-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QCqoADAeOOKLZ6XntyZub0Bmw3gC+f4nGIm5Of8jco1MhKjx4JpgWWfdcIsCDh7Q SmFTyak2MfgUpUge8NPWLg== 0000908834-00-000050.txt : 20000331 0000908834-00-000050.hdr.sgml : 20000331 ACCESSION NUMBER: 0000908834-00-000050 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LINCOLN BANCORP /IN/ CENTRAL INDEX KEY: 0001070259 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 352055553 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-25219 FILM NUMBER: 586216 BUSINESS ADDRESS: STREET 1: 1121 EAST MAIN STREET CITY: PLAINFIELD STATE: IN ZIP: 46168-0510 BUSINESS PHONE: 3178396539 MAIL ADDRESS: STREET 1: 1121 EAST MAIN STREET CITY: PLAINFIELD STATE: IN ZIP: 46168-0510 10-K405 1 FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (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, 1999 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 000-25219 LINCOLN BANCORP (Exact name of registrant as specified in its charter) INDIANA 35-2055553 (State or other Jurisdiction (I.R.S. Employer Identification of Incorporation or Organization) Number) 1121 East Main Street Plainfield, Indiana 46168 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number including area code: (317) 839-6539 Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, Without Par Value (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. (N/A) The aggregate market value of the issuer's voting stock held by non-affiliates, as of March 27, 2000 was $49,277,000. The number of shares of the Registrant's Common Stock, without par value, outstanding as of March 27, 2000, was 5,892,725 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the year ended December 31, 1999, are incorporated into Part II. Portions of the Proxy Statement for the 2000 Annual Meeting of Shareholders are incorporated in Part I and Part III. Exhibit Index on Page E-1 Page 1 of 39 Pages LINCOLN BANCORP Form 10-K INDEX Page Forward Looking Statement.................................................... PART I Item 1 Business..................................................... Item 2. Properties................................................... Item 3. Legal Proceedings............................................ Item 4. Submission of Matters to a Vote of Security Holders.......... Item 4.5. Executive Officers of the Registrant......................... PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters...................................... Item 6. Selected Financial Data...................................... Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... Item 7A. Quantitative and Qualitative Disclosures about Market Risks.. Item 8. Financial Statements and Supplementary Data.................. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................... PART III Item 10. Directors and Executive Officers of Registrant............... Item 11. Executive Compensation....................................... Item 12. Security Ownership of Certain Beneficial Owners and Management................................ Item 13. Certain Relationships and Related Transactions............... PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................. SIGNATURES ......................................................... FORWARD LOOKING STATEMENT This Annual Report on Form 10-K ("Form 10-K") contains statements which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-K and include statements regarding the intent, belief, outlook, estimate or expectations of the Holding Company (as defined below), or its directors or officers primarily with respect to future events and the future financial performance of the Holding Company. Readers of this Form 10-K are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward looking statements as a result of various factors. The accompanying information contained in this Form 10-K identifies important factors that could cause such differences. These factors include changes in interest rates; loss of deposits and loan demand to other savings and financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; regulatory changes; or unanticipated results in pending legal proceedings. Item 1. Business General Lincoln Bancorp (the "Holding Company" and together with the Bank, as defined below, the "Company") is an Indiana corporation organized in September, 1998 to become a savings and loan holding company upon its acquisition of all the issued and outstanding capital stock of Lincoln Federal Savings Bank ("Lincoln Federal" or the "Bank") in connection with the Bank's conversion from mutual to stock form. The Holding Company became the Bank's holding company on December 30, 1998. The principal asset of the Holding Company currently consists of 100% of the issued and outstanding shares of capital stock, $.01 par value per share, of the Bank. Lincoln Federal was originally organized in 1884 as Ladoga Federal Savings and Loan Association, located in Ladoga, Indiana. In 1979 Ladoga Federal merged with Plainfield First Federal Savings and Loan Association, a federal savings and loan association located in Plainfield, Indiana which was originally organized in 1896. Following the merger, the Bank changed its name to Lincoln Federal Savings and Loan Association and, in 1984, adopted its current name, Lincoln Federal Savings Bank. Lincoln Federal currently conducts its business from six full-service offices located in Hendricks, Montgomery, Clinton and Morgan Counties, Indiana, with its main office located in Plainfield. Lincoln Federal opened its newest offices in Avon, Indiana in January, 1999 and Mooresville, Indiana in April, 1999. The Bank's principal business consists of attracting deposits from the general public and originating fixed-rate and adjustable-rate loans secured primarily by first mortgage liens on one- to four-family residential real estate. Lincoln Federal's deposit accounts are insured up to applicable limits by the SAIF of the FDIC. Lincoln Federal offers a number of financial services, including: (i) one- to four-family residential real estate loans; (ii) commercial real estate loans; (iii) real estate construction loans; (iv) land loans; (v) multi-family residential loans; (vi) consumer loans, including home equity loans and automobile loans; (vii) commercial loans; (viii) money market demand accounts ("MMDAs"); (ix) savings accounts; (x) checking accounts; (xi) NOW accounts; and (xii) certificates of deposit. Lending Activities The Bank has historically concentrated its lending activities on the origination of loans secured by first mortgage liens for the purchase, construction or refinancing of one- to four-family residential real property. One- to four-family residential mortgage loans continue to be the major focus of Lincoln Federal's loan origination activities, representing 72.2% of its total loan portfolio at December 31, 1999. Lincoln Federal also offers commercial real estate loans, real estate construction loans and consumer loans. To a limited extent, Lincoln Federal also offers multi-family loans, land loans and commercial loans. Commercial real estate loans totaled approximately 6.6% of the Bank's total loan portfolio, and real estate construction loans totaled approximately 7.5% of Lincoln Federal's total loans as of December 31, 1999. Consumer loans, which consist primarily of home equity and second mortgage loans, have increased significantly in the past two years from $20.6 million, or 8.1% of Lincoln Federal's loan portfolio at December 31, 1997, to $28.6 million, or 11.8% of its loan portfolio at December 31, 1999. Loan Portfolio Data. The following table sets forth the composition of Lincoln Federal's loan portfolio (including loans held for sale) by loan type and security type as of the dates indicated, including a reconciliation of gross loans receivable after consideration of the allowance for loan losses, deferred loan fees and loans in process.
At December 31, 1999 1998 1997 1996 1995 Percent Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) TYPE OF LOAN Real estate mortgage loans: One-to-four-family residential (1)........... $175,095 72.18% $152,893 76.19% $205,976 81.03% $269,618 84.84% $248,947 84.48% Multi-family................... 1,029 .42 1,022 .51 1,133 .45 1,111 .35% 1,012 .34 Commercial real estate......... 16,073 6.63 14,548 7.25 14,914 5.87 14,830 4.66% 15,727 5.34 Construction................... 18,127 7.47 7,411 3.69 9,912 3.90 13,159 4.14% 7,838 2.66 Land........................... 3,609 1.49 2,664 1.33 1,455 .57 2,725 .86% 9,877 3.35 Commercial........................ 91 .04 122 .06 242 .10 --- --- --- --- Consumer loans: Home equity and second mortgages............. 24,272 10.01 18,482 9.21 17,218 6.77 13,239 4.17 7,858 2.67 Other.......................... 4,282 1.76 3,532 1.76 3,340 1.31 3,124 .98 3,409 1.16 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Gross loans receivable....... $242,578 100.00% $200,674 100.00% $254,190 100.00% $317,806 100.00% $294,668 100.00% ======== ====== ======== ====== ======== ====== ======== ====== ======== ====== TYPE OF SECURITY One-to-four-family residential real estate (1).. $209,379 86.31% $177,837 88.62% $232,966 91.65% $290,956 91.55% $264,142 89.64% Multi-family real estate....... 1,029 .43 1,022 .51 1,133 .45 1,111 .35 1,012 .34 Commercial real estate......... 24,188 9.97 15,498 7.72 15,054 5.92 19,890 6.26 16,229 5.51 Land........................... 3,609 1.49 2,664 1.33 1,455 .57 2,725 .86 9,877 3.35 Deposits....................... 675 .28 962 .48 1,106 .44 1,155 .37 995 .34 Auto........................... 3,006 1.24 2,127 1.06 2,041 .80 1,502 .47 1,690 .57 Other security................. 491 .20 475 .24 426 .17 356 .11 611 .21 Unsecured ..................... 201 .08 89 .04 9 -- 111 .03 113 .04 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Gross loans receivable....... 242,578 100.00 200,674 100.00 254,190 100.00 317,806 100.00 294,668 100.00 Deduct: Allowance for loan losses......... 1,761 .73 1,512 .75 1,361 .54 1,241 .39 1,121 .38 Deferred loan fees (1)............ 822 .34 893 .45 1,690 .66 2,707 .85 2,854 .97 Loans in process.................. 6,995 2.88 2,348 1.17 2,504 .99 8,086 2.55 5,347 1.81 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Net loans receivable........... $233,000 96.05% $195,921 97.63% $248,635 97.81% $305,772 96.21% $285,346 96.84% ======== ====== ======== ====== ======== ====== ======== ====== ======== ====== Mortgage Loans: Adjustable-rate................ $ 68,452 28.74% $56,014 28.43% $95,106 37.95% $117,062 37.20% $112,193 38.52% Fixed-rate..................... 169,753 71.26 141,006 71.57 155,502 62.05 197,620 62.80 179,066 61.48 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total........................ $238,205 100.00% $197,020 100.00% $250,608 100.00% $314,682 100.00% $291,259 100.00% ======== ====== ======== ====== ======== ====== ======== ====== ======== ======
(1) Net loans held for sale included in the above categories amounted to $24,201,000 and $15,534,000 at December 31, 1996 and 1995. There were no loans held for sale at December 31, 1999, 1998 and 1997. The following table sets forth certain information at December 31, 1999, regarding the dollar amount of loans maturing in Lincoln Federal's loan portfolio based on the contractual terms to maturity. Demand loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. Management expects prepayments will cause actual maturities to be shorter.
Balance Due During Years Ended December 31, Outstanding at 2003 2005 2010 2015 December 31, to to to and 1999 2000 2001 2002 2004 2009 2014 following -------- ------- ------ ------ ------- ------- ------- -------- (In thousands) Real estate mortgage loans: One- to four-family residential loans................ $175,095 $ 36 $ 361 $ 536 $ 1,133 $16,312 $43,648 $113,069 Multi-family loans................. 1,029 --- --- 111 333 49 47 489 Commercial real estate loans....... 16,073 1,872 963 1,176 3,924 2,931 1,341 3,866 Construction loans................. 18,127 15,975 --- 1,000 1,152 --- --- --- Land loans......................... 3,609 1,574 56 131 1,655 97 96 --- Commercial......................... 91 5 10 37 39 --- --- --- Consumer loans: Installment loans................. 3,607 263 342 610 1,999 374 19 --- Loans secured by deposits.......... 675 412 126 49 88 --- --- --- Home equity loans and and second mortgages............. 24,272 1,298 97 322 2,358 17,915 2,282 --- -------- ------- ------ ------ ------- ------- ------- -------- Total consumer loans............. 28,554 1,973 565 981 4,445 18,289 2,301 --- -------- ------- ------ ------ ------- ------- ------- -------- Total........................ $242,578 $21,435 $1,955 $3,972 $12,681 $37,678 $47,433 $117,424 ======== ======= ====== ====== ======= ======= ======= ========
The following table sets forth, as of December 31, 1999, the dollar amount of all loans due after one year that have fixed interest rates and floating or adjustable interest rates.
Due After December 31, 2000 ------------------------------------------------------------- Fixed Rates Variable Rates Total ----------- -------------- ----- (In thousands) Real estate mortgage loans: One- to four-family residential loans...... $138,723 $36,336 $175,059 Multi-family loans......................... 461 568 1,029 Commercial real estate loans............... 8,308 5,893 14,201 Construction loans......................... 1,152 1,000 2,152 Land loans................................. 2,035 --- 2,035 Commercial.................................... 86 --- 86 Installment loans............................. 3,344 --- 3,344 Loans secured by deposits..................... 263 --- 263 Home equity loans and second mortgages........ 8,097 14,877 22,974 -------- ------- -------- Total...................................... $162,469 $58,674 $221,143 ======== ======= ========
One- to Four-Family Residential Loans. Lincoln Federal's primary lending activity consists of the origination of one- to four-family residential mortgage loans secured by property located in its primary market area. Lincoln Federal generally does not originate one- to four-family residential mortgage loans if the ratio of the loan amount to the lesser of the current cost or appraised value of the property (the "Loan-to-Value Ratio") exceeds 95%. Lincoln Federal requires private mortgage insurance on loans with a Loan-to-Value Ratio in excess of 80%. The cost of such insurance is factored into the annual percentage rate on such loans. In the past, Lincoln Federal's underwriting criteria for one- to four-family residential loans focused heavily on the value of the collateral securing the loan and placed less emphasis on the borrower's debt servicing capacity and other credit factors. Lincoln Federal recently revised its lending policies to emphasize factors other than the value of the underlying collateral, such as the income, debt-to-income ratio, stability of earnings and past credit history of a potential borrower, in making credit decisions. These revised underwriting criteria are based upon FHLMC lending guidelines. The Bank originates fixed-rate loans which provide for the payment of principal and interest over a period of up to 30 years. Lincoln Federal also offers adjustable-rate mortgage ("ARM") loans pegged to the one-year U.S. Treasury securities yield adjusted to a constant maturity. Lincoln Federal no longer offers adjustable rate loans with interest rates pegged to the 11th District Cost of Funds Index ("COFI") because that index adjusts less rapidly to changes in interest rates compared to other indices. Lincoln Federal may offer discounted initial interest rates on ARM loans, but requires that the borrower qualify for the loan at the fully-indexed rate (the index rate plus the margin). A substantial portion of the ARM loans in the Bank's portfolio at December 31, 1999 provide for maximum rate adjustments per year and over the life of the loan of 2% and 6%, respectively. Lincoln Federal's residential ARMs are amortized for terms up to 30 years. In two separate transactions in August, 1997 and April, 1998, Lincoln Federal securitized approximately $41.1 million of the COFI loans in its portfolio and sold the resulting mortgage-backed securities on the secondary market. In June, 1998 Lincoln Federal sold in a direct, whole-loan sale to a private investor an additional $19.3 million of COFI loans. Following the closing of this whole-loan sale, the amount of COFI loans in Lincoln Federal's portfolio was reduced to $4.8 million. Lincoln Federal also pooled $75.0 million of fixed-rate one- to four-family residential loans into FHLMC mortgage-backed securities. Lincoln Federal sold on the secondary market $34.3 million of these securities which were backed by lower-yielding, fixed-rate loans. At December 31, 1999, Lincoln Federal continued to hold in its investment portfolio approximately $23.0 million of these securities that are backed by higher-yielding, fixed-rate mortgage loans that it originated. With the exception of the loans that were securitized during 1997 and 1998 and in the whole-loan sale in 1998, Lincoln Federal determines when it originates a one- to four-family residential loan whether it intends to hold the loan until maturity or sell it in the secondary market. Lincoln Federal generally sells on the secondary market all of the fixed-rate loans that it originates with terms of more than 20 years that are written to FHLMC standards, and retains in its loan portfolio any loans that it originates that are not written to FHLMC standards. Lincoln Federal retains the servicing rights on the loans that it sells. ARM loans decrease the risk associated with changes in interest rates by periodically repricing, but involve other risks because, as interest rates increase, the underlying payments by the borrower also increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustment permitted by the loan documents, and, therefore, is potentially limited in effectiveness during periods of rapidly rising interest rates. At December 31, 1999, approximately 20.8% of Lincoln Federal's one- to four-family residential loans had adjustable rates of interest. All of the one- to four-family residential mortgage loans that Lincoln Federal originates include "due-on-sale" clauses, which give Lincoln Federal the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. However, Lincoln Federal occasionally permits assumptions of existing residential mortgage loans on a case-by-case basis. At December 31, 1999, approximately $175.1 million, or 72.2% of Lincoln Federal's portfolio of loans, consisted of one- to four-family residential loans. Approximately $727,000, or .4% of total residential loans, were included in non-performing assets as of that date. Commercial Real Estate and Multi-Family Loans. Lincoln Federal's commercial real estate loans are secured by churches, warehouses, office buildings, hotels and other commercial properties. Lincoln Federal generally originates commercial real estate loans as five-year balloon loans amortized over a 10- or 15-year period, with an adjustable interest rate indexed primarily to the prime rate. At December 31, 1999 Lincoln Federal had $4.6 million in outstanding balloon loans secured by commercial and multi-family real estate. Lincoln Federal generally requires a Loan-to-Value Ratio of at least 75% on commercial real estate loans, although it may make loans with a Loan-to-Value Ratio of up to 80% on loans secured by owner-occupied commercial real estate or by multi-family residential properties. Commercial real estate loans generally are larger than one- to four-family residential loans and involve a greater degree of risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Payments on these loans depend to a large degree on results of operations and management of the properties and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of the loans makes them more difficult for management to monitor and evaluate. In addition, balloon loans may involve a greater degree of risk to the extent the borrower is unable to obtain financing or cannot repay the loan when the loan matures and the balloon payment is due. At December 31, 1999 Lincoln Federal's largest commercial real estate borrower had loans outstanding in the aggregate amount of $2.4 million which were secured by motels located throughout Central Indiana. Also as of that date, Lincoln Federal's largest commercial real estate loan had an outstanding balance of $1.2 million and was secured by a church located in Plainfield, Indiana. At December 31, 1999, approximately $16.1 million, or 6.6% of Lincoln Federal's total loan portfolio, consisted of commercial real estate loans. On the same date, there were no commercial real estate loans included in non-performing assets. At December 31, 1999, approximately $1.0 million, or .4% of Lincoln Federal's total loan portfolio, consisted of mortgage loans secured by multi-family dwellings (those consisting of more than four units). Lincoln Federal writes multi-family loans on terms and conditions similar to its commercial real estate loans. The largest multi-family loan as of December 31, 1999 was $336,000 and was secured by an apartment building in Clayton, Indiana. On the same date, there were no multi-family loans included in non-performing assets. Multi-family loans, like commercial real estate loans, involve greater risk than do residential loans. Also, the loans-to-one-borrower limitation limits Lincoln Federal's ability to make loans to developers of apartment complexes and other multi-family units. Construction Loans. Lincoln Federal offers construction loans to developers for the acquisition and development of residential and nonresidential real estate and to builders of one- to four-family residential properties. A significant portion of these loans are made on a speculative basis (i.e., before the builder/developer obtains a commitment from a buyer). At December 31, 1999, approximately $18.1 million, or 7.5% of Lincoln Federal's total loan portfolio, consisted of construction loans. Of these loans, approximately $3.2 million were for the acquisition and development of residential housing developments, $6.8 million financed the construction of one- to four-family residential properties and $8.1 million financed the construction of commercial real estate. As of December 31, 1999, Lincoln Federal's largest construction loan relationship and largest construction loan had a balance of $2.1 million and was secured by a church located in Plainfield, Indiana. As of December 31, 1999, this loan was peforming according to its terms. Also on that date, construction loans in the amount of $301,000 were included in non-performing assets. Construction loans on residential properties where the borrower has entered into a verifiable sales contract to a non-related party to purchase the completed home may be made with a maximum Loan-to-Value Ratio of the lesser of 90% of the price stipulated in the sales contract or 80% of the appraised value of the property. With respect to residential properties constructed on a speculative basis, Lincoln Federal generally requires a Loan-to-Value Ratio of 75% of the "as completed" appraised value of the property. Although speculative loans make up a significant percentage of Lincoln Federal's construction loan portfolio, Lincoln Federal generally will finance only one speculative construction project per builder. Residential construction loans are generally written with a fixed rate of interest and for an initial term of six months. Lincoln Federal generally offers construction loans on commercial land development projects with a maximum Loan-to-Value Ratio of 75% of the appraised value of the property or 80% of the property's cost plus 80% of the cost of verifiable improvements to the property. Construction loans on commercial real estate properties are generally written for a term not to exceed 30 months. While providing a comparable, and in some cases higher, yield than a conventional mortgage loan, construction loans involve a higher level of risk. For example, if a project is not completed and the borrower defaults, Lincoln Federal may have to hire another contractor to complete the project at a higher cost. Also, a project may be completed, but may not be salable, resulting in the borrower defaulting and requiring that Lincoln Federal take title to the project. Land Loans. At December 31, 1999, approximately $3.6 million, or 1.5% of Lincoln Federal's total loan portfolio, consisted of mortgage loans secured by undeveloped real estate. Lincoln Federal imposes a maximum Loan-to-Value Ratio of 65% of the appraised value of the land or 90% of the cost of the undeveloped land for pre-development land acquisition loans. Lincoln Federal writes these loans for a maximum term of 12 months. At December 31, 1999, the Bank's largest land loan totaled $468,000 and was secured by bare land located in Plainfield, Indiana. Land loans present greater risk than conventional loans since land development borrowers who are over budget may divert the loan funds to cover cost-overruns rather than direct them toward the purpose for which such loans were made. In addition, land loans are more difficult to monitor than conventional mortgage loans. As such, a defaulting borrower could cause Lincoln Federal to take title to partially improved land that is unmarketable without further capital investment. Consumer Loans. Lincoln Federal's consumer loans consist of variable- and fixed-rate home equity loans and lines of credit, automobile, recreational vehicle, boat and motorcycle loans and loans secured by deposits. Lincoln Federal does not make indirect consumer loans. Consumer loans tend to have shorter terms and higher yields than permanent residential mortgage loans. At December 31, 1999, Lincoln Federal's consumer loans aggregated approximately $28.6 million, or 11.8% of Lincoln Federal's total loan portfolio. Included in consumer loans at December 31, 1999 were $15.4 million of variable-rate home equity lines of credit. These variable-rate loans improve Lincoln Federal's exposure to interest rate risk. Lincoln Federal's home equity lines of credit and fixed-term loans are generally written for up to 95% of the available equity (the appraised value of the property less any first mortgage amount) if Lincoln Federal holds the first mortgage, and up to 90% of the available equity if Lincoln Federal does not hold the first mortgage. Lincoln Federal's home equity and second mortgage loans increased significantly from $13.2 million at December 31, 1996 to $24.3 million at December 31, 1999, primarily as the result of a marketing campaign directed at its existing customers. Lincoln Federal generally will write automobile loans for up to 100% of the acquisition price for a new automobile and up to the NADA retail value for a used automobile. New car loans are written for terms of up to 60 months and used car loans are written for terms up to 48 months, depending on the age of the car. Loans for recreational vehicles and boats are written for no more than 80% of the purchase price or "verified value," whichever is less, for a maximum term of 120 months and 84 months, respectively. Motorcycles loans are written for no more than 75% of the purchase price or "verified value" with a term not to exceed 48 months. All of Lincoln Federal's consumer loans have a fixed rate of interest except for home equity lines of credit, which are offered at a variable rate. At December 31, 1999, consumer loans in the amount of $77,000 were included in non-performing assets. Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. Further, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections depend on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Commercial Loans. Lincoln Federal offers commercial loans, which consist primarily of loans to businesses that are secured by assets other than real estate. As of December 31, 1999, commercial loans amounted to $91,000. Commercial loans tend to bear somewhat greater risk than residential mortgage loans, depending on the ability of the underlying enterprise to repay the loan. Although commercial loans have not historically comprised a large portion of Lincoln Federal's loan portfolio, Lincoln Federal intends to increase the amount of loans it makes to small businesses in the future in order to increase its rate of return and diversify its portfolio. As of December 31, 1999, none of Lincoln Federal's commercial loans were included in nonperforming assets. Origination, Purchase and Sale of Loans. Historically, Lincoln Federal has confined its loan origination activities primarily to Hendricks, Montgomery, Clinton and Morgan Counties. At December 31, 1999, Lincoln Federal did not have any mortgage loans secured by property located outside of Indiana. Lincoln Federal's loan originations are generated from referrals from existing customers, real estate brokers, and newspaper and periodical advertising. Loan applications are underwritten and processed at Lincoln Federal's main office in Plainfield. Lincoln Federal's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan. To assess the borrower's ability to repay, the Bank studies the employment and credit history and information on the historical and projected income and expenses of its mortgagors. Lincoln Federal generally requires appraisals on all real property securing its first-mortgage loans and requires an attorney's opinion and a valid lien on the mortgaged real estate. Appraisals for all real property securing first-mortgage loans are performed by independent appraisers who are state-licensed. Lincoln Federal requires fire and extended coverage insurance in amounts at least equal to the principal amount of the loan and also requires flood insurance to protect the property securing its interest if the property is in a flood plain. Lincoln Federal also generally requires private mortgage insurance for all residential mortgage loans with Loan-to-Value Ratios of greater than 80%. Lincoln Federal generally requires escrow accounts for insurance premiums and taxes for residential mortgage loans that it originates. Lincoln Federal's underwriting standards for consumer loans are intended to protect against some of the risks inherent in making consumer loans. Borrower character, paying habits and financial strengths are important considerations. Lincoln Federal occasionally purchases participation interests in loans originated by other financial institutions in order to diversify its portfolio, supplement local loan demand and to obtain more favorable yields. The participations that Lincoln Federal purchases normally represent a portion of residential or commercial real estate loans originated by other Indiana financial institutions, most of which are secured by property located in Indiana. As of December 31, 1999, Lincoln Federal had $5.8 million loan participations in its asset portfolio. The following table shows loan origination and repayment activity for Lincoln Federal during the periods indicated:
Year Ended December 31, ---------------------------------------------------- 1999 1998 1997 -------- -------- -------- (In thousands) Gross loans receivable at beginning of period............................. $200,674 $254,190 $317,806 -------- -------- -------- Loans Originated: Real estate mortgage loans: One-to-four family loans (1)................ 58,215 59,556 44,472 Multi-family loans.......................... 282 --- 68 Commercial real estate loans................ 4,746 5,271 6,608 Construction loans.......................... 13,469 7,584 10,411 Land loans.................................. 3,435 2,042 3,053 Commercial loans.............................. 43 10 242 Consumer loans................................ 17,484 14,924 12,432 -------- -------- -------- Total originations........................ 97,674 89,387 77,286 -------- -------- -------- Purchases (sales) of participation loans, net...... 6,157 (67,369) (78,887) Reductions: Repayments and other deductions............... 61,709 75,169 61,904 Transfers from loans to real estate owned..... 218 365 111 -------- -------- -------- Total reductions............................ 61,927 75,534 62,015 -------- -------- -------- Total gross loans receivable at end of period........................... $242,578 $200,674 $254,190 ======== ======== ========
(1) Includes certain home equity loans. Lincoln Federal's total loan originations during the year ended December 31, 1999 totaled $97.7 million, compared to $89.4 million during the year ended December 31, 1998 and $77.3 million for the year ended December 31, 1997. Origination and Other Fees. Lincoln Federal realizes income from late charges, checking account service charges, loan servicing fees and fees for other miscellaneous services. Late charges are generally assessed if a loan payment is not received within a specified number of days after it is due. The grace period depends on the individual loan documents. The Bank also receives a loan servicing fee of 1/4% on fixed-rate loans and 3/8% on ARM loans that it services for others. Non-Performing and Problem Assets After a mortgage loan becomes 10 days past due, Lincoln Federal delivers a delinquency notice to the borrower. When loans are 30 to 60 days in default, Lincoln Federal sends additional delinquency notices and makes personal contact by telephone with the borrower to establish acceptable repayment schedules. When loans become 60 days in default, Lincoln Federal again contacts the borrower, this time in person, to establish acceptable repayment schedules. When a mortgage loan is 90 days delinquent, Lincoln Federal will have either entered into a workout plan with the borrower or referred the matter to its attorney for collection. Management is authorized to commence foreclosure proceedings for any loan upon making a determination that it is prudent to do so. Lincoln Federal reviews mortgage loans on a regular basis and places one- to four-family residential loans on a non-accrual status when they become 120 days delinquent. Other loans are placed on a non-accrual status when they become 90 days delinquent. Generally, when loans are placed on a non-accrual status, unpaid accrued interest is written off. Non-performing Assets. At December 31, 1999, $1,147,000, or .3% of Lincoln Federal's total assets, were non-performing (non-performing loans and non-accruing loans) compared to $1,395,000, or .4%, of its total assets at December 31, 1998. At December 31, 1999, residential loans accounted for $727,000 of Lincoln Federal's non-performing assets, construction loans accounted for $301,000 of its non-performing assets, and consumer loans accounted for $77,000 of non-performing assets. Lincoln Federal had real estate owned ("REO") properties in the amount of $42,000 as of December 31, 1999. The table below sets forth the amounts and categories of Lincoln Federal's non-performing assets (non-performing loans, foreclosed real estate and troubled debt restructurings) for the last three years. It is Lincoln Federal's policy that earned but uncollected interest on all loans be reviewed monthly to determine if any portion thereof should be classified as uncollectible for any loan past due in excess of 90 days. Lincoln Federal deems any delinquent loan that is 90 days or more past due to be a non-performing asset.
