the asset/liability static sensitivity as of December 31, 2003. As shown, the Company was asset-sensitive through 3 months, liability-sensitive 3 through 12 months, and asset-sensitive within the one- to five-year period. The cumulative gap as a percent of total assets through one year at the end of 2003 was 7.62%. The balances of transaction type NOW and MMDA accounts are scheduled to run off over their expected lives. Although the entire balance of these deposits is subject to repricing or withdrawal in a relatively short period of time, they have demonstrated over time to be a stable base of retail core deposits for the company. Also, their sensitivity to changes in interest rates is significantly less than some other deposits, such as certificates of deposits. INTEREST RATE GAP ANALYSIS The following table displays the Company's interest rate gap analysis at December 31, 2003 (in thousands):
Total 0-3 Months 3-6 Months 6-12 Months 1-5 Years 5+ Years -------- ---------- ---------- ----------- --------- --------- Loans $288,624 $61,260 $20,746 $ 41,492 $122,295 $ 42,831 Securities 33,085 2,274 3,677 4,203 9,196 13,735 FHLB/FRB Stock 2,230 2,110 120 Short-term funds 8,625 8,625 - - - - -------- ------- -------- -------- -------- -------- Total earning assets $332,564 $74,269 $24,543 $ 45,695 $131,491 $ 56,566 -------- ------- -------- -------- -------- -------- Interest-bearing deposits $108,455 $6,544 $6,544 $ 13,087 $ 50,162 $ 32,118 Time deposits 130,284 18,300 20,492 46,137 45,343 12 Short-term borrowings 2,784 2,186 598 - - - Long-term debt 43,706 999 931 1,862 11,080 28,834 -------- ------- -------- -------- -------- -------- Total interest-bearing liabilities $285,229 $28,029 $28,565 $ 61,086 $106,585 $ 60,964 -------- ------- -------- -------- -------- -------- Period gap $ 47,335 $46,240 $ (4,022) $(15,391) $ 24,906 $ (4,398) Cumulative gap - $46,240 $ 42,218 $ 26,824 $ 51,733 $ 47,335 Gap as a percentage of assets - 13.13% 11.99% 7.62% 14.69% 13.44%
In the Company's simulation models, each asset and liability balance is projected over a time horizon. Net interest income is then projected based on expected cash flows and projected interest rates under a stable rate scenario and analyzed. The results of this analysis are factored into decisions made concerning pricing strategies for loan and deposits, balance sheet mix, securities portfolio strategies, liquidity and capital adequacy. Simulation models are also performed under an instantaneous parallel 200 basis point increase or decrease in interest rates. The model includes assumptions as to repricing and expected prepayments, anticipated calls, and expected decay rates of transaction accounts under the different rate scenarios. The results of these simulations include changes in both net interest income and market value of equity. The Company's rate shock simulation models provide results in extreme interest rate 34 environments and results are used accordingly. Reacting to changes in economic conditions, interest rates and market forces, the Company has been able to alter the mix of short and long-term loans and investments, and increase or decrease the emphasis on fixed and variable rate products in response to changing market conditions. By managing the interest rate sensitivity of its asset composition in this manner, the Company has been able to maintain a fairly stable flow of net interest income. Complicating management's efforts to control non-trading exposure to interest rate risk is the fundamental uncertainty of the maturity, repricing, and/or runoff characteristics of some of the Company's core banking assets and liabilities. This uncertainty often reflects options embedded in these financial instruments. The most important embedded options are contained in consumer deposits and loans. For example, many of the Company's interest bearing retail deposit products (e.g., interest checking, savings and money market deposits) have no contractual maturity. Customers have the right to withdraw funds from these deposit accounts freely. Deposit balances may therefore run off unexpectedly due to changes in competitive or market conditions. To forestall such runoff, rates on interest bearing deposits may have to be increased more (or reduced less) than expected. Such repricing may not be highly correlated with the repricing of prime rate-based or U.S. Treasury-based loans. Finally, balances that leave the banking franchise may have to be replaced with other more expensive retail or wholesale deposits. Given the uncertainties surrounding deposit runoff and repricing, the interest rate sensitivity of core bank liabilities cannot be determined precisely. The following table indicates the Company's interest rate-sensitive instruments and their repricing year and current average yield/(cost) for the periods ended December 31 (in thousands).
