10-Q 1 q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED SEPTEMBER 30, 2001 COMMISSION FILE NUMBER 0-12422 INDIANA UNITED BANCORP (Exact name of registrant as specified in its charter) INDIANA 35-1562245 ------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 201 NORTH BROADWAY GREENSBURG, INDIANA 47240 --------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (812) 663-0157 -------------- (Registrant's telephone number, including area code) NOT APPLICABLE -------------- (Former name, former address and former fiscal year, if changed since last report.) 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 No X --- --- As of November 5, 2001 there were outstanding 6,191,232 shares, without par value of the registrant. INDIANA UNITED BANCORP FORM 10-Q INDEX ------------------------------------------------------------------------------ PART I. FINANCIAL INFORMATION Page Item 1. Financial Statements Consolidated Condensed Balance Sheets 3 Consolidated Condensed Statements of Income and Comprehensive Income 4 Consolidated Condensed Statements of Cash Flows 5 Notes to Consolidated Condensed Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial 10 Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 19 Signatures 20 INDIANA UNITED BANCORP FORM 10-Q CONSOLIDATED CONDENSED BALANCE SHEETS (Dollars in thousands except per share data)
(Unaudited) September 30, December 31, 2001 2000 ----------- ----------- Assets Cash and due from banks $ 41,079 $ 47,665 Money market fund 18,985 6,373 Federal funds sold 3,840 16,050 ----------- ----------- Cash and cash equivalents 63,904 70,088 Interest-bearing time deposits 896 594 Securities Available for sale 256,801 281,716 Held to maturity (fair value of $8,789 and $12,749) 8,542 12,679 Loans held for sale 14,521 1,883 Loans, net of allowance for loan losses of $9,397 and $8,716 777,410 781,834 Premises and equipment (net) 16,622 17,558 Restricted stock, at cost 4,606 3,267 Intangible assets 23,309 23,739 Other assets 19,014 23,578 ----------- ----------- Total assets $ 1,185,625 $ 1,216,936 =========== =========== Liabilities Deposits Noninterest-bearing $ 90,226 $ 103,067 Interest-bearing 918,793 950,503 ----------- ----------- Total deposits 1,009,019 1,053,570 Short-term borrowings 27,356 20,645 Federal Home Loan Bank advances 20,364 22,463 Notes payable 4,876 6,510 Other liabilities 13,593 13,318 ----------- ----------- Subtotal 1,075,208 1,116,506 Guaranteed preferred beneficial interests in company's subordinated debentures 22,425 22,425 Shareholders' equity Preferred stock no par value Authorized - 400,000 Issued and outstanding - none -- -- Common stock $.50 stated value: Authorized - 10,000,000 shares, Issued and outstanding - 6,191,232 and 5,873,900 shares 3,096 2,937 Common stock to be distributed - 147 Additional paid-in capital 30,106 29,739 Retained earnings 51,318 46,176 Accumulated other comprehensive income (loss) 3,472 (994) ----------- ----------- Total shareholders' equity 87,992 78,005 ----------- ----------- Total liabilities and shareholders' equity $ 1,185,625 $ 1,216,936 =========== ===========
See notes to consolidated condensed financial statements. 3 INDIANA UNITED BANCORP FORM 10-Q CONSOLIDATED CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) (Dollars in thousands except per share data)
Three months ended Nine months ended September 30, September 30, ------------------------- -------------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Interest income: Loans, including fees $ 16,507 $ 17,260 $ 50,657 $ 49,300 Investment securities 3,872 4,310 11,829 13,091 Other 396 262 2,008 507 -------- -------- -------- -------- Total interest income 20,775 21,832 64,494 62,898 -------- -------- -------- -------- Interest expense: Deposits 9,220 10,554 30,919 29,512 Trust preferred securities 506 506 1,517 1,517 Other borrowings 573 997 1,825 2,576 -------- -------- -------- -------- Total interest expense 10,299 12,057 34,261 33,605 -------- -------- -------- -------- Net interest income 10,476 9,775 30,233 29,293 Provision for loan losses 409 410 1,147 1,158 -------- -------- -------- -------- Net interest income after provision for loan losses 10,067 9,365 29,086 28,135 Non-interest income: Securities losses (4) - (128) (36) Other income 2,890 2,399 8,466 6,510 -------- -------- -------- -------- Total non-interest income 2,886 2,399 8,338 6,474 Non-interest expense 8,678 8,079 25,179 24,317 -------- -------- -------- -------- Income before income tax 4,275 3,685 12,245 10,292 Income tax expense 1,432 1,212 4,042 3,022 -------- -------- -------- -------- Net income $ 2,843 $ 2,473 $ 8,203 $ 7,270 ======== ======== ======== ======== Comprehensive income $ 4,635 $ 3,967 $ 12,669 $ 8,267 ======== ======== ======== ======== Net income per share (basic and diluted) $ 0.46 $ 0.40 $ 1.33 $ 1.18 Cash dividends declared 0.165 0.157 0.495 0.466
