10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

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 No. 0-14354

LOGO

(Exact name of registrant as specified in its charter)

Indiana

(State of Incorporation)

35-1692825

(IRS Employer Identification No.)

135 N. Pennsylvania St.

Indianapolis, Indiana

(Address of principal executive offices)

46204

(Zip Code)

Registrant’s telephone number, including area code:

(317) 269-1200

Securities Registered Pursuant to Section 12(b) of the Act:

NONE

Securities Registered Pursuant to Section 12(g) of the Act:

 

 
Title of Each Class                        

Common Stock, $.01 par value

                   

Preferred Share Purchase Rights

           
 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨   Accelerated filer  x   Non-accelerated filer   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

State the aggregate market value of the common stock held by non-affiliates of the registrant: $336.0 million as of June 30, 2006.

On February 15, 2007, the registrant had 16,517,222 shares of common stock outstanding, $0.01 par value.

Documents Incorporated by Reference: Portions of the definitive proxy statement for the 2007 Annual Meeting of Shareholders (Part III).

 



Table of Contents

FIRST INDIANA CORPORATION

Form 10-K

Table of Contents

 

          Page

Part I

     
  

Cautionary Statement Regarding Forward-Looking Information

   3
  

Financial Review

   4
  

Five-Year Summary of Selected Financial Data

   4
  

Overview

   5
  

Critical Accounting Policies

   6
  

Statement of Earnings Analysis

   7
  

Financial Condition

   15
  

Asset Quality

   22
  

Liquidity and Market Risk Management

   27
  

Capital

   31
  

Impact of Inflation and Changing Prices

   33
  

Impact of Accounting Standards Not Yet Adopted

   33
  

Fourth Quarter Summary

   33
  

Management’s Responsibility for Financial Statements

   35
  

Management’s Report on Internal Control over Financial Reporting

   35
  

Report of Independent Registered Public Accounting Firm

   36
  

Report of Independent Registered Public Accounting Firm

   37
  

Consolidated Financial Statements

   38
  

Notes to Consolidated Financial Statements

   42

Item 1.

  

Business

   78

Item 1A.

  

Risk Factors

   84

Item 1B.

  

Unresolved Staff Comments

   88

Item 2.

  

Properties

   88

Item 3.

  

Legal Proceedings

   88

Item 4.

  

Submission of Matters to a Vote of Security Holders

   88
  

Executive Officers of the Registrant

   89

Part II

     

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    90

Item 6.

   Selected Financial Data    92

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    92

Item 7A.

   Quantitative and Qualitative Disclosures about Market Risk    92

Item 8.

   Financial Statements and Supplementary Data    92

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    92

Item 9A.

   Controls and Procedures    92

Item 9B.

   Other Information    93

Part III

     

Item 10.

   Directors, Executive Officers and Corporate Governance    94

Item 11.

   Executive Compensation    94

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters    94

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    94

Item 14.

   Principal Accountants’ Fees and Services    94

Part IV

     

Item 15.

  

Exhibits, Financial Statement Schedules

   95

Signatures

   99

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

You are hereby cautioned that this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of First Indiana Corporation and its consolidated subsidiaries (“First Indiana”) may differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to (1) projections of revenue, margins, expenses, tax provisions, earnings, cash flows, benefit obligations, share repurchase or other financial items; (2) statements of the plans, strategies and objectives of management for future operations, including the execution of restructuring plans; (3) statements concerning expected development, performance or market share relating to loans, deposits, fees or other products or services; (4) statements regarding future economic conditions or performance; (5) statements regarding any investigations, claims or disputes; (6) statements of expectation or belief; and (7) statements of assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include but are not limited to (a) macroeconomic trends and events nationally, in the State of Indiana, and in our primary market of Indianapolis; (b) the execution and performance of contracts, including loans, by customers, suppliers and partners; (c) the difficulty of aligning expense levels with revenue changes; (d) assumptions relating to the execution and timing of workforce restructuring programs; (e) the outcome of pending legislation and accounting pronouncements; (f) material changes or disruptions in financial markets which impact our ability to raise funds; (g) changes in investor interest and criteria for the purchase of residential loans originated with the intention of selling the loans to investors; and (h) other risks that are described in this report, including but not limited to the items discussed in “Risk Factors” in Item 1A of this report, and that are otherwise described from time to time in First Indiana’s Securities and Exchange Commission reports filed after this report. First Indiana assumes no obligation and does not intend to update these forward-looking statements.

 

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FINANCIAL REVIEW

FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA

Business Combinations and discontinued operations that affect the comparability of the 2006, 2005 and 2004 information shown in this five-year summary are discussed in Note 2 to the Consolidated Financial Statements.

On January 3, 2006, the Corporation and the Bank sold the assets related to its trust business (“Trust”) to Marshall & Ilsley Trust Company, N. A. (“M&I”), a subsidiary of Marshall & Ilsley Corporation. First Indiana received approximately $15,000,000 in cash proceeds from the sale and recorded an after-tax gain of approximately $8,600,000 in the first quarter of 2006. In addition, the Corporation received approximately $850,000 in cash for the transfer of Trust’s fees receivable to M&I. First Indiana may also receive future incentive payments over the next three years depending upon revenue growth. Trust income and expense has been presented as discontinued operations, and the results of operations and cash flows have been disclosed separately for all periods presented in the Consolidated Statements of Earnings, Consolidated Statements of Cash Flows, and Notes to Consolidated Financial Statements. Likewise, the assets of Trust have been reclassified to assets of discontinued operations on the Consolidated Balance Sheets. Prior to the announced sale, Trust was included in the community bank operating segment.

 

(Dollars in Thousands, except Per Share Data)   2006     2005     2004     2003     2002  

Year-End Balance Sheet Data

         

Total Assets

  $ 2,162,113     $ 1,966,356     $ 1,898,263     $ 2,193,137     $ 2,125,590  

Investment Securities

    282,833       259,516       243,296       240,410       161,320  

Loans

    1,694,687       1,567,186       1,500,190       1,814,991       1,837,633  

Commercial

    937,827       805,381       700,528       886,144       860,159  

Consumer

    488,173       499,465       520,611       612,025       666,150  

Residential Mortgage

    268,687       262,340       279,051       316,822       311,324  

Deposits

    1,611,055       1,449,276       1,370,697       1,489,972       1,339,204  

Non-Interest-Bearing Demand

    242,975       268,682       265,203       235,811       180,389  

Interest-Bearing Demand

    194,878       229,876       189,911       217,353       179,751  

Savings

    664,474       489,713       463,679       400,804       398,752  

Certificates of Deposit

    508,728       461,005       451,904       636,004       580,312  

Short-Term Borrowings

    277,888       220,732       162,208       147,074       170,956  

Federal Home Loan Bank Advances

    19,666       42,365       114,499       265,488       346,532  

Subordinated Notes

    46,905       46,781       46,657       46,534       12,169  

Shareholders’ Equity

    182,094       175,442       172,143       208,894       221,211  

Selected Operations Data

         

Net Interest Income

  $ 71,694     $ 69,110     $ 69,441     $ 76,900     $ 73,780  

Provision for Loan Losses

    (1,600 )     (3,200 )     11,550       38,974       20,756  

Non-Interest Income

    27,884       29,318       36,851       34,635       33,353  

Non-Interest Expense

    62,630       63,061       69,223       70,543       54,627  

Income from Continuing Operations, Net of Taxes

    24,296       24,500       16,393       1,467       20,302  

Income (Loss) from Discontinued Operations, Net of Taxes

    8,653       771       (1,715 )     1,062       878  

Net Income

    32,949       25,271       14,678       2,529       21,180  

Basic Earnings (Loss) Per Share

         

Income from Continuing Operations, Net of Taxes

    1.47       1.43       0.84       0.07       1.04  

Income (Loss) from Discontinued Operations, Net of Taxes

    0.52       0.04       (0.09 )     0.06       0.05  
                                       

Basic Net Earnings Per Share

    1.99       1.47       0.75       0.13       1.09  
                                       

Diluted Earnings (Loss) Per Share

         

Income from Continuing Operations, Net of Taxes

    1.44       1.40       0.83       0.07       1.02  

Income (Loss) from Discontinued Operations, Net of Taxes

    0.50       0.04       (0.09 )     0.06       0.05  
                                       

Diluted Net Earnings Per Share

    1.94       1.44       0.74       0.13       1.07  
                                       

Dividends Declared Per Common Share

    0.800       0.608       0.540       0.528       0.512  

Selected Ratios

         

Net Interest Margin

    3.73 %     3.85 %     3.55 %     3.69 %     3.73 %

Return on Average Total Assets

    1.61       1.32       0.71       0.11       1.02  

Return on Average Shareholders’ Equity

    18.44       14.39       6.94       1.15       9.66  

Average Shareholders’ Equity to Average Total Assets

    8.75       9.21       10.19       9.91       10.51  

Tangible Equity to Tangible Assets

    6.98       7.33       7.38       8.04       10.12  

Dividend Payout Ratio

    41.24       42.22       72.58       412.50       47.76  

Selected Value

         

Book Value Per Share

  $ 10.86     $ 10.22     $ 9.82     $ 10.75     $ 11.39  

Average Common Shares Outstanding

         

Basic

    16,555,127       17,158,145       19,484,426       19,463,135       19,421,483  

Diluted

    16,977,111       17,549,963       19,735,453       19,650,864       19,761,725  

All share and per share amounts have been restated to reflect the 5 for 4 stock split declared January 18, 2006.

 

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OVERVIEW

First Indiana Corporation (“First Indiana” or the “Corporation”) is the holding company for First Indiana Bank, N.A. (the “Bank”), the largest commercial bank headquartered in Indianapolis. First Indiana Bank is a community bank offering a full range of banking services in Central Indiana. The Bank attracts deposits and originates commercial and consumer loans and offers cash management services through 32 banking centers. Additionally, the Bank originates home equity loans on a national basis through a network of agents and brokers. These loans are primarily sold to investors.

In January 2006, First Indiana sold the assets related to its trust business (“Trust”). In October 2004, First Indiana sold substantially all the assets of Somerset Financial Services, LLC (“Somerset Financial”), an accounting and consulting firm. The results of operations of Trust and Somerset Financial are reported as discontinued operations, and their results of operations and cash flows have been disclosed separately for all periods presented in the Consolidated Statements of Earnings, Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements. Likewise, the assets and liabilities of Trust have been reclassified to assets and liabilities of discontinued operations on the Consolidated Balance Sheets.

The Corporation’s success is largely dependent on its ability to manage credit risk and interest rate risk. Making loans is an essential element of the Bank’s business, and there is a risk that loans will not be repaid. The risk of loss on a loan is affected by a number of factors, including credit risks of a particular borrower; changes in economic or industry conditions; the duration of the loan; and, in the case of a collateralized loan, uncertainties about the future value of the collateral. An economic downturn could contribute to deterioration in the quality of the loan portfolio. Loans made up 78 percent of the Corporation’s assets at year-end 2006. If an economic downturn occurs in the economy as a whole, or in Indiana where First Indiana has approximately 72 percent of its loans, borrowers may be unable to repay their loans as scheduled and the value of real estate or other collateral that may secure the loans could be adversely affected.

Interest rate risk is defined as the exposure of net interest income, net earnings, and equity to changes in interest rates. First Indiana manages risk from changes in market interest rates, in part, by controlling the mix of interest rate-sensitive assets and interest rate-sensitive liabilities. The Corporation makes adjustments to its rate-sensitive balance sheet position, as necessary, when its outlook regarding possible movements in interest rates changes.

Net interest income is income that remains after deducting the interest expense attributable to the funds required to support total assets from total interest income generated by earning assets. Income from earning assets includes income from loans, investment securities, and short-term investments. The amount of interest income is dependent on many factors, including the volume of earning assets, the general level of interest rates, and yields on a variety of earning assets, from investments to loans. The cost of funds varies with the amount of funds necessary to support total assets, the rates paid to attract and hold deposits, the rates paid on borrowed funds, and the levels of interest-free funds.

Several major initiatives were implemented in 2006. In January 2006, First Indiana sold the assets related to its trust business and received approximately $15,000,000 in cash proceeds from the sale. An after-tax gain on sale of approximately $8,600,000 was recorded in the first quarter of 2006. Business development efforts led to growth of 16.4 percent in commercial loans during the year. In addition, average deposits in 2006 increased 10.2 percent over average deposits in 2005. During the third quarter of 2006, the bank completed a successful conversion of its core systems to a new service provider. The core systems conversion has enhanced the functionality of the bank’s operating systems and delivery channels, as well as improved the associated business processes.

 

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CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Corporation and its subsidiaries conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. A summary of the Corporation’s significant accounting policies is contained in Note 1 of the Notes to Consolidated Financial Statements. In fulfilling its responsibilities, the Audit Committee of the Board of Directors has reviewed the accounting and reporting policies of the Corporation. In preparing the Consolidated Financial Statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, goodwill, and the valuation allowance for deferred taxes.

Allowance for Loan Losses

The allowance for loan losses is maintained at the level deemed adequate to cover losses inherent in the loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The determination of the adequacy of the allowance for loan losses is based on projections and estimates concerning portfolio trends and credit losses, national and local economic trends, portfolio management, the assessment of credit risk of performing and non-performing loans, and qualitative management factors. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes to one or more of the above-noted risk factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review this allowance and may require the Corporation to recognize additions to the allowance based on their judgment about information available to them at the time of their examination. The allowance for loan losses is included in the community bank segment.

Goodwill

The Corporation accounts for goodwill under the provisions of Financial Accounting Standards Board (“FASB”) Statement No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill and other intangible assets with indefinite useful lives be tested for impairment at least annually. Assets and liabilities, including goodwill, are assigned to reporting units. Reporting units with assigned goodwill are corporate banking and retail banking, which are included in the community bank segment. Goodwill formerly assigned to Somerset Financial was reclassified to Assets of Discontinued Operations and later included as part of the October 2004 asset sale, which is discussed in Note 2 of the Notes to Consolidated Financial Statements. Impairment tests indicated that the fair value of each reporting unit with assigned goodwill exceeded its recorded investment (thus goodwill was not impaired). Risk factors considered in determining reporting unit fair value include future loan and deposit originations and related revenues generated from this activity, future fee revenues and costs associated with the services provided by each reporting unit, and the continued commitment of Corporation resources to each reporting unit. Future tests for impairment will also use this method. Should any of these risk factors change, the fair value of a reporting unit could deteriorate, resulting in goodwill impairment.

Valuation Allowance for Deferred Taxes

The Corporation accounts for deferred income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. Deferred income tax assets and liabilities result from temporary differences in the recognition of income and expense for income tax and financial reporting purposes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Corporation will realize the benefits of these deductible differences. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced.