Later 2004 2005 2006 2007 2008 Years Total Fair Value -------- ------- ------- ------ ------- -------- -------- ---------- Fixed rate loans 37,250 13,486 9,732 6,121 4,070 29,097 99,756 100,265 Average interest rate 6.75% 7.36% 7.20% 7.13% 6.69% 6.31% Adjustable rate loans 102,732 26,127 27,053 9,711 21,207 1,985 188,868 189,376 Average interest rate 5.44% 6.76% 6.21% 7.00% 6.09% 7.20% Securities(1) 12,013 350 555 341 27 20,777 34,064 35,315 Average interest rate 3.12% 5.36% 5.52% 6.33% 5.20% 5.45% Interest-bearing time deposits 84,929 42,914 2,220 126 103 12 130,284 130,517 Average interest rate 2.30% 3.15% 3.15% 2.35% 3.82% 4.74% Interest-bearing demand deposits 108,455 - - - - - 108,455 108,455 Average interest rate 1.41% - - - - - Short-term borrowings 2,784 - - - - - 2,784 2,784 Average interest rate 2.61% - - - - - Long-term debt - - - - - 43,706 43,706 41,492 Average interest rate - - - - - 4.11%
(1) For the purpose of this table, securities include FHLB Stock and FRB Stock 35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Registrant's consolidated audited financial statements and the report of its independent auditor are attached hereto as an exhibit 99. The selected quarterly financial data is provided under Item 5 of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ITEM 9A. CONTROLS AND PROCEDURES The Registrant maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Registrant's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Registrant's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of "disclosure controls and procedures" in Exchange Act Rules 13a-15(e) and 15d-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Registrant has carried out an evaluation, under the supervision and with the participation of the Registrant's management, including the Registrant's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures. Based on the foregoing, the Registrant's Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Registrant's disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Registrant files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required. The Registrant also conducted an evaluation of internal controls over financial reporting to determine whether any changes occurred during the quarter ended December 31, 2003, that have materially affected, or are reasonably likely to materially affect, the Registrant's internal control over financial reporting. Based on this evaluation, there has been no such change during the quarter that ended December 31, 2003. 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Certain information required by this item is set forth in the Company's definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held April 27, 2004 under the sections captioned "ELECTION OF DIRECTORS AND VOTING PROCEDURES," "EXECUTIVE COMPENSATION AND RELATED ITEMS" and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE," and is incorporated herein by reference. The Board of Directors has determined that the Company does not have an audit committee financial expert servings on its audit committee. However, the Board of Directors believes that each audit committee member has sufficient knowledge in financial and auditing matters to effectively serve on the committee. At this time, the Board does not believe it is necessary to actively search for an outside person to serve on the Board who would qualify as a financial expert. The Company has adopted a code of ethics that applies to its principal executive, financial and accounting officers. A copy of the Company's code of ethics will be provided without charge to any person submitting a written request for the code of ethics. All such requests should be submitted to the attention of Ms. Nancy Hendrickson at the address of the main office of the Company. ITEM 11. EXECUTIVE COMPENSATION. The information required by this item is set forth in the Company's definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held April 27, 2004 under the section captioned "EXECUTIVE COMPENSATION AND RELATED ITEMS," and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information required by this item is set forth in the Company's definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held April 27, 2004 under the section captioned "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND Management," and is incorporated herein by reference. The Company currently has no securities authorized for issuance under equity compensation plans which would require the disclosures mandated by Section 201(d) of Regulation S-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this item is set forth in the Company's definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held April 27, 2004 under the section captioned "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS," and is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is set forth in the Company's definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held April 27, 2004 under the section captioned "INDEPENDENT PUBLIC ACCOUNTANT" and is incorporated herein by reference. 