See notes to consolidated condensed financial statements. 4 INDIANA UNITED BANCORP FORM 10-Q CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands)
Nine months ended September 30, ----------------------------------- 2001 2000 --------- --------- Operating Activities Net income $ 8,203 $ 7,270 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,147 1,158 Depreciation and amortization 1,459 1,236 Net accretion/amortization of securities 362 89 Amortization of intangibles 1,472 1,376 Investment securities losses 128 36 Change in loans held for sale (12,638) 1,861 Change in other assets and liabilities 2,859 (277) --------- --------- Net cash provided by operating activities 2,992 12,749 Investing Activities Net change in short term investments (302) 1,228 Proceeds from maturities and payments on securities held to maturity 4,171 4,646 Purchases of securities available for sale (145,536) (26,747) Proceeds from sales, maturities and payments on securities available for sale 177,000 32,488 Net change in loans 3,277 (69,700) Cash received/(disbursed) for acquisitions (655) 42,037 Purchases of restricted stock (1,339) -- Purchases of premises and equipment (1,158) (1,489) --------- --------- Net cash provided (used) by investing activities 35,458 (17,537) Financing Activities Net change in deposits (44,551) 40,851 Short-term borrowings 6,711 (28,944) Repayment of notes payable (1,634) (343) Repayment of FHLB advances (2,099) -- Cash dividends (3,061) (3,153) --------- --------- Net cash provided (used) by financing activities (44,634) 8,411 --------- --------- Net change in cash and cash equivalents (6,184) 3,623 Cash and cash equivalents, beginning of period 70,088 41,879 --------- --------- Cash and cash equivalents, end of period $63,904 $45,502 ========= =========
See notes to consolidated condensed financial statements. 5 INDIANA UNITED BANCORP FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Dollar amounts in thousands except per share data) NOTE 1 SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies followed by Indiana United Bancorp ("Company"), its wholly owned bank subsidiaries, Union Bank and Trust Company of Indiana ("Union"), Regional Bank ("Regional"), People's Trust Company ("People's"), and their subsidiaries, and its subsidiaries IUB Capital Trust, IUB Reinsurance Co., Ltd. and IUB Illinois Holding Company and its subsidiary, Capstone Bank, N.A. ("Capstone"), for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported have been included in the accompanying unaudited consolidated financial statements and all such adjustments are of a normal recurring nature. Effective January 1, 2001, a new accounting pronouncement required all derivatives to be recorded at fair value. Unless designated as hedges, changes in these fair values will be recorded by offsetting gains and losses on the hedge and on the hedged item, even if the fair value of the hedged item is not otherwise recorded. Adoption of this standard on January 1, 2001, did not have a material effect on the Company's financial statements. NOTE 2 BRANCH ACQUISITIONS During the third quarter of 2000, the Company purchased two branch facilities and $43,500 in deposits from Harrington Bank, Richmond, Indiana. The branches are located in Marion County, Indiana and were integrated into Union Bank. The premium paid for the deposits resulted in $1,458 in intangible assets for Union Bank. These branch acquisitions were accounted for using the purchase method of accounting and the results of operations of the branches have been included since their acquisition dates. During the third quarter of 2001, the Company's bid was accepted to acquire a branch in Illinois. The office, which will be merged into Capstone, includes approximately $22 million in deposits and $4 million in loans, and the purchase is expected to result in $550 of intangible assets. The transaction is subject to regulatory approval and is expected to close in the fourth quarter. NOTE 3 BUSINESS COMBINATIONS On May 1, 2000, the Company consummated its acquisition of First Affiliated Bancorp of Watseka, Illinois and its wholly owned banking subsidiary, Capstone Bank N. A. The transaction was accounted for using the pooling of interests method of accounting. The Company issued 1,069,277 shares of its common stock to the shareholders of First Affiliated Bancorp (adjusted for stock dividend). This includes shares issued to redeem First Affiliated Bancorp stock options. The conversion rate was 4.4167 shares of Company stock for each outstanding share of First Affiliated at the effective date of the merger. Merger and related costs were charged against net income during 2000. The financial information contained herein includes Capstone for all periods presented. Effective April 1, 2001, the Company consummated its acquisition of the insurance agencies of Vollmer & Associates, Inc. The transaction was accounted for using the purchase method of accounting. The purchase price consisted of $655 cash and 24,184 shares of Company stock. 6 NOTE 4 SECURITIES