 

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STATEMENT OF EARNINGS ANALYSIS

Earnings Summary

First Indiana reported net income of $32,949,000, or $1.94 per diluted share, in 2006, compared with earnings of $25,271,000, or $1.44 per diluted share, in 2005. Net income in 2004 was $14,678,000 or $0.74 per diluted share. The increase in net income in 2006 compared with 2005 is primarily the result of the after-tax gain on sale of the Bank’s trust operations totaling $8,653,000; pre-tax expenses totaling $1,727,000 associated with the conversion of the Corporation’s core data processor; and a $1,600,000 reduction in the provision for loan losses. The increase in net income in 2005 compared with 2004 is primarily the result of improvements in credit quality which led to a reduction in the provision for loan losses. Non-performing assets decreased to $4,633,000 at December 31, 2005, from $21,445,000 at December 31, 2004, while net charge-offs of loans totaled $10,804,000 in 2005 as compared to $11,575,000 in 2004. Included in 2005 results was a pre-tax loss of $1,649,000 on the sale of the Bank’s third-party loan servicing portfolio. Net income in 2005 was also positively impacted by results of the cost reduction program implemented in the third quarter of 2004.

On January 3, 2006, the Corporation sold the assets related to its trust business and received approximately $15,000,000 in cash proceeds from the sale. An after-tax gain of $8,653,000 was recorded in the first quarter of 2006 and reported as discontinued operations. In the fourth quarter of 2005, the Corporation had announced the agreement to sell the assets related to its trust business, which subsequently closed in January 2006. The 2005 results of operations of the trust business are reported as discontinued operations. In the fourth quarter of 2004, First Indiana sold substantially all the assets of Somerset Financial, and the operations and sale of Somerset Financial are reported as discontinued operations. Earnings from continuing operations, net of taxes, were $24,296,000, or $1.44 per diluted share, in 2006 compared with $24,500,000, or $1.40 per diluted share, in 2005. Earnings from continuing operations, net of taxes in 2004 were $16,393,000, or $0.83 per diluted share. Earnings from discontinued operations, net of taxes, were $8,653,000, or $0.50 per diluted share, in 2006, and $771,000, or $0.04 per diluted share, in 2005 compared with a loss from discontinued operations, net of taxes in 2004 of $1,715,000, or $0.09 per diluted share.

On January 18, 2006, the Board of Directors approved a five-for-four stock split that was effective on February 27, 2006, to shareholders of record as of February 13, 2006. All share and per share information has been restated to reflect the stock split.

Net Interest Income

Net interest income was $71,694,000 in 2006, compared with $69,110,000 in 2005 and $69,441,000 in 2004. Net interest income increased in 2006 compared with 2005 due to an increase in earning assets offset by a decrease in net interest margin. Net interest income decreased slightly in 2005 compared with 2004 due to a decrease in earning assets offset by an increase in net interest margin. Earning assets averaged $1,924,415,000 in 2006, compared with $1,794,154,000 in 2005 and $1,955,281,000 in 2004. The increase in 2006 average earning assets compared with 2005 primarily consisted of increases in business and single-family construction loans totaling $110,888,000 and an increase of $20,304,000 in securities available for sale. These increases were offset by declines in consumer and residential mortgage loans totaling approximately $15,933,000. The decrease in 2005 average earning assets compared with 2004 primarily consisted of reductions in single-family construction and consumer loans. The reduction in single-family construction loans was the result of the sale of the non-Indiana construction loan offices in November 2004, which included approximately $134,373,000 in construction loans outstanding, partially offset by new originations in the Indianapolis market. See “Financial Condition” for a more detailed discussion of the Corporation’s earning assets.

Net interest margin is calculated as the percentage of net interest income to average earning assets. Net interest margin was 3.73 percent in 2006, compared with 3.85 percent in 2005 and 3.55 percent in 2004. While interest rates began to level-off and remain steady during 2006, the Bank’s customers continued to manage their funds more aggressively, choosing higher cost, more rate sensitive products in a market of increasing competitive

 

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pricing pressure. This shift altered the interest rate risk profile of the Corporation’s balance sheet, effectively eliminating the asset-sensitive position that had been maintained in 2005. As a result, net interest margin was compressed during the year ending 2006. During 2005, rate increases by the Federal Reserve Board which began in mid-2004 led to an increase in the 2005 net interest margin, since First Indiana’s balance sheet had been in an asset-sensitive position. Lower yields on consumer and residential mortgage loans in 2004 and continued prepayments compressed net interest margins and net interest income in 2004, as deposit rates were unable to fully absorb the lower market loan yields.

Net interest margin consists of two components: interest rate spread and the contribution of interest-free funds, primarily non-interest-bearing demand deposits and shareholders’ equity. Interest rate spread is the difference between the yield on total earning assets and the cost of total interest-bearing liabilities. While the contribution of interest-free funds had a positive impact on the 2006 net interest margin, the decline of the interest rate spread was more significant, leading to the overall decrease in net interest margin for 2006, as compared to 2005. The interest rate spread for 2006 was 3.12 percent, compared with 3.35 percent in 2005 and 3.17 percent in 2004. The contribution of interest-free funds to net interest margin varies depending on the level of interest-free funds and the level of interest rates. Interest-free funds averaged $310,658,000, or 16.1 percent of earning assets, in 2006, compared with $341,465,000, or 19.0 percent of earning assets, in 2005, and $368,428,000, or 18.8 percent of earning assets, in 2004. Interest-free funds provided 61 basis points to the margin in 2006, compared with 50 basis points in 2005 and 38 basis points in 2004. During 2005, both the interest rate spread and the contribution of interest-free funds were impacted positively by rising interest rates and had a positive impact on the 2005 net interest margin. See “Asset/Liability Management” for a more detailed discussion of the Corporation’s management of interest rate risk.

 

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Net Interest Margin

 

    2006     2005     2004  
(Dollars in Thousands)   Average
Balance
  Interest   Yield /
Rate
    Average
Balance
  Interest   Yield /
Rate
    Average
Balance
  Interest   Yield /
Rate
 

Assets

                 

Interest-Bearing Due from Banks

  $ 7,156   $ 353   4.94 %   $ 5,354   $ 142   2.64 %   $ 29,200   $ 389   1.33 %

Federal Funds Sold

    16,686     847   5.08       2,853     91   3.19       —       —     —    

Securities Available for Sale

    246,817     9,948   4.03       226,513     8,387   3.70       215,159     7,869   3.66  

Other Investments

    24,350     1,209   4.96       26,447     1,159   4.38       25,573     1,170   4.57  

Loans (1)

                 

Business

    580,308     45,129   7.78       504,388     33,236   6.59       491,490     25,577   5.20  

Commercial Real Estate

    168,751     14,095   8.35       167,287     11,497   6.87       176,641     10,238   5.80  

Single-Family Construction

    115,620     9,685   8.38       80,652     5,379   6.67       166,416     8,111   4.87  

Consumer

    498,273     36,653   7.36       509,471     34,625   6.80       554,570     34,177   6.16  

Residential Mortgage

    266,454     13,800   5.18       271,189     12,664   4.67       296,232     14,113   4.76  
                                         

Total Loans

    1,629,406     119,362   7.33       1,532,987     97,401   6.35       1,685,349     92,216   5.47  
                                         

Total Earning Assets

    1,924,415     131,719   6.84       1,794,154     107,180   5.97       1,955,281     101,644   5.20  

Other Assets

    118,195         113,388         119,780    
                             

Total Assets

  $ 2,042,610       $ 1,907,542       $ 2,075,061    
                             

Liabilities and Shareholders’ Equity

                 

Interest-Bearing Deposits

                 

Demand Deposits

  $ 185,060   $ 1,878   1.01 %   $ 189,297   $ 877   0.46 %   $ 185,050   $ 635   0.34 %

Savings Deposits

    599,961     20,647   3.44       477,500     8,835   1.85       472,006     3,977   0.84  

Certificates of Deposit

    523,904     23,133   4.42       473,150     16,218   3.43       565,940     15,821   2.80  
                                         

Total Interest-Bearing Deposits

    1,308,925     45,658   3.49       1,139,947     25,930   2.27       1,222,996     20,433   1.67  

Short-Term Borrowings

    217,873     8,988   4.13       181,930     5,121   2.81       128,676     1,521   1.18  

Federal Home Loan Bank Advances

    40,110     2,013   5.02       84,087     3,653   4.34       188,581     6,880   3.65  

Subordinated Notes

    46,849     3,366   7.18       46,725     3,366   7.20       46,600     3,369   7.23  
                                         

Total Interest-Bearing Liabilities

    1,613,757     60,025   3.72       1,452,689     38,070   2.62       1,586,853     32,203   2.03  

Non-Interest-Bearing Demand Deposits

    218,690         246,113         241,941    

Other Liabilities

    31,459         33,124         34,723    

Shareholders’ Equity

    178,704         175,616         211,544    
                             

Total Liabilities and Shareholders’ Equity

  $ 2,042,610       $ 1,907,542       $ 2,075,061    
                                         

Net Interest Income/Spread

    $ 71,694   3.12 %     $ 69,110   3.35 %     $ 69,441   3.17 %
                                         

Net Interest Margin

      3.73 %       3.85 %       3.55 %
                             

(1) Included in loans are loans held for sale totaling $24.7 million, $32.3 million, and $44.1 million in 2006, 2005, and 2004, respectively, and non-accrual loans.

 

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The following table shows the impact on net interest income of changes in interest rates and volume of the Corporation’s assets and liabilities. The change in interest not due solely to rate or volume has been allocated in proportion to the absolute dollar amounts of the change in each.

 

     2006 Compared with 2005     2005 Compared with 2004  
     Increase (Decrease)
Due to Change in
          Increase (Decrease)
Due to Change in
       
(Dollars in Thousands)    Rate     Volume     Net
Change
    Rate     Volume     Net
Change
 

Interest Income

            

Interest-Bearing Deposits

   $ 152     $ 59     $ 211     $ 214     $ (461 )   $ (247 )

Federal Funds Sold

     —         756       756       —         91       91  

Securities Available for Sale

     776       785       1,561       98       420       518  

Other Investments

     145       (95 )     50       (50 )     39       (11 )

Loans

     15,562       6,399       21,961       14,005       (8,820 )     5,185  
                                                
     16,635       7,904       24,539       14,267       (8,731 )     5,536  

Interest Expense

            

Interest-Bearing Deposits

            

Demand Deposits

     1,021       (20 )     1,001       227       15       242  

Savings Deposits

     9,098       2,714       11,812       4,811       47       4,858  

Certificates of Deposit

     5,039       1,876       6,915       3,238       (2,841 )     397  

Short-Term Borrowings

     2,715       1,152       3,867       2,771       829       3,600  

FHLB Advances

     499       (2,139 )     (1,640 )     1,126       (4,353 )     (3,227 )

Subordinated Notes

     (9 )     9       0       (12 )     9       (3 )
                                                
     18,363       3,592       21,955       12,161       (6,294 )     5,867  
                                                

Net Interest Income

   $ (1,728 )   $ 4,312     $ 2,584     $ 2,106     $ (2,437 )   $ (331 )
                                                

Non-Interest Income

The following table shows First Indiana’s non-interest income for the past three years.

 

     Years Ended December 31  
          Increase (Decrease)           Increase (Decrease)        
(Dollars in Thousands)    2006    Amount     Percent     2005     Amount     Percent     2004  

Deposit Charges

   $ 16,506    $ (254 )   (1.5 )%   $ 16,760     $ (486 )   (2.8 )%   $ 17,246  

Loan Servicing Income (Expense)

     —        (58 )   —         58       294     (124.6 )     (236 )

Loan Fees

     1,718      (100 )   (5.5 )     1,818       (1,221 )   (40.2 )     3,039  

Investment Product Sales Commissions

     763      182     31.3       581       (1,123 )   (65.9 )     1,704  

Sale of Loans

     6,504      (3,684 )   (36.2 )     10,188       (1,350 )   (11.7 )     11,538  

Sale of Loan Servicing

     —        1,649     —         (1,649 )     (1,649 )   —         —    

Net Investment Securities Gain (Loss)

     —        813     —         (813 )     (794 )   (4,178.9 )     (19 )

Other

     2,393      18     0.8       2,375       (1,204 )   (33.6 )     3,579  
                                           
   $ 27,884    $ (1,434 )   (4.9 )%   $ 29,318     $ (7,533 )   (20.4 )%   $ 36,851  
                                           

Non-interest income totaled $27,884,000 in 2006, compared with $29,318,000 in 2005 and $36,851,000 in 2004. Non-interest income in 2005 includes a loss of $1,649,000 on the sale of the Bank’s third-party loan servicing portfolio at the end of the first quarter.

Deposit charges in 2006 decreased 1.5 percent to $16,506,000 following a 2.8 percent decrease to $16,760,000 in 2005. The decrease in deposit charges in 2006 compared with 2005 reflects lower returned check

 

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and demand deposit fees partially offset by an increase in debit card fees. The decrease in deposit charges in 2005 compared with 2004 was primarily due to a reduction in account analysis fees resulting from a higher earnings credit rate in 2005 and a decline in overdraft charges.

The Corporation is no longer servicing loans for others and, therefore, did not record loan servicing income in 2006. Loan servicing income was $58,000 in 2005, compared with loan servicing expense of $236,000 in 2004. Following the sale of the Bank’s third-party loan servicing portfolio in the first quarter of 2005, the transfer of the servicing of the loans to the purchaser was completed in the second quarter. All loans have been sold servicing released since the second quarter of 2004, and the Bank expects to continue this practice. Additional information relating to loan servicing rights can be found in Note 3 of the Notes to the Consolidated Financial Statements.

Loan fees were $1,718,000 in 2006, compared with $1,818,000 in 2005 and $3,039,000 in 2004. Loan fees in 2006 decreased $100,000 from 2005 fees mainly due to lower letter of credit fee accretion. The primary reason for the decrease in loan fees in 2005 compared with 2004 was a reduction in construction loan fees due to the sale of the non-Indiana construction loan offices in November 2004.

Investment and insurance product sales commissions generated by First Indiana Investor Services, Inc., the Bank’s investment products and insurance sales subsidiary, were $763,000 in 2006, compared with $581,000 in 2005 and $1,704,000 in 2004. Sales revenues in 2006 increased from 2005 fees due to higher annuity and mutual fund sales. Sales revenues in 2005 were lower than 2004 fees due to the elimination of the existing sales channel as part of the cost reduction plan implemented in the third quarter of 2004.