At December 31, ----------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------ ------ ------- ------ ------ (Dollars in thousands) Non-performing assets: Non-performing loans..........................$1,105 $1,292 $ 3,257 $ 2,397 $1,797 Troubled debt restructurings.................. --- --- 367 46 598 ------ ------ ------- ------ ------ Total non-performing loans..................$1,105 1,292 3,624 2,443 2,395 Foreclosed real estate........................ 42 103 45 75 --- ------ ------ ------- ------ ------ Total non-performing assets.................$1,147 $1,395 $ 3,669 $2,518 $2,395 ====== ====== ======= ====== ====== Non-performing loans to total loans.............. .47% .65% 1.45% .80% .83% Non-performing assets to total assets............ .28% .38% 1.14% .73% .75%
Interest income of $45,000 for the year ended December 31, 1999, was recognized on the non-performing loans summarized above. Interest income of $83,000 for the year ended December 31, 1999, respectively, would have been recognized under the original loan terms of these loans. At December 31, 1999, Lincoln Federal held loans delinquent from 30 to 89 days totalling $4.1 million. As of that date, Lincoln Federal was not aware of any other loans in which borrowers were experiencing financial difficulties and was not aware of any assets that would need to be disclosed as non-performing assets. Delinquent Loans. The following table sets forth certain information at December 31, 1999, 1998, and 1997, relating to delinquencies in Lincoln Federal's portfolio. Delinquent loans that are 90 days or more past due are considered non-performing assets.
At December 31, 1999 At December 31, 1998 At December 31, 1997 -------------------------------------- ---------------------------------- ---------------------------------- 30-89 Days 90 Days or More 30-89 Days 90 Days or More 30-89 Days 90 Days or More ------------------- ----------------- ------------------ ---------------- ---------------- ---------------- Principal Principal Principal Principal Principal Principal Number Balance Number Balance Number Balance Number Balance Number Balance Number Balance of Loans of Loans of Loansof Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans -------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Residential mortgage loans..... 88 $3,912 16 $722 99 $4,254 18 $ 775 140 $6,040 26 $1,228 Commercial real estate loans.. --- --- --- --- 3 335 1 103 1 100 1 367 Multi-family mortgage loans..... --- --- --- --- --- --- --- --- --- --- Construction loans.... 1 112 2 301 2 300 --- --- 3 1,214 Land loans............ --- --- --- --- --- --- --- --- --- --- Consumer loans........ 17 80 5 55 15 158 3 114 29 379 20 448 --- ------ -- ------ --- ------ -- ------ --- ------ -- ------ Total.............. 106 $4,104 22 $1,078 117 $4,747 24 $1,292 170 $6,519 50 $3,257 === ====== == ====== === ====== == ====== === ====== == ====== Delinquent loans to total loans........ 2.21% 3.06% 3.91% ==== ==== ====
Classified assets. Federal regulations and Lincoln Federal's Asset Classification Policy provide for the classification of loans and other assets such as debt and equity securities considered by the OTS to be of lesser quality as "substandard," "doubtful" or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. An insured institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified substandard or doubtful, as well as for other problem loans. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS which can order the establishment of additional general or specific loss allowances. Lincoln Federal regularly reviews its loan portfolio to determine whether any loans require classification in accordance with applicable regulations. Lincoln Federal's classified assets are made up entirely of non-performing assets. Allowance for Loan Losses The allowance for loan losses is maintained through the provision for loan losses, which is charged to earnings. The allowance for loan losses is determined in conjunction with Lincoln Federal's review and evaluation of current economic conditions (including those of its lending area), changes in the character and size of the loan portfolio, loan delinquencies (current status as well as past and anticipated trends) and adequacy of collateral securing loan delinquencies, historical and estimated net charge-offs, and other pertinent information derived from a review of the loan portfolio. In management's opinion, Lincoln Federal's allowance for loan losses is adequate to absorb probable losses inherent in the loan portfolio at December 31, 1999. However, there can be no assurance that regulators, when reviewing the Bank's loan portfolio in the future, will not require increases in its allowances for loan losses or that changes in economic conditions will not adversely affect its loan portfolio. Summary of Loan Loss Experience. The following table analyzes changes in the allowance during the past five fiscal years ended December 31, 1999.
Year Ended December 31, ----------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------ ------ --------- ------- ------ (Dollars in thousands) Balance at beginning of period...................$1,512 $1,361 $ 1,241 $ 1,121 $1,047 Charge-offs: One- to four-family residential mortgage loans.................. (79) (31) --- --- (15) Commercial real estate mortgage loans......... --- (178) --- --- Construction loans............................ --- (301) --- --- (12) Consumer loans................................ (62) (25) --- --- (2) ------ ------ --------- ------- ------ Total charge-offs........................... (141) (357) (178) --- (29) ------ ------ --------- ------- ------ Recoveries: One- to four-family residential mortgage loans.................. --- 15 --- --- 3 Commercial real estate mortgage loans......... 4 1 --- --- --- Construction loans............................ --- 301 --- --- --- Consumer loans................................ 2 18 --- --- --- ------ ------ --------- ------- ------ Total recoveries............................ 6 335 --- --- 3 ------ ------ --------- ------- ------ Net charge-offs.................................. (135) (22) (178) --- (26) ------ ------ --------- ------- ------ Provision for losses on loans.................... 384 173 298 120 100 ------ ------ --------- ------- ------ Balance end of period............................$1,761 $1,512 $ 1,361 $ 1,241 $1,121 ====== ====== ========= ======= ====== Allowance for loan losses as a percent of total loans outstanding.......................... .75% 0.77% 0.54% 0.40% 0.39% Ratio of net charge-offs to average loans outstanding................................ .06% .01% .06% --- .01%
Allocation of Allowance for Loan Losses. The following table presents an analysis of the allocation of Lincoln Federal's allowance for loan losses at the dates indicated. The information for 1995 is not included because Lincoln Federal did not make the computation.
At December 31, ----------------------------------------------------------------------------------------------- 1999 1998 1997 1996 ------------------- -------------------- --------------------- -------------------- Percent Percent Percent Percent of loans of loans of loans of loans in each in each in each in each category category category category to total total to total to total Amount loans Amount loans Amount loans Amount loans ------ -------- ------- -------- ------ --------- -------- ------- (Dollars in thousands) Balance at end of period applicable to: Real estate mortgage loans: One- to four-family residential............. $718 72.18% $600 76.19% $401 81.03% $206 84.84% Multi-family.............. 10 .42 10 .51 11 .45 --- .35 Commercial................ 241 6.63 218 7.25 221 5.87 468 4.66 Construction loans........ 230 7.47 113 3.69 249 3.90 367 4.14 Land loans................ 54 1.49 40 1.33 15 .57 --- .86 Commercial loans............ 1 .04 2 .06 11 .10 --- --- Consumer loans.............. 436 11.77 349 10.97 268 8.08 98 5.15 Unallocated................. 70 --- 180 --- 185 --- 102 --- ------ ------ ------ ------ ------ ------ ------ ------ Total....................... $1,761 100.00 %$1,512 100.00 %$1,361 100.00 %$1,241 100.00% ====== ====== ====== ====== ====== ====== ====== ======
Investments Investments. During the third quarter of 1997, the Bank adopted a revised investment policy that authorizes investments in U.S. Treasury securities, securities guaranteed by the Government National Mortgage Association ("GNMA"), securities issued by agencies of the U.S. Government, mortgage-backed securities issued by the FHLMC or the Federal National Mortgage Association ("FNMA") and in highly-rated mortgage-backed securities, collateralized mortgage obligations and investment-grade corporate debt securities. This revised policy permits the Bank's management to react quickly to market conditions. Most of the securities in its portfolio are considered available-for-sale. At December 31, 1999, Lincoln Federal's investment portfolio consisted of investments in mortgage-backed securities, corporate securities, federal agency securities, FHLB stock, an investment in Pedcor Investments - 1987 - I, L.P., an investment in Bloomington Housing Associates, L.P., and an investment in an insurance company. See "-Investments in Multi-Family, Low- and Moderate-Income Housing Projects" and "Service Corporation Subsidiary." At December 31, 1999, approximately $162.9 million, or 39.7%, of Lincoln Federal's total assets consisted of such investments. The Bank also had $8.2 million in interest-earning deposits with the FHLB-Indianapolis as of that date. As of that date, Lincoln Federal also had pledged to the FHLB-Indianapolis as collateral, investment securities with a carrying value of $119.0 million, including $81.6 million in mortgage-backed securities and $37.4 million in other securities. Investment Securities. The following table sets forth the amortized cost and the market value of Lincoln Federal's investment portfolio at the dates indicated.
At December 31, ----------------------------------------------------------------- 1999 1998 1997 ------------------ ------------------- ------------------ Amortized Market Amortized Market Amortized Market Cost Value Cost Value Cost Value ------- ------- ------- ------- ------ ------ (In thousands) Investment securities available for sale: Federal agencies......................... $45,992 $41,606 $ 15,598 $ 15,670 $ --- $ --- Mortgage-backed securities............... 85,016 81,596 89,658 90,609 28,495 29,399 Corporate debt obligations............... 23,256 22,673 23,544 22,997 --- --- Federated liquid cash fund............... --- --- --- --- --- --- FHLMC stock.............................. --- --- --- --- -- --- ------- ------- ------- ------- ------ ------ Total investment securities available for sale................... 154,264 145,875 128,800 129,276 28,495 29,399 Investment securities held to maturity-- Federal agency securities.............. 500 498 1,250 1,264 9,635 9,615 ------- ------- ------- ------- ------ ------ Total investment securities.............. 154,764 146,373 130,050 130,540 38,130 39,014 Investment in limited partnerships....... 2,064 (1) 2,387 (1) 2,706 (1) Investment in insurance company.......... 650 (1) 650 (1) --- --- FHLB stock (2)........................... 5,447 5,447 5,447 5,447 5,447 5,447 -------- -------- ------- Total investments........................ $162,925 $138,534 $46,283 ======== ======== =======
(1) Market values are not available (2) Market value is based on the price at which the stock may be resold to the FHLB of Indianapolis. The following table sets forth the amount of investment securities excluding mortgage-backed securities which mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 1999.
Amount at December 31, 1999 which matures in --------------------------------------------------------------------------- One Year Five to After to Five Years Ten Years Ten Years ---------------------- --------------------- ---------------------- Amortized Average Amortized Average Amortized Average Cost Yield Cost Yield Cost Yield --------- -------- --------- ------- --------- -------- (Dollars in thousands) Federal agency securities - available for sale...$ --- ---% $25,650 6.38% $20,342 6.81% Corporates securities -- available for sale...... 8,003 7.45 --- --- 15,253 7.02 Federal agency securities -- held to maturity.... 500 6.11 --- --- --- --- ------ ---- ------- ---- ------- ---- $8,503 7.37% $25,650 6.38% $35,595 6.90% ====== ==== ======= ==== ======= ====
At December 31, 1999, Lincoln Federal had no corporate investments the aggregate book value of which exceeded 10% of its equity capital. Mortgage-backed Securities. The following table sets forth the composition of Lincoln Federal's mortgage-backed securities portfolio at December 31, 1999 and 1998.
December 31, 1999 December 31, 1998 ------------------------------------------ -------------------------------------------- Amortized Percent Market Amortized Percent Market Cost of Total Value Cost of Total Value --------- -------- ------- --------- --------- --------- (Dollars in thousands) Federal Home Loan Mortgage Corporation $23,003 27.1% $22,802 $31,939 35.6% $32,909 Federal National Mortgage Association 4,593 5.4 4,551 6,013 6.7 6,065 Government National Mortgage Association 9,417 11.1 8,872 --- --- --- Collateralized mortgage obligations 48,003 56.4 45,371 51,706 57.7 51,635 ------- ----- ------- ------- ----- ------- Total mortgage-backed securities $85,016 100.0% $81,596 $89,658 100.0% $90,609 ======= ===== ======= ======= ===== =======
At December 31, 1999, mortgage-backed securities having an amortized cost of $2,404,000 mature in five to ten years and have a weighted average yield of 6.68% and mortgage-backed securities having an amortized cost of $82,612,000 mature after ten years and have a weighted average yield of 6.73%. All mortgage-backed securities outstanding at December 31, 1998 mature after ten years and have a weighted average yield of 6.74%. The following table sets forth the changes in Lincoln Federal's mortgage-backed securities portfolio for the years ended December 31, 1999, 1998 and 1997. For the Year Ended December 31, ----------------------------------------- 1999 1998 1997 ------- ------- ------- (Dollars in thousands) Beginning balance $90,609 $29,399 $ --- Securitization of loans --- 39,728 76,455 Purchases 14,772 52,406 7,574 Monthly repayments (19,435) (9,999) (1,237) Proceeds from sales --- (21,089) (54,415) Net accretion --- 4 --- Gains on sales 20 113 118 Change in unrealized gain on securities available for sale (4,370) 47 904 ------- ------- ------- Ending balance $81,596 $90,609 $29,399 ======= ======= ======= Investments in Multi-Family, Low- and Moderate-Income Housing Projects. Lincoln Federal has an investment in Pedcor Investments - 1987 - I, L.P. ("Pedcor"), an Indiana limited partnership that was organized to construct, own and operate a 208-unit apartment complex in Indianapolis, Indiana (the "Pedcor Project"). The Pedcor Project, which is operated as a multi-family, low- and moderate-income housing project, has been completed and is performing as planned. At the inception of the Pedcor Project in August, 1988, Lincoln Federal committed to invest $2.7 million in Pedcor. In January, 1998, the Bank made its final payment pursuant to this commitment and is no longer liable to contribute additional funds for the Pedcor Project. Lincoln Federal holds a separate investment in a multi-family, low- and moderate-income housing project through its wholly-owned subsidiary, LF Service Corp. ("LF"). LF has invested in Bloomington Housing Associates, L.P. ("BHA"), which is an Indiana limited partnership that was organized to construct, own and operate a 130-unit apartment complex in Bloomington, Indiana (the "BHA Project"). Development of the BHA Project has been completed and the project is performing as planned. LF committed to invest approximately $4.9 million in BHA at the inception of the Bloomington Project in August, 1992. Through December 31, 1999, LF had invested cash of approximately $3.2 million in BHA with four additional annual capital contributions remaining to be paid in January of each year through January, 2003, totaling $1.7 million. A low- and moderate-income housing project qualifies for certain federal income tax credits if (i) it is a residential rental property, (ii) the units are used on a nontransient basis, and (iii) 20% or more of the units in the project are occupied by tenants whose incomes are 50% or less of the area median gross income, adjusted for family size, or alternatively, at least 40% of the units in the project are occupied by tenants whose incomes are 60% or less of the area median gross income. Qualified low income housing projects generally must comply with these and other rules for fifteen years, beginning with the first year the project qualified for the tax credit, or some or all of the tax credit together with interest may be recaptured. The tax credit is subject to the limitations on the use of general business credit, but no basis reduction is required for any portion of the tax credit claimed. As of December 31, 1999, 92.0% of the units in the Pedcor Project and 73.9% of the units in the Bloomington Project were occupied and each project complied with the low income occupancy requirements described above. Lincoln Federal has received tax credits of $18,000 from the operation of the Pedcor Project and $355,000 from the operation of the Bloomington Project for the year ended December 31, 1999. The tax credits from the Pedcor Project were completed during 1999; however, the tax credits from the BHA project will be available through 2012. Although Lincoln Federal has reduced income tax expense by the full amount of the tax credit available each year, it has not been able to fully utilize available tax credits to reduce income taxes payable because it may not use tax credits that would reduce its regular corporate tax liability below its alternative minimum tax liability. Lincoln Federal may carry forward unused tax credits for a period of fifteen years and management believes that the Bank will be able to utilize available tax credits during the carry-forward period. Additionally, Pedcor and BHA have incurred operating losses in the early years of their operations primarily due to accelerated depreciation of assets. Lincoln Federal has accounted for its investment in Pedcor, and LF has accounted for Lincoln Federal's investment in BHA, on the equity method. Accordingly, Lincoln Federal and LF have each recorded their share of these losses as reductions to their investments in Pedcor and BHA, respectively. At December 31, 1999, Lincoln Federal had no remaining investment on the books for Pedcor, and LF's investment in BHA was $2.1 million. The following summarizes Lincoln Federal's equity in Pedcor's losses and tax credits and LF's equity in BHA's losses and tax credits recognized in Lincoln Federal's consolidated financial statements. Year Ended December 31, ----------------------------- 1999 1998 1997 ------ ------ ------ (In Thousands) Investment in Pedcor......................... $--- $ --- $ 76 ==== ======== ======= Equity in losses, net of income tax effect...................... $--- $(164) $(167) Tax credit................................... 18 242 300 --- ------- ----- Increase in after-tax net income from Pedcor investment......................... $18 $ 78 $ 133 === ======= ===== Year Ended December 31, ----------------------------- 1999 1998 1997 ------ ------ ------ (In Thousands) Investment in BHA.......................... $2,064 $2,387 $2,630 ====== ====== ====== Equity in losses, net of income tax effect.................... $ (195) $ (147) $ (244) Tax credit................................. 355 355 355 ------ ------ ------ Increase in after-tax net income from BHA investment.......................... $ 160 $ 208 $ 111 ====== ====== ====== Sources of Funds General. Deposits have traditionally been Lincoln Federal's primary source of funds for use in lending and investment activities. In addition to deposits, Lincoln Federal derives funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings, income on earning assets and borrowings. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. Borrowings from the FHLB of Indianapolis have been used in the short-term to compensate for reductions in deposits or deposit inflows at less than projected levels. Deposits. Lincoln Federal attracts deposits principally from within Hendricks, Montgomery, Clinton and Morgan Counties through the offering of a broad selection of deposit instruments, including fixed-rate passbook accounts, NOW accounts, variable rate money market accounts, fixed-term certificates of deposit, individual retirement accounts and savings accounts. Lincoln Federal does not actively solicit or advertise for deposits outside of Hendricks, Montgomery, Clinton and Morgan Counties, and substantially all of Lincoln Federal's depositors are residents of those counties. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds remain on deposit and the interest rate. Lincoln Federal does not accept brokered deposits. Although the Bank sometimes may bid for public deposits, it held only $1.4 million of such funds, or .7% of its total deposits, at December 31, 1999. Lincoln Federal periodically runs specials on certificates of deposit with specific maturities. Lincoln Federal establishes the interest rates paid, maturity terms, service fees and withdrawal penalties on a periodic basis. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by competitors, growth goals, and applicable regulations. Lincoln Federal relies, in part, on customer service and long-standing relationships with customers to attract and retain its deposits. The Bank also closely prices its deposits to the rates offered by its competitors. Approximately 64.7% of Lincoln Federal's deposits consist of certificates of deposit, which generally have higher interest rates than other deposit products that it offers. Certificates of deposit have decreased 10.1% during the year ended December 31, 1999. Money market savings accounts represent 20.4% of Lincoln Federal's deposits and have grown 26.7% during the year ended December 31, 1999. Lincoln Federal offers special rates on certificates of deposit with maturities that fit its asset and liability strategies. The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts that Lincoln Federal offers has allowed it to compete effectively in obtaining funds and to respond with flexibility to changes in consumer demand. Lincoln Federal has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. Lincoln Federal manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience, management believes that Lincoln Federal's savings accounts, NOW and MMDAs are relatively stable sources of deposits. However, the ability to attract and maintain certificates of deposit, and the rates Lincoln Federal pays on these deposits, have been and will continue to be significantly affected by market conditions. An analysis of Lincoln Federal's deposit accounts by type and maturity at December 31, 1999, is as follows:
Minimum Balance at Opening December 31, % of Type of Account Balance 1999 Deposits - ---------------- ------------ ------------- --------- (Unaudited) (Dollars in thousands) Withdrawable: Savings accounts........................... $ 25 $16,505 8.05% Money market............................... 1,000 41,745 20.37 NOW accounts............................... 200 10,729 5.23 Non-interest bearing demand accounts....... 200 3,396 1.66 -------- ------ Total withdrawable....................... 72,375 35.31 -------- ------ Certificates (original terms): 3 months or less........................... 1,000 230 .11 6 months................................... 1,000 3,150 1.54 12 months.................................. 1,000 20,980 10.24 18 months.................................. 1,000 18,717 9.13 24 months.................................. 1,000 35,598 17.37 30 months.................................. 1,000 25,179 12.28 36 months ................................. 1,000 18,312 8.93 60 months.................................. 1,000 9,007 4.39 Public fund certificates...................... 1,434 .70 -------- ------ Total certificates............................ 132,607 64.69 -------- ------ Total deposits................................ $204,982 100.00% ======== ======
The following table sets forth by various interest rate categories the composition of Lincoln Federal's time deposits at the dates indicated: At December 31, ----------------------------------------------------- 1999 1998 1997 -------- -------- -------- (In thousands) 3.00 to 3.99%...... $ 228 $ 191 $ --- 4.00 to 4.99%...... 54,803 24,274 15,926 5.00 to 5.99%...... 62,883 81,030 81,199 6.00 to 6.99%...... 14,693 41,966 48,872 -------- -------- -------- Total........... $132,607 $147,461 $145,997 ======== ======== ======== The following table represents, by various interest rate categories, the amounts of time deposits maturing during each of the three years following December 31, 1999. Matured certificates, which have not been renewed as of December 31, 1999, have been allocated based upon certain rollover assumptions. Amounts at December 31, 1999 Maturing In ----------------------------------------------- One Year Two Three Greater Than or Less Years Years Three Years ------- ----- ----- ----------- (In thousands) 3.00 to 3.99%.... $ 228 $ --- $ --- $ --- 4.00 to 4.99%.... 37,766 15,049 1,109 879 5.00 to 5.99%.... 35,316 18,885 7,616 1,066 6.00 to 6.99%.... 1,632 4,350 8,611 100 ------- ------- ------- ------ Total......... $74,942 $38,284 $17,336 $2,045 ======= ======= ======= ====== The following table indicates the amount of Lincoln Federal's other certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 1999. At December 31, 1999 -------------------- Maturity Period (In thousands) Three months or less.................................... $ 2,474 Greater than three months through six months............ 1,006 Greater than six months through twelve months........... 3,969 Over twelve months...................................... 8,322 ------- Total.............................................. $15,771 =======
DEPOSIT ACTIVITY -------------------------------------------------------------------------------------------- Balance Increase Balance Increase Balance at (Decrease) at (Decrease) at December 31, % of from December 31, % of from December 31, % of 1999 Deposits 1998 1998 Deposits 1997 1997 Deposits -------- ------ ------ -------- ------ ------ -------- ------ (Dollars in thousands) Withdrawable: Savings accounts................... $16,505 8.05% (4,077) $20,582 9.71% $(1,385) $21,967 10.78% Money market accounts.............. 41,745 20.37 8,803 32,942 15.54 6,940 26,002 12.75 NOW accounts....................... 10,729 5.23 2,188 8,541 4.03 976 7,565 3.71 Noninterest-bearing demand accounts.................. 3,396 1.66 912 2,484 1.17 163 2,321 1.14 -------- ------ ------ -------- ------ ------ -------- ------ Total withdrawable............... 72,375 35.31 7,826 64,549 30.45 6,694 57,855 28.38 -------- ------ ------ -------- ------ ------ -------- ------ Certificates (original terms): 91 days............................ 230 .11 (376) 606 .29 284 322 0.16 6 months........................... 3,150 1.54 (625) 3,775 1.78 (787) 4,562 2.24 12 months.......................... 20,980 10.24 (11,190) 32,170 15.17 2,457 29,713 14.58 18 months.......................... 18,717 9.13 9,473 9,244 4.36 (8,642) 17,886 8.77 24 months.......................... 35,598 17.37 14,027 21,571 10.18 20,298 1,273 0.62 30 months.......................... 25,179 12.28 (32,984) 58,163 27.43 (7,527) 65,690 32.22 36 months ......................... 18,312 8.93 9,380 8,932 4.21 (2,318) 11,250 5.52 60 months.......................... 9,007 4.39 (1,654) 10,661 5.03 (3,510) 14,171 6.95 Public fund certificates.............. 1,434 .70 (905) 2,339 1.10 1,209 1,130 0.56 -------- ------ ------ -------- ------ ------ -------- ------ Total certificates.................... 132,607 64.69 (14,854) 147,461 69.55 1,464 145,997 71.62 -------- ------ ------ -------- ------ ------ -------- ------ Total deposits........................ $204,982 100.00% (7,028) $212,010 100.00% $8,158 $203,852 100.00% ======== ====== ====== ======== ====== ====== ======== ======
Total deposits at December 31, 1999 were approximately $205.0 million, compared to approximately $203.9 million at December 31, 1997. Lincoln Federal's deposit base depends somewhat upon the manufacturing sector of Hendricks, Montgomery, Clinton and Morgan Counties. Although the manufacturing sector in these counties is relatively diversified and does not significantly depend upon any industry, a loss of a material portion of the manufacturing workforce could adversely affect Lincoln Federal's ability to attract deposits due to the loss of personal income attributable to the lost manufacturing jobs and the attendant loss in service industry jobs. In the unlikely event of the Bank's liquidation, all claims of creditors (including those of deposit account holders, to the extent of their deposit balances) would be paid first followed by distribution of the liquidation account to certain deposit account holders, with any assets remaining thereafter distributed to the Holding Company as the sole shareholder of Lincoln Federal. Borrowings. Lincoln Federal focuses on generating high quality loans and then seeking the best source of funding from deposits, investments or borrowings. At December 31, 1999, Lincoln Federal had borrowings in the amount of $103.9 million from the FHLB of Indianapolis which bear fixed and variable interest rates and which are due at various dates through 2009. Lincoln Federal is required to maintain eligible loans and investment securities, including mortgage-backed securities, in its portfolio of at least 160% of outstanding advances as collateral for advances from the FHLB of Indianapolis. As an additional funding source, Lincoln Federal has also sold securities under repurchase agreements. Lincoln Federal had outstanding securities sold under repurchase agreement in the amount of $4.6 million at December 31, 1999. Lincoln Federal does not anticipate any difficulty in obtaining advances and other borrowings appropriate to meet its requirements in the future. The following table presents certain information relating to Lincoln Federal's borrowings at or for the years ended December 31, 1999, 1998 and 1997.