September 30, 2001 December 31,2000 ------------------ ---------------- Amortized Fair Amortized Fair Cost Value Cost Value Available for Sale Federal agencies $163,743 $167,729 $167,925 $167,887 State and municipal 31,962 32,872 32,398 32,247 Corporate and other securities 28,389 28,466 33,758 32,574 Mortgage-backed securities 27,224 27,734 49,225 49,008 -------- -------- -------- -------- Totals 251,318 256,801 283,306 281,716 September 30, 2001 December 31,2000 ------------------ ---------------- Amortized Fair Amortized Fair Cost Value Cost Value Held to Maturity State and municipal $7,406 $7,534 $11,587 $11,559 Corporate and other securities 1,136 1,255 1,092 1,190 ------ ------ ------- ------- Totals $8,542 $8,789 $12,679 $12,749
7 NOTE 5 LOANS
September 30, December 31, 2001 2000 -------- ------- Loans: Commercial and industrial loans $ 83,888 $ 77,648 Agricultural production financing 23,126 20,744 Farm real estate 46,383 49,284 Commercial real estate mortgage 149,470 138,132 Residential real estate mortgage 355,009 389,622 Construction and development 50,528 40,813 Consumer 70,274 64,548 State & political 8,129 9,759 -------- ------- Total loans 786,807 790,550 Less: Allowance for loan losses (9,397) (8,716) -------- ------- Net loans $ 777,410 $ 781,834 ========= ========= September 30, December 31, 2001 2000 -------- ------- Non-performing loans: Non-accrual loans $ 9,432 $ 3,454 Accruing loans contractually past due 90 days or more as to principal or interest payments 849 532 -------- ------- Total $ 10,281 $ 3,986 ======== ======= % of total loans 1.31% 0.50%
NOTE 6 DEPOSITS
September 30, December 31, 2001 2000 ------------------- -------------------- Noninterest-bearing demand $ 90,226 $ 103,067 Interest-bearing demand 196,876 173,495 Savings 198,475 214,443 Certificates of deposit of $100 or more 108,167 113,287 Other certificates and time deposits 415,274 449,278 ------------------- -------------------- Total deposits $ 1,009,019 $ 1,053,570 =================== ====================
NOTE 7 SHORT-TERM BORROWINGS
September 30, December 31, 2001 2000 -------------------- ------------------- Short-term borrowings: Federal funds purchased $ 12,600 $ 3,400 Securities sold under agreement to repurchase 14,756 17,245 -------------------- ------------------- Total short-term borrowings $27,356 $20,645 ==================== ===================
8 NOTE 8 EARNINGS PER SHARE Earnings per share (EPS) were computed as follows:
For the three months ended September 30, 2001 September 30, 2000 ------------------------------------ ------------------------------------- Weighted Per Weighted Per Net Average Share Net Average Share Income Shares Amount Income Shares Amount ------ ------ ------ ------ ------ ------ Basic earnings per share: Income available to common shareholders $2,843 6,191,232 $0.46 $2,473 6,167,048 $0.40 Effect of dilutive shares - - ===== - - ===== ------ --------- ------ --------- Diluted earnings per share $2,843 6,191,232 $0.46 $2,473 6,167,048 $0.40 ====== ========= ===== ====== ========= ===== For the nine months ended September 30, 2001 September 30, 2000 ------------------------------------ ------------------------------------- Weighted Per Weighted Per Net Average Share Net Average Share Income Shares Amount Income Shares Amount ------ ------ ------ ------ ------ ------ Basic earnings per share: Income available to common shareholders $8,203 6,183,259 $1.33 $7,270 6,159,044 $1.18 Effect of dilutive shares - - ===== - 8,004 ===== ------ --------- ------ --------- Diluted earnings per share $8,203 6,183,259 $1.33 $7,270 6,167,048 $1.18 ====== ========= ===== ====== ========= =====