Gain on the sale of loans (primarily closed-end and line of credit home equity loans) in 2006 was $6,504,000, a decrease of $3,684,000 from comparable revenues in 2005 of $10,188,000. Gain on the sale of loans in 2004 was $11,538,000 which included a net gain of $958,000 from the sale of the non-Indiana construction loan offices. The decrease of gains on the sale of loans in 2006 compared with 2005 was a result of increased competition and rising interest rates, which caused lower volume in the sale of loans. In addition during the third quarter of 2006, an investor which previously has purchased approximately one-half of the Corporation’s volume of loans significantly reduced loan purchases and notified us of its intent to significantly reduce future purchases of loans. The investor’s action was in response to the credit deterioration of sub-prime loans in the national marketplace. In response to these developments in the market and the resulting negative trend in gains on the sale of loans, the Corporation is continuing to evaluate its Consumer Finance Bank segment to develop a clear strategy going forward. Consumer loans sold were $256,906,000 in 2006, compared with $328,515,000 in 2005 and $339,595,000 in 2004. Gain on the sale of loans decreased in 2005 from 2004 levels due to a reduction in loans sold as more loans were retained in the Bank’s portfolio. As a result of shifts in market demand and an increase in retail production in 2005, a greater share of originated loans met the criteria for the Bank’s portfolio. Gain on the sale of residential loans was $193,000 in 2006, compared with $191,000 in 2005 and $104,000 in 2004.

The net investment securities loss in 2005 was $813,000, compared with a net loss of $19,000 in 2004. In addition to the sale of $35,000,000 in Federal Home Loan Bank bonds in the first quarter of 2005 resulting in a loss of $804,000, the Bank sold its holding of Fannie Mae and Freddie Mac preferred stock in the same quarter at a loss of $9,000. The Bank had previously recognized impairment losses of $299,000 in 2004 on this preferred stock.

Other non-interest income in 2006 was $2,393,000, compared with $2,375,000 in 2005 and $3,579,000 in 2004. The majority of the other income totals for these periods is comprised of earnings on the cash surrender value of life insurance and other consumer loan fees. Income from late charges, prepayment penalties, and other consumer and residential loan fees in 2005 was reduced from the previous year due to the sale of the loan servicing portfolio, the contraction in the consumer and mortgage loan portfolios, and the expiration of the prepayment penalty period on aging consumer loans.

 

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Non-Interest Expense

The following table shows First Indiana’s non-interest expense for the past three years.

 

    Years Ended December 31
          Increase
(Decrease)
          Increase
(Decrease)
      
(Dollars in Thousands)   2006     Amount     Percent     2005     Amount     Percent     2004

Salaries

  $ 27,519     $ (449 )   (1.6 )%   $ 27,968     $ (1,941 )   (6.5 )%   $ 29,909

Benefits

    9,592       265     2.8       9,327       423     4.8       8,904

Net Occupancy

    4,029       (301 )   (7.0 )     4,330       357     9.0       3,973

Equipment

    6,496       1,128     21.0       5,368       (578 )   (9.7 )     5,946

Professional Services

    3,755       (363 )   (8.8 )     4,118       (710 )   (14.7 )     4,828

Marketing

    2,131       (13 )   (0.6 )     2,144       9     0.4       2,135

Telephone, Supplies, and Postage

    2,905       (99 )   (3.3 )     3,004       (425 )   (12.4 )     3,429

Other Intangible Asset Amortization

    342       (354 )   (50.9 )     696       (22 )   (3.1 )     718

Other Real Estate Owned Operations – Net

    (199 )     (105 )   111.7       (94 )     (1,309 )   (107.7 )     1,215

Deposit Insurance

    185       (5 )   (2.6 )     190       (31 )   (14.0 )     221

Miscellaneous

    5,875       (135 )   (2.2 )     6,010       (1,935 )   (24.4 )     7,945
                                         
  $ 62,630     $ (431 )   (0.7 )%   $ 63,061     $ (6,162 )   (8.9 )%   $ 69,223
                                         

Non-interest expense in 2006 was $62,630,000, compared with $63,061,000 in 2005. Included in 2006 non-interest expense was $1,727,000 for the conversion of the Bank’s core data processor. Included in non-interest expense in 2004 were charges totaling $1,197,000 associated with the expense reduction plan announced in the third quarter of that year. A significant portion of the remaining decrease in 2005 non-interest expense compared with 2004 was the result of the cost reduction plan and the sale of the non-Indiana construction loan offices in the fourth quarter of 2004.

Salary expense decreased $449,000 in 2006, compared with 2005. This decrease is primarily attributable to lower stock-based compensation cost and a decrease in management performance bonuses. In 2005, First Indiana accounted for restricted and deferred stock awards as variable awards under the principles of Accounting Principals Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Compensation expense related to these awards was significantly higher than 2006 expense due to an increase in the Corporation’s stock price. The Corporation had 514 full-time equivalent employees at year-end 2006, compared with 541 full-time equivalent employees at the end of 2005. Salary expense in 2005 declined $1,941,000 from 2004. Included in 2004 salary expense was severance expense of $932,000 associated with the plan to reduce operating expenses. Additionally, the decrease in salary expense in 2005 was the result of a lower number of employees as part of the cost reduction plan and the sale of the non-Indiana construction loan offices in 2004. The Corporation had 579 full-time equivalent employees at year-end 2004.

Employee benefits expense in 2006 increased $265,000 or 2.8 percent over comparable expense in 2005. Increases in pension plan expense in 2006, compared with 2005 and 2004, were partially offset by decreases in group insurance expense. Group insurance expense declined due to a reduction in the number of covered associates.

Net occupancy expense in 2006 decreased $301,000 from 2005 expense. Included in 2005 expense was a write-off of $400,000 for a lease on land previously held for banking center expansion.

Equipment expense in 2006 was $1,128,000 higher than equipment expense in 2005. This increase is largely explained by the core conversion costs recognized during 2006, including a $689,000 core processor contract cancellation fee expensed during the first quarter of 2006. Equipment expense in 2005 was $578,000 lower than in 2004. Decreases were achieved in equipment lease expense, repairs and maintenance, and depreciation.

 

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Professional services expense in 2006 decreased 8.8 percent or $363,000 from comparable expense in 2005. A reduction in legal fees explains the majority of this decrease reflecting lower legal costs associated with loan delinquencies and foreclosures. Professional services expense in 2005 decreased $710,000 from 2004, primarily due to a reduction in legal fees and a non-recurring charge of $296,000 incurred in 2004 related to the cancellation of a consulting agreement. Partially offsetting these reductions in 2005 was approximately $470,000 of one-time expense related to the imaging of the Bank’s loan files. An increase in audit fees expense in 2005 reflects the increased cost of compliance with laws and regulations.

Marketing expense in 2006 was relatively flat compared with 2005. This follows relatively flat marketing expense for 2005 compared with 2004.

Telephone, supplies, and postage expense was $99,000 lower in 2006 than in 2005, and was $425,000 lower in 2005 than in 2004. These decreases reflect cost reduction efforts in both years.

Other intangible asset amortization was $342,000 in 2006. Other intangible asset amortization decreased in 2006 when compared to 2005 and 2004 primarily because the non-compete agreement intangible was fully amortized by the end of 2005. Additional information relating to other intangible asset amortization expense can be found in Note 3 of the Notes to Consolidated Financial Statements.

Net revenue on other real estate owned (“OREO”) operations in 2006 was $199,000, compared with net revenue of $94,000 in 2005 and net expense of $1,215,000 in 2004. In the third quarter of 2004, First Indiana expensed $1,128,000 as a fair value adjustment on a group of OREO properties associated with one credit relationship. Gains of $232,000 in the first quarter of 2006 and $364,000 in the third quarter of 2005 were recorded on the disposal of some of those properties.

Miscellaneous expense in 2006 was $5,875,000, compared with $6,010,000 in 2005 and $7,945,000 in 2004. The decrease in 2006 expense from the prior year is primarily due to a reduction in check losses. In 2005, the Corporation began to charge net losses on overdrafts against the allowance for loan losses, in addition to reserving for estimated losses on overdrafts within the allowance for loan losses, in accordance with the “Joint Guidance on Overdraft Protection Programs” issued by the federal financial institution regulators in February 2005. Previously these losses were included in non-interest expense. When compared to 2004 expense, decreases in debit card, ATM, personnel, charitable contributions, and other miscellaneous expenses in 2005 are primarily the result of the cost reduction plan implemented in the third quarter of 2004.

The Corporation’s efficiency ratio was 62.90 percent in 2006, compared with 64.07 percent in 2005 and 65.13 percent in 2004. The cost of the core conversion and the expenses associated with the realignment of the senior management increased non-interest expense and had the effect of increasing the efficiency ratio by 193 basis points. The loss on the servicing sale and the loss on the sale of securities reduced non-interest income and had the effect of increasing the 2005 efficiency ratio by 157 basis points. The charges incurred as part of the expense reduction plan had a 113 basis point negative effect on the 2004 efficiency ratio.

Income Tax Expense

The following table shows the Corporation’s earnings from continuing operations, applicable income taxes, and effective tax rates for each of the past three years.

 

(Dollars in Thousands)    2006     2005     2004  

Earnings from Continuing Operations

   $ 38,548     $ 38,567     $ 25,519  

Income Taxes

     14,252       14,067       9,126  

Effective Tax Rate

     37.0 %     36.5 %     35.8 %

Additional data on income taxes can be found in Note 12 of the Notes to Consolidated Financial Statements.

 

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Discontinued Operations

On January 3, 2006, the Corporation and the Bank sold the assets related to its trust business (“Trust”) to Marshall & Ilsley Trust Company, N. A., a subsidiary of Marshall & Ilsley Corporation and recorded an after-tax gain of approximately $8,600,000. First Indiana may also receive future incentive payments over the next three years depending upon revenue growth. Trust income and expense have been presented as discontinued operations, and the results of operations and cash flows have been disclosed separately for all periods presented in the Consolidated Statements of Earnings, Consolidated Statements of Cash Flows, and Notes to Consolidated Financial Statements. Likewise, the assets of Trust have been reclassified to assets of discontinued operations on the Consolidated Balance Sheets. Prior to the announced sale, Trust was included in the community bank operating segment.

On October 25, 2004, First Indiana Corporation sold substantially all the assets of Somerset Financial Services, LLC, to Somerset CPAs, P.C. Somerset Financial Services, LLC, is a subsidiary of the Corporation and represented a majority of the operations of The Somerset Group, Inc., which was acquired by the Corporation in September 2000. Somerset CPAs was formed by a management group from Somerset Financial and assumed substantially all the liabilities of Somerset Financial. The sales price was $6,000,000 excluding $5,405,000 of existing cash at Somerset Financial which was paid to the Corporation as a distribution before the sale. Somerset Financial’s results of operations are reported as discontinued operations, and the results of operations and cash flows have been disclosed separately for all periods presented in the Consolidated Statements of Earnings, Consolidated Statements of Cash Flows, and Notes to Consolidated Financial Statements. Prior to the announced sale, Somerset Financial Services, LLC, was included in the Somerset Financial operating segment.

Earnings from discontinued operations, net of taxes, were $8,653,000, or $0.50 per diluted share, in 2006 compared with earnings from discontinued operations, net of taxes, of $771,000, or $0.04 per diluted share, in 2005. The loss from discontinued operations, net of taxes in 2004 was $1,715,000, or $0.09 per diluted share. The 2004 pre-tax income from discontinued operations of $239,000 included a goodwill impairment loss of $1,852,000 related to Somerset Financial and $300,000 in costs incurred to sell that business. The Somerset Financial sale resulted in a taxable gain and no tax benefit was accrued for the goodwill impairment or the costs to sell the business. Tax expense of $981,000 was recorded in connection with the sale. Additional information on discontinued operations can be found in Note 2 of the Notes to Consolidated Financial Statements.

 

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FINANCIAL CONDITION

First Indiana’s total assets at December 31, 2006 were $2,162,113,000, compared with $1,966,356,000 at December 31, 2005, and $1,898,263,000 at December 31, 2004. The reasons for the increases in total assets at year-end 2006 as compared to 2005 and year-end 2005 as compared to 2004 were primarily due to growth in both business and single-family construction loans.

Loans

Loan Portfolio Composition. The following table sets forth information concerning the composition of the Bank’s loan portfolio in dollar amounts and in percentages by type of loan.

 

     At December 31  
    2006     2005     2004     2003     2002  
(Dollars in Thousands)   Amount   Percent     Amount   Percent     Amount   Percent     Amount   Percent     Amount   Percent  

Commercial Loans

                   

Business

  $ 619,891   36.6 %   $ 545,215   34.8 %   $ 466,703   31.1 %   $ 515,316   28.4 %   $ 501,213   27.3 %

Commercial Real Estate

    191,020   11.3       167,715   10.7       175,145   11.7       178,378   9.8       146,174   8.0  

Single-Family Construction

    126,916   7.5       92,451   5.9       58,680   3.9       192,450   10.6       212,772   11.6  

Consumer Loans

                   

Home Equity

    475,160   28.0       485,111   31.0       505,702   33.7       591,565   32.6       654,930   35.6  

Other Consumer

    13,013   0.8       14,354   0.9       14,909   1.0       20,460   1.1       11,220   0.6  

Residential Mortgage Loans

    268,687   15.8       262,340   16.7       279,051   18.6       316,822   17.5       311,324   16.9  
                                                           

Total Loans

  $ 1,694,687   100.0 %   $ 1,567,186   100.0 %   $ 1,500,190   100.0 %   $ 1,814,991   100.0 %   $ 1,837,633   100.0 %
                                                           

Commercial Loans. The Bank offers a variety of commercial loans, including business loans, commercial real estate loans, and single-family construction loans. Business loans increased $74,676,000 from $545,215,000 at December 31, 2005, to $619,891,000 at December 31, 2006. At December 31, 2004, business loans totaled $466,703,000, which equated to an increase of $78,512,000 in business loans during 2005. These increases are primarily due to the deliberate and continuing shift in the mix of loans in the Bank’s portfolios, emphasizing credits that match the Corporation’s targeted risk profile, and expansion of the business loan portfolio through its business development programs. The majority of business loans are loans to small and middle-market companies in Central Indiana. Business loans as a percentage of total loans have grown from 31.1 percent in 2004 to 36.6 percent in 2006. Strategies for 2007 and beyond call for continued growth in this market segment, as well as an overall increase in the market share of the Indianapolis area.

The majority of First Indiana’s business loans have variable rates, which provide immediate adjustments when interest rate changes occur. This portfolio of loans is diversified with loans to companies in a variety of industries, including distribution, manufacturing, transportation, finance, and various services. The Bank had 7.3 percent of business loan commitments to a single industry group (specialty finance) at December 31, 2006. The next highest industry group concentration was 7.1 percent of business loan commitments (mortgage bankers and brokers). At December 31, 2006, the Bank had 77 loan relationships with commitments over $5,000,000.