At or for the Year Ended December 31, ----------------------------------------------------- 1999 1998 1997 -------- ---------- ----------- (Dollars in thousands) Outstanding at end of period Securities sold under repurchase agreements............ $ 4,600 $ --- $ --- FHLB advances.......................................... 103,938 33,263 70,136 Average balance outstanding for period Securities sold under repurchase agreements............ 3,680 --- --- FHLB advances.......................................... 78,874 49,773 92,121 Maximum amount outstanding at any month-end during the period Securities sold under repurchase agreements............ 4,600 --- --- FHLB advances.......................................... 104,188 35,136 106,932 Weighted average interest rate during the period Securities sold under repurchase agreements............ 5.16% ---% ---% FHLB advances.......................................... 5.30 5.74 5.70 Weighted average interest rate at end of period Securities sold under repurchase agreements............ 5.09 --- --- FHLB advances.......................................... 4.94 5.50 5.71 Note payable to Bloomington................................. $1,714 $ 2,203 $ 2,691
Service Corporation Subsidiary OTS regulations permit federal savings associations to invest in the capital stock, obligations or other specified types of securities of subsidiaries (referred to as "service corporations") and to make loans to such subsidiaries and joint ventures in which such subsidiaries are participants in an aggregate amount not exceeding 2% of the association's assets, plus an additional 1% of assets if the amount over 2% is used for specified community or inner-city development purposes. In addition, federal regulations permit associations to make specified types of loans to such subsidiaries (other than special purpose finance subsidiaries) in which the association owns more than 10% of the stock, in an aggregate amount not exceeding 50% of the association's regulatory capital if the association's regulatory capital is in compliance with applicable regulations. A savings association that acquires a non-savings association subsidiary, or that elects to conduct a new activity within a subsidiary, must give the FDIC and the OTS at least 30 days advance written notice. The FDIC may, after consultation with the OTS, prohibit specified activities if it determines such activities pose a serious threat to the SAIF. Moreover, a savings association must deduct from capital, for purposes of meeting the core capital, tangible capital and risk-based capital requirements, its entire investment in and loans to a subsidiary engaged in activities not permissible for a national bank (other than exclusively agency activities for its customers or mortgage banking subsidiaries). Lincoln Federal currently owns one subsidiary, LF, whose assets consist of an investment in Family Financial Life Insurance Company ("Family Financial") and in BHA. See "- Investments in Low- and Moderate-Income Housing Projects." LF received regulatory approval in February, 1998 to invest in Family Financial, an Indiana stock insurance company. In May, 1998, LF acquired a 16.7% interest in Family Financial for $650,000. The remaining interests are held in equal amounts by service corporations of five other financial institutions, four of which are located in Indiana and one in South Carolina. Fifty percent of the common stock of Family Financial is held by Consortium Partners, a Louisiana general partnership in which the six participating service corporations own equal interests. The service corporations directly own, in equal amounts, the remaining 50% of the common stock of Family Financial. Family Financial primarily engages in retail sales of mortgage and credit insurance products in connection with loans originated by Lincoln Federal's constituent shareholder financial institutions. Products offered by Family Financial include group and individual term mortgage life insurance, group mortgage disability insurance, group accidental death insurance, group credit life insurance, and group credit accident and disability insurance policies. Family Financial also markets a variety of tax-deferred annuity contracts which are wholly reinsured by other insurance companies. LF expects to receive (1) dividends paid on Family Financial shares owned directly by it, (2) a pro rata allocation of dividends received on shares held by Consortium Partners, which are divided among the partners based on the actuarially determined value of Family Financial's various lines of insurance generated by customers of these partners, and (3) commissions on sales of insurance products made to customers. For the period ended December 31, 1999, Lincoln Federal received dividends of $37,000 from Family Financial. Employees As of December 31, 1999, Lincoln Federal employed 84 persons on a full-time basis and five on a part-time basis. None of Lincoln Federal's employees are represented by a collective bargaining group and management considers employee relations to be good. Employee benefits for Lincoln Federal's full-time employees include, among other things, an employee stock ownership plan, a Pentegra Group (formerly known as Financial Institutions Retirement Fund) defined benefit pension plan, which is a noncontributory, multiple-employer comprehensive pension plan (the"Pension Plan"), and hospitalization/major medical insurance, long-term disability insurance, life insurance, and participation in the Lincoln Federal 401(k) Plan, which is administered by Pentegra Group. Lincoln Federal considers its employee benefits to be competitive with those offered by other financial institutions and major employers in its area. See "Executive Compensation and Related Transactions of Lincoln Federal." COMPETITION Lincoln Federal originates most of its loans to and accepts most of its deposits from residents of Hendricks, Montgomery, Clinton and Morgan Counties, Indiana. Lincoln Federal is subject to competition from various financial institutions, including state and national banks, state and federal savings associations, credit unions, and certain nonbanking consumer lenders that provide similar services in those counties with significantly larger resources than are available to Lincoln Federal. Lincoln Federal also competes with money market funds with respect to deposit accounts and with insurance companies with respect to individual retirement accounts. The primary factors influencing competition for deposits are interest rates, service and convenience of office locations. Lincoln Federal competes for loan originations primarily through the efficiency and quality of the services that it provides borrowers and through interest rates and loan fees charged. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions, current interest rate levels, and other factors that management cannot readily predict. REGULATION General As a federally chartered, SAIF-insured savings association, Lincoln Federal is subject to extensive regulation by the OTS and the FDIC. For example, Lincoln Federal must obtain OTS approval before it may engage in certain activities and must file reports with the OTS regarding its activities and financial condition. The OTS periodically examines Lincoln Federal's books and records and, in conjunction with the FDIC in certain situations, has examination and enforcement powers. This supervision and regulation are intended primarily for the protection of depositors and federal deposit insurance funds. A savings association must pay a semi-annual assessment to the OTS based upon a marginal assessment rate that decreases as the asset size of the savings association increases, and which includes a fixed-cost component that is assessed on all savings associations. The assessment rate that applies to a savings association depends upon the institution's size, condition, and the complexity of its operations. Lincoln Federal's semi-annual assessment is $42,000. Lincoln Federal is also subject to federal and state regulation as to such matters as loans to officers, directors, or principal shareholders, required reserves, limitations as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuances or retirements of Lincoln Federal's securities, and limitations upon other aspects of banking operations. In addition, Lincoln Federal's activities and operations are subject to a number of additional detailed, complex and sometimes overlapping federal and state laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-In-Lending Act and Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Community Reinvestment Act, anti-redlining legislation and antitrust laws. Savings and Loan Holding Company Regulation The Holding Company is regulated as a "non-diversified savings and loan holding company" within the meaning of the Home Owners' Loan Act, as amended (the "HOLA"), and subject to regulatory oversight of the Director of the OTS. As such, the Holding Company is registered with the OTS and is thereby subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, Lincoln Federal is subject to certain restrictions in its dealings with the Holding Company and with other companies affiliated with the Holding Company. In general, the HOLA prohibits a savings and loan holding company, without obtaining the prior approval of the Director of the OTS, from acquiring control of another savings association or savings and loan holding company or retaining more than 5% of the voting shares of a savings association or of another holding company which is not a subsidiary. The HOLA also restricts the ability of a director or officer of the Holding Company, or any person who owns more than 25% of the Holding Company's stock, from acquiring control of another savings association or savings and loan holding company without obtaining the prior approval of the Director of the OTS. The Holding Company currently operates as a unitary savings and loan holding company. Prior to the enactment of the Gramm-Leach-Bliley Act (the "GLB Act") on November 12, 1999, there were no restrictions on the permissible business activities of a unitary savings and loan holding company. The GLB Act included a provision that prohibits any new unitary savings and loan holding company, defined as a company that acquires a thrift after May 4, 1999, from engaging in commercial activities. This provision also includes a grandfather clause, however, that permits a company that was a savings and loan holding company as of May 4, 1999, or had an application to become a savings and loan holding company on file with the OTS as of that date, to acquire and continue to control a thrift and to continue to engage in commercial activities. Because the Holding Company qualifies under this grandfather provision, the GLB Act did not affect the Holding Company's authority to engage in diversified business activities. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary holding company would be deemed to be a bank holding company subject to all of the provisions of the Bank Holding Company Act of 1956 and other statutes applicable to bank holding companies, to the same extent as if the Holding Company were a bank holding company and Lincoln Federal were a bank. See "-Qualified Thrift Lender." At December 31, 1999, Lincoln Federal's asset composition was in excess of that required to qualify as a Qualified Thrift Lender. If the Holding Company were to acquire control of another savings association other than through a merger or other business combination with Lincoln Federal, the Holding Company would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings association meets the QTL test, the activities of the Holding Company and any of Lincoln Federal's subsidiaries (other than Lincoln Federal or other subsidiary savings associations) would thereafter be subject to further restrictions. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings association shall commence or continue for a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof, any business activity other than (i) furnishing or performing management services for a subsidiary savings association, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings association, (iv) holding or managing properties used or occupied by a subsidiary savings association, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by the FSLIC by regulation as of March 5, 1987, to be engaged in by multiple holding companies, or (vii) those activities authorized by the Federal Reserve Board (the "FRB") as permissible for bank holding companies, unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above must also be approved by the Director of the OTS before a multiple holding company may engage in such activities. The Director of the OTS may also approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings associations in more than one state, if the multiple savings and loan holding company involved controls a savings association which operated a home or branch office in the state of the association to be acquired as of March 5, 1987, or if the laws of the state in which the association to be acquired is located specifically permit associations to be acquired by state-chartered associations or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings associations). Also, the Director of the OTS may approve an acquisition resulting in a multiple savings and loan holding company controlling savings associations in more than one state in the case of certain emergency thrift acquisitions. Indiana law permits federal and state savings association holding companies with their home offices located outside of Indiana to acquire savings associations whose home offices are located in Indiana and savings association holding companies with their principal place of business in Indiana ("Indiana Savings Association Holding Companies") upon receipt of approval by the Indiana Department of Financial Institutions. Moreover, Indiana Savings Association Holding Companies may acquire savings associations with their home offices located outside of Indiana and savings association holding companies with their principal place of business located outside of Indiana upon receipt of approval by the Indiana Department of Financial Institutions. No subsidiary savings association of a savings and loan holding company may declare or pay a dividend on its permanent or nonwithdrawable stock unless it first gives the Director of the OTS 30 days advance notice of such declaration and payment. Any dividend declared during such period or without giving notice shall be invalid. Federal Home Loan Bank System Lincoln Federal is a member of the FHLB of Indianapolis, which is one of twelve regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLB is funded primarily from funds deposited by banks and savings associations and proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. The Federal Housing Finance Board ("FHFB"), an independent agency, controls the FHLB System, including the FHLB of Indianapolis. Prior to the enactment of the GLB Act, a federal savings association was required to become a member of the FHLB for the district in which the thrift is located. The GLB Act abolished this requirement, effective six months following the enactment of the statute. At that time, membership with the FHLB will become voluntary. Any savings association that chooses to become (or remain) a member of the FHLB following the expiration of this six-month period will have to qualify for membership under the criteria that existed prior to the enactment of the GLB Act. Lincoln Federal currently intends to remain a member of the FHLB of Indianapolis. As a member of the FHLB, Lincoln Federal is required to purchase and maintain stock in the FHLB of Indianapolis in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts, or similar obligations at the beginning of each year. At December 31, 1999, Lincoln Federal's investment in stock of the FHLB of Indianapolis was $5.4 million. The FHLB imposes various limitations on advances such as limiting the amount of certain types of real estate-related collateral to 30% of a member's capital and limiting total advances to a member. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Indianapolis and the purpose of the borrowing. The FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. For the fiscal year ended December 31, 1999, dividends paid by the FHLB of Indianapolis to Lincoln Federal totaled approximately $436,000, for an annual rate of 8.0%. Insurance of Deposits Deposit Insurance. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of banks and thrifts and safeguards the safety and soundness of the banking and thrift industries. The FDIC administers two separate insurance funds, the BIF for commercial banks and state savings banks and the SAIF for savings associations such as Lincoln Federal and banks that have acquired deposits from savings associations. The FDIC is required to maintain designated levels of reserves in each fund. During 1996, the reserves of the SAIF were below the level required by law, primarily because a significant portion of the assessments paid into the SAIF had been used to pay the cost of prior thrift failures, while the reserves of the BIF met the level required by law. In 1996, however, legislation was enacted to recapitalize the SAIF and eliminate the premium disparity between the BIF and SAIF. See "- Assessments" below. Assessments. The FDIC is authorized to establish separate annual assessment rates for deposit insurance for members of the BIF and members of the SAIF. The FDIC may increase assessment rates for either fund if necessary to restore the fund's ratio of reserves to insured deposits to the target level within a reasonable time and may decrease these rates if the target level has been met. The FDIC has established a risk-based assessment system for both SAIF and BIF members. Under this system, assessments vary depending on the risk the institution poses to its deposit insurance fund. An institution's risk level is determined based on its capital level and the FDIC's level of supervisory concern about the institution. In 1996, legislation was enacted that included provisions designed to recapitalize the SAIF and eliminate the significant premium disparity between the BIF and the SAIF. Under the new law, Lincoln Federal was charged a one-time special assessment equal to $.657 per $100 in assessable deposits at March 31, 1995. Lincoln Federal recognized this one-time assessment as a non-recurring operating expense of approximately $1.3 million ($785,000 after tax) during the three-month period ending September 30, 1996, and paid this assessment during the fourth quarter of 1996. The assessment was fully deductible for both federal and state income tax purposes. Beginning January 1, 1997, Lincoln Federal's annual deposit insurance premium was reduced from .23% to .0644% of total assessable deposits. BIF institutions pay lower assessments than comparable SAIF institutions because BIF institutions pay only 20% of the rate paid by SAIF institutions on their deposits with respect to obligations issued by the federally-chartered corporation which provided some of the financing to resolve the thrift crisis in the 1980's ("FICO"). Although Congress has considered merging the SAIF and the BIF, until then, savings associations with SAIF deposits may not transfer deposits into the BIF system without paying various exit and entrance fees, and SAIF institutions will continue to pay higher FICO assessments. Such exit and entrance fees need not be paid if a SAIF institution converts to a bank charter or merges with a bank, as long as the resulting bank continues to pay applicable insurance assessments to the SAIF, and as long as certain other conditions are met. Savings Association Regulatory Capital Currently, savings associations are subject to three separate minimum capital-to-assets requirements: (i) a leverage limit, (ii) a tangible capital requirement, and (iii) a risk-based capital requirement. The leverage limit requires that savings associations maintain "core capital" of at least 3% of total assets. Core capital is generally defined as common shareholders' equity (including retained income), noncumulative perpetual preferred stock and related surplus, certain minority equity interests in subsidiaries, qualifying supervisory goodwill, purchased mortgage servicing rights and purchased credit card relationships (subject to certain limits) less nonqualifying intangibles. The OTS recently amended this requirement to require a core capital level of 3% of total adjusted assets for savings associations that receive the highest rating for safety and soundness, and 4% to 5% for all other savings associations. This amendment became effective April 1, 1999. Under the tangible capital requirement, a savings association must maintain tangible capital (core capital less all intangible assets except purchased mortgage servicing rights which may be included after making the above-noted adjustment in an amount up to 100% of tangible capital) of at least 1.5% of total assets. Under the risk-based capital requirements, a minimum amount of capital must be maintained by a savings association to account for the relative risks inherent in the type and amount of assets held by the savings association. The risk-based capital requirement requires a savings association to maintain capital (defined generally for these purposes as core capital plus general valuation allowances and permanent or maturing capital instruments such as preferred stock and subordinated debt, less assets required to be deducted) equal to 8.0% of risk-weighted assets. Assets are ranked as to risk in one of four categories (0-100%). A credit risk-free asset, such as cash, requires no risk-based capital, while an asset with a significant credit risk, such as a non-accrual loan, requires a risk factor of 100%. Moreover, a savings association must deduct from capital, for purposes of meeting the core capital, tangible capital and risk-based capital requirements, its entire investment in and loans to a subsidiary engaged in activities not permissible for a national bank (other than exclusively agency activities for its customers or mortgage banking subsidiaries). At December 31, 1999, Lincoln Federal was in compliance with all capital requirements imposed by law. The OTS has promulgated a rule which sets forth the methodology for calculating an interest rate risk component to be used by savings associations in calculating regulatory capital. The OTS has delayed the implementation of this rule, however. The rule requires savings associations with "above normal" interest rate risk (institutions whose portfolio equity would decline in value by more than 2% of assets in the event of a hypothetical 200-basis-point move in interest rates) to maintain additional capital for interest rate risk under the risk-based capital framework. Even though the OTS has delayed implementing this rule, Lincoln Federal nevertheless measures its interest rate risk in conformity with the OTS regulation and, as of December 31, 1999, would have been required to deduct $6.5 million from its total capital available to calculate its risk-based capital requirement. The OTS recently updated its standards regarding the management of interest rate risk to include summary guidelines to assist savings associations in determining their exposures to interest rate risk. If an association is not in compliance with the capital requirements, the OTS is required to prohibit asset growth and to impose a capital directive that may restrict, among other things, the payment of dividends and officers' compensation. In addition, the OTS and the FDIC generally are authorized to take enforcement actions against a savings association that fails to meet its capital requirements. These actions may include restricting the operating activities of the association, imposing a capital directive, cease and desist order, or civil money penalties, or imposing harsher measures such as appointing a receiver or conservator or forcing the association to merge into another institution. Prompt Corrective Regulatory Action The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FedICIA") requires, among other things, that federal bank regulatory authorities take "prompt corrective action" with respect to institutions that do not meet minimum capital requirements. For these purposes, FedICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 1999, Lincoln Federal was categorized as "well capitalized," meaning that its total risk-based capital ratio exceeded 10%, its Tier I risk-based capital ratio exceeded 6%, its leverage ratio exceeded 5%, and it was not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. The FDIC may order savings associations which have insufficient capital to take corrective actions. For example, a savings association which is categorized as "undercapitalized" would be subject to growth limitations and would be required to submit a capital restoration plan, and a holding company that controls such a savings association would be required to guarantee that the savings association complies with the restoration plan. "Significantly undercapitalized" savings associations would be subject to additional restrictions. Savings associations deemed by the FDIC to be "critically undercapitalized" would be subject to the appointment of a receiver or conservator. Dividend Limitations The OTS adopted a regulation, which became effective on April 1, 1999, that revised the restrictions that apply to "capital distributions" by savings associations. The amended regulation defines a capital distribution as a distribution of cash or other property to a savings association's owners, made on account of their ownership. This definition includes a savings association's payment of cash dividends to shareholders, or any payment by a savings association to repurchase, redeem, retire, or otherwise acquire any of its shares or debt instruments that are included in total capital, and any extension of credit to finance an affiliate's acquisition of those shares or interests. The amended regulation does not apply to dividends consisting only of a savings association's shares or rights to purchase such shares. The amended regulation exempts certain savings associations from the requirement under the prior version of the regulation that all savings associations file either a notice or an application with the OTS before making any capital distribution. As revised, the regulation requires a savings association to file an application for approval of a proposed capital distribution with the OTS if the association is not eligible for expedited treatment under OTS's application processing rules, or the total amount of all capital distributions, including the proposed capital distribution, for the applicable calendar year would exceed an amount equal to the savings association's net income for that year to date plus the savings association's retained net income for the preceding two years (the "retained net income standard"). At December 31, 1999, Lincoln Federal's retained net income standard was approximately $6.1 million. A savings association must also file an application for approval of a proposed capital distribution if, following the proposed distribution, the association would not be at least adequately capitalized under the OTS prompt corrective action regulations, or if the proposed distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the association and the OTS or the FDIC. The amended regulation requires a savings association to file a notice of a proposed capital distribution in lieu of an application if the association or the proposed capital distribution do not meet the conditions described above, and: (1) the savings association will not be at least well capitalized (as defined under the OTS prompt corrective action regulations) following the capital distribution; (2) the capital distribution would reduce the amount of, or retire any part of the savings association's common or preferred stock, or retire any part of debt instruments such as notes or debentures included in the association's capital under the OTS capital regulation; or (3) the savings association is a subsidiary of a savings and loan holding company. Because Lincoln Federal is a subsidiary of a savings and loan holding company, this latter provision requires, at a minimum, that Lincoln Federal file a notice with the OTS 30 days before making any capital distributions to the Holding Company. In addition to these regulatory restrictions, Lincoln Federal's Plan of Conversion imposes additional limitations on the amount of capital distributions it may make to the Holding Company. The Plan of Conversion requires Lincoln Federal to establish and maintain a liquidation account for the benefit of Eligible Account Holders and Supplemental Eligible Account Holders and prohibits Lincoln Federal from making capital distributions to the Holding Company if its net worth would be reduced below the amount required for the liquidation account. Limitations on Rates Paid for Deposits Regulations promulgated by the FDIC pursuant to FedICIA place limitations on the ability of insured depository institutions to accept, renew or roll over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in the institution's normal market area. Under these regulations, "well-capitalized" depository institutions may accept, renew or roll such deposits over without restriction, "adequately capitalized" depository institutions may accept, renew or roll such deposits over with a waiver from the FDIC (subject to certain restrictions on payments of rates) and "undercapitalized" depository institutions may not accept, renew or roll such deposits over. The regulations contemplate that the definitions of "well-capitalized," "adequately-capitalized" and "undercapitalized" will be the same as the definition adopted by the agencies to implement the corrective action provisions of FedICIA. Management does not believe that these regulations will have a materially adverse effect on Lincoln Federal's current operations. Safety and Soundness Standards In 1995, the federal banking agencies adopted final safety and soundness standards for all insured depository institutions. The standards, which were issued in the form of guidelines rather than regulations, relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan may result in enforcement proceedings. During 1996, the federal banking agencies added asset quality and earning standards to the safety and soundness guidelines. Real Estate Lending Standards OTS regulations require savings associations to establish and maintain written internal real estate lending policies. Each association's lending policies must be consistent with safe and sound banking practices and be appropriate to the size of the association and the nature and scope of its operations. The policies must establish loan portfolio diversification standards; establish prudent underwriting standards, including loan-to-value limits, that are clear and measurable; establish loan administration procedures for the association's real estate portfolio; and establish documentation, approval, and reporting requirements to monitor compliance with the association's real estate lending policies. The association's written real estate lending policies must be reviewed and approved by the association's Board of Directors at least annually. Further, each association is expected to monitor conditions in its real estate market to ensure that its lending policies continue to be appropriate for current market conditions. Loans to One Borrower Under OTS regulations, Lincoln Federal may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily marketable collateral, including certain debt and equity securities but not including real estate. In some cases, a savings association may lend up to 30% of unimpaired capital and surplus to one borrower for purposes of developing domestic residential housing, provided that the association meets its regulatory capital requirements and the OTS authorizes the association to use this expanded lending authority. Lincoln Federal has established an "in-house" lending limit of $3 million to a single or related group of borrowers, which is significantly lower than the regulatory lending limit described above. Any loan that exceeds this "in-house" lending limit up to the regulatory lending limit must first be approved by Lincoln Federal's board of directors. At December 31, 1999, Lincoln Federal had no loan relationships that exceeded its "in-house" lending limit. Also on that date, Lincoln Federal did not have any loans or extensions of credit to a single or related group of borrowers in excess of its regulatory lending limits. Management does not believe that the loans-to-one-borrower limits will have a significant impact on Lincoln Federal's business operations or earnings. Qualified Thrift Lender Savings associations must meet a QTL test that requires the association to maintain an appropriate level of qualified thrift investments ("QTIs") (primarily residential mortgages and related investments, including certain mortgage-related securities) and otherwise to qualify as a QTL. The required percentage of QTIs is 65% of portfolio assets (defined as all assets minus intangible assets, property used by the association in conducting its business and liquid assets equal to 10% of total assets). Certain assets are subject to a percentage limitation of 20% of portfolio assets. In addition, savings associations may include shares of stock of the FHLBs, FNMA, and FHLMC as QTIs. Compliance with the QTL test is determined on a monthly basis in nine out of every twelve months. As of December 31, 1999, Lincoln Federal was in compliance with its QTL requirement, with approximately 86.6% of its assets invested in QTIs. A savings association which fails to meet the QTL test must either convert to a bank (but its deposit insurance assessments and payments will be those of and paid to the SAIF) or be subject to the following penalties: (i) it may not enter into any new activity except for those permissible for a national bank and for a savings association; (ii) its branching activities shall be limited to those of a national bank; (iii) it shall be bound by regulations applicable to national banks respecting payment of dividends. Three years after failing the QTL test the association must dispose of any investment or activity not permissible for a national bank and a savings association. If such a savings association is controlled by a savings and loan holding company, then such holding company must, within a prescribed time period, become registered as a bank holding company and become subject to all rules and regulations applicable to bank holding companies (including restrictions as to the scope of permissible business activities). Acquisitions or Dispositions and Branching The Bank Holding Company Act specifically authorizes a bank holding company, upon receipt of appropriate regulatory approvals, to acquire control of any savings association or holding company thereof wherever located. Similarly, a savings and loan holding company may acquire control of a bank. Moreover, federal savings associations may acquire or be acquired by any insured depository institution. Regulations promulgated by the FRB restrict the branching authority of savings associations acquired by bank holding companies. Savings associations acquired by bank holding companies may be converted to banks if they continue to pay SAIF premiums, but as such they become subject to branching and activity restrictions applicable to banks. Subject to certain exceptions, commonly-controlled banks and savings associations must reimburse the FDIC for any losses suffered in connection with a failed bank or savings association affiliate. Institutions are commonly controlled if one is owned by another or if both are owned by the same holding company. Such claims by the FDIC under this provision are subordinate to claims of depositors, secured creditors, and holders of subordinated debt, other than affiliates. The OTS has adopted regulations which permit nationwide branching to the extent permitted by federal statute. Federal statutes permit federal savings associations to branch outside of their home state if the association meets the domestic building and loan test in ss. 7701(a)(19) of the Code or the asset composition test of ss. 7701(c) of the Code. Branching that would result in th formation of a multiple savings and loan holding company controlling savings associations in more than one state is permitted if the law of the state in which the savings association to be acquired is located specifically authorizes acquisitions of its state-chartered associations by state-chartered associations or their holding companies in the state where the acquiring association or holding company is located. Moreover, Indiana banks and savings associations are permitted to acquire other Indiana banks and savings associations and to establish branches throughout Indiana. Finally, The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act") permits bank holding companies to acquire banks in other states and, with state consent and subject to certain limitations, allows banks to acquire out-of-state branches either through merger or de novo expansion. The State of Indiana enacted legislation establishing interstate branching provisions for Indiana state-chartered banks consistent with those established by the Riegle-Neal Act (the "Indiana Branching Law"). The Indiana Branching Law, which became effective in 1996, authorizes Indiana banks to branch interstate by merger or de novo expansion, provided that such transactions are not permitted to out-of-state banks unless the laws of their home states permit Indiana banks to merge or establish de novo banks on a reciprocial basis. Transactions with Affiliates Lincoln Federal is subject to Sections 22(h), 23A and 23B of the Federal Reserve Act, which restrict financial transactions between banks and their directors, executive officers and affiliated companies. The statute limits credit transactions between a bank or savings association and its executive officers and its affiliates, prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restricts the types of collateral security permitted in connection with a bank's extension of credit to an affiliate. Federal Securities Law The shares of Common Stock of the Holding Company have been registered with the SEC under the 1934 Act and, as a result, the Holding Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the 1934 Act and the rules of the SEC thereunder. After three years following Lincoln Federal's conversion to stock form, if the Holding Company has fewer than 300 shareholders, it may deregister its shares under the 1934 Act and cease to be subject to the foregoing requirements. Shares of Common Stock held by persons who are affiliates of the Holding Company may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the 1933 Act. If the Holding Company meets the current public information requirements under Rule 144, each affiliate of the Holding Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of the Holding Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks. Community Reinvestment Act Matters Federal law requires that ratings of depository institutions under the Community Reinvestment Act of 1977 ("CRA") be disclosed. The disclosure includes both a four-unit descriptive rating -- outstanding, satisfactory, needs to improve, and substantial noncompliance -- and a written evaluation of an institution's performance. Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLBs. The standards take into account a member's performance under the CRA and its record of lending to first-time home buyers. The OTS has designated Lincoln Federal's record of meeting community credit needs as satisfactory. TAXATION Federal Taxation Historically, savings associations, such as Lincoln Federal, have been permitted to compute bad debt deductions using either the bank experience method or the percentage of taxable income method. However, for years beginning after December 31, 1995, no savings association may use the percentage of taxable income method of computing its allowable bad debt deduction for tax purposes. Instead, all savings associations are required to compute their allowable deduction using the experience method. As a result of the repeal of the percentage of taxable income method, reserves taken after 1987 using the percentage of taxable income method generally must be included in future taxable income over a six-year period, although a two-year delay may be permitted for associations meeting a residential mortgage loan origination test. Lincoln Federal does not have any reserves taken after 1987 that must be recaptured. In addition, the pre-1988 reserve, for which no deferred taxes have been recorded, need not be recaptured into income unless (i) the savings association no longer qualifies as a bank under the Code, or (ii) the savings association pays out excess dividends or distributions. Although Lincoln Federal does have some reserves from before 1988, Lincoln Federal is not required to recapture these reserves. Depending on the composition of its items of income and expense, a savings association may be subject to the alternative minimum tax. A savings association must pay an alternative minimum tax on the amount (if any) by which 20% of alternative minimum taxable income ("AMTI"), as reduced by an exemption varying with AMTI, exceeds the regular tax due. AMTI equals regular taxable income increased or decreased by certain tax preferences and adjustments, including depreciation deductions in excess of that allowable for alternative minimum tax purposes, tax-exempt interest on most private activity bonds issued after August 7, 1986 (reduced by any related interest expense disallowed for regular tax purposes), the amount of the bad debt reserve deduction claimed in excess of the deduction based on the experience method and 75% of the excess of adjusted current earnings over AMTI (before this adjustment and before any alternative tax net operating loss). AMTI may be reduced only up to 90% by net operating loss carryovers, but alternative minimum tax paid can be credited against regular tax due in later years. For federal income tax purposes, Lincoln Federal has been reporting its income and expenses on the accrual method of accounting. Lincoln Federal's federal income tax returns have not been audited in recent years. State Taxation Lincoln Federal is subject to Indiana's Financial Institutions Tax ("FIT"), which is imposed at a flat rate of 8.5% on "adjusted gross income." "Adjusted gross income," for purposes of FIT, begins with taxable income as defined by Section 63 of the Code and, thus, incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications. Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes. Lincoln Federal's state income tax returns have not been audited in recent years. Item 2. Properties. The following table provides certain information with respect to Lincoln Federal's offices as of December 31, 1999: Net Book Value of Property, Approximate Description Owned or Year Total Furniture & Square and Address leased Opened Deposits Fixtures Footage (Dollars in Thousands) 1121 East Main Street Owned 1970 $86,309 $1,307 9,925 Plainfield, IN 46168 134 South Washington Street Owned 1962 47,021 389 9,340 Crawfordsville, IN 47933 1900 East Wabash Street Owned 1974 31,664 288 2,670 Frankfort, IN 46041 975 East Main Street Owned 1981 28,609 286 2,890 Brownsburg, IN 46112 7648 East U.S. Highway 36 Owned 1999 7,375 1,071 2,800 Avon, IN 590 S. State Road 67 Leased 1999 4,004 332 1,500 Mooresville, IN 46158 Lincoln Federal owns computer and data processing equipment which it uses for transaction processing, loan origination, and accounting. The net book value of Lincoln Federal's electronic data processing equipment was approximately $417,000 at December 31, 1999. Lincoln Federal currently operates five automatic teller machines ("ATMs"), with one ATM located at its main office and each of its branch offices. Lincoln Federal's ATMs participate in the Cirrus(R) and MAC(R) networks. Lincoln Federal has also contracted for the data processing and reporting services of On-Line Financial Services, Inc. in Oak Brook, Illinois. The cost of these data processing services is approximately $46,000 per month. Lincoln Federal has also executed a Correspondent Services Agreement with the FHLB of Indianapolis under which it receives item processing and other services for a fee of approximately $6,700 per month. Item 3. Legal Proceedings. Although the Holding Company and Lincoln Federal are involved, from time to time, in various legal proceedings in the normal course of business, there are no material legal proceedings to which they presently are a party or to which any of the Holding Company's or Lincoln Federal's property is subject. Item 4. Submission of Matters to a Vote of Security Holders. No matter was submitted to a vote of the Holding Company's shareholders during the quarter ended December 31, 1999. Item 4.5. Executive Officers of the Registrant. The executive officers of the Holding Company are identified below. The executive officers of the Holding Company are elected annually by the Holding Company's Board of Directors. Name Position with Holding Company ---- ----------------------------- T. Tim Unger Chairman of the Board, President and Chief Executive Officer John M. Baer Secretary and Treasurer T. Tim Unger (age 59) has been President and Chief Executive Officer of Lincoln Federal since January, 1996. Before then, Mr. Unger served as President and Chief Executive Officer of Summit Bank of Clinton County from 1989 through 1995. Mr. Unger has served the banking industry since 1966. John M. Baer (age 51) has served as Lincoln Federal's Chief Financial Officer since June, 1997 and as Lincoln Federal's Secretary and Treasurer since January, 1998. Before working for Lincoln Federal, Mr. Baer served as Vice President and Chief Financial Officer of the Community Bank Group of Bank One in Indianapolis, Indiana from June, 1996 through June, 1997. From October, 1989 through June, 1996 he served as Senior Vice President and Chief Financial Officer of Bank One, Merrillville, NA, in Merrillville, Indiana. Mr. Baer has served the banking industry since 1978. PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters. The information required by this item is incorporated by reference to the material under the heading "Shareholder Information" on page 47 of the Holding Company's 1999 Shareholder Annual Report (the "Shareholder Annual Report"). Item 6. Selected Financial Data. The information required by this item is incorporated by reference to the material under the heading "Selected Consolidated Financial Data of Lincoln Bancorp and Subsidiary" on pages 3 and 4 of the Shareholder Annual Report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation. The information required by this item is incorporated by reference to pages 4 through 19 of the Shareholder Annual Report. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information required by this item is incorporated by reference to pages 16 through 19 of the Shareholder Annual Report. Item 8. Financial Statements and Supplementary Data. The Holding Company's Consolidated Financial Statements and Notes thereto contained on pages 20 through 45 in the Shareholder Annual Report are incorporated herein by reference. The Company's unaudited quarterly results of operations contained on page 16 in the Shareholder Annual Report are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant. The information required by this item with respect to directors is incorporated by reference to pages 3 through 5 and page 11 of the Holding Company's Proxy Statement for its 2000 Annual Shareholder Meeting (the "2000 Proxy Statement"). Information concerning the Holding Company's executive officers is included in Item 4.5 in Part I of this report. Item 11. Executive Compensation. Management Remuneration and Related Transactions Remuneration of Named Executive Officer During the fiscal year ended December 31, 1999, no cash compensation was paid directly by the Holding Company to any of its executive officers. Each of such officers was compensated by the Bank. The following tables set forth information as to annual, long term and other compensation for services in all capacities to the President and Chief Executive Officer of the Holding Company for the last three fiscal years and the Chief Financial Officer, Secretary and Treasurer of the Holding Company for the last two fiscal years (the "Named Executive Officers"). There were no other executive officers of the Holding Company who earned over $100,000 in salary and bonuses during the fiscal year ended December 31, 1999.