Weighted average shares are restated for all stock dividends and splits. NOTE 9 NEW ACCOUNTING PRONOUNCEMENTS In 2001, new accounting guidance was issued that requires the purchase method of accounting for all business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interests method of accounting after this time. Beginning in 2002, the new guidance revises the accounting for goodwill and intangible assets. Intangible assets with indefinite lives and goodwill will no longer be amortized, but will periodically be reviewed for impairment and written down if impaired. Additional disclosures about intangible assets and goodwill may be required. An initial goodwill impairment test is required during the first six months of 2002. Management is currently evaluating the financial impact of this new standard. 9 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) Overview Indiana United Bancorp ("Company") is a multi-bank, bank holding company that provides an array of financial services and is headquartered in Greensburg, Indiana. On September 30, 2001, the Company controlled four bank subsidiaries, People's Trust Company ("People's"), Union Bank and Trust Company of Indiana ("Union"), Regional Bank ("Regional"), and Capstone Bank, N.A. ("Capstone"). In addition to the banking subsidiaries, the Company owned, either directly or indirectly, the following subsidiaries: The Insurance Group, Inc., IUB Capital Trust, IUB Reinsurance Company, Ltd., People's Investment Company, Ltd., and Union Investment Company, Ltd. Forward-Looking Statements Except for historical information contained herein, the discussion in this Form 10-Q quarterly report includes certain forward-looking statements based upon management expectations. Factors which could cause future results to differ from these expectations include the following: general economic conditions; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; the costs of funds; general market rates of interest; interest rates on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; and changes in the quality or composition of the Company's loan and investment portfolios. The forward-looking statements included in the Management's Discussion and Analysis ("MD&A") relating to certain matters involve risks and uncertainties, including anticipated financial performance, business prospects, and other similar matters, which reflect management's best judgment based on factors currently known. Actual results and experience could differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements as a result of a number of factors, including but not limited to those discussed in the MD&A. Results of Operations Net income for the third quarter of 2001 increased $370, or 15.0%, to $2,843 compared to the third quarter of 2000 due mainly to a significant increase in the Company's non-interest income and an improvement in net interest margin. Net income for the first nine months of 2001 was $8,203, which represents an increase of 12.8% over the same period last year. Earnings per share for the third quarter equaled $.46 in 2001, compared to $.40 in 2000, an increase of 15.0%. For the first nine months of 2001, earnings per share were $1.33, or an increase of 12.7% over the $1.18 reported for the same period in 2000. The Company's return on average total assets for the third quarter was .94% in 2001 compared to .85% in 2000. Return on average shareholders' equity (excluding accumulated other comprehensive income) for the third quarter was 13.38% in 2001 and 12.86% in 2000. For the first nine months of 2001, return on average shareholders' equity (excluding accumulated other comprehensive income) 10 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) was 13.36% versus 13.13% for the same period last year. Net Interest Income The volume and yield of earning assets and interest-bearing liabilities influence net interest income. Net interest income reflects the mix of interest-bearing and non-interest-bearing liabilities that fund earning assets, as well as interest spreads between the rates earned on these assets and the rates paid on interest-bearing liabilities. Third quarter net interest income of $10,067 in 2001 increased 7.5% over the third quarter of 2000. Net interest income on a tax equivalent basis, reflected as a percentage of average earning assets (net interest margin), was 3.85% for the third quarter of 2001 and 3.70% for the same time frame in 2000. For the first nine months of 2001, the Company's net interest margin was 3.72% compared to 3.79% for the first nine months of 2000. With the significant drop in interest rates, this compression of the net interest margin was common throughout the industry. Provision for Loan Losses This topic is discussed under the heading "Loans, Credit Risk and the Allowance and Provision for Possible Loan Losses". Non-interest Income Third quarter non-interest income in 2001 exceeded the prior year by $487 or 20.3%. For the first nine months of 2001, non-interest