Commercial real estate loans were $191,020,000, $167,715,000 and $175,145,000 at December 31, 2006, 2005 and 2004, respectively. Commercial real estate loans outstanding as of these periods are predominately either on properties located in the Bank’s local market area or are loans to entities headquartered in the Indianapolis market. The Bank’s portfolio of commercial real estate loans includes office buildings, strip centers, and multi-family units with usual terms of one to five years and land development loans generally with terms of three years or less.

Single-family construction loans are made both to builders and to individuals. At December 31, 2006, 2005 and 2004, the Bank’s construction loans outstanding equaled $126,916,000, $92,451,000 and $58,680,000,

 

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respectively. Since the sale of its non-Indiana residential construction loan business in 2004, the Bank’s strategy has been to grow this portfolio through lending in the local market. As the construction loan portfolio increases, the Corporation is subject to additional credit risk inherent within construction lending. The Corporation continues to manage credit risk through appropriate loan selection, by defining and limiting exposures to a single client, by requiring collateral and integrating consistent lending policies and underwriting criteria throughout the credit process.

The impact of the 2004 sale of the out-of-state residential construction loan business, which included $134,373,000 of outstanding residential construction loans, was fully reflected in the balance sheet and no further reduction in the construction loan portfolio occurred as a result of the sale.

The following table presents the remaining maturities and interest rate sensitivity of commercial loans at December 31, 2006.

 

      Remaining Maturities            
(Dollars in Thousands)    One Year
or Less
   Over One
Year to
Five Years
   Over Five
Years
   Total    Percent  

Type of Loan:

              

Business

   $ 479,554    $ 140,337    $ —      $ 619,891    66.1 %

Commercial Real Estate

     172,707      6,094      12,219      191,020    20.4  

Single-Family Construction

     126,916      —        —        126,916    13.5  
                                  

Total

   $ 779,177    $ 146,431    $ 12,219    $ 937,827    100.0 %
                                  

Rate Sensitivity:

              

Fixed Rate

   $ 27,438    $ 146,431    $ 12,219    $ 186,088    19.8 %

Adjustable Rate

     751,739      —        —        751,739    80.2  
                                  

Total

   $ 779,177    $ 146,431    $ 12,219    $ 937,827    100.0 %
                                  

Consumer Loans. First Indiana Bank’s consumer bank operates both a retail lending network and a wholesale lending network. The retail network essentially functions through the Bank’s 32 banking centers located throughout the Central Indiana market area. The wholesale network originates loans nationally. The wholesale network originates a full range of fixed rate and adjustable rate consumer loans with varying levels of credit risk. These range from “A” to sub-prime credits. The sub-prime loans typically involve lower credit scores with higher loan-to-value ratios, up to 125 percent. The wholesale originated loans are generally sold to investors.

At December 31, 2006, consumer loans totaled $488,173,000, compared with $499,465,000 and $520,611,000 at December 31, 2005 and 2004, respectively. The decreases in consumer loans have resulted as management has narrowed its consumer portfolio focus to locally sourced customer products. The generally flat to inverted yield curve during 2006 produced a shift in consumer preference to longer term fixed-rate loans. Consumer loans generally have shorter terms and higher interest rates than residential loans, but involve higher credit risk. Of the Bank’s consumer loans outstanding at December 31, 2006, 97.3 percent were secured by first or second mortgages on real property. At December 31, 2006, approximately 36 percent of the home equity portfolio loans are revolving lines of credit which are prime-based while 33 percent are closed-end loans with ARM features.

Home equity loan originations in 2006 totaled $367,853,000 ($80,958,000 retail, $286,895,000 wholesale). This compares with 2005 home equity loan originations of $461,809,000 ($53,584,000 retail, $408,225,000 wholesale) and 2004 home equity loan originations of $408,031,000 ($32,894,000 retail, $375,137,000 wholesale). During 2006, the Bank sold $256,906,000 in home equity loans, compared with sales of $328,515,000 in 2005 and $339,595,000 in 2004. The Bank regularly sells the majority of wholesale loan

 

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originations into the secondary market. The success of its business depends on the continued participation of investors in this market. In the third quarter of 2006, an investor which previously has purchased approximately one-half of the Bank’s volume of loans significantly reduced loan purchases and notified us of its intent to significantly reduce future purchases of loans. Management is currently seeking new investors to replace the resultant shortfall in sales. However, should additional secondary market sources not be found, both the liquidity and revenues attributable to these sales could decrease. Further, recent experience indicates that the market for these loans has generated lower prices and therefore lower sales margins.

At December 31, 2006, the Bank had $22,156,000 in closed-end consumer loans held for sale and $2,490,000 in home equity lines of credit held for sale. At December 31, 2005, the Bank had $26,697,000 in closed-end consumer loans held for sale and $5,645,000 in home equity lines of credit held for sale. At December 31, 2004, the Bank had $18,393,000 in closed-end consumer loans held for sale and $25,744,000 in home equity lines of credit held for sale.

In addition, the Bank makes loans secured by deposits and overdraft loans in connection with its checking accounts, auto loans, and fixed rate and fixed term secured and unsecured loans, and offers Visa credit cards through an agent.

Residential Mortgage Loans. First Indiana Bank’s residential loan strategy, during 2006 and 2005, emphasized mortgage production from the Bank’s internal referral sources. The retail banking centers market mortgage purchase and refinance products to the Bank’s client base. In addition, mortgages are originated in partnership with selected realtors, builders, and mortgage correspondents. Fixed rate mortgages continue to be brokered or sold into the secondary market, while adjustable rate mortgages are primarily retained for the Bank’s portfolio. The original contractual loan payment period for residential mortgage loans originated by the Bank generally ranges from 10 to 30 years. Because borrowers may refinance or prepay their loans, they normally remain outstanding for a substantially shorter period.

Residential mortgage loans outstanding totaled $268,687,000 at December 31, 2006, compared with $262,340,000 and $279,051,000 at year-end 2005 and 2004, respectively. Due to relatively low residential loan interest rates throughout 2005, First Indiana experienced significant loan prepayments in its residential loan portfolio. However, prepayments during 2006 have slowed in response to gradual increases in market interest rates. In 2006, the Bank originated $51,615,000 in primarily adjustable rate residential mortgage loans and purchased $9,322,000 in primarily fixed rate residential mortgage loans. In 2005, the Bank originated $48,355,000 and purchased no adjustable rate residential mortgage loans. In 2004, the Bank originated $16,173,000 and purchased $41,814,000 in primarily adjustable rate residential mortgage loans. Sales of fixed rate residential mortgage loans into the secondary market in 2006, 2005, and 2004 were $10,684,000, $10,051,000, and $6,481,000, respectively. Gains on residential loan sales in 2006 were $193,000, compared with $191,000 in 2005 and $104,000 in 2004.

As part of its residential loan origination activities, First Indiana developed a network of residential loan brokers with whom the Bank links prospective borrowers. First Indiana does not fund these mortgages, but collects a fee for this service. In 2006, First Indiana produced $851,000 of residential loans for brokers and fees of $16,000 were recognized. In 2005, First Indiana produced $3,573,000 of residential loans for brokers and fees of $66,000 were recognized. In 2004, First Indiana produced $12,458,000 of residential loans for brokers and fees of $207,000 were recognized. Broker loan fees decreased in 2005 from 2004 in part due to a shift in the method of delivering residential loans to the secondary market. In 2005 a greater percentage of residential loans were delivered by the Bank as correspondent with the gain recorded in gain on the sale of loans rather than as a broker with the gain recorded in other non-interest income.

In the fourth quarter of 2006, the Bank established First Indiana Mortgage, LLC (“First Indiana Mortgage”), a joint venture with Wells Fargo Mortgage. First Indiana Mortgage operates within the Indianapolis marketplace utilizing selected branch offices and offers a wide array of mortgage products to First Indiana clients and

 

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prospects. The purpose of this joint venture is to expand and deepen relationships with First Indiana clients and provide products that the Bank is unable to profitably provide. The Bank expects this collaboration to both increase fee income and reduce expenses (primarily related to residential loan originations). First Indiana Mortgage’s activities will not conflict with our consumer finance business, but will reduce the amount of residential mortgages on the balance sheet as the existing portfolio pays down.

Investments

The relative mix of investment securities and loans in the Bank’s portfolio is dependent upon management’s evaluation of the yields available on loans compared with investment securities. The Board of Directors has established an investment policy, and management meets quarterly with the Risk Committee of the Board and provides information relating to types of investments, relative amounts, and maturities. Credit risk is controlled by limiting the number, size, and type of investments and by approving the brokers and agents through which investments are made.

At December 31, 2006, First Indiana’s investments totaled $282,833,000, or 13.1 percent of total assets, and consisted of securities available for sale, carried at fair market value, and other investments carried at cost.

The distribution of securities available for sale is detailed below.

 

     December 31
(Dollars in Thousands)    2006    2005    2004

U.S. Government Treasuries, Agencies & Other

   $ 206,011    $ 163,461    $ 137,268

Mortgage-Backed Securities

     56,816      69,515      80,001

Other Asset-Backed Securities

     —        —        —  
                    

Total

   $ 262,827    $ 232,976    $ 217,269
                    

U.S. Treasuries, Agencies and Other included $1,165,000 of Fannie Mae and Freddie Mac preferred stock at December 31, 2004. Other-than-temporary impairment losses of $299,000 were recognized in 2004 on the Bank’s holdings of Fannie Mae and Freddie Mac preferred stock. This preferred stock was sold in the first quarter of 2005 at an additional loss of $9,000.

At December 31, 2006, securities available for sale had the following maturity and yield characteristics.

 

     Due in One
Year or Less
    Due after One Year
through Five
Years
    Due after Five Years
through Ten
Years
    Due after
Ten Years
    Total  
(Dollars in Thousands)   Book
Value
  Yield     Book
Value
  Yield     Book
Value
  Yield     Book
Value
  Yield     Book
Value
  Yield  

U.S. Government Treasuries, Agencies & Other

  $ 117,307   4.14 %   $ 88,704   4.14 %   $ —     —   %   $ —     —   %   $ 206,011   4.14 %

Mortgage-Backed Securities

    —     —         45,402   3.81       11,167   4.15       247   5.94       56,816   3.89  
                                       

Total

  $ 117,307   4.14 %   $ 134,106   4.03 %   $ 11,167   4.15 %   $ 247   5.94 %   $ 262,827   4.08 %
                                       

For additional information concerning securities available for sale, see Note 4 of the Notes to Consolidated Financial Statements.

Included in other investments are Federal Reserve Bank stock, Federal Home Loan Bank stock, and Common Securities in the Corporation’s grantor trusts: First Indiana Capital Trust I and First Indiana Capital Statutory Trust II. The Bank is required by the Federal Reserve Board to own shares of Federal Reserve Bank (“FRB”) stock. FRB stock, which is a restricted investment security, is carried at its cost. In addition, as a

 

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member of the Federal Home Loan Bank of Indianapolis (“FHLB”), the Bank is required to own shares of capital stock in the FHLB. FHLB stock is carried at its cost, since it is a restricted investment security. The Bank is required to hold FHLB stock with a value of approximately $5,949,000. The Corporation’s holdings in FHLB stock are redeemable only upon five years’ notice to the FHLB. In connection with the formation of First Indiana Capital Trust I (“Trust I”) and First Indiana Capital Statutory Trust II (“Trust II”), Trust I and Trust II issued Common Securities to the Corporation. The Common Securities for each trust are carried at their cost since they are restricted investment securities. The Common Securities are not redeemable until the related subordinated notes are redeemed (according to the subordinated note terms).

The composition of other investments is summarized as follows.

 

      December 31
(Dollars in Thousands)    2006    2005    2004

FRB Stock

   $ 1,110    $ 1,110    $ 1,110

FHLB Stock

     18,152      24,686      24,173

Capital Trusts Common Securities

     744      744      744
                    
   $ 20,006    $ 26,540    $ 26,027
                    

Sources of Funds

General. Deposits are an important source of the Bank’s funds for use in lending and for other general business purposes. In addition to deposits, the Bank derives funds from repayments of loans and investment securities, Federal Home Loan Bank advances, federal funds purchased, repurchase agreements, and sales of loans. Repayments of loans and investment securities are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used to compensate for reductions in normal sources of funds, such as deposit inflows at less than projected levels, or to support expanded activities. At December 31, 2006, First Indiana Corporation’s outside sources of funds included a $10,000,000 line of credit with a commercial bank and subordinated notes.

Deposits. Growth in deposits has reduced funding costs, improved the liquidity position of the Bank, and lowered the ratio of loans to deposits. Deposits grew to $1,611,055,000 at December 31, 2006. The growth can largely be attributed to increases in both commercial savings and retail time deposits, with 141.6 percent and 25.8 percent growth rates, respectively. The Bank experienced a decline in demand deposit balances in 2006. Commercial checking balances declined 33.5 percent, partially offset by growth in retail checking balances of 6.3 percent. Bank initiatives are in place to support more deposit growth through retail branch expansion and maximization of the current retail branch network.

The following table reflects the increase (decrease) in various types of deposits offered by the Bank for each of the periods indicated.

 

(Dollars in Thousands)   Balance at
December 31,
2006
  2006
Net Increase
(Decrease)
    Balance at
December 31,
2005
  2005
Net Increase
(Decrease)
    Balance at
December 31,
2004
  2004
Net Increase
(Decrease)
    Balance at
December 31,
2003

Non-Interest-Bearing Demand

  $ 242,975   $ (25,707 )   $ 268,682   $ 3,479     $ 265,203   $ 29,392     $ 235,811

Interest-Bearing Demand

    194,878     (34,998 )     229,876     39,965       189,911     (27,442 )     217,353

Savings

    664,474     174,761       489,713     26,034       463,679     62,875       400,804

CDs under $100,000

    349,239     64,034       285,205     23,037       262,168     (49,883 )     312,051

CDs $100,000 and Greater

    159,489     (16,311 )     175,800     (13,936 )     189,736     (134,217 )     323,953
                                               

Total Deposits

  $ 1,611,055   $ 161,779     $ 1,449,276   $ 78,579     $ 1,370,697   $ (119,275 )   $ 1,489,972
                                               

 

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The Bank currently issues certificates of deposit in denominations of $100,000 and greater to public entities such as municipalities and to retail customers. Certificates of deposit of $100,000 or more totaled $159,489,000 at December 31, 2006, compared with $175,800,000 at December 31, 2005 and $189,736,000 at December 31, 2004. At December 31, 2006, these certificates of deposit included no brokered funds, $10,012,000 in public funds, and $149,477,000 in retail funds. At December 31, 2005, these certificates of deposit included no brokered funds, $58,133,000 in public funds, and $117,667,000 in retail funds. At December 31, 2004, these certificates of deposit included $19,844,000 in brokered funds, $86,475,000 in public funds, and $83,417,000 in retail funds. The Bank’s certificates of deposit of $100,000 or more at December 31, 2006, the maturities of such deposits, and the percentage of total deposits represented by these certificates are set forth in the table below.