Summary Compensation Table Annual Compensation Long Term Compensation Annual Compensation Awards Other All Annual Restricted Securities Other Name and Fiscal Compen- Stock Underlying Compen- Principal Position Year Salary ($)(1) Bonus ($) sation($)(2) Awards($) Options(#) sation($)(3) - -------------------------------------------------------------------------------------------------------------------- T. Tim Unger, President 1999 $165,000 $25,000 --- $700,925 (4) 175,231 $3,451 and Chief Executive Officer1998 $135,000 $30,000 --- --- --- $3,555 1997 $125,000 $10,000 --- --- --- $3,330 John M. Baer, Chief 1999 $105,000 $10,500 --- $438,075 (4) 60,092 $3,618 Financial Officer, 1998 $ 95,000 $15,000 --- --- --- $ 990 Secretary and Treasurer
(1) Mr. Unger does not receive any directors fees. Includes amounts deferred pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Code") under the Bank's 401(k) Plan. (2) The Named Executive Officers received certain perquisites, but the incremental cost of providing such perquisites did not exceed the lesser of $50,000 or 10% of their salary and bonus. (3) All Other Compensation includes the Bank's matching contributions under its 401(k) Plan. (4) The value of the restricted stock awards was determined by multiplying the fair market values of the Common Stock on the date the shares were awarded by the number of shares awarded. These shares vest over a five year period commencing July 6, 1999. As of December 31, 1999, the number and aggregate value of restricted stock holdings by Mr. Unger were 56,074 and $587,025, respectively, and by Mr. Baer were 35,046 and $366,888, respectively. Awards paid on the restricted shares are payable to the grantee as the shares are vested and are not included in the table. Stock Options The following table sets forth information related to options granted during fiscal year 1999 to the Named Executive Officers.
Potential Realizable Value at Assumed % of Total Annual Rates of Stock Options Granted Exercise or Price Appreciation Options to Employees Base Price Expiration for Option Term Name Granted(#) In Fiscal Year ($/Share)(3) Date 5% ($) 10% ($) ---- ---------- -------------- ------------ ---- ------ ------- T. Tim Unger 175,231 (1) 47.25% $12.50 7/5/2009 $3,567,910 $5,681,301 John M. Baer 60,092 (2) 16.21% $12.50 7/5/2009 $1,223,544 $1,948,289
(1) These are options to acquire shares of the Holding Company's Common Stock. They are exercisable at the rate of 20% per year over a 5-year period commencing July 6, 1999. Subject to earlier vesting under certain circumstances. (2) These are options to acquire shares of the Holding Company's Common Stock. These options become exercisable as to 8,000 shares on July 6, 2000, as to 8,000 shares on July 6, 2001, as to 8,000 shares the first days of years 2002 - 2006, and as to 4,092 shares on January 1, 2007, subject to earlier vesting under certain circumstances. (3) The option exercise price may be paid in cash or with the approval of the Stock Compensation Committee beginning on December 30, 2001, in shares of Holding Company Common Stock or a combination thereof. The option exercise price equaled the market value of a share of the Holding Company Common Stock on the date of grant. The following table includes the number of shares covered by exercisable and unexercisable stock options held by the Named Executive Officers as of December 31, 1999. Also reported are the values for "in-the-money" options (options whose exercise price is lower than the market value of the shares at fiscal year end) which represent the spread between the exercise price of any such existing stock options and the fiscal year-end market price of the stock. Outstanding Stock Option Grants and Value Realized as of 12/31/99 Number of Value of Unexercised Securities Underlying In-the-Money Unexercised Options Options at at Fiscal Year End (#) Fiscal Year End ($) (1) Name Exercisable Unexercisable Exercisable Unexercisable - ------------------------------------------------------------------------------ T. Tim Unger --- 175,231 --- --- John M. Baer --- 60,092 --- --- (1) Since the average between the high asked and low bid prices for the shares on December 31, 1999, was $10.46875 per share, and this price is below the $12.50 per share exercise price of the options, none of these options were "in-the-money" on December 31, 1999. No stock options were exercised during fiscal 1999 by the Named Executive Officers. Employment Contract The Bank entered into a three-year employment contract with Mr. Unger. The contract with Mr. Unger extends annually for an additional one-year term to maintain its three-year term if the Bank's Board of Directors determines to so extend it, unless notice not to extend is properly given by either party to the contract. Mr. Unger receives a salary under the contract equal to his current salary with the Bank, subject to increases approved by the Board of Directors. The contract also provides, among other things, for participation in other fringe benefits and benefit plans available to the Bank's employees. Mr. Unger may terminate his employment upon 60 days' written notice to the Bank. The Bank may discharge Mr. Unger for cause (as defined in the contract) at any time or in certain specified events. If the Bank terminates Mr. Unger's employment for other than cause or if Mr. Unger terminates his own employment for cause (as defined in the contract), Mr. Unger will receive his base compensation under the contract for an additional three years if the termination follows a change of control in the Holding Company, and for the balance of the contract if the termination does not follow a change in control. In addition, during such period, Mr. Unger will continue to participate in the Bank's group insurance plans and retirement plans, or receive comparable benefits. Moreover, within a period of three months after such termination following a change of control, Mr. Unger will have the right to cause the Bank to purchase any stock options he holds for a price equal to the fair market value (as defined in the contract) of the shares subject to such options minus their option price. If the payments provided for in the contract, together with any other payments made to Mr. Unger by the Bank, are deemed to be payments in violation of the "golden parachute" rules of the Code, such payments will be reduced to the largest amount which would not cause the Bank to lose a tax deduction for such payments under those rules. As of the date hereof, the cash compensation which would be paid under the contract to Mr. Unger if the contract were terminated after a change of control of the Holding Company, without cause by the Bank, or for cause by Mr. Unger, would be $525,000. For purposes of this employment contract, a change of control of the Holding Company is generally an acquisition of control, as defined in regulations issued under the Change in Bank Control Act and the Savings and Loan Holding Company Act. The employment contract protects the Bank's confidential business information and protects the Bank from competition by Mr. Unger should he voluntarily terminate his employment without cause or be terminated by the Bank for cause. Compensation of Directors The Bank pays its non-employee directors a monthly retainer of $884 plus $416 for each regular meeting attended and $208 for each committee meeting attended, with a maximum of $1,600 in annual committee fees. The Bank's directors emeritus receive a $1,000 annual retainer. Directors also typically receive a year-end bonus depending on the Bank's performance during the year. Total fees paid to Bank directors and directors emeritus for the year ended December 31, 1999 were approximately $154,100. The Bank's directors and directors emeritus may, pursuant to a deferred compensation agreement, defer payment of some or all of their directors fees, bonuses or other compensation into a retirement account. Under this agreement, deferred directors fees are to be distributed either in a lump-sum payment or in equal annual or monthly installments over any period of from five to ten years. The lump sum or first installment is payable to the director, at the director's discretion, on the first day of the calendar year immediately following the year in which he ceases to be a director, or in the year in which the director attains that age specified by the retirement income test of the Social Security Act. Any additional installments will be paid on the first day of each succeeding year thereafter. At present, the following directors participate in the deferred compensation plan: Lester N. Bergum, Jr., W. Thomas Harmon, and Wayne E. Kessler. Directors of the Holding Company and the Bank are not currently paid directors' fees. The Holding Company may, if it believes it is necessary to attract qualified directors or is otherwise beneficial to the Holding Company, adopt a policy of paying directors' fees. The Bank has also adopted a Deferred Director Supplemental Retirement Plan (the "Supplemental Plan") which provides for the continuation of directors fees to a director upon the later of a director's attainment of age 70 or the date on which he ceases to be a director. A director's interest in the Supplemental Plan will vest gradually over a five-year period commencing upon the director's completion of five years of service on our board. Upon completing nine years of service, the director's interest in the Supplemental Plan will be fully vested. The interests of directors who, as of December 1, 1997, had served at least one year on the Board vested immediately upon the adoption of the Supplemental Plan. The benefits payable to a director under the Supplemental Plan are calculated by multiplying the director's vested percentage times the rate of directors fees paid to the director immediately prior to his attainment of age 70 or, if earlier, the date his status as a director terminated. In the event that a director's death occurs prior to the commencement of payments under the Supplemental Plan, the director's designated beneficiary shall receive a monthly payment calculated by multiplying the director's vested percentage times the rate of directors fees in effect immediately prior to the director's death or, if earlier, the date on which his status as a director terminated. Payments under the Supplemental Plan will continue for 120 months. Pension Plan The Bank's full-time employees are included in the Pension Plan. Separate actuarial valuations are not made for individual employer members of the Pension Plan. The Bank's employees are eligible to participate in the plan once they have attained the age of 21 and completed one year of service for the Bank and provided that the employee is expected to complete a minimum of 1,000 hours of service in the 12 consecutive months following his enrollment date. An employee's pension benefits are 100% vested after five years of service. The Pension Plan provides for monthly or lump sum retirement benefits determined as a percentage of the employee's average salary (for the employee's highest five consecutive years of salary) times his years of service. Salary includes base annual salary as of each January 1, exclusive of overtime, bonuses, fees and other special payments. Early retirement, disability, and death benefits are also payable under the Pension Plan, depending upon the participant's age and years of service. The Bank recorded no expense for the Pension Plan during the fiscal year ended December 31, 1999, as the Plan was fully funded that year. The estimated base annual retirement benefits presented on a straight-line basis payable at normal retirement age (65) under the Pension Plan to persons in specified salary and years of service classifications are as follows (benefits noted in the table are not subject to any offset). Years of Service Highest 5-Year Average Compensation 15 20 25 30 35 40 45 - ------------------------------------------------------------------------------ $ 60,000 13,500 18,000 22,500 27,000 31,500 36,000 40,500 80,000 18,000 24,000 30,000 36,000 42,000 48,000 54,000 100,000 22,500 30,000 37,500 45,000 52,500 60,000 67,500 120,000 27,000 36,000 45,000 54,000 63,000 72,000 81,000 140,000 31,500 42,000 52,500 63,000 73,500 84,000 94,500 Benefits are currently subject to maximum Code limitations of $135,000 per year. The years of service credited to Mr. Unger under the Pension Plan as of December 31, 1999 were four, and to Mr. Baer under the Pension Plan as of December 31, 1999 were three. Transactions With Certain Related Persons The Bank follows a policy of offering to its directors, officers, and employees real estate mortgage loans secured by their principal residence as well as other loans. Current law authorizes the Bank to make loans or extensions of credit to its executive officers, directors, and principal shareholders on the same terms that are available with respect to loans made to all of its employees. At present, the Bank offers loans to its executive officers, directors, principal shareholders and employees with an interest rate that is .5% lower than the rate generally available to the public, but otherwise are offered with substantially the same terms as those prevailing for comparable transactions. All loans to directors and executive officers must be approved in advance by a majority of the disinterested members of the Board of Directors. Loans to directors, executive officers and their associates totaled approximately $1.261 million, or 1.4% of equity capital at December 31, 1999. The law firm Robison Robison Bergum & Johnson, based in Frankfort, Indiana, of which Lester N. Bergum, Jr., a director of the Holding Company is a partner, serves as counsel to the Bank in connection with loan delinquencies, title searches, and related matters in Frankfort, Clinton County, Indiana. The Bank expects to continue using the services of the law firm for such matters in the current fiscal year. Joint Report of the Compensation Committee and the Stock Compensation Committee The Compensation Committee of the Board of Directors was comprised during fiscal 1999 of Messrs. Harmon, Holifield, Mansfield and Milholland. The Committee reviews payroll costs, establishes policies and objectives relating to compensation, and approves the salaries of all employees, including executive officers. All decisions by the Compensation Committee relating to salaries of the Holding Company's executive officers are approved by the full Board of Directors. In fiscal 1999, there were no modifications to Compensation Committee actions and recommendations made by the full Board of Directors. In approving the salaries of executive officers, the Committee has access to and reviews compensation data for comparable financial institutions in the Midwest. Moreover, from time to time the Compensation Committee reviews information provided to it by independent compensation consultants in making its decisions. The objectives of the Compensation Committee and the Stock Compensation Committee with respect to executive compensation are the following: (1) provide compensation opportunities comparable to those offered by other similarly situated financial institutions in order to be able to attract and retain talented executives who are critical to the Holding Company's long-term success; (2) reward executive officers based upon their ability to achieve short-term and long-term strategic goals and objectives and to enhance shareholder value; and (3) align the interests of the executive officers with the long-term interests of shareholders by granting stock options which will become more valuable to the executives as the value of the Holding Company's shares increases. At present, the Holding Company's executive compensation program is comprised of base salary and annual incentive bonuses. The Option Plan and the RRP provide long-term incentive bonuses in the form of stock options and awards of Common Stock. Reasonable base salaries are awarded based on salaries paid by comparable financial institutions, particularly in the Midwest, and individual performance. The annual incentive bonuses are tied to the Holding Company's performance in the areas of growth, profit, quality, and productivity as they relate to earnings per share and return on equity for the current fiscal year, and it is expected that stock options will have a direct relation to the long-term enhancement of shareholder value. In years in which the performance goals of the Holding Company are met or exceeded, executive compensation tends to be higher than in years in which performance is below expectations. Base Salary. Base salary levels of the Holding Company's executive officers are intended to be comparable to those offered by similar financial institutions in the Midwest. In determining base salaries, the Compensation Committee also takes into account individual experience and performance. Mr. Unger was the Holding Company's Chief Executive Officer throughout fiscal 1999. Mr. Unger received a base salary of $135,000 in 1998 and $165,000 in 1999. Annual Incentive Bonuses. Under the Holding Company's Annual Incentive Plan, all employees of the Holding Company receive a cash bonus for any fiscal year in which the Holding Company achieves certain goals, as established by the Board of Directors, in the areas of growth, profit, quality and productivity as they relate to earnings per share and return on equity. Individual bonuses are equal to a percentage of the employee's base salary, which percentage varies with the extent to which the Holding Company exceeds these goals for the fiscal year. The Holding Company believes that this program provides an excellent link between the value created for shareholders and the incentives paid to executives, since executives receive no bonuses unless the above-mentioned goals are achieved and since the level of those bonuses will increase with greater achievement of those goals. Mr. Unger's bonus for fiscal 1999 was $25,000 compared to $30,000 for fiscal 1998. Stock Options. The Option Plan is intended to align executive and shareholder long-term interests by creating a strong and direct link between executive pay and shareholder return, and enable executives to acquire a significant ownership position in the Holding Company's Common Stock. Stock options are granted at the prevailing market price and will only have a value to the executives if the stock price increases. The Stock Compensation Committee has determined and will determine the number of option grants to make to executive officers based on the practices of comparable financial institutions as well as the executive's level of responsibility and contributions to the Holding Company. RRP. The RRP is intended to provide directors and officers with an ownership interest in the Holding Company in a manner designed to encourage them to continue their service with the Holding Company. Last fiscal year, the Bank contributed funds to the RRP to enable the RRP to acquire 280,370 shares of Common Stock. Of these shares, 233,724 were awarded to the Holding Company's directors and officers, and vest gradually over a five-year period at a rate of 20% of the shares awarded at the end of each 12-month period of service by the director or officer with the Holding Company. This gradual vesting of a director's or officer's interest in the shares awarded under the RRP is intended to create a long-term incentive for the director or officer to continue his service with the Holding Company. Finally, the Committee notes that Section 162(m) of the Code, in certain circumstances, limits to $1 million the deductibility of compensation, including stock-based compensation, paid to top executives by public companies. None of the compensation paid to the executive officers named in the compensation table on page five for fiscal 1999 exceeded the threshold for deductibility under section 162(m). The Compensation Committee and the Stock Compensation Committee believe that linking executive compensation to corporate performance results in a better alignment of compensation with corporate goals and the interests of the Holding Company's shareholders. As performance goals are met or exceeded, most probably resulting in increased value to shareholders, executives are rewarded commensurately. The Committee believes that compensation levels during fiscal 1999 for executives and for the chief executive officer adequately reflect the Holding Company's compensation goals and policies. Compensation Committee Members Stock Compensation Committee Members - ------------------------------ ------------------------------------ W. Thomas Harmon W. Thomas Harmon Jerry R. Holifield Jerry R. Holifield David E. Mansfield David E. Mansfield John C. Milholland John C. Milholland Performance Graph The following graph shows the performance of the Holding Company's Common Stock since January 1, 1999, in comparison to the NASDAQ Combined Bank Index, KBW Bank Index and the SNL Thrift Index. Relative Return* Analysis 1999 - 2000 Year-to-Date [graph omitted] DATE LNCB BKX Nasdaq Combined Bank Index SNL Thrift Index ---- ---- --- -------------------------- ---------------- 1/1/99 100% 100% 100% 100% 1/8/99 105% 108% 101% 103% 1/15/99 103% 101% 99% 101% 1/22/99 102% 98% 96% 100% 1/29/99 102% 101% 98% 101% 2/5/99 98% 96% 95% 98% 2/12/99 96% 97% 95% 98% 2/19/99 98% 100% 96% 98% 2/26/99 95% 102% 96% 99% 3/5/99 96% 107% 99% 102% 3/12/99 97% 110% 99% 105% 3/19/99 98% 108% 99% 102% 3/26/99 97% 105% 96% 100% 4/2/99 96% 105% 95% 99% 4/9/99 91% 113% 96% 100% 4/16/99 91% 113% 99% 102% 4/23/99 92% 115% 100% 104% 4/30/99 99% 114% 102% 105% 5/7/99 102% 112% 102% 104% 5/14/99 105% 111% 101% 104% 5/21/99 110% 109% 101% 102% 5/28/99 109% 105% 100% 100% 6/4/99 107% 104% 100% 100% 6/11/99 108% 103% 98% 98% 6/18/99 107% 109% 100% 98% 6/25/99 113% 106% 99% 97% 7/2/99 114% 113% 102% 99% 7/9/99 114% 113% 102% 98% 7/16/99 118% 112% 102% 98% 7/23/99 120% 107% 101% 98% 7/30/99 117% 103% 99% 96% 8/6/99 117% 98% 96% 92% 8/13/99 117% 103% 97% 94% 8/20/99 116% 105% 97% 94% 8/27/99 114% 102% 97% 93% 9/3/99 112% 101% 95% 91% 9/10/99 111% 97% 94% 90% 9/17/99 112% 94% 92% 89% 9/24/99 108% 93% 90% 85% 10/1/99 110% 93% 91% 86% 10/8/99 107% 98% 95% 89% 10/15/99 97% 88% 90% 84% 10/22/99 102% 100% 93% 88% 10/29/99 103% 110% 98% 94% 11/5/99 107% 110% 100% 95% 11/12/99 108% 110% 99% 92% 11/19/99 105% 108% 99% 90% 11/26/99 108% 104% 96% 87% 12/3/99 104% 105% 97% 87% 12/10/99 105% 99% 92% 81% 12/17/99 92% 93% 90% 79% 12/24/99 97% 96% 92% 80% 12/31/99 93% 93% 87% 80% 1/7/00 92% 96% 87% 77% 1/14/00 93% 90% 84% 73% 1/21/00 94% 91% 84% 74% 1/28/00 96% 91% 85% 75% 2/4/00 97% 88% 83% 71% 2/11/00 95% 83% 80% 71% * $100 invested on 1/1/99 in Stock or Index Including Reinvestment of Dividends Fiscal Year Ending December 31 Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required by this item is incorporated by reference to pages 1 through 3 of the 2000 Proxy Statement. Item 13. Certain Relationships and Related Transactions. The information required by this item is incorporated by reference to page 8 of the 2000 Proxy Statement. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) List the following documents included in the financial statements filed as part of the report:
Independent Auditor's Report......................................... See Shareholder Annual Report Page 20 Consolidated Balance Sheet at December 31, 1999, and 1998............ See Shareholder Annual Report Page 21 Consolidated Statement of Income for the Years Ended December 31, 1999, 1998, and 1997.................................... See Shareholder Annual Report Page 22 Consolidatd Statement of Comprehensive Income for the Years Ended December 31, 1999, 1998 and 1997......................... See Shareholder Annual Report Page 23 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1999, 1998, and 1997............... See Shareholder Annual Report Page 24 Consolidated Statement of Cash Flows for the Years Ended December 31, 1999, 1998, and 1997.................................... See Shareholder Annual Report Page 25 Notes to Consolidated Financial Statements........................... See Shareholder Annual Report Page 26
(b) Reports on Form 8-K. The Holding Company filed no reports on Form 8-K during the quarter ended December 31, 1999. (c) The exhibits filed herewith or incorporated by reference herein are set forth on the Exhibit Index on page E-1. Included in those exhibits is an executive compensation plan and arrangement which is identified as Exhibit 10(5). (d) All schedules are omitted as the required information either is not applicable or is included in the Consolidated Financial Statements or related notes. SIGNATURES Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on behalf of the undersigned, thereto duly authorized. LINCOLN BANCORP Date: March 30, 2000 By: /s/ T. Tim Unger ------------------------------ T. Tim Unger, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 30th day of March, 2000. Signatures Title Date (1) Principal Executive Officer: /s/ T. Tim Unger ) ------------------------ ) T. Tim Unger President and ) Chief Executive Officer ) ) ) (2) Principal Financial ) and Accounting Officer: ) ) ) /s/ John M. Baer Treasurer ) ------------------------ ) John M. Baer ) ) ) March 30, 2000 ) (3) The Board of Directors: ) ) ) /s/ Lester N. Bergum Director ) ------------------------ ) Lester N. Bergum ) ) ) /s/ Dennis W. Dawes Director ) ------------------------ ) Dennis W. Dawes ) ) ) /s/ W. Thomas Harmon Director ) ------------------------ ) W. Thomas Harmon ) ) ) /s/ Jerry R. Holifield Director ) ------------------------ ) Jerry R. Holifield ) ) ) /s/ Wayne E. Kessler Director ) ------------------------ ) Wayne E. Kessler ) ) ) /s/ David E. Mansfield Director ) ------------------------ ) David E. Mansfield ) ) ) March 30, 2000 Director ) ------------------------ ) John C. Milholland ) ) ) /s/ T. Tim Unger Director ) ------------------------ ) T. Tim Unger ) ) ) /s/ John L. Wyatt Director ) ------------------------ ) John L. Wyatt ) ) EXHIBIT INDEX Exhibit No. Description 3(1) Registrant's Articles of Incorporation are incorporated by reference to to Exhibit 3(1) to the Registration Statement (2) Registrant's Code of By-Laws is incorporated by reference to to Exhibit 3(2) to the Registration Statement 10 (5) Employment Agreement between Lincoln Federal Savings Bank and T. Tim Unger is incorporated by reference to to Exhibit 10(5) to the Registration Statement 21 Subsidiaries of the Registrant 23 Consent of Independent Auditors 27 Financial Data Schedule (filed electronically) EX-13 2 SHAREHOLDER ANNUAL REPORT Message to Shareholders.................................................... 2 Selected Consolidated Financial Data....................................... 3 Management's Discussion and Analysis....................................... 4 Report of Independent Auditor.............................................. 20 Consolidated Balance Sheet................................................. 21 Consolidated Statement of Income........................................... 22 Consolidated Statement of Comprehensive Income............................. 23 Consolidated Statement of Shareholders' Equity............................. 24 Consolidated Statement of Cash Flows....................................... 25 Notes to Consolidated Financial Statements................................. 26 Directors and Executive Officers........................................... 46 Shareholder Information.................................................... 47 Officers and Branch Locations of Lincoln Federal Savings Bank.............. 48 Lincoln Bancorp (the "Holding Company" and together with the Bank, as defined below, the "Company") is an Indiana corporation organized in September, 1998 to become a savings and loan holding company upon its acquisition of all the issued and outstanding capital stock of Lincoln Federal Savings Bank ("Lincoln Federal" or the "Bank") in connection with the Bank's conversion from mutual to stock form. The Holding Company became the Bank's holding company on December 30, 1998. The principal asset of the Holding Company currently consists of 100% of the issued and outstanding shares of capital stock, $.01 par value per share, of the Bank. Lincoln Federal was originally organized in 1884 as Ladoga Federal Savings and Loan Association, located in Ladoga, Indiana. In 1979, Ladoga Federal merged with Plainfield First Federal Savings and Loan Association, a federal savings and loan association located in Plainfield, Indiana which was originally organized in 1896. Following the merger, the Bank changed its name to Lincoln Federal Savings and Loan Association and, in 1984, adopted its current name, Lincoln Federal Savings Bank. At December 31, 1999, Lincoln Federal conducted its business from six full-service offices located in Hendricks, Montgomery, Clinton and Morgan Counties, Indiana, with its main office located in Plainfield. Lincoln Federal opened its newest offices in Avon, Indiana in January, 1999 and in Mooresville, Indiana in April, 1999. The Bank's principal business consists of attracting deposits from the general public and originating fixed-rate and adjustable-rate loans secured primarily by first mortgage liens on one- to four-family residential real estate. Lincoln Federal's deposit accounts are insured up to applicable limits by the SAIF of the FDIC. Lincoln Federal offers a number of financial services, including: (i) one- to four-family residential real estate loans; (ii) commercial real estate loans; (iii) real estate construction loans; (iv) land loans; (v) multi-family residential loans; (vi) consumer loans, including home equity loans and automobile loans; (vii) commercial loans; (viii) money market demand accounts ("MMDAs"); (ix) savings accounts; (x) checking accounts; (xi) NOW accounts; and (xii) certificates of deposit. To our shareholders and friends, Lincoln Bancorp celebrated its first year as a publicly traded company in 1999 with great success. Our original earnings estimate was $.63 per share and we finished the year at $.71 per share. Our first stock repurchase program resulted in the repurchase of 10% of the total shares outstanding, or 700,925 shares. Dividends were paid each quarter and increased by 33 1/3% in the third quarter. Our accomplishments and our commitment to positioning the bank for the future are the results of an excellent staff, who make our bank a special place to work and do business. Lincoln Federal Savings Bank's significant accomplishments during the past year included new facilities, products, technology, and staff. Our new offices in Avon and Mooresville have exceeded our expectations while increasing our customer base. Several new products, with new technology and a new deposit operations department, were developed during the year to allow us to compete on a direct level with even our largest competitors. New key staff additions included a Human Resource Director, Retail Sales Manager and Residential Lending Manager. Our team looks forward to the year ahead and we intend to increase our market share by enhancing our existing products and services, developing our commercial lending capabilities and expanding our mortgage lending products. We also plan to reach out into new markets surrounding Indianapolis and continue developing a presence on the Internet at www.lincolnfederal.com. As always, there will be a strong community commitment in all Lincoln Federal markets. The Lincoln Federal Charitable Foundation will continue to provide grants to help support community programs. We are dedicated to increasing the long-term value of our company by expanding through acquisition and/or branching, and are equally committed to providing excellent service to our customers. We hope you share the pride of our directors and employees in our first year as a publicly traded company and we appreciate your continued support and confidence. Very truly yours, /s/ Tim Unger Tim Unger President and CEO The following selected consolidated financial data of the Company is qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements, including notes thereto, included elsewhere in this Shareholder Annual Report.