income increased $1,864, or 28.8%, to $8,338. Mortgage banking income, which consists of gains and losses on loan sales and service fee income, was $724 for the third quarter of 2001 compared to $280 for the same period in 2000, an increase of $444, or 158.6%. For the first nine months of 2001, mortgage banking income was $1,780 versus $614 for the same period in 2000, an increase of 189.9%. This increase was due to the significant decrease in mortgage interest rates during the first nine months of 2001, which led many customers to refinance their existing loans. The Company elected to sell the majority of these loans while maintaining the servicing rights. Insurance commissions increased in the third quarter of 2001 to $499 versus $380 for the same period last year. The increase of 31.3% was primarily due to the acquisition of the Vollmer & Associates insurance agencies in April 2001. Non-interest Income
Three months ended Nine months ended September 30, September 30, -------------------------- ------------------------- 2001 2000 2001 2000 ------- ------- ------- ------- Trust fees $ 100 $ 97 $ 379 $ 341 Insurance commissions 499 380 1,445 1,130 Mortgage banking income 724 280 1,780 614 Service charges on deposit accounts 986 958 2,861 2,581 Gain (loss) on sales of securities (4) - (128) (36) Other income 581 684 2,001 1,844 ------- ------- ------- ------- Total $ 2,886 $ 2,399 $ 8,338 $ 6,474 ======= ======= ======= =======
11 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) Non-interest expense Total non-interest expense was $8,678 for the third quarter of 2001, which represented an increase of $599 from the third quarter of 2000. The largest component of non-interest expense is personnel expense. Personnel expenses increased in the third quarter of 2001 by $485, or 11.3% compared to the prior year period. For the first nine months of 2001, personnel expense was $14,158, which represented an increase of 7.8% over the comparable period in 2000. Normal staff salary adjustments and increased benefit costs were incurred in 2001. In addition, the Company incurred personnel costs related to the staffing of the new branches acquired from Harrington and the insurance agencies of Vollmer & Associates. A ratio frequently used to measure the efficiency of a financial institution is computed by dividing non-interest expense by the total of tax-effected net interest income plus non-interest income excluding securities gains or losses. The lower the ratio, the more efficient the Company is in managing net interest margin, non-interest income and non-interest expense. The Company's efficiency ratios were 64.20% for the first nine months of 2001 compared to 66.54% for the same period in 2000. The improvement in the efficiency ratio is due to the increase in mortgage banking income and the Company's continued attention to cost controls. Non-interest Expense
Three months ended Nine months ended September 30, September 30, -------------------------- --------------------------- 2001 2000 2001 2000 ------- ------- -------- -------- Salaries and employee benefits $ 4,784 $ 4,299 $ 14,158 $ 13,129 Net occupancy 557 565 1,610 1,561 Equipment expense 784 522 2,007 1,587 Merger expenses - - - 440 Deposit insurance 115 49 250 145 Intangible amortization 496 462 1,472 1,379 Stationary, printing, and supplies 214 257 648 684 Other expenses 1,728 1,925 5,034 5,392 ------- ------- -------- -------- Total non-interest expense $ 8,678 $ 8,079 $ 25,179 $ 24,317 ======= ======= ======== ========
Income Taxes The effective tax rate for the first nine months was 33.0% for 2001 and 29.4% for 2000. The effective tax rate increased compared to the prior year, as First Affiliated was an S-corporation with no corporate income tax during the first four months of 2000. The Company and its subsidiaries will file consolidated income tax returns for 2001. 12 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) Financial Condition Total assets at September 30, 2001 decreased $31,311 since the end of 2000. The decrease was primarily in securities as declining interest rates during the first nine months of 2001 caused the Company to have a significant number of investment securities called. The Company elected to allow higher-priced deposits to mature and not renew in order to offset the decrease in assets. In addition, the Company's loan portfolio decreased slightly in the first nine months of 2001 (see section titled "Loans, Credit Risk, and the Allowance and Provision for Possible Loan Losses" for a discussion of the Company's loan portfolio). Average earning assets represented 92.8% of average total assets