 

(Dollars in Thousands)   Three
Months or
Less
  Over Three
Months to Six
Months
  Over Six
Months to
One Year
  Over One
Year
  Total   Percent of
Deposits
 

Certificates of Deposit $100,000
and Greater

  $ 59,359   $ 26,789   $ 45,780   $ 27,561   $ 159,489   9.9 %
                                   

Borrowings. The Federal Home Loan Bank of Indianapolis functions as a central bank providing credit for depository institutions in Indiana and Michigan. As a member of the FHLB, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of the Bank’s residential mortgage loans, low loan-to value home equity loans, and other assets, subject to credit standards. The FHLB advances are made pursuant to several different credit programs, each with its own interest rate and range of maturities. At December 31, 2006, the Bank had $19,666,000 in FHLB advances, with a weighted average interest rate of 5.39 percent. All of these advances carried fixed interest rates. The FHLB had the right to require the Bank to repay $10,000,000 of putable advances at certain designated dates.

The Bank and approved correspondent banks from time to time enter into short-term borrowing agreements that are classified as federal funds purchased. These borrowings are not collateralized and generally have maturities from one to 30 days. At December 31, 2006, the Bank did not have federal funds purchased borrowings.

First Indiana has repurchase agreements with depositors, under which clients’ funds are invested daily into a non-FDIC-insured, interest-bearing account. In addition, the Bank from time to time enters into repurchase agreements with registered government securities dealers as a short-term source of borrowing. At December 31, 2006, the Bank had repurchase agreements totaling $277,888,000, with a weighted average interest rate of 4.08 percent. First Indiana’s repurchase agreements are collateralized by qualifying investment securities. Additional information relating to short-term borrowings may be found in Note 10 of the Notes to Consolidated Financial Statements.

In October 2002, the Corporation formed First Indiana Capital Trust I (“Trust I”) for the purpose of issuing $12,000,000 of trust preferred securities to the public. This unconsolidated grantor trust’s sole assets are junior subordinated notes issued by the Corporation. The notes have a stated term of 30 years (October 30, 2032) but may be redeemed at par in part or in full beginning October 30, 2007, and any calendar quarter end date thereafter, subject to approval by the Federal Reserve Board. The notes have a fixed rate of interest of 6.92 percent through October 30, 2007, and a floating rate of interest, reset quarterly, equal to the London interbank offered rate (“LIBOR”) plus 3.35 percent thereafter to maturity. Interest is payable quarterly and the distribution rate of the trust preferred securities is equal to the interest rate of the notes. The balance of the Trust I junior subordinated notes, net of unamortized discount, was $12,337,000 at December 31, 2006, and $12,295,000 at December 31, 2005.

In June 2003, First Indiana formed First Indiana Capital Statutory Trust II (“Trust II”) for the purpose of issuing $12,000,000 in trust preferred securities through a private placement. This unconsolidated grantor trust’s sole assets are junior subordinated notes issued by the Corporation. The notes have a stated term of 30 years

 

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(June 26, 2033) but may be redeemed at par in part or in full beginning June 26, 2008, and quarterly thereafter, subject to approval by the Federal Reserve Board. The notes have a fixed rate of interest of 5.55 percent through June 26, 2008, and a floating rate of interest, reset quarterly, equal to LIBOR plus 3.10 percent thereafter to maturity. Interest on the notes is payable quarterly in arrears. The distribution rate on the trust preferred securities equals the interest rate of the notes. The balance of the Trust II junior subordinated notes, net of unamortized discount, was $12,300,000 at December 31, 2006, and $12,252,000 at December 31, 2005.

In connection with the notes issued to Trust I and Trust II, the Corporation has the right to defer payment of interest on the notes at any time or from time to time for a period not to exceed five years, provided that no extension period may extend beyond the stated maturity of the notes. During any such extension period, distributions on the trust preferred securities will also be deferred and First Indiana’s ability to pay dividends on its common stock will be restricted. With respect to Trust I and Trust II, the trust preferred securities are subject to mandatory redemption upon repayment of the notes at their stated maturity dates or their earlier redemption at a redemption price equal to their liquidation amount plus accrued distributions to the date fixed for redemption and the premium, if any, paid by the Corporation upon concurrent repayment of the notes. Periodic cash payments and payments upon liquidation or redemption with respect to trust preferred securities are guaranteed by First Indiana to the extent of funds held by the grantor trust (“the Preferred Securities Guarantee”). The Preferred Securities Guarantee, when taken together with the Corporation’s other obligations, including its obligations under the notes, will constitute a full and unconditional guarantee, on a subordinated basis, by the Corporation of payments due on the trust preferred securities.

In December 2003, FASB issued revised Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) that required the deconsolidation of these statutory trusts. In July 2003, the Board of Governors of the Federal Reserve System issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. In May 2004, the Federal Reserve issued a proposal to allow the continued inclusion of trust preferred securities in Tier 1 capital. However, there can be no assurance that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier 1 capital.

In November 2003, the Corporation issued $22,500,000 in ten-year subordinated notes with a 7.50 percent fixed rate of interest. Interest is payable semi-annually and the notes qualify as Tier 2 capital for regulatory purposes. The balance of these subordinated notes, net of discount, was $22,268,000 at December 31, 2006, and $22,234,000 at December 31, 2005.

 

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ASSET QUALITY

General

The Corporation’s asset quality is directly affected by the credit risk of the assets on the Bank’s balance sheet. Most of the Bank’s credit risk is concentrated in its loan portfolios. There are varying degrees of credit risk within each of the individual loan portfolios. Credit risk is managed through asset selection, focusing on portfolio diversification by loan types, by defining and limiting exposures to a single client or industry, by requiring collateral, and by integrating consistent lending policies and underwriting criteria throughout the credit process. The accurate and timely identification of credit risk is verified independently from the relationship management and loan operation areas of the Bank through the Bank’s loan review process.

Additional information relating to non-performing assets, loan charge-offs, and impaired loans may be found in Note 1, Note 6, and Note 7 of the Notes to Consolidated Financial Statements.

Non-Performing Assets

Non-performing assets consist of non-accrual loans, loans 90 days or more past due and still accruing interest, and foreclosed assets, primarily other real estate owned (“OREO”). Non-performing assets were $13,101,000, or 0.77 percent of loans and foreclosed assets, at December 31, 2006; $4,633,000, or 0.30 percent of loans and foreclosed assets, at December 31, 2005; and $21,445,000, or 1.43 percent of loans and foreclosed assets at December 31, 2004. Non-performing business loans increased to $9,774,000 at December 31, 2006, compared with $1,586,000 at December 31, 2005. During the fourth quarter of 2006, one business relationship with a loan balance of $7,997,000, after charge-off, was added to non-performing loans. This relationship was included as a potential problem loan at December 31, 2005 and December 31, 2004. Commercial real estate non-performing loans at December 31, 2006 totaled $932,000 compared to $0 at December 31, 2005. One commercial real estate relationship totaling $723,000, after charge-off, was added to non-performing loans during the fourth quarter of 2006. Non-performing consumer loans were $1,362,000 at year-end 2006, compared with $2,148,000 at year-end 2005. The decrease is attributable to the improving credit quality for the consumer loan portfolio, which includes active management of non-performing loans through the on-going sale of these loans.

The amount of interest on non-accrual loans that was contractually due in 2006 totaled $254,000. Interest received on these loans in 2006 totaled $1,392,000.

 

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Non-Performing Assets

 

     December 31  
(Dollars in Thousands)    2006     2005     2004     2003     2002  

Non-Performing Loans

          

Non-Accrual Loans

          

Business

   $ 9,064     $ 1,383     $ 10,637     $ 9,483     $ 20,234  

Commercial Real Estate

     723       —         1,184       4,743       2,059  

Single-Family Construction

     —         —         45       7,165       4,286  

Consumer

     917       1,323       3,078       7,402       9,405  

Residential Mortgage

     705       698       961       2,211       2,474  
                                        

Total Non-Accrual Loans

     11,409       3,404       15,905       31,004       38,458  
                                        

Accruing Loans Past Due 90 Days or More

          

Business

     710       203       459       1,053       1,535  

Commercial Real Estate

     209       —         881       —         —    

Single-Family Construction

     —         —         494       354       —    

Consumer

     445       825       2,025       2,691       3,093  

Residential Mortgage

     303       123       —         —         —    
                                        

Total Accruing Loans Past Due 90 Days or More

     1,667       1,151       3,859       4,098       4,628  
                                        

Total Non-Performing Loans

     13,076       4,555       19,764       35,102       43,086  

Foreclosed Assets

     25       78       1,681       3,780       8,670  
                                        

Total Non-Performing Assets

   $ 13,101     $ 4,633     $ 21,445     $ 38,882     $ 51,756  
                                        

Non-Performing Loans to Loans at End of Year

     0.77 %     0.29 %     1.32 %     1.93 %     2.34 %

Non-Performing Assets to Loans and OREO at End of Year

     0.77       0.30       1.43       2.14       2.80  

Potential Problem Assets

Potential problem loans are those loans that are currently performing according to their repayment terms, but the borrowers’ financial operations or financial condition caused the Bank’s management to question their ability to comply with present repayment terms in the future.

The Bank had $16,511,000 in potential problem loans at December 31, 2006. Of this amount, $13,114,000 represented loans to 15 separate business credits with an average loan amount of $874,000. These business loans are collateralized with real estate and other assets. Four of the business credits have a current loan amount over $1,000,000. The remaining potential problem loans totaled $3,397,000 and consisted of nine construction and commercial real estate credits. These construction and commercial real estate loans are collateralized with completed residential and commercial real estate and developed lots.

Potential problem loans decreased $16,831,000 from December 31, 2005. Included in this decrease is the one business relationship that was added to non-performing loans during the fourth quarter of 2006 with a balance of $7,997,000, after charge-off. Included in the net decrease is one credit totaling $707,000 that was added to potential problem loans during 2006.

Allowance for Loan Losses

An analysis of the adequacy of the allowance is completed each quarter and reviewed and approved by the Risk Committee of the Board of Directors. The allowance for loan losses is maintained at the level deemed adequate to cover losses inherent in the loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. While

 

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management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes to one or more risk factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review this allowance and may require the Corporation to recognize additions to the allowance based on their judgment about information available to them at the time of their examination.

An assessment of the credit risk of each loan greater than $250,000 in the commercial portfolio, including business, construction, and commercial real estate loans, is completed, which results in a risk rating (risk grade). Each relationship manager is responsible and accountable for the timely and accurate risk rating of each credit within his or her loan portfolio. The Bank utilizes a ten grade risk rating system with six pass grades and four criticized grades which correlate to the banking regulators’ grades of special mention, substandard, doubtful, and loss. For homogeneous loan portfolios and smaller balance commercial loans, loans that are current or less than 90 days past due are considered pass loans and loans 90 days or more past due are assigned a risk rating of substandard.

The determination of the adequacy of the allowance for loan losses is based on projections and estimates concerning portfolio trends and credit losses. However, there are several other factors which impact the projections and estimates, which include national and local economic trends, portfolio management and the assessment of credit risk on performing loans and non-performing loans. Regardless of the extent of the analysis in determining the adequacy of the allowance for loan losses, certain inherent but undetected losses are probable in the loan portfolio. These undetected losses are due to several factors, including delays in obtaining information concerning a customer’s financial condition, interpretation of economic trends and events, the sensitivity of assumptions, and the judgmental nature of loss estimates. Therefore, the analysis incorporates qualitative management factors to address the external factors that impact credit losses and the level of imprecision in the analysis.

The reserve requirement for each loan portfolio is segmented into four components: (i) the required reserve on pass loans; (ii) the required reserve on performing criticized loans; (iii) the required reserve on non-performing loans; and (iv) the qualitative management adjustment (“Management Factors”). The loans and groups of loans in the criticized risk rating categories that are both performing and non-performing loans inherently have a higher degree of risk and are generally assigned a higher reserve requirement, or in the case of impaired collateral dependent loans, the amount of the impairment may be charged off. The allowance is allocated to each portfolio based on the sum of the reserve requirement established for each of the four components.

The assessment of Management Factors is qualitative and their absolute correlation with credit losses cannot be determined. Therefore, the required reserve is determined based on a range for the Management Factors. An upper limit is calculated based on the assigned weight plus 10.0 percentage points, and a lower limit is established based on the assigned weight less 5.0 percentage points.

 

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Allocation of Allowance for Loan Losses

The following table presents an allocation of the Bank’s allowance for loan losses at the dates indicated.

 

     December 31  
    2006     2005     2004     2003     2002  
(Dollars in Thousands)   Amount   Percent of
Loan Type
to Total
Loans
    Amount   Percent of
Loan Type
to Total
Loans
    Amount   Percent of
Loan Type
to Total
Loans
    Amount   Percent of
Loan Type
to Total
Loans
    Amount   Percent of
Loan Type
to Total
Loans
 

Balance at End of Period Applicable to:

                   

Business Loans

  $ 12,970   36.6 %   $ 18,733   34.8 %   $ 30,287   31.1 %   $ 30,449   28.4 %   $ 15,959   27.3 %

Commercial Real Estate Loans

    1,550   11.3       1,281   10.7       1,712   11.7       1,400   9.8       2,154   8.0  

Single-Family Construction Loans

    603   7.5       415   5.9       616   3.9       5,798   10.6       1,797   11.6  

Consumer Loans

    7,676   28.7       7,815   31.9       8,355   34.7       10,463   33.7       17,576   36.2  

Residential Mortgage Loans

    787   15.9       360   16.7       413   18.6       656   17.5       546   16.9  

Unallocated

    6,877   —         10,564   —         11,789   —         4,431   —         6,437   —    
                                                           
  $ 30,463   100.0 %   $ 39,168   100.0 %   $ 53,172   100.0 %   $ 53,197   100.0 %   $ 44,469   100.0 %
                                                           

Summary of Allowance for Loan Loss Activity

The provision for loan losses was a negative $1,600,000 for 2006, compared with a negative $3,200,000 for 2005 and a charge of $11,550,000 for 2004. The negative provisions for loan losses for 2006 and 2005 reflect continued improvements in the credit quality of the loan portfolio. Net loan charge-offs for 2006 totaled $7,105,000, compared with $10,804,000 for 2005 and $11,575,000 for 2004. In addition, net charge-offs to average loans in 2006 was 0.44 percent compared with a net charge-off ratio of 0.70 percent in 2005 and 0.69 percent in 2004. At December 31, 2006, net loans charged-off included one business loan that was charged-off, in the fourth quarter of 2006, totaling $3,626,000. In addition, net loan charge-offs in 2005 included $5,240,000 related to one non-accrual business loan. Net consumer loan charge-offs were $2,828,000 for 2006, compared with $5,265,000 for 2005 and $4,095,000 for 2004. The decreased provision for loan losses in 2005, compared with 2004, reflected the improved credit quality of the loan portfolio and a stabilized level of net charged-off loan amounts. Throughout 2004, the Bank developed and implemented specific initiatives to actively manage and resolve non-performing loans and improve credit quality by reducing risk in the loan portfolio through asset selection and management.