At December 31, --------------------------------------------------------- 1999 1998 1997 1996 1995 ------- ------- ------- ------- ------- (In thousands) Summary of Financial Condition Data: Total assets............................................ $410,828 $366,448 $321,391 $345,552 $319,777 Cash and interest bearing deposits in other banks (1)... 10,819 22,907 18,958 10,394 8,882 Investment securities available for sale................ 145,875 129,276 29,399 118 116 Investment securities held to maturity.................. 500 1,250 9,635 15,185 11,600 Mortgage loans held for sale............................ --- --- --- 24,200 15,534 Loans................................................... 234,761 197,433 249,996 282,813 270,933 Allowance for loan losses............................... (1,761) (1,512) (1,361) (1,241) (1,121) Net loans............................................... 233,000 195,921 248,635 281,572 269,812 Investment in limited partnerships...................... 2,064 2,387 2,706 3,187 3,583 Deposits................................................ 204,982 212,010 203,852 210,823 196,117 Borrowings.............................................. 110,252 35,466 72,827 94,412 85,604 Shareholders' equity.................................... 91,743 106,108 41,978 37,919 34,930 Year Ended December 31, ------------------------------------------------------------ 1999 1998 1997 1996 1995 ------- ------- ------- ------- ------- (In thousands) Summary of Operating Data: Total interest income................................... $27,742 $ 22,999 $ 25,297 $ 24,453 $ 22,065 Total interest expense.................................. 13,947 13,827 15,652 15,119 14,486 ------- ------- ------- ------- ------- Net interest income.................................. 13,795 9,127 9,645 9,334 7,579 Provision for loan losses............................... 384 173 298 120 100 ------- ------- ------- ------- ------- Net interest income after provision for loan losses . 13,411 8,999 9,347 9,214 7,479 ------- ------- ------- ------- ------- Other income (losses): Net realized-and unrealized-gain (loss) on loans held for sale............................. 11 (61) 299 (160) 1,463 Net realized- and unrealized-gains on securities available for sale................................. (4) 113 118 --- --- Equity in losses of limited partnerships............. (323) (514) (681) (596) (1,595) Other................................................ 930 833 674 503 473 ------- ------- ------- ------- ------- Total other income (loss).......................... 614 371 410 (253) 341 ------- ------- ------- ------- ------- Other expenses: Salaries and employee benefits....................... 3,859 2,724 2,247 1,719 1,529 Net occupancy expenses............................... 357 249 272 236 272 Equipment expenses................................... 541 626 526 361 176 Deposit insurance expense............................ 150 188 194 1,725 438 Data processing expense.............................. 736 658 581 313 228 Professional fees.................................... 209 201 238 69 48 Director and committe fees........................... 224 319 227 110 102 Mortgage servicing rights amortization............... 124 280 67 12 9 Charitable contributions............................. 22 2,023 32 18 37 Other................................................ 1,109 842 701 540 405 ------- ------- ------- ------- ------- Total other expenses.............................. 7,331 8,110 5,085 5,103 3,244 ------- ------- ------- ------- ------- Income before income taxes and extraordinary item.... 6,694 1,260 4,672 3,858 4,576 Income taxes (benefit)............................... 2,346 (7) 1,159 870 1,193 ------- ------- ------- ------- ------- Income before extraordinary item........................ 4,348 1,267 3,513 2,988 3,383 Extraordinary item-early extinguishment of debt, net of income taxes of $99........................... --- (150) --- --- --- Net income......................................... $4,348 $ 1,117 $ 3,513 $ 2,988 $ 3,383 ======= ======= ======= ======= ======= (Continued)
Year Ended December 31, 1999 1998 1997 1996 1995 ------- ------- ------- ------- ------- (In thousands) Supplemental Data: Basic earnings per share................................ $.71 --- --- --- --- Diluted earnings per share.............................. .71 --- --- --- --- Divendends per share.................................... .28 --- --- --- --- Dividend payout ratio................................... 39.44% --- --- --- --- Return on assets (2).................................... 1.09 .35% 1.02% .90% 1.09% Return on equity (3).................................... 4.29 2.58 8.71 8.08 9.92 Equity to assets (4).................................... 22.33 28.96 13.06 10.97 10.92 Interest rate spread during period (5).................. 2.32 2.24 2.41 2.36 1.99 Net yield on interest-earning assets (6)................ 3.57 3.02 2.92 2.91 2.55 Efficiency ratio (7).................................... 50.88 84.98 50.57 56.19 40.96 Other expenses to average assets (8).................... 1.84 2.55 1.47 1.54 1.05 Average interest-earning assets to average interest-bearing liabilities......................... 134.83 117.02 110.88 111.80 111.31 Non-performing assets to total assets (4)............... .28 .38 1.14 .73 .75 Allowance for loan losses to total loans outstanding (4) (9)............................ .75 .77 .54 .40 .39 Allowance for loan losses to non-performing loans (4)... 159.37 117.03 37.56 50.80 46.81 Net charge-offs to average total loans outstanding ..... .06 .01 .06 --- .01 Number of full service offices (4)...................... 6 4 4 4 4
(1) Includes certificates of deposit in other financial institutions. (2) Net income divided by average total assets. (3) Net income divided by average total equity. (4) At end of period. (5) Interest rate spread is calculated by substracting combined average interest cost from combined average interest rate earned for the period indicated. (6) Net interest income divided by average interest-earning assets. (7) Other expenses (excluding income tax expense) divided by the sum of net interest income and noninterest income. Excluding the effect of the $2.0 million contribution to the charitable foundation, the efficiency ratio would have been 64.03% for the year ended December 31, 1998. Excluding the effect of the one-time SAIF assessment, the efficiency ratio would have been 42.28% for the year ended December 31, 1996. (8) Other expenses divided by average total assets. (9) Total loans include loans held for sale. Management's Discussion and Analysis of Financial Condition and Results of Operation General The Holding Company was incorporated for the purpose of owning all of the outstanding shares of Lincoln Federal. The following discussion and analysis of the Holding Company's financial condition as of December 31, 1999 and Lincoln Federal's results of operations should be read in conjunction with and with reference to the consolidated financial statements and the notes thereto included herein. In addition to the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Holding Company's operations and actual results could differ significantly from those discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences are discussed herein but also include changes in the economy and interest rates in the nation and the Holding Company's general market area. The forward-looking statements contained herein include, but are not limited to, those with respect to the following matters: 1. Management's determination of the amount of loan loss allowance; 2. The effect of changes in interest rates; 3. Changes in deposit insurance premiums; and 4. Proposed legislation that would eliminate the federal thrift charter and the separate federal regulation of thrifts. Average Balances and Interest Rates and Yields The following tables present the years ended December 31, 1999, 1998 and 1997, the average daily balances, of each category of Lincoln Federal's interest-earning assets and interest-bearing liabilities, and the interest earned or paid on such amounts.
Year Ended December 31, ------------------------------------------------------------------------------------------- 1999 1998 1997 ----------------------------- ----------------------------- ----------------------------- Average Average Average Average Average Average Balance Interest(6)Yield/Cost Balance Interest(6)Yield/Cost Balance Interest(6)Yield/Cost ------- ---------- ---------- ------- ---------- ---------- ------- ---------- ---------- (Dollars in thousands) Assets: Interest-earning assets: Interest-bearing deposits............ $6,614 $263 3.98% $29,949 $1,544 5.16% $11,853 $ 653 5.51% Mortgage-backed securities available for sale (1)............. 89,385 5,903 6.60 41,011 2,962 7.22 13,089 1,086 8.30 Other investment securities available for sale (1)............. 64,526 4,234 6.56 11,940 785 6.57 66 5 7.58 Other investment securities held to maturity .................. 649 40 6.16 4,176 248 5.94 12,758 768 6.02 Loans receivable (2) (5) (6).........219,312 16,866 7.69 211,260 17,024 8.06 286,912 22,369 7.80 Stock in FHLB of Indianapolis........ 5,447 436 8.00 5,447 436 8.00 5,199 416 8.00 -------- ------ ------- ------ ------- ------ Total interest-earning assets......385,933 27,742 7.19 303,783 22,999 7.57 329,877 25,297 7.67 ------ ------ ------ Non-interest earning assets, net of allowance for loan losses and unrealized gain/loss on securities available for sale..... 12,107 14,587 15,694 -------- -------- -------- Total assets......................$398,040 $318,370 $345,571 ======== ======== ======== Liabilities and equity capital: Interest-bearing liabilities: Interest-bearing demand deposits..... $9,296 137 1.47 $7,905 150 1.90 $ 7,438 154 2.07 Savings deposits..................... 17,940 499 2.78 20,691 625 3.02 25,159 781 3.10 Money market savings deposits........ 39,614 1,759 4.44 29,883 1,440 4.82 21,278 1,044 4.91 Certificates of deposit..............136,840 7,184 5.25 151,344 8,757 5.79 151,507 8,425 5.56 FHLB advances and securities sold under repurchase agreements........ 82,554 4,368 5.29 49,773 2,855 5.74 92,121 5,248 5.70 -------- ------ ------- ------ ------- ------ Total interest-bearing liabilities.....................286,244 13,947 4.87 259,596 13,827 5.33 297,503 15,652 5.26 ------ ------ ------ Other liabilities....................... 10,495 15,497 7,729 -------- -------- -------- Total liabilities................296,739 275,093 305,232 Shareholders' equity....................101,301 43,277 40,339 -------- -------- -------- Total liabilities and equity capital..............$398,040 $318,370 $345,571 ======== ======== ======== Net interest-earning assets............ $99,689 $ 44,187 $ 32,374 Net interest income..................... $13,795 $ 9,172 $ 9,645 ======= ======= ======= Interest rate spread (3)................ 2.32% 2.24% 2.41% ==== ==== ==== Net yield on weighted average interest-earning assets (4).......... 3.57% 3.02% 2.92% ==== ==== ==== Average interest-earning assets to average interest-bearing liabilities........ 134.83% 117.02% 110.88% ======== ======== ========
(1) Mortgage-backed securities available for sale and other investment securities available for sale are at amortized cost prior to SFAS No. 115 adjustments. (2) Total loans, including loans held for sale, less loans in process. (3) Interest rate spread is calculated by subtracting weighted average interest rate cost from weighted average interest rate yield for the period indicated. (4) The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated. (5) The balances include nonaccrual loans. (6) Interest income on loans receivable includes loan fee income of $394,000, $511,000 and $554,000 for the years ended December 31, 1999, 1998 and 1997. Interest Rate Spread The Company's results of operations have been determined primarily by net interest income and, to a lesser extent, fee income, miscellaneous income and general and administrative expenses. Net interest income is determined by the interest rate spread between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities and by the relative amounts of interest-earning assets and interest-bearing liabilities. The following table sets forth the weighted average effective interest rate that the Company earned on its loan and investment portfolios, the weighted average effective cost of its deposits and advances, its interest rate spread and the net yield on weighted average interest-earning assets for the periods shown. Average balances are based on average daily balances.
Year Ended December 31, -------------------------------------------------------- 1999 1998 1997 ---- ---- ---- Weighted average interest rate earned on: Interest-earning deposits......................... 3.98% 5.16% 5.51% Mortgage-backed securities available for sale..... 6.60 7.22 8.30 Other investment securities available for sale.... 6.56 6.57 7.58 Other investment securities held to maturity...... 6.16 5.94 6.02 Loans............................................. 7.69 8.06 7.80 FHLB stock........................................ 8.00 8.00 8.00 Total interest-earning assets................... 7.19 7.57 7.67 Weighted average interest rate cost of: Interest-bearing demand deposits.................. 1.47 1.90 2.07 Savings deposits.................................. 2.78 3.02 3.10 Money market savings deposits..................... 4.44 4.82 4.91 Certificates of deposit........................... 5.25 5.79 5.56 FHLB advances and securities sold under repurchase agreements........................... 5.29 5.74 5.70 Total interest-bearing liabilities.............. 4.87 5.33 5.26 Interest rate spread (1)............................. 2.32 2.24 2.41 Net yield on weighted average interest-earning assets (2)....................... 3.57 3.02 2.92
(1) Interest rate spread is calculated by subtracting combined weighted average interest rate cost from combined weighted average interest rate earned for the period indicated. Interest rate spread figures must be considered in light of the relationship between the amounts of interest-earning assets and interest-bearing liabilities. (2) The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated. The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected the Company's interest income and expense during the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume) and (2) changes in volume (changes in volume multiplied by old rate). Changes attributable to both rate and volume which cannot be segregated have been allocated proportionally to the change due to volume and the change due to rate.
Increase (Decrease) in Net Interest Income --------------------------------------------------- Total Due to Due to Net Rate Volume Change ---- ------ ------ (In thousands) Year ended December 31, 1999 compared to year ended December 31, 1998 Interest-earning assets: Interest-earning deposits.................................. $(291) $(990) $(1,281) Mortgage-backed securities available for sale.............. (274) 3,215 2,941 Other investment securities available for sale............. (2) 3,451 3,449 Other investment securities held to maturity............... 9 (217) (208) Loans receivable........................................... (793) 635 (158) FHLB stock................................................. --- --- --- --------- ----------- ----------- Total.................................................... (1,351) 6,094 4,743 --------- ----------- ----------- Interest-bearing liabilities: Interest-bearing demand deposits........................... (37) 24 (13) Savings deposits........................................... (47) (79) (126) Money market savings deposits.............................. (120) 439 319 Certificates of deposit.................................... (773) (800) (1,573) FHLB advances and securities sold under repurchase agreements........................... (237) 1,750 1,513 --------- ----------- ----------- Total.................................................... (1,214) 1,334 120 --------- ----------- ----------- Net change in net interest income............................ $(137) $4,760 $4,623 ===== ====== ====== Year ended December 31, 1998 compared to year ended December 31, 1997 Interest-earning assets: Interest-earning deposits.................................. $ (45) $ 936 $ 891 Mortgage-backed securities available for sale.............. (158) 2,034 1,876 Other investment securities available for sale............. (1) 781 780 Other investment securities held to maturity............... (10) (510) (520) Loans receivable........................................... 729 (6,074) (5,345) FHLB stock................................................. --- 20 20 --------- ----------- ----------- Total.................................................... 515 (2,813) (2,298) --------- ----------- ----------- Interest-bearing liabilities: Interest-bearing demand deposits........................... (13) 9 (4) Savings deposits........................................... (21) (135) (156) Money market savings deposits.............................. (19) 415 396 Certificates of deposit.................................... 341 (9) 332 FHLB advances.............................................. 36 (2,429) (2,393) --------- ----------- ----------- Total.................................................... 324 (2,149) (1,825) --------- ----------- ----------- Net change in net interest income............................ $ 191 $ (664) $ (473) ========= ========= ========== Year ended December 31, 1997 compared to year ended December 31, 1996 Interest-earning assets: Interest-earning deposits.................................. $ (42) $ 439 $ 397 Mortgage-backed securities available for sale.............. --- 1,086 1,086 Other investment securities available for sale............. --- (4) (4) Other investment securities held to maturity............... (9) (156) (165) Loans receivable........................................... 197 (730) (533) FHLB stock................................................. 9 54 63 --------- ----------- ----------- Total.................................................... 155 689 844 --------- ----------- ----------- Interest-bearing liabilities: Interest-bearing demand deposits........................... (2) 5 3 Savings deposits........................................... (85) (226) (311) Money market savings deposits.............................. 25 699 724 Certificates of deposit.................................... (200) (50) (250) FHLB advances.............................................. 112 255 367 --------- ----------- ----------- Total.................................................... (150) 683 533 --------- ----------- ----------- Net change in net interest income............................ $ 305 $ 6 $ 311 ========= =========== ===========
Financial Condition at December 31, 1999 Compared to Financial Condition at December 31, 1998 Total assets increased $44.4 million, or 12.1% at December 31, 1999, compared to December 31, 1998. The increase was primarily in investment securities available for sale and net loans. Investment securities available for sale increased $16.6 million, or 12.8%, while net loans increased $37.1 million, or 18.9%. These increases in investment securities available for sale and net loans were offset by a decrease in cash and cash equivalents. Cash and cash equivalents decreased by $12.1 million, or 52.8%. These balance sheet changes were a result of a leverage strategy to increase interest income and improve the Company's return on average equity. Loans and Allowance for Loan Losses. The increase in net loans from $195.9 million at December 31, 1998 to $233.0 million at December 31, 1999 was due in part to the funding of one- to four-family residential mortgage loans that were in process at December 31, 1998 and the purchase of approximately $4.0 million of one- to four-family residential mortgage loans from another financial institution during the first quarter of 1999. Loan growth continued throughout 1999 in nearly all loan categories. The allowance for loan losses as a percentage of total loans decreased slightly to .75% from .77%. The allowance for loan losses as a percentage of non-performing loans was 159.4% and 117.0% at December 31, 1999 and December 31, 1998, respectively. Non-performing loans were $1.1 million and $1.3 million at each date, respectively. Included in non-performing loans at December 31, 1999 were impaired loans of approximately $300,000. Impaired loans at December 31, 1999 consisted of two loans to one borrower collateralized by residential acquisition and development real estate. Deposits. Deposits decreased $7.0 million, or 3.3%, at December 31, 1999, compared to December 31, 1998. Certificates of deposit decreased approximately $15.0 million, or 10.0%, while other deposits increased approximately $8.0 million, or 12.0%. The increase in other deposits was primarily due to an increase in money market accounts of approximately $9.0 million, or 27.0%. Borrowed Funds. FHLB advances increased $70.7 million at December 31, 1999 compared to December 31, 1998. During 1999, the Company sold securities under repurchase agreements of $4.6 million which was outstanding at December 31, 1999. The additional borrowed funds were primarily used to fund loan growth. Shareholders' Equity. Shareholders' equity decreased $14.4 million from $106.1 million at December 31, 1998 to $91.7 million at December 31, 1999. The decrease was due to unrealized losses of $5.4 million on investment securities available for sale, a contribution of $3.7 million to fund the Recognition and Retention Plan ("RRP"), stock repurchases of $8.7 million, cash dividends of $1.7 million and additional stock conversion costs of $16,000. Net income for the year of $4.3 million, Employee Stock Ownership Plan ("ESOP") shares earned of $448,000 and unearned compensation amortization of $292,000 offset these decreases. The Company has obtained approval from the OTS to purchase an additional 10% of its shares and is currently in the process of repurchasing these shares. Financial Condition at December 31, 1998 Compared to Financial Condition at December 31, 1997 Total assets increased $45.1 million, or 14.0%, at December 31, 1998, compared to December 31, 1997. The primary increases were in investment securities available for sale and held to maturity which increased $91.5 million and cash and interest-bearing deposits in other banks which increased $3.9 million. These increases were primarily due to net proceeds from the conversion and the loan securitization and sales. Net proceeds of the Holding Company's stock issuance, after costs and excluding the shares issued for the ESOP, were $61.3 million. These increases were in part offset by a $52.7 million decrease in net loans. The decrease was primarily due to the securitization of approximately $39.9 million of one- to four- family residential loans and the subsequent sale of approximately $21.1 million of these mortgage-backed securities. In addition, $19.6 million of portfolio loans were transferred to loans held for sale during 1998 and $17.2 million were subsequently sold. Loans, Loans Held for Sale and Allowance for Loan Losses. The decrease in net loans including loans held for sale of $52.7 million, or 21.2%, from December 31, 1997 to December 31, 1998 was due primarily to the securitization of $39.9 million of loans in the second quarter of 1998 and the sale of $17.2 million of loans in the third quarter of 1998. The loans securitized were one- to four- family residential loans. The strategy behind the securitization and sale of mortgage-backed securities was to change the mix of assets on the balance sheet to reduce interest rate risk and to improve liquidity. Lincoln Federal has no plans to securitize or sell additional portfolio loans and will continue to service all loans sold and securitized. The allowance for loan losses as a percentage of total loans increased to .77% from .54%. The allowance for loan losses as a percentage of non-performing loans was 117.0% and 37.6% at December 31, 1998 and December 31, 1997, respectively. Non-performing loans were $1.3 million and $3.6 million at each date, respectively. The decline in non-performing loans was a result of a combination of factors including improved collection efforts on one- to four- family residential and consumer loans, payoffs of non-performing loans totaling $1.1 million and receipt of additional collateral on loans totaling $218,000 allowing these loans to be removed from non-accrual status. Included in non-performing loans at December 31, 1998 were impaired loans of approximately $300,000. Impaired loans at December 31, 1998 consisted of two loans to one borrower collateralized by residential acquisition and development real estate. Deposits. Deposits increased $8.2 million, or 4.0%, at December 31, 1998, compared to December 31, 1997. Certificates of deposit increased $1.5 million, or 1.0%, while other deposits increased $6.7 million, or 11.6%. The increase in deposits was primarily due to an increase in money market accounts of $6.9 million, or 26.7%. Borrowed Funds. FHLB advances decreased $36.9 million, or 52.6%, at December 31, 1998 compared to December 31, 1997. Proceeds from the sales of mortgage-backed securities available for sale and loans were used to repay a portion of FHLB advances. Shareholders' Equity. Shareholders' equity increased $64.1 million from $42.0 million at December 31, 1997 to $106.1 million at December 31, 1998. The increase was due to net proceeds of the Holding Company's stock issuance after costs and excluding the shares issued for the ESOP, of $61.3 million, stock contributed to the charitable foundation of $2.0 and net income for 1998 of $1.1 million. These increases were offset by a decrease in the unrealized gains on securities available for sale of $258,000. Comparison of Operating Results For Years Ended December 31, 1999 and 1998 General. Net income for the year ended December 31, 1999 increased $3.2 million to $4.3 million compared to $1.1 million for the year ended December 31, 1998. The increase in net income was primarily a result of an increase in net interest income and a decrease in other expenses offset by an increase in tax expense. The largest single reason for the increase was the $2.0 million contribution to the Lincoln Federal Charitable Foundation, Inc. (the "Foundation") made in 1998 in connection with the stock conversion. Return on average assets for the year ended December 31, 1999 and 1998 was 1.09% and .35%, respectively. Return on average equity was 4.29% for the year ended December 31, 1999 and 2.58% for the year ended December 31, 1998. Interest Income. Total interest income was $27.7 million for 1999 compared to $23.0 million for 1998. The increase in interest income was due primarily to an increase in average interest-earning assets. Average interest-earning assets increased $82.2 million, or 27.0%, primarily due to a increase in average securities available for sale of $101.0 million and average loans of $8.1 million offset by a decrease in interest-bearing deposits of $23.3 million. The average yield on interest-earning assets was 7.19% and 7.57% for the years ended December 31, 1999 and 1998, respectively. Interest Expense. Interest expense increased $120,000 during the year ended December 31, 1999 as compared to 1998. While average interest-bearing liabilities increased $26.6 million, or 10.3%, the average cost of interest bearing liabilities decreased from 5.33% for the 1998 period to 4.87% for the 1999 period. Net Interest Income. Net interest income increased $4.7 million, or 51.1%, during the year ended December 31, 1999 as compared to 1998. Net interest income increased $4.8 million due to an increase in volume of net interest earning assets and liabilities and decreased $137,000 as a result of the average rate of the net interest earning assets and liabilities. The interest rate spread was 2.32% and 2.24% for 1999 and 1998, respectively. The net yield on interest-earning assets was 3.57% and 3.02% for the 1999 and 1998 periods, respectively. The increase in net yield on interest-earning assets was greater than the increase in the interest rate spread because average interest-earning assets as a percentage of interest-bearing liabilities increased from 117.0% for 1998 to 134.8% for 1999. Provision for Loan Losses. The provision for loan losses for the year ended December 31, 1999 was $384,000 as compared to $173,000 for 1998. During the year ended December 31, 1999, net charge-offs were $135,000 as compared to net charge-offs of $22,000 for 1998. The 1999 provision and the allowance for loan losses were considered adequate based on size, condition and components of the loan portfolio, past history of loan losses and peer comparisons. While management estimates loan losses using the best available information, no assurance can be given that future additions to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding problem loans, identification of additional problem loans and other factors, both within and outside of management's control. Net realized and unrealized gain (loss) on loans held for sale. Net realized and unrealized gains on loans held for sale of $11,000 were recorded during the year ended December 31, 1999 as compared to net realized and unrealized losses of $61,000 recorded during 1998. Net realized and unrealized gains on securities available for sale. Proceeds from sales of securities available for sale during the years ended December 31, 1999 and 1998 amounted to $10.3 million and $21.1 million, respectively. Net losses of $4,000 and net gains of $113,000 were realized on those sales during the years ended December 31, 1999 and 1998, respectively. Equity in losses of limited partnerships. Equity in losses of limited partnerships decreased $191,000, or 37.2%, from $514,000 for the year ended December 31, 1998 to $323,000 for 1999 due to the operating results of the limited partnership investments. Other Income. Other income increased $97,000, or 11.6%, from $833,000 for the year ended December 31, 1998 to $930,000 for 1999. This increase was due to increases in a variety of other income categories and was not attributable to any one item. Salaries and Employee Benefits. Salaries and employee benefits were $3.9 million for the year ended December 31, 1999 compared to $2.7 million for 1998, an increase of approximately 42.0%. This increase resulted primarily from compensation expense incurred by the Company in connection with the ESOP and the RRP. Also, the Company's compensation expense increased as a result of additional staffing for the two branches opened in 1999. There were 89 full-time equivalent employees at December 31, 1999 compared to 76 at December 31, 1998. Net Occupancy and Equipment Expenses. Combined occupancy expenses and equipment expenses increased $23,000, or 2.6%, from $875,000 in 1998 to $898,000 in 1999 due primarily to the addition of two new branches opened during 1999. Deposit Insurance Expense. Deposit insurance expense decreased $38,000, or 20.2%, from $188,000 in 1998 to $150,000 in 1999. Data Processing Expense. Data processing expense increased $78,000, or 11.9%, from the year ended December 31, 1998 to the same period in 1999. Professional Fees. Professional fees increased $8,000, or 4.0%, from the year ended December 31, 1998 to the same period in 1999. Director and Committee fees. Director and committee fees decreased $95,000, or 29.8%, from the year ended December 31, 1998 to 1999. This decrease was due primarily to additional meetings held during 1998 in connection with the stock conversion. Mortgage Servicing Rights Amortization. Mortgage servicing rights amortization decreased $156,000 from $280,000 for the year ended December 31, 1998 to $124,000 for the same period in 1999. The decrease from 1998 to 1999 relates to a reduction in prepayment speeds. Charitable Contributions. Charitable contributions decreased $2.0 million from the year ended December 31, 1998 to 1999 due to the $2.0 million contribution to the Foundation made in 1998 in connection with the stock conversion. Other Expenses. Other expenses, consisting primarily of expenses related to advertising, loan expenses, supplies, and postage increased $267,000, or 31.7%, from 1998 to 1999. The increase