for the first nine months of 2001 compared to 93.4% for the same period of 2000. Average loans represented approximately 76.6% of average deposits in the first nine months of 2001 and 77.5% for the comparable period in 2000. Management continues to emphasize quality loan growth to increase these averages. Average loans as a percent of assets were 66.0% and 66.9% for the nine-month period ended September 30, 2001 and 2000 respectively. The decrease in deposits of $44,551 from December 31, 2000 to September 30, 2001 is due mainly to the seasonal fluctuation of deposits as many corporate customers build up cash balances for year-end. In addition, the Company has become less aggressive in competing for higher-priced funds. Shareholders' equity was $87,992 on September 30, 2001 compared to $78,005 on December 31, 2000. Book value per common share increased to $14.21 or 12.3% from $12.65 at year-end 2000. The unrealized gain on securities available for sale, net of taxes, totaled $3,472 or $.56 per share at September 30, 2001 compared to an unrealized loss of $994 or $.16 per share at December 31, 2000. Excluding the net unrealized gains and losses on securities available for sale, book value per share would be $13.65 at September 30, 2001 or an increase of 6.6% over the comparable book value at year-end 2000. Loans, Credit Risk and the Allowance and Provision for Possible Loan Losses Loans remain the Company's largest concentration of assets and, by their nature, carry a higher degree of risk. The loan underwriting standards observed by the Company's subsidiaries are viewed by management as a means of controlling problem loans and the resulting charge-offs. The Company's conservative loan underwriting standards have historically resulted in higher loan quality and lower levels of net charge-offs than peer bank averages. The Company also believes credit risks may be elevated if undue concentrations of loans in specific industry segments and to out-of-area borrowers are incurred. Accordingly, the Company's Board of Directors regularly monitors such concentrations to determine compliance with its loan allocation policy. The Company believes it has no undue concentrations of loans. Total loans, excluding those held for sale, decreased $3,743 since December 31, 2000. The commercial loan portfolio, construction and development loans, and consumer loans all grew from December 31, 2000. Offsetting the increases in these portfolios was a decrease in residential real estate loans of approximately $35 million as customers took advantage of the 13 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) decrease in mortgage interest rates and refinanced their existing loans. The Company, in turn, elected not to retain the majority of these new loans in its own portfolio and instead, sold these in the secondary market. Residential real estate loans continue to represent a significant portion of the total loan portfolio. Such loans represented 45.1% of total loans at September 30, 2001 and 49.3% at December 31, 2000. On September 30, 2001, the Company had $14,521 of residential real estate loans held for sale. The Company generally retains the servicing rights on mortgages sold. The Company regards its ability to identify and correct loan quality problems as one of its greatest strengths. Loans are placed on non-accrual status when in management's judgment the collateral value and/or the borrower's financial condition do not justify accruing interest. As a general rule, commercial and real estate loans are reclassified to non-accruing status at or before becoming 90 days past due. Interest previously recorded but not deemed collectible is reversed and charged against current income. Subsequent interest payments collected on non-accrual loans may thereafter be recognized as interest income or may be applied as a reduction of the loan balance, as circumstances warrant. Non-real estate secured consumer loans are not placed in non-accruing status, but are charged off when policy-determined delinquent status is reached. The provision for loan losses was $1,147 in the first nine months of 2001 compared to $1,158 for the same period in 2000. Net charge-offs were $466 for the first nine months of 2001 compared to $281 for the comparable period in 2000. On an annualized basis as a percentage of average loans, net charge-offs equaled .08% for the nine-month period ended September 30, 2001. Foreclosed real estate held by the Company at September 30, 2001 was $717 and $449 at December 31, 2000. As of September 30, 2001, the Company had $9,432 of loans on non-accrual status compared to $3,454 at December 31, 