37 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. A. Annual Financial Statements Independent Auditors' Report Consolidated Balance Sheets, December 31, 2003 and 2002 Consolidated Statements of Income, Years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Changes in Shareholders' Equity Years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows, Years ended December 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements, December 31, 2003, 2002 and 2001 B. Reports on Form 8-K No reports on Form 8-K were filed by the registrant during its fiscal quarter ended December 31, 2003. C. Exhibits (3) Corporate Governance Items 3.1 Articles of Incorporation, filed as Exhibit (3)(I) to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. 3.2 Code of Regulations, filed as Exhibit (3)(II) to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. (10) Material Contracts: 10.1 The Merchants National Bank Defined Benefit Retirement Plan, filed as Exhibit 10.1 to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. 10.2 The Merchants National Bank Profit Sharing and 401(k) Savings Retirement Plan and Trust, filed as Exhibit 10.2 to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. - Defined Contribution Prototype Plan; and - Non-Standardized 401(k) Savings Plan and Trust Prototype Plan Adoption Agreement 10.3 The Merchants National Bank Profit Sharing Bonus Plan, filed as Exhibit 10.3 to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. 10.4 The Merchants National Bank of Hillsboro, Ohio Executive Investment Plan, filed as Exhibit 10.4 to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. 10.5 The Merchants National Bank Directors' Deferred Compensation Plan, filed as Exhibit 10.5 to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. 38 (21) Subsidiaries of the Registrant, filed as Exhibit (21) to the Form 10 filed with the SEC on April 30, 2002 and incorporated herein by reference. Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer and Chief Financial Officer (31) Rule 13a-14(a) Certification (32) Section 1350 Certification (99) Independent Auditors' Report and Consolidated Financial Statements 39 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act or 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. Merchants Bancorp, Inc. --------------------------------- (Registrant) Date March 30, 2004 By /s/ Paul W. Pence, Jr. --------------------------------- Paul W. Pence, Jr., President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date March 30, 2004 By /s/ Paul W. Pence, Jr. -------------------------------------------- Paul W. Pence, Jr. Principal Executive Officer, Principal Financial Officer and Director Date March 30, 2004 By /s/ James D. Evans -------------------------------------------- James D. Evans, Principal Accounting Officer Date March 30, 2004 By /s/ Donald Fender, Jr. -------------------------------------------- Donald Fender, Jr., Director Date March 30, 2004 By /s/ Richard S. Carr -------------------------------------------- Richard S. Carr, Director Date March 30, 2004 By /s/ James R. Vanzant -------------------------------------------- James R. Vanzant, Director Date March 30, 2004 By /s/ Robert Hammond -------------------------------------------- Robert Hammond, Director Date March 30, 2004 By /s/ William Butler -------------------------------------------- William Butler, Director Date March 30, 2004 By /s/ Charles A. Davis -------------------------------------------- Charles A. Davis, Director Date March 30, 2004 By /s/ Jack Walker -------------------------------------------- Jack Walker, Director 40 EXHIBIT INDEX
Exhibit Page Number Number Exhibit Description ------- ------ ----------------------------------------------------------- 3.1 N/A Articles of Incorporation(1) 3.2 N/A Code of Regulations(1) 10.1 N/A Merchants National Bank Defined Benefit Retirement Plan(1) 10.2 N/A Merchants National Bank Profit Sharing and 401(k) Savings Retirement Plan and Trust(1) 10.3 N/A Merchants National Bank Profit Sharing Bonus Plan(1) 10.4 N/A Merchants National Bank of Hillsboro, Ohio Executive Investment Plan(1) 10.5 N/A Merchants National Bank Directors' Deferred Compensation Plan(1) 21 N/A Subsidiaries of the Registrant(1) 31 42 Rule 13a-14(a) Certification 32 43 Section 1350 Certification 99 44 Independent Auditors' Report and Consolidated Financial Statements
(1) Incorporated by reference to the Company's Form 10 filed with the SEC on April 30, 2002 41