resulted from increases in a variety of expense categories and was not attributable to any one item. Income Tax Expense. Income tax expense increased $2.4 million from the year ended December 31, 1998 to 1999. These variations in income tax expense are directly related to taxable income and the low income housing income tax credits earned during those years. The effective tax rate was 35.1% and (.5)% for 1999 and 1998, respectively. Comparison of Operating Results For Years Ended December 31, 1998 and 1997 General. Net income for the year ended December 31, 1998 decreased $2.4 million to $1.1 million compared to $3.5 million for the year ended December 31, 1997. The decline in net income was primarily a result of a reduction in net interest income, an increase in other expenses, an extraordinary item related to the prepayment of FHLB advances offset by a reduction in the provision for loan losses and tax expense. The largest single reason for the decrease was the $2.0 million contribution to the Lincoln Federal Charitable Foundation, Inc. (the "Foundation") made in connection with the stock conversion. Return on average assets for the year ended December 31, 1998 and 1997 was .35% and 1.02%, respectively. Return on average equity was 2.58% for the year ended December 31, 1998 and 8.71% for the year ended December 31, 1997. Interest Income. Total interest income was $23.0 million for 1998 compared to $25.3 million for 1997. The decrease in interest income was due primarily to a decrease in average interest-earning assets. Average interest-earning assets decreased $26.1 million, or 7.9%, primarily due to a decrease in average loans of $75.7 million offset by an increase in average mortgage-backed securities and other investment securities available for sale and held to maturity of $31.2 million. The average yield on interest-earning assets was 7.57% and 7.67% for the years ended December 31, 1998 and 1997, respectively. Interest Expense. Interest expense decreased $1.8 million, or 11.7%, during the year ended December 31, 1998 as compared to 1997. The decrease in interest expense was primarily the result of a decrease in average interest-bearing liabilities of $37.9 million, or 12.7%. The decline in average interest-bearing liabilities was primarily attributable to the repayment of FHLB advances. The average balances of FHLB advances decreased $42.3 million. The average cost of interest-bearing liabilities increased from 5.26% for the 1997 period to 5.33% for the 1998 period resulting primarily from a 23 basis points increase in the cost of certificates of deposit offset by decreases in the remaining deposit applications. Net Interest Income. Net interest income decreased $473,000, or 4.9%, during the year ended December 31, 1998 as compared to 1997. Net interest income declined $664,000 due to a decrease in volume of net interest earning assets and liabilities and increased $191,000 as a result of an improvement in net yield on interest earning assets. The interest rate spread was 2.24% and 2.41% for 1998 and 1997, respectively. The net yield on interest-earning assets was 3.02% and 2.92% for the 1998 and 1997 periods, respectively. Although the interest rate spread decreased during 1998, the yield on interest-earning assets improved because average interest-earning asset as a percentage of interest-bearing liabilities increased from 110.9% for 1997 to 117.0% for 1998. Provision for Loan Losses. The provision for loan losses for the year ended December 31, 1998 was $173,000 as compared to $298,000 for 1997. During the year ended December 31, 1998, net charge-offs were $22,000 as compared to net charge-offs of $178,000 for 1997. The 1998 provision and the allowance for loan losses were considered adequate based on size, condition and components of the loan portfolio, past history of loan losses and peer comparisons. While management estimates loan losses using the best available information, no assurance can be given that future additions to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding problem loans, identification of additional problem loans and other factors, both within and outside of management's control. Net realized and unrealized gain (loss) on loans held for sale. Net realized and unrealized losses on loans held for sale of $61,000 were recorded during the year ended December 31, 1998 as compared to net realized and unrealized gains of $299,000 recorded during 1997. The primary reason for the change was due to the recovery during 1997 of an unrealized loss of $266,000 recorded during 1996. Net realized and unrealized gains on securities available for sale. Proceeds from sales of securities available for sale during the years ended December 31, 1998 and 1997 amounted to $21.1 million and $54.5 million, respectively. Net gains of $113,000 and $118,000 were realized on those sales during the years ended December 31, 1998 and 1997, respectively. Equity in losses of limited partnerships. Equity in losses of limited partnerships decreased $167,000, or 24.5%, from $681,000 for the year ended December 31, 1997 to $514,000 for 1998 due to the operating results of the limited partnership investments. Other Income. Other income increased $159,000, or 23.6%, from $674,000 for the year ended December 31, 1997 to $833,000 for 1998. This increase was due to increases in a variety of other income categories and was not attributable to any one item. Salaries and Employee Benefits. Salaries and employee benefits were $2.7 million for the year ended December 31, 1998 compared to $2.2 million for 1997, an increase of approximately 22.0%. These increases were primarily a result of additional personnel. Lincoln Federal had 76 full time equivalent employees at December 31, 1998 compared to 72 full time equivalent employees at December 31, 1997. Lincoln Federal increased its number of employees and added personnel with the specialized skills to more effectively service existing customers and to position itself for future customer and product growth. Net Occupancy and Equipment Expenses. Occupancy expenses decreased $23,000, or 8.5%, and equipment expenses increased $100,000, or 19.0%, from the year ended December 31, 1997 compared to 1998. The increases in equipment expenses were primarily attributable to increased deprecation and amortization on computers, software and other equipment and fees associated with computer equipment maintenance. Deposit Insurance Expense. Deposit insurance expense decreased $6,000, or 3.1%, from $194,000 in 1997 to $188,000 in 1998. Data Processing Expense. Data processing expense increased $77,000, or 13.3%, from the year ended December 31, 1997 to the same period in 1998. This increase was primarily due to additional costs associated with Year 2000 compliance and testing. Professional Fees. Professional fees decreased $37,000, or 15.5%, from the year ended December 31, 1997 to the same period in 1998. This decrease was due to a variety of decreased expenses and was not attributable to any one item. Director and Committee fees. Director and committee fees increased $92,000, or 40.5%, from the year ended December 31, 1997 to 1998. This increase was due to the addition of one director in 1998, an increase in the fee paid per meeting and additional meetings held during 1998 in connection with the stock conversion. Mortgage Servicing Rights Amortization. Mortgage servicing rights amortization increased $213,000 from $67,000 for the year ended December 31, 1997 to $280,000 for the same period in 1998 due to increased servicing activity and the adoption of Statement of Financial Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage Serving Rights", and SFAS No. 125, "Accounting for Transfers of Financial Assets, Servicing Rights and Extinguishment of Liabilities". Average mortgage loans serviced for others were approximately $91.6 million for the 1998 period as compared to $60.9 million for the 1997 period. Charitable Contributions. Charitable contributions increased $2.0 million from the year ended December 31, 1997 to 1998 due to the $2.0 million contribution to the Foundation made in connection with the stock conversion. Other Expenses. Other expenses, consisting primarily of expenses related to advertising, loan expenses, supplies, and postage increased $141,000, or 20.1%, from 1997 to 1998. The increase resulted from increases in a variety of expense categories and was not attributable to any one item. Income Tax Expense. Income tax expense decreased $1.2 million, or 100.6%, from the year ended December 31, 1997 to 1998. These variations in income tax expense are directly related to taxable income and the low income housing income tax credits earned during those years. The effective tax rate was (.5)% and 24.8% for 1998 and 1997, respectively. The effective rate declined in 1998 as compared to 1997 because the low-income housing income tax credits remained relatively constant while the level of income declined. The effective tax rate is expected to increase in future periods. Extraordinary Item - Early Extinguishment of Debt, Net of Income Taxes. Prepayment penalties of $249,000 on FHLB advances were recorded during the year ended December 31, 1998. Due to the securitization of loans and loans held for sale and the subsequent sales of a portion of these mortgage-backed securities, funds were available to prepay a portion of FHLB advances. Liquidity and Capital Resources Lincoln Federal's primary sources of funds are deposits, borrowings and the proceeds from principal and interest payments on loans and mortgage-backed securities and the sales of loans and mortgage-backed securities available for sale. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage and mortgage-backed securities prepayments are greatly influenced by general interest rates, economic conditions and competition. Lincoln Federal's primary investing activity is the origination of loans. During the years ended December 31, 1999, 1998 and 1997, cash used to originate loans exceeded repayments and other changes by $30.5 million, $6.9 million and $20.0 million, respectively. The growth in loans in 1999 was primarily funded by cash flow generated from monthly repayments of mortgage-backed securities, and in 1998 was funded by growth in deposits, while proceeds from the sale of mortgage-backed securities available for sale funded Lincoln Federal's 1997 loan growth. During the years ended December 31, 1999, 1998 and 1997, Lincoln Federal purchased mortgage-backed securities and other securities available for sale and held to maturity in the amounts of $64.8 million, $81.5 million and $7.8 million, respectively. These purchases were funded primarily with borrowings. During the years ended December 31, 1999, 1998 and 1997, Lincoln Federal received proceeds from maturities of mortgage-backed securities and other securities available for sale and held to maturity of $20.2 million, $18.4 million and $6.8 million, respectively. During the years ended December 31, 1999, 1998 and 1997, Lincoln Federal received proceeds for the sale of mortgage-backed and other securities available for sale of $10.3 million, $21.1 million and $54.5 million which funds were used to fund its loan growth. During 1997 and 1998, the funds were also used to reduce the level of FHLB advances. Lincoln Federal had outstanding loan commitments and unused lines of credit of $23.4 million and standby letters of credit outstanding of $86,000 at December 31, 1999. Management anticipates that Lincoln Federal will have sufficient funds from loan repayments, loan sales, and from its ability to borrow additional funds from the FHLB of Indianapolis to meet current commitments. Certificates of deposit scheduled to mature in one year or less at December 31, 1999 totaled $74.9 million. Management believes that a significant portion of such deposits will remain with Lincoln Federal based upon historical deposit flow data and Lincoln Federal's competitive pricing in its market area. Liquidity management is both a daily and long-term function of Lincoln Federal's management strategy. In the event that Lincoln Federal should require funds beyond its ability to generate them internally, additional funds are available through the use of FHLB advances. Lincoln Federal had outstanding FHLB advances in the amount of $103.9 million at December 31, 1999. As an additional funding source, Lincoln Federal has also sold securities under repurchase agreements. Lincoln Federal had outstanding securities sold under repurchase agreements in the amount of $4.6 million at December 31, 1999. Federal law requires that savings associations maintain an average daily balance of liquid assets in a minimum amount not less than 4% or more than 10% of their withdrawable accounts plus short-term borrowings. Liquid assets include cash, certain time deposits, certain bankers' acceptances, specified U.S. government, state or federal agency obligations, certain corporate debt securities, commercial paper, certain mutual funds, certain mortgage-related securities, and certain first-lien residential mortgage loans. The OTS regulation that implements this statutory liquidity requirement requires a savings association to hold liquid assets in a minimum amount of 4% of the association's net withdrawable accounts and short-term borrowings. A savings association may calculate its compliance with this requirement based upon its average daily balance of liquid assets during each quarter. The OTS may impose monetary penalties on savings associations that fail to meet these liquidity requirements. As of December 31, 1999, Lincoln Federal had liquid assets of $89.3 million, and a regulatory liquidity ratio of 45.7%. Pursuant to OTS capital regulations in effect at December 31, 1999, savings associations were required to maintain a 1.5% tangible capital requirement, a 4% leverage ratio (or core capital) requirement, and a total risk-based capital to risk-weighted assets ratio of 8%. At December 31, 1999, Lincoln Federal's capital levels exceeded all applicable regulatory capital requirements in effect as of that date. The following table provides the minimum regulatory capital requirements and Lincoln Federal's capital ratios as of December 31, 1999:
At December 31, 1999 OTS Requirement Lincoln Federal's Capital Level ------------------------ -------------------------------------------- % of % of Amount Capital Standard Assets Amount Assets(1) Amount of Excess - ---------------- ------ ------ --------- ------ --------- (Dollars in thousands) Tangible capital 1.5% $6,289 18.5% $77,569 $71,280 Core capital (2) 4.0 16,771 18.5 77,569 60,798 Risk-based capital 8.0 17,931 35.4 79,330 61,399
(1) Tangible and core capital levels are shown as a percentage of adjusted total assets; risk-based capital levels are shown as a percentage of risk-weighted assets. (2) The OTS has adopted a core capital requirement for savings associations comparable to that required by the OCC for national banks. The regulation requires core capital of at least 3% of total adjusted assets for savings associations that receive the highest supervisory rating for safety and soundness, and 4% to 5% for all other savings associations. Lincoln Federal is in compliance with this requirement. Current Accounting Issues The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement requires companies to record derivatives on the balance sheet at their fair value. SFAS No. 133 also acknowledges that the method of recording a gain or loss depends on the use of the derivative. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. o For a derivative designated as hedging the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as a fair value hedge), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. o For a derivative designated as hedging the exposure to variable cash flows of a forecasted transaction (referred to as a cash flow hedge), the effective portion of the derivative's gain or loss is initially reported as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. o For a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation, the gain or loss is reported in other comprehensive income (outside earnings) as part of the cumulative translation adjustment. The accounting for a fair value hedge described above applies to a derivative designated as a hedge of the foreign currency exposure of an unrecognized firm commitment or an available-for-sale security. Similarly, the accounting for a cash flow hedge described above applies to a derivative designated as a hedge of the foreign currency exposure of a foreign-currency-denominated forecasted transaction. o For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change. The new Statement applies to all entities. If hedge accounting is elected by the entity, the method of assessing the effectiveness of the hedging derivative and the measurement approach of determining the hedge's ineffectiveness must be established at the inception of the hedge. SFAS No. 133 amends SFAS No. 52 and supercedes SFAS Nos. 80, 105, and 119. SFAS No. 107 is amended to include the disclosure provisions about the concentrations of credit risk from SFAS No. 105. Several Emerging Issues Task Force consensuses are also changed or nullified by the provisions of SFAS No. 133. SFAS No. 133 was to be effective for all fiscal years beginning after June 15, 1999. The implementation date has been deferred and SFAS No. 133 will now be effective for all fiscal quarters beginning after June 15, 2000. Early application is encouraged; however, this Statement may not be applied retroactively to financial statements of prior periods. Impact of Inflation The consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The Company's primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of general levels of inflation. Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since such prices are affected by inflation. In a period of rapidly rising interest rates, the liquidity and maturities structures of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels. The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of noninterest expense. Such expense items as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that Lincoln Federal has made. Lincoln Federal is unable to determine the extent, if any, to which properties securing its loans have appreciated in dollar value due to inflation. Quarterly Results of Operations The following table sets forth certain quarterly results for the years ended December 31, 1999 and 1998.
Net Provision Basic Diluted Quarter Interest Interest Interest For Loan Net Earnings Earnings Dividends Ended Income Expense Income Losses Income Per Share Per Share Per Share - ------------------------------------------------------------------------------------------------------------- 1999: March $6,474 $3,128 $3,346 $31 $1,244 $.19 $.19 $.06 June 6,980 3,488 3,492 200 1,013 .16 .16 .06 September 7,072 3,570 3,502 59 1,145 .19 .19 .08 December 7,216 3,761 3,455 94 946 .17 .17 .08 ------- ------- ------- ---- ------ ---- ---- ---- $27,742 $13,947 $13,795 $384 $4,348 $.71 $.71 $.28 ======= ======= ======= ==== ====== ==== ==== ==== 1998: March $ 5,788 $ 3,448 $2,340 $ 45 $ 731 June 5,625 3,407 2,218 365 86 September 5,564 3,384 2,180 41 681 December 6,022 3,588 2,434 (278) (381) ------- ------- ------- ---- ------ $22,999 $13,827 $9,172 $173 $1,117 ======= ======= ======= ==== ======
Earnings per share information for the periods before Lincoln Federal's conversion to a stock savings bank on Decmeber 31, 1998 is not meaningful. Quantitative and Qualitative Disclosures about Market Risks An important component of Lincoln Federal's asset/liability management policy includes examining the interest rate sensitivity of its assets and liabilities and monitoring the expected effects of interest rate changes on the net portfolio value of its assets. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. If Lincoln Federal's assets mature or reprice more quickly or to a greater extent than its liabilities, net portfolio value and net interest income would tend to increase during periods of rising interest rates but decrease during periods of falling interest rates. Conversely, if Lincoln Federal's assets mature or reprice more slowly or to a lesser extent than its liabilities, net portfolio value and net interest income would tend to decrease during periods of rising interest rates but increase during periods of falling interest rates. Lincoln Federal's policy has been to mitigate the interest rate risk inherent in the historical business of savings associations, the origination of long-term loans funded by short-term deposits, by pursuing certain strategies designed to decrease the vulnerability of Lincoln Federal's earnings to material and prolonged changes in interest rates. ALCO Committee. The Bank's board of directors has delegated responsibility for the day-to-day management of interest rate risk to the Asset/Liability ("ALCO") Committee, which consists of its President, T. Tim Unger, Chief Financial Officer John M. Baer, Vice President-Secondary Marketing Maxwell O. Magee, Retail Sales Manager Rebecca Morgan, Residential Lending Manager Steve Schilling, and Marketing Director Angela Coleman. The ALCO Committee meets weekly to manage and review Lincoln Federal's assets and liabilities. The ALCO Committee establishes daily interest rates for deposits and approves the interest rates on one- to four-family residential loans, which are based upon current rates established by the Federal Home Loan Mortgage Corporation ("FHLMC"). The ALCO Committee also approves interest rates for other types of loans based upon the national prime rate and local market rates. Loan Portfolio Restructuring. The Bank's principal strategy to reduce exposure to fluctuating market interest rates is to manage the interest-rate sensitivity of its interest-earning assets and interest-bearing liabilities. In early 1997, the Bank's new management concluded that its asset portfolio exposed the Bank to significant risks in the event of a material and prolonged increase or decrease in interest rates. To address this problem, in 1997 the Bank securitized and sold certain one- to four-family residential loans in its portfolio in order to reduce its exposure to interest rate risk. The Bank presented to FHLMC pools of one- to four-family residential mortgage loans with either fixed interest rates or variable interest rates pegged to the 11th District Cost of Funds Index ("COFI"). COFI loans increase the Bank's exposure to interest rate risk because the COFI index does not follow, and usually lags behind, the U.S. Treasury yield curve, which is the index the Bank uses to establish the interest rates for its deposits. In addition, many of the COFI loans did not adjust quickly enough to changes in market interest rates as the result of annual rate adjustment limitations in the loan agreements. Many of the loans the Bank securitized did not include all of the documentation required by FHLMC. The Bank was able to securitize these loans by representing to FHLMC that, other than the loans with the missing documentation specifically identified in the FHLMC Master Commitment, the loans that the Bank securitized did not otherwise vary from FHLMC's standard underwriting and mortgage eligibility requirements. After grouping these loans into pools with similar loans that it originated, the Bank assigned the notes and mortgages to FHLMC in consideration for several mortgage-backed securities representing the different loan pools. In August, 1997, the Bank securitized approximately $76.2 million of one- to four-family residential mortgage loans in this manner, consisting of $26.9 million in COFI loans and $49.3 million in fixed-rate loans. The Bank immediately sold on the secondary market all of the mortgage-backed securities representing the COFI loans and $27.4 million of the securities backed by lower-yielding fixed-rate loans for a gain of $118,000. The Bank retained in its investment portfolios mortgage-backed securities representing $21.9 million of higher-yielding fixed-rate loans. In April, 1998, the Bank securitized an additional $39.9 million of its one- to four-family residential mortgage loans, consisting of $14.2 million of COFI loans and $25.7 million of fixed-rate loans for a gain of $105,000. The Bank sold on the secondary market the mortgage-backed security representing the COFI loans and $6.9 million of lower-yielding fixed-rate loans. The Bank retained in its investment portfolio mortgage-backed securities representing $18.8 million of higher-yielding fixed-rate loans. The Bank continues to service all of the loans that it originated that have been securitized by FHLMC in consideration of a fee of .25% and .375% of the outstanding loan balance for fixed-rated and variable-rate loans, respectively. Investors who purchased the mortgage-backed securities are repaid from the regular principal and interest payments made by the borrowers on the underlying loans, which "pass through" to the investors. FHLMC acts as a guarantor with respect to these regular payments to the investors in consideration of a fee that varies up to .375% of the outstanding balance on loans in the different loan pools. Although the loans that the Bank securitized were sold without recourse, the Bank agreed to indemnify FHLMC pursuant to the Master Commitment in the event that FHLMC makes a payment to an investor pursuant to its guarantee on certain loans noted in the Master Commitment as lacking the documentation required by FHLMC's underwriting standards. The Bank's indemnification to FHLMC pursuant to this provision is limited, however, solely to losses that arise as a result of the documentation exception or discrepancy noted in the Master Commitment. FHLMC may also require the Bank to repurchase a loan upon a borrower's default if the due diligence information contained in the loan data report that the Bank provided to FHLMC was not accurate, true or complete, if the Bank fails to provide additional information or documentation to FHLMC upon request, or if the Bank breaches any representation or warranty in the Master Commitment. The Bank has not experienced any significant losses on these loans in the past and do not anticipate any significant losses as a result of this indemnification. In June, 1998, the Bank sold an additional $19.3 million of its adjustable-rate COFI loans in a whole-loan sale to a private investor that closed in July, 1998. The Bank recognized a loss of $218,000 from this transaction. The securitization of certain of the Bank's loans and the whole loan sale reduced the heavy concentration of fixed-rate and adjustable-rate COFI mortgages in its portfolio while converting those assets to more liquid and marketable mortgage-backed securities. In the aggregate, the Bank has sold $75.4 million of the securities generated from the securitization and have retained securities with a face value of $40.7 million in its available-for-sale securities portfolio. The Bank used the proceeds from these sales of mortgage-backed securities to repay outstanding FHLB advances from a balance of $106.9 million at June 30, 1997 to $45.7 million at June 30, 1998. The Bank also used some of the proceeds from these sales to purchase interest rate-sensitive securities. The Bank also restructured its remaining FHLB debt by prepaying advances with higher interest rates and extending the repayment terms of other debt, thereby reducing the Bank's exposure to interest rate risk and reducing its cost of funds. Because of the lack of customer demand for adjustable rate loans in its market area, Lincoln Federal primarily originates fixed-rate real estate loans, which accounted for approximately 77.3% of its loan portfolio at December 31, 1999. Lincoln Federal continues to offer and attempts to increase its volume of adjustable rate loans when market interest rates make these type loans more attractive to customers. During the first quarter of 1999, the Company initiated a leverage strategy that involved buying approximately $53 million of marketable securities and loans funded by an increase in securities sold under repurchase agreements and Federal Home Loan Bank advances. The purpose of this strategy was to utilize the high equity position of the Company to support additional earning assets in order to increase operating income. Investments were made in collateralized mortgage obligations, mortgage backed securities, agency notes and corporate notes as well as a package of variable rate whole mortgage loans. The leverage positions from these transactions are monitored regularly and no other leverage transactions were done during the remainder of the year. Loan growth continued through 1999 in all categories. Most of this growth was funded by cash flow generated from monthly payments of mortgage backed securities and collateralized mortgage obligations purchased with funds generated from the conversion to a stock institution at the end of 1998 and from the leverage transaction discussed above. The Bank manages the relationship between interest rates and the effect on Lincoln Federal's net portfolio value ("NPV"). This approach calculates the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities, as well as cash flows from off-balance sheet contracts. Lincoln Federal manages assets and liabilities within the context of the marketplace, regulatory limitations and within limits established by Lincoln Federal's Board of Directors on the amount of change in NPV which is acceptable given certain interest rate changes. The OTS issued a regulation, which uses a net market value methodology to measure the interest rate risk exposure of savings associations. Under this OTS regulation, an institution's "normal" level of interest rate risk in the event of an assumed change in interest rates is a decrease in the institution's NPV in an amount not exceeding 2% of the present value of its assets. Savings associations with over $300 million in assets or less than a 12% risk-based capital ratio are required to file OTS Schedule CMR. Data from Schedule CMR is used by the OTS to calculate changes in NPV (and the related "normal" level of interest rate risk) based upon certain interest rate changes (discussed below). Associations which do not meet either of the filing requirements are not required to file OTS Schedule CMR, but may do so voluntarily. Because Lincoln Federal's assets exceed $300 million, it is required to file Schedule CMR. Under the regulation, associations which must file are required to take a deduction (the interest rate risk capital component) from their total capital available to calculate their risk based capital requirement if their interest rate exposure is greater than "normal." The amount of that deduction is one-half of the difference between (a) the institution's actual calculated exposure to a 200 basis point interest rate increase or decrease (whichever results in the greater pro forma decrease in NPV) and (b) the institution's "normal" level of exposure which is 2% of the present value of its assets. It is estimated that at December 31, 1999, NPV would decrease 28% and 42% in the event of 200 and 300 basis point increases in market interest rates, respectively, compared to 17% and 27% for the same increases at December 31, 1998. Lincoln Federal's NPV at December 31, 1999 would increase 18% and 21% in the event of 200 and 300 basis point decreases in market rates, respectively. A year earlier, 200 and 300 basis point decreases in market rates would have increased NPV 6% and 10%, respectively. Presented below, as of December 31, 1999, is an analysis performed by the OTS of Lincoln Federal's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up and down 300 basis points and in accordance with the proposed regulations. At December 31, 1999, 2% of the present value of Lincoln Federal's assets was approximately $8.2 million. Because the interest rate risk of a 200 basis point increase in market rates (which was greater than the interest rate risk of a 200 basis point decrease) was $21.2 million at December 31, 1999, Lincoln Federal would have been required to deduct $6.5 million from its capital if the OTS' NPV methodology had been in effect. Lincoln Federal's exposure to interest rate risk results primarily from the concentration of fixed rate mortgage loans in its portfolio.