2000, which represents an increase of $5,978. During the second quarter of 2001, the Company placed a large commercial credit on non-accrual status. This single credit contributed to approximately $4.8 million of the increase in non-accrual loans. Management has reviewed the credit and is of the opinion that adequate allowance allocations have been provided for this loan. The adequacy of the allowance for loan losses in each subsidiary is reviewed at least quarterly. The determination of the provision amount in any period is based on management's continuing review and evaluation of loan loss experience, changes in the composition of the loan portfolio, current economic conditions, the amount of loans presently outstanding, and the amount and composition of growth expectations. The allowance for loan losses as of September 30, 2001 is considered adequate by management. Investment Securities Investment securities offer flexibility in the Company's management of interest rate risk, and are an important source of liquidity as a response to changing characteristics of assets and 14 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) liabilities. The Company's investment policy prohibits trading activities and does not allow investment in high-risk derivative products, junk bonds or foreign investments. As of September 30, 2001, $256,801 of investment securities are classified as "available for sale" ("AFS") and are carried at fair value with unrealized gains and losses, net of taxes, reported as a separate component of shareholders' equity. An unrealized pre-tax gain of $5,483 was recorded to adjust the AFS portfolio to current market value at September 30, 2001, compared to an unrealized pre-tax loss of $1,590 at December 31, 2000. In September 2000, the Company formed two investment subsidiaries, People's Investment Company, Ltd. and Union Investment Company, Ltd. Incorporated in Bermuda, these subsidiaries now hold a large portion of both People's and Union's investment portfolios and were formed with the intent to enhance the organization's profitability. Sources of Funds The Company relies primarily on customer deposits, securities sold under agreement to repurchase ("agreements") and shareholders' equity to fund earning assets. FHLB advances are also used to provide additional funding. Deposits generated within local markets provide the major source of funding for earning assets. Total deposits funded 92.1% and 94.9% of total earning assets at September 30, 2001 and December 31, 2000. Total interest-bearing deposits averaged 91.9% and 90.6% of average total deposits for the periods ending September 30, 2001 and December 31, 2000, respectively. Management constantly strives to increase the percentage of transaction-related deposits to total deposits due to the positive effect on earnings. Short-term borrowings increased $6,711 or 32.5% from year-end 2000 as higher-rate certificates of deposit matured and were not aggressively pursued. The Company had FHLB advances of $20,364 outstanding at September 30, 2001. These advances have interest rates ranging from 6.20% to 6.95%. Approximately $20,000 of these advances mature in 2005 or later. Capital Resources Total shareholders' equity increased $9,987 to $87,992 at September 30, 2001 as compared to December 31, 2000. The Federal Reserve Board and other regulatory agencies have adopted risk-based capital guidelines that assign risk weightings to assets and off-balance sheet items. The Company's core capital consists of shareholders' equity, excluding accumulated other comprehensive income, while Tier 1 consists of core capital less goodwill and intangibles. Trust preferred securities qualify as Tier 1 capital or core capital with respect to the Company under the risk-based capital guidelines established by the Federal Reserve. Under such guidelines, capital received from the proceeds of the sale of trust preferred securities cannot constitute more than 25% of the total core capital of the Company. Consequently, the amount of trust preferred securities in excess of the 25% limitation will constitute Tier 2 capital of the Company. Total regulatory capital consists of Tier 1, certain debt instruments and a portion of the allowance for credit losses. At September 30, 2000, Tier 1 capital to total average assets was 7.21%. Tier 1 15 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) capital to risk-adjusted assets was 10.92%. Total capital to risk-adjusted assets was 12.14%. All three ratios exceed all required ratios established for bank holding companies. Risk-adjusted capital levels of the Company's subsidiary banks exceed regulatory