The unallocated portion of the allowance for loan losses decreased to $6,877,000 at December 31, 2006, compared with $10,564,000 at December 31, 2005 and $11,789,000 at December 31, 2004. Although the unallocated portion of the allowance for loan losses decreased 34.9 percent in absolute dollars in 2006, the percent of unallocated allowance to total allowance decreased to 22.6 percent at year-end 2006, compared with 27.0 percent at year-end 2005. The decrease in the unallocated reserve is consistent with the improving credit quality trends within the loan portfolio. The allowance for loan losses, including the current level of the unallocated reserve, is adequate and is within the policy and methodology discussed above.

The ratio of the allowance for loan losses to loans at December 31, 2006, was 1.80 percent, compared with 2.50 percent and 3.54 percent at December 31, 2005 and 2004, respectively. The decreases in the allowance for loan losses to total loans ratio for 2006 and 2005 are attributable to increases in total loans for the periods and decreases in the allowance for loan losses. In addition, the lower ratios reflect the continued credit quality improvement in the Bank’s loan portfolio during the twelve months ended December 31, 2006, as compared to the same period of 2005. The decrease in the allowance is directionally consistent with the improving credit quality of the portfolio affirmed by lower net charge-offs for the year ending December 31, 2006.

The ratio of the allowance for loan losses to non-performing loans at December 31, 2006 decreased to 232.52 percent, compared to 859.89 percent at December 31, 2005, while this ratio was 269.03 percent at

 

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December 31, 2004. The decrease in this ratio for 2006 is directly attributable to the increase in the level of non-performing loans, an increase of $8,521,000 from 2005. This 2006 increase in non-performing loans was primarily due to one business loan outstanding, totaling $7,997,000, which was placed on non-accrual with a corresponding charge-off of $3,626,000 during the fourth quarter of 2006. This credit has been with the Bank since 1992 and has been actively managed for some time. Over the past few years, the Bank has been able to manage this credit down from a high of $25 million. Management believes that the classification of this loan to non-performing status is not indicative of prevalent credit quality deterioration within the loan portfolio. The increase in this ratio for 2005 from 2004 is directly attributable to the decrease in the level of non-performing loans, a $15,209,000 decrease from 2004. This decrease is evident of the credit quality improvement in the Bank’s loan portfolio that are a result of management’s ongoing review activities to manage and resolve non-performing loans, as well as processes to improve credit quality and reduce risk in the loan portfolios.

Changes in Allowance for Loan Losses

 

      Years Ended December 31  
(Dollars in Thousands)    2006     2005     2004     2003     2002  

Balance of Allowance for Loan Losses at Beginning of Year

   $ 39,168     $ 53,172     $ 53,197     $ 44,469     $ 37,135  

Charge-Offs

          

Business

     4,936       6,719       9,963       22,820       6,813  

Commercial Real Estate

     498       —         630       101       729  

Single-Family Construction

     —         —         1,973       5,026       641  

Consumer

     4,926       7,215       4,760       5,737       6,323  

Residential Mortgage

     430       224       200       157       150  
                                        

Total Charge-Offs

     10,790       14,158       17,526       33,841       14,656  

Recoveries

          

Business

     1,501       889       4,752       1,155       293  

Commercial Real Estate

     10       278       49       34       15  

Single-Family Construction

     73       237       485       254       72  

Consumer

     2,098       1,950       665       878       851  

Residential Mortgage

     3       —         —         7       3  
                                        

Total Recoveries

     3,685       3,354       5,951       2,328       1,234  
                                        

Net Charge-Offs

     7,105       10,804       11,575       31,513       13,422  

Provision for Loan Losses

     (1,600 )     (3,200 )     11,550       38,974       20,756  

Allowance Related to Bank Acquired

     —         —         —         1,709       —    

Transfer to Reserve for Off-Balance Sheet Credit Exposures

     —         —         —         (442 )     —    
                                        

Balance of Allowance for Loan Losses at End of Year

   $ 30,463     $ 39,168     $ 53,172     $ 53,197     $ 44,469  
                                        

Net Charge-Offs to Average Loans

     0.44 %     0.70 %     0.69 %     1.68 %     0.74 %

Allowance for Loan Losses to Loans at End of Year

     1.80       2.50       3.54       2.93       2.42  

Allowance for Loan Losses to Non-Performing Loans

     232.52       859.89       269.03       151.55       103.21  

 

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LIQUIDITY AND MARKET RISK MANAGEMENT

Liquidity Management

First Indiana Corporation is a financial holding company and has conducted substantially all of its operations through the Bank. As a result, the ability to finance the Corporation’s activities and fund interest on its debt depends primarily upon the receipt of earnings from the Bank that it pays to the holding company through dividends. The Corporation had no significant assets other than its investment in the Bank and a receivable of $14,363,000 due from the Bank at December 31, 2006. Additionally, First Indiana Corporation has a $10,000,000 line of credit with a commercial bank. In 2006, the Corporation purchased on the open market 629,756 shares of its common stock for $16,765,000 and received $1,434,000 in proceeds from the exercise of stock options.

The Corporation is not subject to any bank regulatory restrictions on the payment of dividends to its shareholders although Federal Reserve Board policy and capital maintenance requirements may impose practical limits on the amount of dividends that can be paid. See Part I, Item 1, “Business – Supervision and Regulation.” However, applicable laws and regulations limit the amount of dividends the Bank may pay. Prior regulatory approval is required if dividends to be declared by the Bank in any year would exceed net earnings of the current year (as defined under the National Bank Act) plus retained net profits for the preceding two years. At January 1, 2007, the Bank could have paid dividends to the Corporation of approximately $888,000 without regulatory approval. The Bank paid dividends of $39,100,000 in 2006. Due to the payment of an $11,000,000 special dividend in January 2003 (to partially fund the acquisition of MetroBanCorp), the Bank sought and received approval from the Office of the Comptroller of the Currency (“OCC”) to make its regularly scheduled dividend payments in 2005, not to exceed $20,000,000. The Bank paid dividends of $20,000,000 to the Corporation in 2005. The Bank sought and received approval from the OCC to make its regularly scheduled dividend payments in 2004, not to exceed $19,000,000. The Bank paid dividends of $16,000,000 to the Corporation in 2004. Under federal law, a depository institution is prohibited from paying a dividend if the depository institution would thereafter be “undercapitalized” as determined by the federal bank regulatory agencies. While the Bank is currently classified as “well-capitalized” and should have sufficient net income to fund projected liquidity needs, any failure by the Bank in the future to generate sufficient net income or maintain sufficient levels of capital to permit payment of dividends would result in its inability to pay dividends to the Corporation.

The Bank’s primary source of funds is deposits, which were $1,611,055,000 at December 31, 2006, and $1,449,276,000 at December 31, 2005. The Bank also relies on advances from the Federal Home Loan Bank of Indianapolis, short term borrowings, loan payments, loan payoffs, and sale of loans as sources of funds. Although the Bank continues to rely on deposits as its chief source of funds, the use of borrowed funds continues to be an important component of the Bank’s liquidity. Scheduled loan payments are a relatively stable source of funds, but loan payoffs, the sale of loans, and deposit inflows and outflows fluctuate, depending on interest rates and economic conditions. However, management does not expect any of these fluctuations to occur in amounts that would affect the Corporation’s ability to meet consumer demand for liquidity or regulatory liquidity requirements.

The Bank’s primary use of funds is loans, which totaled $1,694,687,000 at December 31, 2006, and $1,567,186,000 at December 31, 2005. In addition, the Bank invests in short-term investments and securities available for sale.

 

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The Corporation and its subsidiaries had the following obligations to make payments under long term debt (excluding interest), lease agreements, and pension plans at December 31, 2006.

 

(Dollars in Thousands)    2007    2008 - 2009    2010 - 2011    After
2011
   Total

FHLB Advances (1)

   $ —      $ 10,000    $ —      $ 9,666    $ 19,666

Subordinated Notes

     —        —        —        46,905      46,905

Operating Leases

     5,586      9,677      7,176      4,324      26,763

Defined Benefit Pension Plan (2)

     2,604      —        —        —        2,604

Supplemental Pension (3)

     1,103      2,334      2,550      5,222      11,209
                                  

Total Contractual Cash Obligations

   $ 9,293    $ 22,011    $ 9,726    $ 66,117    $ 107,147
                                  

(1) The FHLB has the option to require the Bank to repay $10,000,000 at certain designated dates.

 

(2) Estimated cash contributions for 2007 were based upon actuarial estimates. The Corporation was unable to develop a reasonable estimate for future contributions for years after 2007. Future contributions are impacted by future levels of interest rates, investment fund performance, and increases in beneficiary compensation.

 

(3) These calculations assume plan beneficiaries retire upon attaining age 65, or immediately if already over age 65, and elect a lump sum payment. Certain participants have their benefit defined as a notional account balance that is tracked by the Corporation and paid out over the course of their future life expectancy. The estimated future benefit payments reflect these expected cash flows.

At December 31, 2006, the Bank had the following outstanding commitments to fund lines of credit, letters of credit, and loans.

 

     Amount of Commitment Expiration per Period
(Dollars in Thousands)    Total
Commitments
   Less than
One Year
   1-3 years    3-5 years    Thereafter

Lines of Credit:

              

Business Loans

   $ 260,851    $ 202,375    $ 43,235    $ 12,813    $ 2,428

Commercial Real Estate Loans

     46,054      792      21,786      22,247      1,229

Single-Family Construction Loans

     30,314      14,480      15,834      —        —  

Home Equity Loans

     179,148      7,175      13,021      18,818      140,134
                                  

Total Lines of Credit

     516,367      224,822      93,876      53,878      143,791

Standby Letters of Credit

     31,653      14,795      15,763      997      97

Commitments to Originate Loans:

              

Business Loans

     69,946      69,946      —        —        —  

Commercial Real Estate Loans

     26,638      26,638      —        —        —  

Home Equity Loans

     8,520      8,520      —        —        —  

Other Consumer Loans

     365      365      —        —        —  

Residential Loans

     —        —        —        —        —  
                                  

Total Commitments to Originate Loans

     105,469      105,469      —        —        —  
                                  

Total Commercial Commitments

   $ 653,489    $ 345,086    $ 109,639    $ 54,875    $ 143,888
                                  

Of the lines of credit and commitments to fund loans at December 31, 2006, substantially all are variable interest rate products.

Standby letters of credit are contingent commitments issued by the Corporation to support the obligations of a customer to a third party. Standby letters of credit are issued to support public and private financing, and other

 

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financial or performance obligations of customers. The credit risk involved in issuing standby letters of credit is the same as that involved in extending loans to customers and, as such, is collateralized when necessary. Standby letters of credit are generally collateralized by assets of the borrower. Evaluation of the credit risk associated with these letters of credit is part of the Bank’s commercial loan review process.

Asset/Liability Management

First Indiana engages in formal asset/liability management with objectives to manage interest rate risk, ensure adequate liquidity, and coordinate sources and uses of funds. The management of interest rate risk entails the control, within acceptable guidelines, of the impact on earnings caused by fluctuating interest rates and changing rate relationships. In this process, management uses an earnings simulation model to identify and measure interest rate sensitivity. The Asset/Liability Committee (“ALCO”) reviews the earnings impact of various changes in interest rates each month and manages the risk to maintain an acceptable level of change in net interest income. The Risk Committee of the Board of Directors also reviews this information quarterly.

The Corporation uses a model that measures interest rate sensitivity to determine the impact on net interest income of immediate and sustained upward and downward movements in interest rates. Incorporated into the model are assumptions regarding the current and anticipated interest rate environment, estimated prepayment rates of certain assets and liabilities, forecasted loan and deposit originations, contractual maturities and renewal rates on certificates of deposit, estimated borrowing needs, expected repricing spreads on variable-rate products, and contractual maturities and repayments on lending and investment products. The model incorporates interest rate sensitive instruments that are held to maturity or available for sale. The Corporation has no trading assets. Based on the information and assumptions in effect at December 31, 2006, the model forecasts that a 100 basis point increase in interest rates over a 12-month period would result in a 0.1 percent increase in net interest income while a 100 basis point decrease in interest rates would result in a 2.1 percent decrease in net interest income. Because of the numerous assumptions used in the computation of interest rate sensitivity, and the fact that the model does not assume any actions ALCO could take in response to the change in interest rates, the model forecasts may not be indicative of actual results.

Another interest rate risk measurement used by the Corporation is the fair value at risk under change in market interest rates. The Corporation uses modeling techniques with assumptions similar to the interest sensitivity model described above to determine the fair value of all asset and liability cash flows. The net change in the fair value of the asset and liability cash flows under different parallel rate movements is the amount of fair value at risk. The most recent economic value of equity at risk in a 100 basis point shift in rates was less than 5 percent of the market value of the Corporation.

The Corporation also monitors interest rate sensitivity using traditional gap analysis. Gap analysis is a static management tool used to identify mismatches in the repricing of assets and liabilities within specified periods of time. Since it is a static indicator it does not attempt to predict the net interest income of a dynamic business in a rapidly changing environment. Significant adjustments may be made when the rate outlook changes. At December 31, 2006, First Indiana’s six-month and one-year cumulative gaps stood at a negative 1.18 percent and a negative 2.46 percent of total interest-earning assets. This means that 1.18 and 2.46 percent of First Indiana’s liabilities will reprice within six months and one year, respectively, without a corresponding repricing of earning assets. This compares with a positive six-month gap of 7.41 percent and a positive one-year gap of 9.25 percent at December 31, 2005. The Corporation became liability sensitive in 2006 as certificates of deposit which formerly repriced in the one-to-five year range moved to the over 180 days to one year and within six months repricing categories. In addition, growth of business and retail deposits is primarily reflected in the repricing categories of under one year. The Corporation seeks to maintain a relatively neutral interest rate sensitivity position primarily through the pricing and term features its loan and deposit products. However, interest rate sensitivity may also be managed through the selective additions of certain investments and, short-term and long-term borrowings.

 

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Interest Rate Sensitivity

The following table shows First Indiana’s interest rate sensitivity at December 31, 2006 and 2005.