Change Net Portfolio Value NPV as % of PV of Assets In Rates $ Amount $ Change % Change NPV Ratio Change - -------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) +300 bp* $43,966 $(31,847) (42)% 11.85% (661)bp +200 bp 54,354 (21,458) (28) 14.16 (431)bp +100 bp 65,284 (10,528) (14) 16.43 (204)bp 0 bp 75,812 18.46 -100 bp 84,772 8,960 12 20.07 161bp -200 bp 89,722 13,910 18 20.86 239bp -300 bp 91,506 15,694 21 21.04 257bp * Basis points. In contrast, the following chart presents the calculation of Lincoln Federal's exposure to interest rate risk as of December 31, 1998, as determined by the OTS. Change Net Portfolio Value NPV as % of PV of Assets In Rates $ Amount $ Change % Change NPV Ratio Change - -------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) +300 bp* $61,270 $(22,722) (27)% 17.65% (483)bp +200 bp 69,565 (14,427) (17) 19.51 (297)bp +100 bp 77,499 (6,494) (8) 21.19 (130)bp 0 bp 83,993 22.48 -100 bp 87,115 3,123 4 23.03 55bp -200 bp 89,343 5,350 6 23.38 90bp -300 bp 92,108 8,116 10 23.83 135bp
* Basis points. As with any method of measuring interest rate risk, certain shortcomings are inherent in the methods of analysis presented above. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumed in calculating the table. INDEPENDENT AUDITORS REPORT Board of Directors Lincoln Bancorp Plainfield, Indiana We have audited the accompanying consolidated balance sheet of Lincoln Bancorp and subsidiary as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements described above present fairly, in all material respects, the consolidated financial position of Lincoln Bancorp and subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. Olive LLP Indianapolis, Indiana February 8, 2000
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana December 31 1999 1998 - ---------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 2,576,080 $ 4,245,128 Interest-bearing demand deposits in other banks 8,242,552 18,662,229 ------------ ------------ Cash and cash equivalents 10,818,632 22,907,357 Investment securities Available for sale 145,875,328 129,275,575 Held to maturity (market value $497,813 and $1,264,375) 500,000 1,250,000 ------------ ------------ Total investment securities 146,375,328 130,525,575 Loans, net of allowance for loan losses of $1,760,706 and $1,512,205 233,000,179 195,920,792 Premises and equipment 3,672,650 3,379,460 Investments in limited partnerships 2,063,661 2,386,994 Federal Home Loan Bank stock 5,446,700 5,446,700 Interest receivable Loans 930,963 745,584 Mortgage-backed securities 469,904 446,786 Other investment securities and interest-bearing deposits 846,003 580,693 Deferred income tax 5,026,690 2,034,327 Other assets 2,177,333 2,073,836 ------------ ------------ Total assets $410,828,043 $366,448,104 ============ ============ Liabilities Deposits Noninterest bearing $ 3,395,618 $ 2,484,444 Interest bearing 201,586,609 209,525,347 ------------ ------------ Total deposits 204,982,227 212,009,791 Securities sold under repurchase agreements 4,600,000 Federal Home Loan Bank advances 103,937,608 33,263,455 Note payable 1,714,001 2,202,501 Due to broker 10,025,000 Interest payable 1,096,519 1,108,514 Other liabilities 2,754,552 1,731,061 ------------ ------------ Total liabilities 319,084,907 260,340,322 ------------ ------------ Commitments and Contingencies Shareholders' Equity Preferred stock, without par value Authorized and unissued--2,000,000 shares Common stock, without par value Authorized--20,000,000 shares Issued and outstanding--6,308,325 and 7,009,250 shares 61,853,916 68,879,373 Retained earnings 43,575,208 42,548,260 Accumulated other comprehensive income (loss) (5,065,649) 287,549 Unearned recognition and retention plan (RRP) shares (3,407,119) Unearned employee stock ownership plan (ESOP) shares (5,213,220) (5,607,400) ------------ ------------ Total shareholders' equity 91,743,136 106,107,782 ------------ ------------ Total liabilities and shareholders' equity $410,828,043 $366,448,104 ============ ============
See notes to consolidated financial statements.
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana Year Ended December 31 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Interest and Dividend Income Loans receivable, including fees $16,865,580 $17,024,353 $22,369,033 Investment securities Mortgage-backed securities 5,903,252 2,961,611 1,086,165 Other investment securities 4,273,404 1,033,105 773,033 Deposits with financial institutions 263,459 1,543,391 652,814 Dividend income 435,736 436,148 415,502 ------------ ------------ ------------ Total interest and dividend income 27,741,431 22,998,608 25,296,547 ------------ ------------ ------------ Interest Expense Deposits 9,578,692 10,971,993 10,403,452 Short-term borrowings 189,914 Federal Home Loan Bank advances 4,178,146 2,854,876 5,248,400 ------------ ------------ ------------ Total interest expense 13,946,752 13,826,869 15,651,852 ------------ ------------ ------------ Net Interest Income 13,794,679 9,171,739 9,644,695 Provision for loan losses 383,902 172,757 297,555 ------------ ------------ ------------ Net Interest Income After Provision for Loan Losses 13,410,777 8,998,982 9,347,140 ------------ ------------ ------------ Other Income Net realized and unrealized gains (losses) on loans 10,539 (61,074) 299,020 Net realized gains (losses) on sales of available-for-sale securities (3,904) 112,554 118,283 Equity in losses of limited partnerships (323,333) (514,003) (681,426) Other income 930,667 833,400 674,139 ------------ ------------ ------------ Total other income 613,969 370,877 410,016 ------------ ------------ ------------ Other Expenses Salaries and employee benefits 3,859,409 2,724,332 2,247,436 Net occupancy expenses 357,135 248,935 272,101 Equipment expenses 541,007 625,653 525,734 Deposit insurance expense 150,433 187,775 193,672 Data processing fees 735,771 657,991 581,087 Professional fees 209,387 200,796 237,819 Director and committee fees 223,634 319,404 226,538 Mortgage servicing rights amortization 124,340 280,214 66,784 Charitable contributions 21,537 2,022,567 31,912 Other expenses 1,108,454 842,197 702,305 ------------ ------------ ------------ Total other expenses 7,331,107 8,109,864 5,085,388 ------------ ------------ ------------ Income Before Income Tax and Extraordinary Item 6,693,639 1,259,995 4,671,768 Income tax expense (benefit) 2,346,116 (6,894) 1,158,560 ------------ ------------ ------------ Income Before Extraordinary Item 4,347,523 1,266,889 3,513,208 Extraordinary item--early extinguishment of debt, net of income taxes of $98,583 (150,303) ------------ ------------ ------------ Net Income $ 4,347,523 $ 1,116,586 $ 3,513,208 ============ ============ ============ Basic Earnings per Share $ .71 ============ Diluted Earnings per Share .71 ============ See notes to consolidated financial statements.
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana Year Ended December 31 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------- Net income $4,347,523 $1,116,586 $3,513,208 ----------- ----------- ---------- Other comprehensive income, net of tax Unrealized gains (losses) on securities available for sale Unrealized holding gains (losses) arising during the period, net of tax expense (benefit) of $(3,512,727), $(124,935) and $404,318 (5,355,556) (190,478) 616,429 Less: Reclassification adjustment for gains (losses) included in net income, net of tax expense (benefit) of $(1,546), $44,583 and $46,852 (2,358) 67,971 71,431 ----------- ----------- ---------- (5,353,198) (258,449) 544,998 ----------- ----------- ---------- Comprehensive income $(1,005,675) $ 858,137 $4,058,206 =========== =========== ==========
See notes to consolidated financial statements. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana
Accumulated Other Common Stock Comprehensive Unearned Shares Retained Income Unearned ESOP Outstanding Amount Earnings (Loss) Compensation Shares Total -------------------------------------------------------------------------------------------- Balances, January 1, 1997 $37,918,466 $ 1,000 $37,919,466 Net income 3,513,208 3,513,208 Unrealized gains on securities, net of reclassification adjustment 544,998 544,998 -------------------------------------------------------------------------------------------- Balances, December 31, 1997 41,431,674 545,998 41,977,672 Net income 1,116,586 1,116,586 Unrealized losses on securities, net of reclassification adjustment (258,449) (258,449) Stock issued in conversion, net of costs 6,809,250 $66,879,373 66,879,373 Stock contributed to charitable foundation 200,000 2,000,000 2,000,000 Contribution of unearned ESOP shares $(5,607,400) (5,607,400) -------------------------------------------------------------------------------------------- Balances, December 31, 1998 7,009,250 68,879,373 42,548,260 287,549 (5,607,400) 106,107,782 Net income 4,347,523 4,347,523 Unrealized gains on securities, net of reclassification adjustment (5,353,198) (5,353,198) Purchase of common stock (700,925) (7,009,250) (1,663,342) (8,672,592) ESOP shares earned 53,904 394,180 448,084 Contribution for unearned RRP shares $(3,716,977) (3,716,977) Amortization of unearned compensation expense (17,702) 309,858 292,156 Additional conversion costs (16,207) (16,207) Cash dividends ($.28 per share) (1,693,435) (1,693,435) -------------------------------------------------------------------------------------------- Balances, December 31, 1999 6,308,325 $61,853,916 $43,575,208 $(5,065,649) $(3,407,119) $(5,213,220) $91,743,136 ============================================================================================
See notes to consolidated financial statements.
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana Year Ended December 31 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 4,347,523 $ 1,116,586 $ 3,513,208 Adjustments to reconcile net income to net cash provided by operating activities Provision for loan losses 383,902 172,757 297,555 Common stock contributed to Lincoln Federal Charitable Foundation 2,000,000 Gain on sale of foreclosed real estate (2,498) (10,550) (17,297) Loss on disposal of premises and equipment 4,219 13,190 Investment securities accretion, net (393,358) (43,449) (173) Investment securities (gains) losses 3,904 (112,554) (118,283) Equity in losses of limited partnerships 323,333 514,003 681,426 Amortization of net loan origination fees (321,642) (417,831) (318,087) Depreciation and amortization 476,818 478,784 441,824 Deferred income tax benefit 518,817 (890,363) (48,394) Amortization of unearned compensation expense 292,156 ESOP shares earned 448,084 Change in Loans held for sale 19,502,357 1,353,983 Interest receivable (473,807) (240,098) 358,839 Interest payable (11,995) (45,003) 669,785 Other liabilities 210,274 313,544 242,329 Other assets (309,970) 98,626 143,797 Income taxes receivable/payable 356,049 98,386 (604,950) ----------- ----------- ----------- Net cash provided by operating activities 5,851,809 22,548,385 6,595,562 ----------- ----------- ----------- Investing Activities Net change in interest-bearing deposits 595,000 Purchases of securities available for sale (64,794,311) (81,482,573) (7,798,838) Proceeds from sales of securities available for sale 10,259,375 21,088,545 54,532,285 Proceeds from maturities of securities available for sale 19,435,259 9,998,768 1,236,765 Proceeds from maturities of securities held to maturity 750,000 8,385,000 5,550,000 Purchase of loans (6,768,743) (999,737) Other net changes in loans (30,533,720) (6,920,309) (20,033,888) Purchase of premises and equipment (774,227) (1,046,344) (677,841) Purchase of FHLB of Indianapolis stock (650,000) Proceeds from sale of foreclosed real estate 224,378 318,017 157,901 Improvements to foreclosed real estate (151) Contribution to limited partnership (195,000) (200,000) Other investing activities (650,000) (378,759) ----------- ----------- ----------- Net cash provided (used) by investing activities (72,201,989) (50,503,896) 31,332,737 ----------- ----------- ----------- Financing Activities Net change in Noninterest-bearing, interest-bearing demand, money market and savings deposits 7,825,832 6,694,106 4,449,683 Certificates of deposit (14,853,396) 1,463,861 (11,421,208) Short-term borrowings 4,600,000 Proceeds from FHLB advances 105,634,899 15,000,000 73,400,000 Repayment of FHLB advances (34,960,746) (51,872,693) (94,496,337) Payment on note payable to limited partnership (488,500) (488,500) (488,500) Net change in advances by borrowers for taxes and insurance 142,770 (163,560) (213,140) Cash dividends (1,233,628) Contribution of unearned compensation (3,716,977) Purchase of common stock (8,672,592) Additional conversion costs (16,207) Proceeds from sale of common stock, net of costs 61,271,973 ----------- ----------- ----------- Net cash provided (used) by financing activities 54,261,455 31,905,187 (28,769,502) ----------- ----------- ----------- Net Change in Cash and Cash Equivalents (12,088,725) 3,949,676 9,158,797 Cash and Cash Equivalents, Beginning of Year 22,907,357 18,957,681 9,798,884 ----------- ----------- ----------- Cash and Cash Equivalents, End of Year $10,818,632 $22,907,357 $18,957,681 =========== =========== =========== Additional Cash Flows and Supplementary Information Interest paid $13,958,747 $13,871,872 $14,982,067 Income tax paid 1,471,250 686,500 1,814,998 Loan balances transferred to foreclosed real estate 218,416 365,108 110,767 Securitization of loans and loans held for sale 39,903,448 76,229,830 Common stock issued to ESOP leveraged with an employee loan 5,607,400 Transfer of loans to loans held for sale 19,611,025 3,137,084 Due to broker 10,025,000
See notes to consolidated financial statements. LINCOLN BANCORP AND SUBSIDIARY Plainfield Indiana (Table Dollar Amounts in Thousands) Note 1 -- Nature of Operations and Summary of Significant Accounting Policies The accounting and reporting policies of Lincoln Bancorp (Company) and its wholly owned subsidiary, Lincoln Federal Savings Bank (Bank), and the Bank's wholly owned subsidiary, L-F Service Corporation (L-F Service), conform to generally accepted accounting principles and reporting practices followed by the thrift industry. The more significant of the policies are described below. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company is a thrift holding company whose principal activity is the ownership and management of the Bank. The Bank operates under a federal thrift charter and provides full banking services in a single significant business segment. As a federally chartered thrift, the Bank is subject to regulation by the Office of Thrift Supervision. The Bank generates commercial, mortgage and consumer loans and receives deposits from customers located primarily in Central Indiana. The Bank's loans are generally secured by specific items of collateral including real property, consumer assets and business assets. L-F Service invests in low income housing partnerships. Consolidation--The consolidated financial statements include the accounts of the Company and Bank after elimination of all material intercompany transactions and accounts. Investment Securities--Debt securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Securities held to maturity are carried at amortized cost. Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses reported separately in accumulated other comprehensive income, net of tax. Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method. Loan securitizations--The Company securitized certain mortgage loans and created mortgage-backed securities for sale in the secondary market. Because the resulting securities were collateralized by the identical loans previously held, no gain or loss was recognized at the time of the securitization transactions. When securitized loans are sold to an outside party, the specific-identification method is used to determine the cost of the security sold, and a gain or loss is recognized in income. Loans held for sale are carried at the lower of aggregate cost or market. Market is determined using the aggregate method. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income based on the difference between estimated sales proceeds and aggregate cost. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Loans are carried at the principal amount outstanding. A loan is impaired when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with insignificant delays not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially delinquent loans may be considered to be impaired. The Company considers its investment in one-to-four family residential loans and consumer loans to be homogeneous and therefore excluded from separate identification for evaluation of impairment. Interest income is accrued on the principal balances of loans. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed when considered uncollectible. Interest income is subsequently recognized only to the extent cash payments are received. Certain loan fees and direct costs are being deferred and amortized as an adjustment of yield on the loans over the contractual lives of the loans. When a loan is paid off or sold, any unamortized loan origination fee balance is credited to income. Allowance for loan losses is maintained to absorb loan losses based on management's continuing review and evaluation of the loan portfolio and its judgment as to the impact of economic conditions on the portfolio. The evaluation by management includes consideration of past loss experience, changes in the composition of the portfolio, the current condition and amount of loans outstanding, and the probability of collecting all amounts due. Impaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loan, if collateral dependent. The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that as of December 31, 1999, the allowance for loan losses is adequate based on information currently available. A worsening or protracted economic decline in the area within which the Company operates would increase the likelihood of additional losses due to credit and market risks and could create the need for additional loss reserves. Premises and equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line method based principally on the estimated useful lives of the assets which range from 3 to 39 years. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations. Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank (FHLB) system. The required investment in the common stock is based on a predetermined formula. Foreclosed assets are carried at the lower of cost or fair value less estimated selling costs. When foreclosed assets are acquired, any required adjustment is charged to the allowance for loan losses. All subsequent activity is included in current operations. Mortgage servicing rights on originated loans are capitalized by allocating the total cost of the mortgage loans between the mortgage servicing rights and the loans based on their relative fair values. Capitalized servicing rights, which include purchased servicing rights, are amortized in proportion to and over the period of estimated servicing revenues. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Investments in limited partnerships are recorded using the equity method of accounting. Losses due to impairment are recorded when it is determined that the investment no longer has the ability to recover its carrying amount. The benefits of low income housing tax credits associated with the investment are accrued when earned. Pension plan costs are based on actuarial computations and charged to current operations. The funding policy is to pay at least the minimum amounts required by ERISA. Income tax in the consolidated statement of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes. The Company files consolidated income tax returns with its subsidiary. Earnings per share have been computed based upon the weighted average common shares outstanding during the year. Unearned ESOP shares have been excluded from the computation of average shares outstanding. For the year ended December 31, 1999, basic and diluted earnings per share were $.71 based on shares outstanding of 6,115,522 for both basic and diluted earnings per share. Options to purchase 596,095 shares of common stock at prices ranging from $11.47 to $12.50 per share were outstanding at December 31, 1999, but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares. Net income per share for the periods before the conversion to a stock savings bank on December 30, 1998, is not meaningful. Reclassifications of certain amounts in the 1998 and 1997 consolidated financial statements have been made to conform to the 1999 presentation. Note 2 -- Conversion On December 30, 1998, the Bank completed the conversion from a federally chartered mutual institution to a federally chartered stock savings bank and the formation of the Company as the holding company of the Bank. As part of the conversion, the Company issued 6,809,250 shares of common stock at $10 per share. Net proceeds of the Company's stock issuance, after costs of $1,213,000 and excluding the shares issued for the ESOP, were $61,272,000, of which $33,440,000 was used to acquire 100% of the stock and ownership of the Bank. The transaction was accounted for at historical cost in a manner similar to that utilized in a pooling of interests. In connection with the Conversion, the Company contributed 200,000 shares of common stock to Lincoln Federal Charitable Foundation, Inc. (Foundation), a charitable foundation dedicated to community development activities in the Company's market areas. This resulted in the recognition of an additional $2,000,000 charitable contribution expense for the year ended December 31, 1998. Note 3 -- Restriction on Cash and Due From Banks The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 1999, was $223,000. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 4 -- Investment Securities
1999 --------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair December 31 Cost Gains Losses Value - ---------------------------------------------------------------------------------------------------------------------- Available for sale Federal agencies $ 45,992 $4,386 $ 41,606 Mortgage-backed securities Federal Home Loan Mortgage Corporation 23,003 $112 313 22,802 Federal National Mortgage Association 4,593 42 4,551 Government National Mortgage Association 9,417 545 8,872 Collateralized mortgage obligations 48,003 2,632 45,371 Corporate obligations 23,256 32 615 22,673 --------------------------------------------------------------- Total available for sale 154,264 144 8,533 145,875 Held to maturity Federal agencies 500 2 498 --------------------------------------------------------------- Total investment securities $154,764 $144 $8,535 $146,373 ===============================================================
1998 --------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair December 31 Cost Gains Losses Value - ---------------------------------------------------------------------------------------------------------------------- Available for sale Federal agencies $ 15,598 $ 72 $ 15,670 Mortgage-backed securities Federal Home Loan Mortgage Corporation 31,939 970 32,909 Federal National Mortgage Corporation 6,013 52 6,065 Collateralized mortgage obligations 51,706 3 $ 74 51,635 Corporate obligations 23,544 59 606 22,997 --------------------------------------------------------------- Total available for sale 128,800 1,156 680 129,276 Held to maturity Federal agencies 1,250 14 1,264 --------------------------------------------------------------- Total investment securities $130,050 $1,170 $680 $130,540 ===============================================================
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) The amortized cost and fair value of securities at December 31, 1999, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
1999 ----------------------------------------------------------- Available for Sale Held to Maturity ----------------------------------------------------------- Amortized Fair Amortized Fair December 31 Cost Value Cost Value - ------------------------------------------------------------------------------------------ One to five years $ 8,003 $ 7,834 $500 $498 Five to ten years 25,650 23,818 Over ten years 35,595 32,627 ----------------------------------------------------------- 69,248 64,279 500 498 Mortgage-backed securities 85,016 81,596 ----------------------------------------------------------- Totals $154,264 $145,875 $500 $498 ===========================================================
Securities with a carrying value of $4,700,000 were pledged at December 31, 1999 to secure securities sold under agreements to repurchase. Securities with a carrying value of $119,002,000 and $97,503,000 were pledged at December 31, 1999 and 1998 to secure FHLB advances. Proceeds from sales of securities available for sale during the years ended December 31, 1999 and 1998 were $10,259,000, $21,089,000 and $54,500,000. Gross gains of $77,000, $113,000 and $208,000 and gross losses of $81,000, $0 and $90,000 for the years ended December 31, 1999, 1998 and 1997 were realized on those sales. Note 5 -- Loans and Allowance December 31 1999 1998 - -------------------------------------------------------------------------------- Real estate mortgage loans One-to-four family $175,095 $152,893 Multi-family 1,029 1,022 Real estate construction loans 18,127 7,411 Commercial, industrial and agricultural loans 19,773 17,334 Consumer loans 28,554 22,014 -------- -------- 242,578 200,674 Less Undisbursed portion of loans 6,995 2,348 Deferred loan fees 822 893 Allowance for loan losses 1,761 1,512 -------- -------- Total loans $233,000 $195,921 ======== ======== LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Year Ended December 31 1999 1998 1997 - -------------------------------------------------------------------------------- Allowance for loan losses Balances, January 1 $1,512 $1,361 $1,241 Provision for losses 384 173 298 Recoveries on loans 6 335 Loans charged off (141) (357) (178) ----------------------------------------- Balances, December 31 $1,761 $1,512 $1,361 ========================================= Information on impaired loans is summarized below. December 31 1999 1998 - -------------------------------------------------------------------------------- Impaired loans for which the discounted cash flows or collateral value exceeds the carrying value of the loan $300 $300 ==== ==== Year Ended December 31 1999 1998 1997 - -------------------------------------------------------------------------------- Average balance of impaired loans $300 $951 $1,933 Interest income recognized on impaired loans 9 64 Cash-basis interest included above 9 64 Note 6 -- Premises and Equipment December 31 1999 1998 - -------------------------------------------------------------------------------- Land $ 881 $ 881 Buildings and land improvements 3,572 2,720 Furniture and equipment 2,177 1,778 Construction in progress 10 495 ------ ------ Total cost 6,640 5,874 Accumulated depreciation (2,967) (2,495) ------ ------ Net $3,673 $3,379 ====== ====== LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 7 -- Investments In Limited Partnerships The Company's investments in limited partnership of $2,064,000 and $2,387,000 at December 31, 1999 and 1998 represent equity in certain limited partnerships organized to build, own and operate apartment complexes. The Company records its equity in the net income or loss of the partnerships based on the Company's interest in the partnerships, which interests are 49.5 percent in Pedcor Investments-1987-I (Pedcor) and 99 percent in Bloomington Housing Associates L.P. (Bloomington Housing). In addition to recording its equity in the losses of the partnerships, the Company has recorded the benefit of low income housing tax credits of $373,000, $597,000 and $655,000 for the years ended December 31, 1999, 1998 and 1997. Condensed combined financial statements of the partnerships are as follows: December 31 1999 1998 - -------------------------------------------------------------------------------- Assets Cash $ 115 $ 202 Note receivable--limited partner 1,714 2,203 Land and property 9,219 9,339 Other assets 1,118 1,347 ------- ------- Total assets $12,166 $13,091 ------- ------- Liabilities Notes payable $ 8,771 $ 9,041 Other liabilities 710 706 ------- ------- Total liabilities 9,481 9,747 Partners' equity 2,685 3,344 ------- ------- Total liabilities and partners' equity $12,166 $13,091 ======= ======= Year Ended December 31 1999 1998 1997 - -------------------------------------------------------------------------------- Condensed statement of operations Total revenue $1,601 $1,575 $1,677 Total expenses (2,261) (2,644) (2,633) ------- ------- ------- Net loss $ (660) $(1,069) $ (956) ======= ======= ======= LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 8 -- Deposits December 31 1999 1998 - -------------------------------------------------------------------------------- Noninterest-bearing demand deposits $ 3,396 $ 2,484 Interest-bearing demand 10,729 8,541 Money market savings deposits 41,745 32,942 Savings deposits 16,505 20,582 Certificates and other time deposits of $100,000 or more 15,771 16,333 Other certificates and time deposits 116,836 131,128 -------- -------- Total deposits $204,982 $212,010 ======== ======== Certificates and other time deposits maturing in years ending December 31 2000 $ 74,942 2001 38,284 2002 17,336 2003 1,056 2004 989 -------- $132,607 ======== Note 9 -- Securities Sold Under Repurchase Agreements Securities sold under agreements to repurchase were $4,600,000 at December 31, 1999 and consist of obligations of the Company to other parties. The obligations are secured by federal agencies and such collateral is held by a financial services company. The maximum amount of outstanding agreements at any month-end during 1999 totaled $4,6000,000, and the daily average of such agreements totaled $3,680,000. The agreements at December 31, 1999, mature March 15, 2000. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 10 -- Federal Home Loan Bank Advances