definitions of well-capitalized institutions. The Company declared and paid common dividends of $.165 per share in the third quarter of 2001 versus $.157 for the third quarter of 2000. For the first nine months of 2001 the Company declared and paid common dividends of $.495 per share versus $.466 for the same period in 2000. Liquidity Liquidity management involves maintaining sufficient cash levels to fund operations and to meet the requirements of borrowers, depositors, and creditors. Higher levels of liquidity bear higher corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets, and higher interest expense involved in extending liability maturities. Liquid assets include cash and cash equivalents, loans and securities maturing within one year, and money market instruments. In addition, the Company holds AFS securities maturing after one year, which can be sold to meet liquidity needs. Maintaining a relatively stable funding base, which is achieved by diversifying funding sources and extending the contractual maturity of liabilities, supports liquidity and limits reliance on volatile short-term purchased funds. Short-term funding needs arise from declines in deposits or other funding sources, funding of loan commitments and requests for new loans. The Company's strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low-cost funds. Average core deposits funded approximately 82.9% of total earning assets for the nine months ended September 30, 2001 and 81.7% for the same period in 2000. Management believes the Company has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment. In addition, the affiliates have access to the Federal Home Loan Bank for borrowing purposes. The Company has not received any recommendations from regulatory authorities that would materially affect liquidity, capital resources or operations. Interest Rate Risk Asset/liability management strategies are developed by the Company to manage market risk. Market risk is the risk of loss in financial instruments including investments, loans, deposits and borrowings arising from adverse changes in prices/rates. Interest rate risk is the Company's primary market risk exposure, and represents the sensitivity of earnings to changes in market interest rates. Strategies are developed that impact asset/liability committee activities based on interest rate risk sensitivity, board policy limits, desired sensitivity gaps and interest rate trends. Effective asset/liability management requires the maintenance of a proper ratio between maturing or repriceable interest-earning assets and interest-bearing liabilities. It is the policy of the Company that the cumulative GAP divided by total assets shall be plus or minus 20% at the 3-month, 6-month, and 1-year time horizons. 16 INDIANA UNITED BANCORP FORM 10-Q MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollar amounts in thousands except per share data) At September 30, 2001, the Company held approximately $360,301 in assets comprised of securities, loans, short-term investments, and federal funds sold, which were interest sensitive in one year or less time horizons. Other The Securities and Exchange Commission ("Commission") maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including the Company. That address is http://www.sec.gov. 17 INDIANA UNITED BANCORP QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Dollar amounts in thousands except per share data) Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk of the Corporation encompasses exposure to both liquidity and interest rate risk and is reviewed monthly by the Asset/Liability Committee and the Board of Directors. There have been no material changes in the quantitative and qualitative disclosures about market risks as of September 30, 2001 from the analysis and disclosures provided in the Corporation's Form 10-K for the year ended December 31, 2000. 18 INDIANA UNITED BANCORP FORM 10-Q PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K The following exhibits are furnished in accordance with the provisions of Item 601 of Regulation S-K. a) None b) Reports on Form 8-K There were no reports filed on Form 8-K for the third quarter of 2001. No other information is required to be filed under Part II of this form. 19 INDIANA UNITED BANCORP FORM 10-Q SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INDIANA UNITED BANCORP November 5, 2001 /s/ James L. Saner Sr ----------------------------------- James L. Saner Sr President and Chief Executive Officer November 5, 2001 /s/ Donald A. Benziger ----------------------------------- Donald A. Benziger Senior Vice President & Chief Financial Officer 20