 

(Dollars in Thousands)    Rate     Balance    Percent of
Total
   

Within

180 Days

    Over 180
Days to
One Year
    Over One
Year to
Five Years
    Over Five
Years
 

Interest-Earning Assets

               

Interest-Bearing Due from Banks

   5.20 %   $ 6,317    0.31 %   $ 6,317     $ —       $ —       $ —    

Federal Funds Sold

   5.20       41,500    2.05       41,500       —         —         —    

Securities Available for Sale

   5.07       262,827    12.98       71,620       52,530       138,677       —    

Other Investments

   4.65       20,006    0.99       —         —         —         20,006  

Loans (1)

               

Business

   7.91       619,891    30.60       467,786       11,768       140,337       —    

Commercial Real Estate

   8.45       191,020    9.43       169,521       3,186       6,094       12,219  

Single-Family Construction

   8.57       126,916    6.27       126,916       —         —         —    

Consumer

   7.32       488,173    24.10       217,900       24,305       150,792       95,176  

Residential Mortgage

   5.39       268,687    13.27       47,362       42,233       152,607       26,485  
                                               
   7.06     $ 2,025,337    100.00 %     1,148,922       134,022       588,507       153,886  
                                               

Interest-Bearing Liabilities

               

Deposits

               

Demand Deposits (2)

   0.60     $ 194,878    11.38 %     20,024       —         —         174,854  

Savings Deposits (2)

   3.75       664,474    38.80       615,691       1,251       10,007       37,525  

Certificates of Deposit under $100,000

   4.74       349,239    20.39       173,051       100,478       75,555       155  

Certificates of Deposit $100,000 or Greater

   5.13       159,489    9.31       86,148       45,780       27,561       —    
                                               
   3.71       1,368,080    79.88       894,914       147,509       113,123       212,534  

Borrowings

               

Short-Term Borrowings

   4.08       277,888    16.23       277,888       —         —         —    

FHLB Advances

   5.39       19,666    1.15       —         —         10,710       8,956  

Subordinated Notes

   7.15       46,905    2.74       —         12,409       12,252       22,244  
                                               
   3.89       1,712,539    100.00 %     1,172,802       159,918       136,085       243,734  
                   

Net – Other (3)

       312,798        —         —         —         312,798  
                                           

Total

     $ 2,025,337        1,172,802       159,918       136,085       556,532  
                                           

Rate Sensitivity Gap

          $ (23,880 )   $ (25,896 )   $ 452,422     $ (402,646 )
                                       

December 31, 2006 – Cumulative Rate Sensitivity Gap

          $ (23,880 )   $ (49,776 )   $ 402,646    
                                 

Percent of Total Interest-Earning Assets

            -1.18 %     -2.46 %     19.88 %  
                                 

December 31, 2005 – Cumulative Rate Sensitivity Gap

          $ 136,403     $ 170,253     $ 482,089    
                                 

Percent of Total Interest-Earning Assets

            7.41 %     9.25 %     26.20 %  
                                 

(1) The distribution of fixed rate loans and mortgage-backed securities is based upon contractual maturity and scheduled contractual repayments adjusted for estimated prepayments. The distribution of adjustable rate loans is based upon the earliest repricing date for each loan. Included in consumer loans are $24.6 million of home equity loans held for sale.

 

(2) A portion of these deposits has been included in the Over Five Years category to reflect management’s assumption that these accounts are not rate-sensitive. This assumption is based upon the historic trends on these types of deposits experienced through periods of significant increases and decreases in interest rates with minimal changes in rates paid on these deposits. The rates represent a blended rate on all deposit types in the category.

 

(3) Net – Other is the excess of non-interest-bearing liabilities and capital over non-interest-bearing assets.

 

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CAPITAL

At December 31, 2006, shareholders’ equity was $182,094,000, or 8.42 percent of total assets, compared with $175,442,000, or 8.92 percent of total assets, at December 31, 2005, and $172,143,000, or 9.07 percent of total assets, at December 31, 2004. At December 31, 2006, the Corporation’s tangible capital (shareholders’ equity minus the sum of goodwill and other intangible assets) was $148,548,000, or 6.98 percent of tangible assets (total assets minus the sum of goodwill and other intangible assets), compared with $141,554,000, or 7.33 percent of tangible assets at December 31, 2005, and $137,559,000, or 7.38 percent of tangible assets at December 31, 2004. In 2006, shareholders’ equity was reduced by the Corporation’s purchase of 629,756 shares of its common stock on the open market for $16,765,000. In 2005, shareholders’ equity was reduced by the Corporation’s purchase of 689,536 shares of its common stock on the open market for $16,859,000. Shareholders’ equity decreased in 2004 primarily due to the fourth quarter repurchase of 2,162,500 shares of common stock through a self-tender offer which reduced shareholders’ equity by $40,901,000. The decrease in the equity ratios in 2004 due to the stock repurchase was partially offset by the reduction in total assets during the year.

First Indiana paid a dividend of $0.20 per common share in each of the four quarters of 2006, an increase of 25.0 percent from the $0.16 dividend per common share paid in the third and fourth quarters of 2005. On January 18, 2006, the Board of Directors approved a five-for-four stock split. The stock split was effective February 27, 2006, to shareholders of record as of February 13, 2006. All share and per share information herein has been restated to reflect the stock split. Also on January 17, 2007, the Board of Directors approved a quarterly dividend of $0.21 per common share, an increase of 5 percent from the quarterly dividends paid in 2006, payable March 15, 2007, to shareholders of record as of March 6, 2007. This will be the 81st consecutive quarter First Indiana has paid a cash dividend.

See Part II, Item 5, “Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities” and Note 13 of the Notes to Consolidated Financial Statements for additional information on the Corporation’s repurchases of its common stock and its shareholder rights agreement.

Regulatory Capital Requirements

First Indiana Corporation is subject to capital requirements and guidelines imposed on bank holding companies and financial holding companies by the Federal Reserve Board. The Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”) impose similar requirements on First Indiana Bank. The Federal Deposit Insurance Corporation Improvement Act of 1999 (“FDICIA”) established ratios and guidelines for banks to be considered “well-capitalized.” These capital requirements establish higher capital standards for banks and bank holding companies that assume greater risks. For this purpose, a bank holding company’s or a bank’s assets and certain off-balance sheet commitments are assigned to four risk categories, each weighted differently based on credit risk. Total capital, in turn, is divided into two tiers:

 

   

Tier 1 capital, which includes common equity, certain qualifying cumulative and noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries; and

 

   

Tier 2 capital, which includes perpetual preferred stock, and related surplus not meeting the Tier 1 definition, hybrid capital instruments, perpetual debt and mandatory convertible securities, certain term subordinated debt, intermediate-term preferred stock, and allowances for loan and lease losses (subject to certain limitations).

Goodwill, certain intangible assets, and certain other assets must be deducted in calculating the sum of the capital elements.

The Federal Reserve Board, the FDIC, and the OCC have incorporated market and interest rate risk components into their risk-based capital standards. Under these market risk requirements, capital is allocated to

 

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support the amount of market risk related to a financial institution’s ongoing trading activities. The Federal Reserve Board also requires a minimum “leverage ratio” (Tier 1 capital to adjusted average assets) of three percent for bank holding companies that have the highest regulatory rating or have implemented the risk-based capital measures for market risk, or four percent for holding companies that do not meet either of these requirements. The Bank is subject to similar requirements adopted by the OCC.

While the federal regulators may set capital requirements higher than the minimums noted above if circumstances warrant it, no federal banking regulator has imposed any such capital requirements on the Corporation or the Bank.

Under Federal Reserve Board policy, a bank holding company is expected to serve as a source of financial strength to its subsidiary bank and to stand prepared to commit resources to support it (known as the Source of Strength Doctrine). There are no specific quantitative rules on the holding company’s potential liability. If the Bank were to encounter financial difficulty, the Federal Reserve Board could invoke the doctrine and require a capital contribution from the Corporation.

The Corporation formed statutory trusts for the purpose of issuing trust preferred securities. These trust preferred securities are included in the Corporation’s Tier 1 capital and total capital at December 31, 2006 and December 31, 2005. At December 31, 2006 and 2005, the balance of trust preferred securities, net of discount, was $24,637,000 and $24,547,000, respectively.

The following table shows the Corporation’s and the Bank’s capital levels and compliance with all capital requirements at December 31, 2006. In addition, the Bank exceeds the capital levels set by FDICIA for a bank to be considered well-capitalized.

 

      December 31, 2006  
     Actual    

Minimum

Capital Adequacy

   

To be

Well-Capitalized

 
(Dollars in Thousands)    Amount    Ratio     Amount    Ratio     Amount    Ratio  

Leverage (Tier 1 Capital to Average Assets)

               

First Indiana Corporation

   $ 175,348    8.43 %   $ 83,209    4.00 %     N/A    N/A  

First Indiana Bank, N.A.

     177,836    8.56       83,089    4.00     $ 103,862    5.00 %

Tier 1 Capital to Risk-Weighted Assets

               

First Indiana Corporation

   $ 175,348    10.56 %   $ 66,412    4.00 %     N/A    N/A  

First Indiana Bank, N.A.

     177,836    10.74       66,256    4.00     $ 99,384    6.00 %

Total Capital to Risk-Weighted Assets

               

First Indiana Corporation

   $ 218,496    13.16 %   $ 132,824    8.00 %     N/A    N/A  

First Indiana Bank, N.A.

     198,667    11.99       132,511    8.00     $ 165,639    10.00 %
     December 31, 2005  
     Actual    

Minimum

Capital Adequacy

   

To be

Well-Capitalized

 
     Amount    Ratio     Amount    Ratio     Amount    Ratio  

Leverage (Tier 1 Capital to Average Assets)

               

First Indiana Corporation

   $ 168,434    8.70 %   $ 77,401    4.00 %     N/A    N/A  

First Indiana Bank, N.A.

     182,509    9.45       77,283    4.00     $ 96,604    5.00 %

Tier 1 Capital to Risk-Weighted Assets

               

First Indiana Corporation

   $ 168,434    10.78 %   $ 62,495    4.00 %     N/A    N/A  

First Indiana Bank, N.A.

     182,509    11.70       62,371    4.00     $ 93,556    6.00 %

Total Capital to Risk-Weighted Assets

               

First Indiana Corporation

   $ 210,446    13.47 %   $ 124,990    8.00 %     N/A    N/A  

First Indiana Bank, N.A.

     202,248    12.97       124,742    8.00     $ 155,927    10.00 %

 

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IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and related data presented herein have been prepared to conform to accounting principles generally accepted in the United States of America, which generally 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.

Almost all of the assets and liabilities of a bank are monetary, which limits the usefulness of data derived by adjusting a bank’s financial statements for the effects of changing prices.

IMPACT OF ACCOUNTING STANDARDS NOT YET ADOPTED

In July 2006, the Financial Accounting Standards Board issued Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes”, which is effective January 1, 2007. The purpose of FIN 48 is to clarify and set forth consistent rules for accounting for uncertain tax positions in accordance with SFAS 109, “Accounting for Income Taxes”. The cumulative effect of applying the provisions of this interpretation are required to be reported separately as an adjustment to the opening balance of retained earnings in the year of adoption. The Corporation is in process of reviewing and evaluating FIN 48; however, the impact of its adoption to First Indiana’s financial condition, results of operations, or cash flows is not expected to be material.

In September 2006, FASB issued SFAS 157 “Fair Value Measurements.” The statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Corporation is in the process of reviewing and evaluating SFAS 157, and therefore the impact of its adoption to First Indiana’s financial condition, results of operations, or cash flows is not yet known.

In September 2006, FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF 06-5 “Purchases of Life Insurance” (“the Consensus”). The Consensus explains how to determine the amount that could be realized from a life insurance contract, which is the measurement amount for the asset under current GAAP. First Indiana owns several life insurance contracts on certain of its officers and directors. The Consensus concluded that companies purchasing a life insurance policy should record as an asset the amount that could be realized, considering any additional amounts beyond the cash surrender value included in the contractual terms of the policy. The amount that could be realized should be based on the assumed surrender at the individual policy or certificate level, unless all policies or certificates are required to be surrendered as a group. When it is probable that contractual restrictions would limit the amount that could be realized, such contractual limitations should be considered and any amounts recoverable at the insurance company’s discretion should be excluded from the amount that could be realized. Policyholders adopting the Consensus would choose between retrospective application to all prior periods or recognizing the adoption as a cumulative-effect adjustment to the beginning retained earnings or to other components of equity or assets. The Corporation adopted the provisions of the Consensus on January 1, 2007 with no material impact to First Indiana’s financial condition, results of operations, or cash flows.

FOURTH QUARTER SUMMARY

First Indiana recorded net income of $6,010,000, or $0.35 per diluted share, in the fourth quarter of 2006, compared with income of $6,751,000, or $0.39 per diluted share, for the same period of 2005.

Net interest income for the fourth quarter of 2006 was $18,179,000, with a net interest margin of 3.65 percent, compared with fourth quarter 2005 net interest income of $17,799,000 and a net interest margin of 3.85 percent. Although interest rates in 2006 began to level-off and remain steady with an easing of competitive

 

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pricing pressures in the market, the Bank’s customers continued to manage their funds more aggressively, choosing higher cost, more rate sensitive products. This shift altered the interest rate risk profile of the Corporation’s balance sheet, effectively eliminating the asset-sensitive position maintained in the past. As a result, net interest margin was compressed during 2006. Earning assets averaged $1,992,289,000 in the fourth quarter of 2006, compared with $1,847,463,000 for the same quarter in 2005. Loans outstanding averaged $1,697,462,000 for the fourth quarter of 2006, compared with $1,582,859,000 for the fourth quarter of 2005. The increase in average loans outstanding was due to an increase in business, commercial real estate and construction loans, partially offset by a decrease in residential mortgages and consumer loans. Interest-bearing liabilities in the fourth quarter of 2006 averaged $1,684,826,000 compared with $1,511,456,000 in the fourth quarter of 2005. Average core deposits, including demand, savings and retail certificates of deposits, in the fourth quarter of 2006 were $1,561,252,000, compared with $1,305,371,000 in the fourth quarter of 2005.

No provision for loan losses was recorded in the fourth quarter of 2006 or the fourth quarter of 2005. Net loan charge-offs were $4,509,000 in the fourth quarter of 2006, compared with $1,878,000 for the fourth quarter of 2005. Non-performing assets increased to $13,101,000 at December 31, 2006, from $5,907,000 at September 30, 2006, and $4,633,000 at December 31, 2005. The increase in both net charge-offs and non-performing assets was due to one business loan relationship totaling $7,997,000 moved to non-accrual status, net of a related $3,626,000 charge-off. The ratio of the allowance for loan losses to loans at December 31, 2006, was 1.80 percent, compared with 2.07 percent at September 30, 2006, and 2.50 percent at December 31, 2005. The ratio of the allowance for loan losses to non-performing loans at December 31, 2006, was 232.5 percent, compared with 604.22 percent at September 30, 2006, and 859.89 at December 31, 2005.