1999 1998 ------------------------------------------------------------- Weighted- Weighted- Average Average December 31 Amount Rate Amount Rate - --------------------------------------------------------------------------------------------------------- Maturities in years ending December 31 1999 $ 7,000 5.21% 2000 $ 23,250 4.05% 2002 10,000 5.67 10,000 5.67 2003 688 5.36 1,263 5.36 2008 15,000 5.53 15,000 5.53 2009 55,000 5.02 -------- ------- $103,938 4.94% $33,263 5.50% ======== =======
The FHLB advances are secured by first mortgage loans and investment securities totaling $289,949,000 and $245,344,000 at December 31, 1999 and 1998. Advances are subject to restrictions or penalties in the event of prepayment. During 1998, the Company prepaid FHLB advances of $16,450,000. The early repayments resulted in prepayment penalties of $150,000, net of income taxes of $99,000, which has been accounted for as an extraordinary item as required by generally accepted accounting principles. Note 11 -- Note Payable The note payable to Bloomington Housing dated August 18, 1992 in the original amount of $4,945,000 bears no interest so long as there exists no event of default. In the instance where an event of default has occurred, interest shall be calculated at a rate of five percent above the Indiana base rate as described in the note. The following table summarizes the payment terms of the note. December 31 Payments due in years ending - -------------------------------------------------------------------------------- 2000 $ 489 2001 489 2002 489 2003 247 ------ $1,714 ====== LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 12 -- Loan Servicing Mortgage loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of these loans consist of the following: December 31 1999 1998 1997 - -------------------------------------------------------------------------------- Mortgage loan portfolio serviced for FHLMC $71,991 $82,815 $84,879 Other investors 11,541 15,346 84 ------- ------- ------- $83,532 $98,161 $84,963 ======= ======= ======= The aggregate fair value of capitalized mortgage servicing rights at December 31, 1999 and 1998 totaled $487,000 and $605,000. Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. For purposes of measuring impairment, risk characteristics including product type, investor type, and interest rates, were used to stratify the originated mortgage servicing rights. December 31 1999 1998 1997 - -------------------------------------------------------------------------------- Mortgage Servicing Rights Balances, January 1 $605 $530 $ 85 Servicing rights capitalized 6 355 512 Amortization of servicing rights (124) (280) (67) ---- ---- ---- Balances, December 31 $487 $605 $530 ==== ==== ==== LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 13 -- Income Tax
Year Ended December 31 1999 1998 1997 - ----------------------------------------------------------------------------------------------- Income tax expense (benefit) Currently payable Federal $1,196 $532 $ 841 State 631 351 366 Deferred Federal 552 (881) (58) State (33) (9) 10 ------ ------ ------ Total income tax expense (benefit) $2,346 $ (7) $1,159 ====== ====== ====== Reconciliation of federal statutory to actual tax expense Federal statutory income tax at 34% $2,276 $428 $1,588 Effect of state income taxes 395 226 248 Tax credits (373) (597) (655) Other 48 (64) (22) ------ ------ ------ Actual tax expense (benefit) $2,346 $ (7) $1,159 ====== ====== ====== Effective tax rate 35.1% (.5)% 24.8%
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) The components of the deferred tax asset are as follows at: December 31 1999 1998 - -------------------------------------------------------------------------------- Assets Depreciation $ 45 $ 38 Allowance for loan losses 748 643 Loan fees 19 58 Deferred director fees 414 375 Loss on limited partnerships 259 377 Business tax credits 95 549 Charitable contributions 374 591 Employee benefits 173 Securities available for sale 3,323 ------ ------ Total assets 5,450 2,631 ------ ------ Liabilities State income tax (91) (79) FHLB stock dividends (78) (79) Mortgage servicing rights (203) (250) Securities available for sale (189) Other (32) ------ ------ Total liabilities (404) (597) ------ ------ 5,046 2,034 Valuation Allowance (19) ------ ------ $5,027 $2,034 ====== ====== The valuation allowance of December 31, 1999 is $19,000, all of which arose during the current year. At December 31, 1999, the Company had an unused business income tax credit carryforward of $95,000 expiring in 2013 and a charitable contribution carryover of $1,101,000 expiring in 2003. Income tax expense (benefit) attributable to securities gains (losses) was $(1,500), $45,000 and $47,000 for the years ended December 31, 1999, 1998 and 1997. Retained earnings include approximately $5,928,000 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which income would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amounts at December 31, 1999 was approximately $2,348,000. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 14 -- Commitments and Contingent Liabilities In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated statement of financial condition. Financial instruments whose contract amount represents credit risk were as follows: December 31 1999 1998 - -------------------------------------------------------------------------------- Loan commitments $23,397 $21,293 Standby letters of credit 86 366 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation. Collateral held varies, but may include residential real estate, income-producing commercial properties, or other assets of the borrower. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company and subsidiary are also subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate determination of such possible claims or lawsuits will not have a material adverse effect on the consolidated financial position of the Company. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 15 -- Dividend and Capital Restrictions Without prior approval, current regulations allow the Bank to pay dividends to the Company not exceeding retained net income for the current year plus those for the previous two years. The Bank normally restricts dividends to a lesser amount because of the need to maintain an adequate capital structure. At the time of conversion, a liquidation account was established in an amount equal to the Banks' net worth as reflected in the latest statement of condition used in its final conversion offering circular. The liquidation account is maintained for the benefit of eligible deposit account holders who maintain their deposit account in the Banks after conversion. In the event of a complete liquidation, and only in such event, each eligible deposit account holder will be entitled to receive a liquidation distribution from the liquidation account in the amount of the then current adjusted subaccount balance for deposit accounts then held, before any liquidation distribution may be made to shareholders. Except for the repurchase of stock and payment of dividends, the existence of the liquidation account will not restrict the use or application of net worth. The initial balance of the liquidation account was $42,800,000. At December 31, 1999, the shareholder's equity of the Bank was $72,503,000, of which approximately $6,129,000 was available for the payment of dividends to the Company. Note 16 -- Regulatory Capital The Bank is subject to various regulatory capital requirements administered by the federal banking agencies and is assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations: total risk adjusted capital, Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. At December 31, 1999 and 1998, the Bank is categorized as well capitalized and met all subject capital adequacy requirements. There are no conditions or events since December 31, 1999 that management believes have changed the Bank's classification. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) The Bank's actual and required capital amounts and ratios are as follows:
December 31, 1999 ------------------------------------------------------------------ Required for To Be Well Actual Adequate Capital 1 Capitalized 1 ------------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------------- Total risk-based capital 1 (to risk-weighted assets) $79,330 35.4% $17,931 8.0% $22,414 10.0% Tier I capital 1 (to risk-weighted assets) 77,569 34.6% 8,966 4.0% 13,448 6.0% Core capital 1 (to adjusted total assets) 77,569 18.5% 16,771 4.0% 20,964 5.0% Core capital 1 (to adjusted tangible assets) 77,569 18.5% 8,385 2.0% N/A Tangible capital 1 (to adjusted total assets) 77,569 18.5% 6,289 1.5% N/A 1 As defined by regulatory agencies December 31, 1998 ------------------------------------------------------------------ Required for To Be Well Actual Adequate Capital 1 Capitalized 1 ------------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio - ----------------------------------------------------------------------------------------------------------------------- Total risk-based capital 1 (to risk-weighted assets) $78,815 41.4% $15,222 8.0% $19,027 10.0% Tier I capital 1 (to risk-weighted assets) 77,303 40.6% 7,611 4.0% 11,416 6.0% Core capital 1 (to adjusted total assets) 77,303 21.1% 14,624 4.0% 18,279 5.0% Core capital 1 (to adjusted tangible assets) 77,303 21.1% 7,312 2.0% N/A Tangible capital 1 (to adjusted total assets) 77,303 21.1% 5,484 1.5% N/A
1 As defined by regulatory agencies Note 17 -- Employee Benefits The Bank is a participant in a pension fund known as the Financial Institutions Retirement Fund (FIRF). This plan is a multi-employer plan. There was no pension expense or benefit for the year ended December 31, 1999 and 1998. Pension benefit was $26,000 for the year ended December 31, 1997. This plan provides pension benefits for substantially all of the Bank's employees. The Bank has a retirement savings 401(k) plan in which substantially all employees may participate. The Bank matches employees' contributions at the rate of 50 percent for the first 6 percent of W-2 earnings contributed by participants. The Bank's expense for the plan was $47,000, $29,000 and $19,000 for the years ended December 31, 1999, 1998 and 1997. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) As part of the conversion in 1998, the Company established an ESOP covering substantially all employees of the Company and Bank. The ESOP acquired 560,740 shares of the Company common stock at $10 per share in the conversion with funds provided by a loan from the Company. Accordingly, the $5,607,000 of common stock acquired by the ESOP is shown as a reduction of shareholders' equity. Unearned ESOP shares totaled 521,322 and 560,740 at December 31, 1999 and 1998 and had a fair value of $5,474,000 and $6,098,000 at December 31, 1999 and 1998. Shares are released to participants proportionately as the loan is repaid. Dividends on allocated shares are recorded as dividends and charged to retained earnings. Dividends on unallocated shares are used to repay the loan are treated as compensation expense. Compensation expense is recorded equal to the fair market value of the stock when contributions, which are determined annually by the Board of Directors of the Company and Bank, are made to the ESOP. ESOP expense for the year ended December 31, 1999 was $448,000. There was no expense under the ESOP for the year ended December 31, 1998. At December 31, 1999, the ESOP had 39,418 allocated shares, 521,322 suspense shares and no committed-to-be released shares. At December 31, 1998, the ESOP had no allocated shares, 560,740 suspense shares and no committed-to-be released shares. In connection with the conversion, the Board of Directors approved a Recognition and Retention Plan (RRP). The Bank contributed $3,717,000 to the RRP for the purchase of 280,370 shares of Company common stock, and effective July 6, 1999, awards of grants for 233,724 of these shares were issued to various directors, officers and employees of the Bank. The awards generally are to vest and be earned by the recipient at a rate of 20 percent per year, commencing July 6, 2000. The unearned portion of these stock awards is presented as a reduction of shareholders' equity. RRP expense for the year ended December 31, 1999 was $292,000. There was no RRP expense for the year ended December 31, 1998. Note 18 -- Stock Option Plan Under the Company's incentive stock option plan, which is accounted for in accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations, the Company grants selected executives and other key employees stock option awards which generally vest at a rate of 20 percent a year. During 1999, the Company authorized the grant of options for up to 700,925 shares of the Company's common stock. The exercise price of each option, which has a 10-year life, was equal to the market price of the Company's stock on the date of grant; therefore, no compensation expense was recognized. Although the Company has elected to follow APB No. 25, SFAS No. 123 requires pro forma disclosures of net income and earnings per share as if the Company had accounted for its employee stock options under that Statement. The fair value of each option grant was estimated on the grant date using an option-pricing model with the following assumptions: 1999 - -------------------------------------------------------------------------------- Risk-free interest rates 6.0 and 6.4% Dividend yields 2.5% Volatility factors of expected market price of common stock 11.5% Weighted-average expected life of the options 8 years LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Under SFAS No. 123, compensation cost is recognized in the amount of the estimated fair value of the options and amortized to expense over the options' vesting period. The pro forma effect on net income and earnings per share of this statement are as follows: 1999 - -------------------------------------------------------------------------------- Net income As reported $4,348 Pro forma 4,085 Basic earnings per share As reported .71 Pro forma .67 Diluted earnings per share As reported .71 Pro forma .67 The following is a summary of the status of the Company's stock option plan and changes in that plan as of and for the years ended December 31, 1999. Year Ended December 31 1999 - -------------------------------------------------------------------------------- Weighted- Average Options Shares Exercise Price - -------------------------------------------------------------------------------- Outstanding, beginning of year Granted 596,095 $12.47 ------- Outstanding, end of year 596,095 12.47 ======= Options exercisable at year end 0 Weighted-average fair value of options granted during the year $3.98 As of December 31, 1999, the 596,095 options outstanding have exercise prices ranging from $11.47 to $12.50 and a weighted-average remaining contractual life of 9.5 years. Note 18 -- Fair Values of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument. Cash and Cash Equivalents--The fair value of cash and cash equivalents approximates carrying value. Securities--Fair values are based on quoted market prices. Loans--The fair value for loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. FHLB Stock--Fair value of FHLB stock is based on the price at which it may be resold to the FHLB. LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Interest Receivable/Payable--The fair value of accrued interest receivable/payable approximates carrying values. Deposits--Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits. Securities Sold Under Repurchase Agreements--Securities sold under repurchase agreements are short-term borrowing arrangements. The rates at December 31, 1999, approximate market rates, thus the fair value approximates carrying value. FHLB Advances--The fair value of these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt. Note Payable--Limited Partnership--The fair value of the borrowing is estimated using a discounted cash flow calculation based on the prime interest rate. Advance Payments by Borrowers for Taxes and Insurance--The fair value approximates carrying value. Off-Balance Sheet Commitments--Commitments include commitments to originate mortgage and consumer loans and standby letters of credit and are generally of a short-term nature. The fair value of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The carrying amounts of these commitments, which are immaterial, are reasonable estimates of the fair value of these financial instruments. The estimated fair values of the Company's financial instruments are as follows:
1999 1998 -------------------------------------------------------------- Carrying Fair Carrying Fair December 31 Amount Value Amount Value - ------------------------------------------------------------------------------------------------------------------------ Assets Cash and cash equivalents $10,819 $10,819 $22,907 $22,907 Securities available for sale 145,875 145,875 129,276 129,276 Securities held to maturity 500 498 1,250 1,264 Loans, net 233,000 226,939 195,921 198,972 Stock in FHLB 5,447 5,447 5,447 5,447 Interest receivable 2,247 2,247 1,773 1,773 Liabilities Deposits 204,982 203,819 212,010 212,903 Borrowings Securities sold under repurchase agreements 4,600 4,600 FHLB advances 103,938 101,529 33,263 33,409 Note payable--limited partnership 1,714 1,456 2,203 1,872 Interest payable 1,097 1,097 1,109 1,109 Advances by borrowers for taxes and insurance 703 703 560 560
LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Note 20 -- Condensed Financial Information (Parent Company Only) Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company: Condensed Balance Sheet December 31 1999 1998 - -------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 4 Short-term interest-bearing deposit with subsidiary 19,426 $ 27,900 -------- -------- Total cash and cash equivalents 19,430 27,900 Investment in common stock of subsidiary 72,503 77,590 Other assets 506 717 -------- -------- Total assets $ 92,439 $106,207 ======== ======== Liabilities--other $ 696 $ 99 Shareholders' Equity 91,743 106,108 -------- -------- Total liabilities and shareholders' equity $ 92,439 $106,207 ======== ======== Condensed Statement of Income Year Ended December 31 1999 1998 - -------------------------------------------------------------------------------- Income Interest income on short-term interest-bearing deposit with subsidiary $1,105 $ 215 Other income 267 ------- -------- 1,372 215 ------- -------- Expenses Interest expense 206 Charitable contribution 2,000 Other expenses 261 ------- -------- Total expenses 261 2,206 ------- -------- Income (loss) before income tax benefit and equity in undistributed income of subsidiary 1,111 (1,991) Income tax expense (benefit) 461 (677) ------- -------- Income (loss) before equity in undistributed income of subsidiary 650 (1,314) Equity in undistributed income of subsidiary 3,698 2,431 ------- -------- Net Income $4,348 $1,117 ====== ====== LINCOLN BANCORP AND SUBSIDIARY Plainfield, Indiana (Table Dollar Amounts in Thousands) Condensed Statement of Cash Flows
Year Ended December 31 1999 1998 - -------------------------------------------------------------------------------------------- Operating Activities Net income $ 4,348 $ 1,117 Adjustments to reconcile net income to net cash provided by operating activities Charitable contribution of Company's common stock 2,000 Other (2,895) (3,049) ------- ------- Net cash provided by operating activities 1,453 68 ------- ------- Investing Activity--capital contribution to subsidiary (33,440) ------- ------- Financing Activities Proceeds from sale of common stock, net of costs 61,272 Repurchase of common stock (8,673) Cash dividend (1,234) Conversion costs (16) ------- ------- Net cash provided (used) by financing activities (9,923) 61,272 ------- ------- Net Change in Cash and Cash Equivalents (8,470) 27,900 Cash and Cash Equivalents at Beginning of Year 27,900 ------- ------- Cash and Cash Equivalents at End of Year $19,430 $27,900 ======= ======= Additional Cash Flow and Supplementary Information Common stock issued to ESOP leveraged with an employer loan $5,607
Board of Directors T. Tim Unger Chairman of the Board President and Chief Executive Officer Lester N. Bergum, Jr. Attorney Dennis W. Dawes President/Chief Executive Officer Hendricks Community Hospital W. Thomas Harmon Co-owner, Crawfordsville Town and Country Homecenter, Inc. Jerry Holifield Superintendent, Plainfield Community School Corporation Wayne E. Kessler Farmer (Retired) David E. Mansfield Administrative Supervisor, Marthon Oil Company John C. Milholland Principal, Frankfort Senior High School John L. Wyatt District Agent, Northwestern Mutal Life Insurance Company Edward E. Whalen Emeritus Executive Officers of Lincoln Bancorp T. Tim Unger John M. Baer Chairman of the Board, Secretary and Treasurer President and Chief Executive Officer Executive Officers of Lincoln Federal Savings Bank T. Tim Unger Jerry R. Holifield John M. Baer President and Chief Chairman of the Board Chief Financial Officer, Executive Officer Secretary and Treasurer Lester N. Bergum, Jr. (age 51) is an attorney and partner with the firm of Robison, Robison, Bergum & Johnson in Frankfort, Indiana, where he has practiced since 1974. He has also served since 1989 as president of Title Insurance Services, Inc., a title agency located in Frankfort, Indiana. Dennis W. Dawes (age 54) has been President and Chief Executive Officer of Hendricks Community Hospital since 1974. W. Thomas Harmon (age 60) has served as the co-owner, Vice President, Treasurer and Secretary of Crawfordsville Town & Country Homecenter, Inc. in Crawfordsville, Indiana, since 1978. Mr Harmon is also a co-owner and officer of RGW, Inc., in Crawfordsville, a company that develops real estate subdivisions and manages apartment rental properties, a position he has held since 1965. Jerry Holifield (age 58) has been the Superintendent of the Plainfield Community School Corporation since 1991. Wayne E. Kessler (age 69) has been a self-employed farmer in Crawfordsville, Indiana since 1949. Mr. Kessler is currently semi-retired. David E. Mansfield (age 57) is an Administrative Supervisor for Marathon Oil Company where he has worked since 1973. John C. Milholland (age 63) has been Principal of Frankfort Senior High School in Frankfort, Indiana since 1989. T. Tim Unger (age 59) has been President and Chief Executive Officer of Lincoln Federal since January, 1996. Before then, Mr. Unger served as President and Chief Executive Officer of Summit Bank of Clinton County from 1989 through 1995. John L. Wyatt (age 63) is a District Agent for Northwestern Mutual Life Insurance Company where he has been employed since 1960. The Holding Company's common stock, without par value ("Common Stock"), is listed on the NASDAQ National Market System under the symbol "LNCB." The Holding Company shares began to trade on December 30, 1998. The high and low bid prices for the period January 1, 1999 to December 31, 1999, were $13 5/8 and $9 11/16, respectively. On February 21, 2000, there were 1,044 shareholders of record. Under current federal income tax law, dividend distributions to the Holding Company, to the extent that such dividends paid are from the current or accumulated earnings and profits of Lincoln Federal (as calculated for federal income tax purposes), will be taxable as ordinary income to the Holding Company and will not be deductible by Lincoln Federal. Any dividend distributions in excess of current or accumulated earnings and profits will be treated for federal income tax purposes as a distribution from Lincoln Federal's accumulated bad debt reserves, which could result in increased federal income tax liability for Lincoln Federal. Since the Holding Company has no independent operation or other subsidiaries to generate income, its ability to accumulate earnings for the payment of cash dividends to shareholders directly depends upon the ability of Lincoln Federal to pay dividends to the Holding Company and upon the earnings on Lincoln Federal's investment securities. Applicable law restricts the amount of dividends Lincoln Federal may pay to the Holding Company without obtaining the prior approval of the OTS to an amount that does not exceed Lincoln Federal's year-to-date net income plus its retained net income for the preceding two years. Moreover, Lincoln Federal may not pay dividends to the Holding Company if such dividends would result in the impairment of the liquidation account established in connection with the Conversion. The FDIC also has authority under current law to prohibit a financial institution from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the financial institution. Generally, there is no OTS regulatory restriction on the payment of dividends by the Holding Company unless there is a determination by the Director of the OTS that there is reasonable cause to believe that the payment of dividends constitutes a serious risk to the financial safety, soundness or stability of Lincoln Federal. Indiana law, however, would prohibit the Holding Company from paying a dividend if, after giving effect to the payment of that dividend, the Holding Company would not be able to pay its debts as they become due in the usual course of business or the Holding Company's total assets would be less than the sum of its total liabilities plus preferential rights of holders of preferred stock, if any. Stock Price Dividends Month Ended High Low Per Share January 31, 1999 11 7/16 10 3/4 February 28, 1999 11 1/8 10 3/16 March 31, 1999 10 3/4 10 3/8 .06 April 30, 1999 11 9 11/16 May 31, 1999 12 10 13/16 June 30, 1999 12 1/2 11 9/16 .06 July 31, 1999 13 5/8 12 1/4 August 31, 1999 12 7/8 12 1/8 September 30, 1999 12 3/8 11 5/8 .08 October 31, 1999 12 1/4 10 3/8 November 30, 1999 12 1/8 10 7/8 December 31, 1999 11 3/4 9 7/8 .08 Transfer Agent and Registrar The Fifth Third Bank Corporate Trust Operations 38 Fountain Square Plaza, MD - 1090F5 Cincinnati, Ohio 45202 (513) 579-5320 or (800) 837-2755 GENERAL COUNSEL Barnes & Thornburg 11 South Meridian Street Indianapolis, Indiana 46204 INDEPENDENT AUDITOR Olive LLP 201 N. Illinois Street, Suite 700S Indianapolis, Indiana 46204 SHAREHOLDERS AND GENERAL INQUIRIES The Company filed an Annual Report on Form 10-K for its fiscal year ended December 31, 1999 with the Securities and Exchange Commission. Copies of this annual report may be obtained without charge upon written request to: T. Tim Unger President and Chief Executive Officer Lincoln Bancorp 1121 East Main Street P.O. Box 510 Plainfield, Indiana 46168-0510 The following officers were elected/re-elected at the January 18, 2000, Board of Directors Meeting: President/Chief Executive Officer..................T. Tim Unger Chief Financial Officer/Secretary/Treasurer........John M. Baer Retail Sales Manager...............................Rebecca Morgan Residential Lending Manager........................Steve Schilling Vice President/Secondary Marketing.................Maxwell O. Magee Technology Manager.................................Roger S. Chalkley Vice President.....................................James W. Hiatt Vice President/Crawfordsville Branch...............Donald A. Peterson Vice President.....................................Jay H. Oxley Assistant Vice President/Mooresville Branch........Rebecca S. Henderson Assistant Vice President/Commercial Lender.........M. Steve Johnson Human Resource Officer.............................Ronald Love Compliance Officer.................................Sidnye Georgette Plainfield Branch Manager..........................Sonja White Marketing Director.................................Angela S. Coleman Frankfort Branch Manager...........................Deborah L. Graves Loan Servicing Manager.............................Patti A. Wilcher Collections Manager................................Tonda L. Mucho Financial Analyst..................................Andrew J. LoCascio Accounting Manager.................................Helen Pipkin Deposit Operations Manager.........................Donna Coulson Avon Branch Manager................................Melissa Yetter Brownsburg Branch Manager..........................Paul Ross Loan Operations Manager............................Sara Vermillion Avon 7648 E. US Highway 36 Avon, IN 46123 317-272-0467 Fax 317-272-7838 Crawfordsville 134 S. Washington Crawfordsville, IN 47933 765-362-0200 Fax 765-392-9216 Brownsburg 975 E. Main Street Brownsburg, IN 46112 317-852-3134 Fax 317-852-9472 Frankfort 1900 E. Wabash Street Frankfort, IN 46041 765-654-8742 Fax 765-654-9885 Main Office 1121 E. Main Street Plainfield, IN 46168 317-839-6539 Fax 317-839-6775 Mooresville 590 S. State Rd. 67 Mooresville, IN 46158 317-834-4100 Fax 317-834-4114 Lincoln Online www.lincolnfederal.com newest banking location! TELEBANK 1-888-655-LFSB (5372) 24 hours a day EX-21 3 SUBSIDIARIES OF LINCOLN BANCORP SUBSIDIARIES OF LINCOLN BANCORP Subsidiaries of Lincoln Bancorp: Name Jurisdiction of Incorporation Lincoln Federal Savings Bank Federal LF Service Corp. Indiana EX-23 4 CONSENTS OF INDEPENDENT AUDITORS Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS We consent to the incorporation by reference to the Registration Statement on Form S-8 of Lincoln Bancorp (the "Company"), File Number 000-25219, of our report dated February 8, 2000 on the consolidated financial statements of the Company which report is incorporated by reference in the Company's Annual Report on Form 10-K for the three years ended December 31, 1999 filed pursuant to the Securities and Exchange Act of 1934. /s/ Olive LLP Olive LLP Indianapolis, Indiana March 28, 2000 EX-27 5 FDS FOR LINCOLN BANCORP
9 (Replace this text with the legend) 0001070259 Lincoln Bancorp 1,000 U.S. Dollars 12-MOS DEC-31-1999 JAN-1-1999 DEC-31-1999 1.000 2,576 8,243 0 0 145,875 500 498 234,761 1,761 410,828 204,982 28,339 3,851 81,913 61,854 0 0 29,889 410,828 16,866 10,177 699 27,742 9,579 13,947 13,795 384 (4) 7,331 6,694 0 0 0 4,348 .71 .71 3.57 929 176 0 0 1,512 141 6 1,761 1,761 0 70
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