Non-interest income for the fourth quarter of 2006 was $6,530,000, compared with $7,619,000 for the same period in 2005. The most significant reason for this quarter to quarter decrease was a lower level of consumer loan sales and related gains. Gain on the sale of loans was $1,119,000 for the fourth quarter of 2006, compared with $2,402,000 for the fourth quarter of 2005. The decreases of gains on the sale of loans were a result of increased competition and rising interest rates, which caused lower volume in the sale of loans. In addition during the third quarter of 2006, an investor which previously has purchased approximately one-half of the Corporation’s volume of loans significantly reduced loan purchases and notified us of its intent to significantly reduce future purchases of loans. In response to these developments in the market and the resulting negative trend in gains on the sale of loans, the Corporation is evaluating its Consumer Finance Bank segment to develop a clear strategy going forward.

Non-interest expense for the fourth quarter of 2006 was $15,345,000, compared with $15,261,000 for the fourth quarter of 2005. Salary expense was $6,591,000 for the fourth quarter of 2006, compared with $6,726,000 for the fourth quarter of 2005. The decrease in salary expense was largely due to reductions in certain incentive accruals in response to the bank not meeting all of its performance objectives. Employee benefits expense was $2,244,000 for the fourth quarter of 2006, compared with $2,375,000 for the fourth quarter of the previous year. The decrease in employee benefits expense was primarily attributable to a decrease in pension plan expense. Marketing expense in the fourth quarter of 2006 was $632,000 compared to $234,000 for the fourth quarter of the previous year. Marketing expense increased as part of the bank’s overall strategy to grow deposits and loans. Other non-interest expense was $1,668,000 for the fourth quarter of 2006, compared with $1,576,000 for the fourth quarter of 2005. This increase is largely due to higher expenses of the bank’s commercial lending division and reflects, in part, the increase in loan origination activities in 2006.

Additional information relating to the fourth quarter of 2006 and 2005 can be found in Note 19 of the Notes to the Consolidated Financial Statements.

 

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MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS

Management of First Indiana Corporation has prepared and is responsible for the financial statements and for the integrity and consistency of other related information contained in this Annual Report. In the opinion of management, the financial statements, which necessarily include amounts based on management’s estimates and judgments, fairly reflect the form and substance of transactions and the financial statements reasonably present the Corporation’s financial position and results of operations in conformity with accounting principles generally accepted in the United States of America.

The Corporation, through the auspices of the Audit Committee of the Corporation’s Board of Directors, engaged the firm of KPMG LLP, an independent registered public accounting firm, to render an opinion on the financial statements. The accountants have advised management that they were provided with access to all information and records necessary to render their opinion.

The Board of Directors exercises its responsibility for the financial statements and related information through the Audit Committee, which is composed entirely of independent directors. The Audit Committee meets regularly with management, the internal auditor of the Corporation, and KPMG LLP to assess the scope of the annual audit plan; to review the status and results of audits; to review the Annual Report on Form 10-K, including major changes in accounting policies and reporting practices; to review earnings reports and the preparation of the Form 10-Q prior to their release to the general public; and to approve non-audit services rendered by the independent auditors.

KPMG LLP, the Audit Committee, and the Corporation’s internal auditors have direct and confidential access to each other at all times to discuss the adequacy of compliance with established corporate policies and procedures and the quality of financial reporting.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of First Indiana Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the principal executive officer and principal financial officer, the Corporation conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the framework in Internal Control – Integrated Framework, management concluded that the Corporation’s internal control over financial reporting was effective as of December 31, 2006. KPMG LLP, an independent registered public accounting firm, as auditors of the Corporation’s financial statements, has issued an attestation report on management’s assessment of the Corporation’s internal control over financial reporting as of December 31, 2006, as stated in their report which is included herein.

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

First Indiana Corporation:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that First Indiana Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). First Indiana Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Corporation’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that First Indiana Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, First Indiana Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of First Indiana Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated March 2, 2007 expressed an unqualified opinion on those consolidated financial statements.

LOGO

Indianapolis, Indiana

March 2, 2007

 

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R eport of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

First Indiana Corporation:

We have audited the accompanying consolidated balance sheets of First Indiana Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 referred to above present fairly, in all material respects, the financial position of First Indiana Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of First Indiana Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

LOGO

Indianapolis, Indiana

March 2, 2007

 

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C ONSOLIDATED FINANCIAL STATEMENTS

FIRST INDIANA CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

(Dollars in Thousands, Except Per Share Data)    December 31
2006
    December 31
2005
 

Assets

    

Cash

   $ 53,511     $ 49,903  

Interest-Bearing Due from Banks

     6,317       3,151  

Federal Funds Sold

     41,500       10,000  
                

Cash and Cash Equivalents

     101,328       63,054  

Securities Available for Sale

     262,827       232,976  

Other Investments

     20,006       26,540  

Loans

    

Business

     619,891       545,215  

Commercial Real Estate

     191,020       167,715  

Single-Family Construction

     126,916       92,451  

Consumer

     488,173       499,465  

Residential Mortgage

     268,687       262,340  
                

Total Loans

     1,694,687       1,567,186  

Allowance for Loan Losses

     (30,463 )     (39,168 )
                

Net Loans

     1,664,224       1,528,018  

Premises and Equipment

     27,218       24,272  

Accrued Interest Receivable

     11,710       10,474  

Goodwill

     30,682       30,682  

Other Intangible Assets

     2,864       3,206  

Assets of Discontinued Operations

     —         1,020  

Other Assets

     41,254       46,114  
                

Total Assets

   $ 2,162,113     $ 1,966,356  
                

Liabilities

    

Non-Interest-Bearing Deposits

   $ 242,975     $ 268,682  

Interest-Bearing Deposits

    

Demand Deposits

     194,878       229,876  

Savings Deposits

     664,474       489,713  

Certificates of Deposit

     508,728       461,005  
                

Total Interest-Bearing Deposits

     1,368,080       1,180,594  
                

Total Deposits

     1,611,055       1,449,276  

Short-Term Borrowings

     277,888       220,732  

Federal Home Loan Bank Advances

     19,666       42,365  

Subordinated Notes

     46,905       46,781  

Accrued Interest Payable

     2,612       1,830  

Advances by Borrowers for Taxes and Insurance

     1,265       873  

Other Liabilities

     20,628       29,057  
                

Total Liabilities

     1,980,019       1,790,914  
                

Shareholders’ Equity

    

Preferred Stock, $.01 Par Value: 2,000,000 Shares Authorized; None Issued

     —         —    

Common Stock, $.01 Par Value: 33,000,000 Shares Authorized; Issued: 2006 – 20,518,538 Shares; 2005 – 20,284,569 Shares

     205       203  

Capital Surplus

     18,121       16,152  

Retained Earnings

     225,365       204,089  

Accumulated Other Comprehensive Loss

     (2,908 )     (3,077 )

Treasury Stock at Cost: 2006 – 3,750,811 Shares; 2005 – 3,121,165 Shares

     (58,689 )     (41,925 )
                

Total Shareholders’ Equity

     182,094       175,442  
                

Total Liabilities and Shareholders’ Equity

   $ 2,162,113     $ 1,966,356  
                

See Notes to Consolidated Financial Statements

 

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F IRST INDIANA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

 

     Years Ended December 31  
(Dollars in Thousands, except Per Share Data)    2006     2005     2004  

Interest Income

      

Loans

   $ 119,362     $ 97,401     $ 92,216  

Securities Available for Sale

     9,948       8,387       7,869  

Dividends on Other Investments

     1,209       1,159       1,170  

Federal Funds Sold

     847       91       —    

Interest-Bearing Due from Banks

     353       142       389  
                        

Total Interest Income

     131,719       107,180       101,644  

Interest Expense

      

Deposits

     45,658       25,930       20,433  

Short-Term Borrowings

     8,988       5,121       1,521  

Federal Home Loan Bank Advances

     2,013       3,653       6,880  

Subordinated Notes

     3,366       3,366       3,369  
                        

Total Interest Expense

     60,025       38,070       32,203  
                        

Net Interest Income

     71,694       69,110       69,441  

Provision for Loan Losses

     (1,600 )     (3,200 )     11,550  
                        

Net Interest Income after Provision for Loan Losses

     73,294       72,310       57,891  

Non-Interest Income

      

Deposit Charges

     16,506       16,760       17,246  

Loan Servicing Income (Expense)

     —         58       (236 )

Loan Fees

     1,718       1,818       3,039  

Investment Product Sales Commissions

     763       581       1,704  

Sale of Loans

     6,504       10,188       11,538  

Sale of Loan Servicing

     —         (1,649 )     —    

Net Investment Securities Loss

     —         (813 )     (19 )

Other

     2,393       2,375       3,579  
                        

Total Non-Interest Income

     27,884       29,318       36,851  

Non-Interest Expense

      

Salaries and Benefits

     37,111       37,295       38,813  

Net Occupancy

     4,029       4,330       3,973  

Equipment

     6,496       5,368       5,946  

Professional Services

     3,755       4,118       4,828  

Marketing

     2,131       2,144       2,135  

Telephone, Supplies, and Postage

     2,905       3,004       3,429  

Other Intangible Asset Amortization

     342       696       718  

OREO Expenses (Income)

     (199 )     (94 )     1,215  

Other

     6,060       6,200       8,166  
                        

Total Non-Interest Expense

     62,630       63,061       69,223  
                        

Income from Continuing Operations

     38,548       38,567       25,519  

Income Taxes

     14,252       14,067       9,126  
                        

Income from Continuing Operations, Net of Taxes

     24,296       24,500       16,393  

Discontinued Operations

      

Income from Discontinued Operations

     14,254       1,296       239  

Income Taxes

     5,601       525       1,954  
                        

Income (Loss) from Discontinued Operations, Net of Taxes

     8,653       771       (1,715 )
                        

Net Income

   $ 32,949     $ 25,271     $ 14,678  
                        

Basic Earnings (Loss) Per Share

      

Earnings from Continuing Operations, Net of Taxes

   $ 1.47     $ 1.43     $ 0.84  

Earnings (Loss) from Discontinued Operations, Net of Taxes

     0.52       0.04       (0.09 )
                        

Basic Net Earnings Per Share

   $ 1.99     $ 1.47     $ 0.75  
                        

Diluted Earnings (Loss) Per Share

      

Earnings from Continuing Operations, Net of Taxes

   $ 1.44     $ 1.40     $ 0.83  

Earnings (Loss) from Discontinued Operations, Net of Taxes

     0.50       0.04       (0.09 )
                        

Diluted Net Earnings Per Share

   $ 1.94     $ 1.44     $ 0.74  
                        

Dividends Per Common Share

   $ 0.800     $ 0.608     $ 0.540  
                        

See Notes to Consolidated Financial Statements

 

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FIRST INDIANA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

    Common Stock     Capital
Surplus
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Treasury
Stock
    Total
Shareholders’
Equity
 
(Dollars in Thousands, except Per Share Data)   Outstanding
Shares
    Amount            

Balance at December 31, 2003

  19,433,433     $ 216     $ 46,554     $ 185,012     $ 1,756     $ (24,644 )   $ 208,894  

Comprehensive Income:

             

Net Income

  —         —         —         14,678       —         —         14,678  

Unrealized Loss on Securities Available for Sale of $5,202, Net of Income Taxes and Reclassification Adjustment of $(12), Net of Income Taxes

  —         —         —         —         (3,154 )     —         (3,154 )
                   

Total Comprehensive Income

                11,524  

Dividends on Common Stock – $0.540 per share

  —         —         —         (10,569 )     —         —         (10,569 )

Exercise of Stock Options

  216,144       1       2,326       —         —         —         2,327  

Redemption of Common Stock

  (20,540 )     —         (339 )     —         —         —         (339 )

Tax Benefit of Option Compensation

  —         —         398       —         —         —         398  

Common Stock Issued under Deferred Compensation Plan

  —         —         (58 )     —         —         —         (58 )

Common Stock Issued under Stock Incentive Plan

  3,481       —         49       —         —         —         49  

Common Stock to Be Issued under Stock Incentive Plan

  —         —         —         70       —         —         70  

Common Stock Issued under Restricted Stock Plans

  117,188       1       2,411       (2,412 )     —         —         —    

Common Stock Cancelled under Restricted Stock Plans

  (31,140 )     —         (498 )     498       —         —         —    

Amortization of Restricted Common Stock

  —         —         —         1,147       —         —         1,147  

Purchase and Retirement of Common Stock

  (2,162,500 )     (17 )     (40,884 )     —         —         —         (40,901 )

Purchase of Treasury Stock

  (32,375 )     —         —         —         —         (472 )     (472 )

Reissuance of Treasury Stock

  4,788       —         48       —         —         25       73  
                                                     

Balance at December 31, 2004

  17,528,479       201       10,007       188,424       (1,398 )     (25,091 )     172,143  
                                                     

Comprehensive Income:

             

Net Income

  —         —         —         25,271       —         —         25,271  

Unrealized Loss on Securities Available for Sale of $3,588 Net of Income Taxes and Reclassification Adjustment of $(488), Net of Income Taxes

  —         —         —         —         (1,679 )     —         (1,679 )
                   

Total Comprehensive Income

                23,592  

Dividends on Common Stock – $0.608 per share

  —         —         —         (10,544 )     —         —         (10,544 )

Exercise of Stock Options

  321,744       2       3,997       —         —         —         3,999  

Redemption of Common Stock

  (15,075 )     —         (344 )     —         —         —         (344 )

Tax Benefit of Option Compensation

  —         —         852       —         —         —         852  

Common Stock Issued under Deferred Compensation Plan

  —         —         (21 )     —         —         —         (21 )

Common Stock to Be Issued under Stock Incentive Plans

  —         —         —         624       —         —         624  

Common Stock Issued under Restricted Stock Plans

  14,000       —         289       (289 )     —         —         —    

Common Stock Cancelled under Restricted Stock Plans

  (938 )     —         (17 )     17       —         —         —    

Amortization of Restricted Common Stock

  —         —         1,353       586       —         —         1,939  

Purchase and Retirement of Common Stock

  —         —         (23 )     —         —         —         (23 )

Purchase of Treasury Stock

  (689,536 )     —         —         —         —         (16,859 )     (16,859 )

Reissuance of Treasury Stock

  4,730       —         59       —         —         25       84  
                                                     

Balance at December 31, 2005

  17,163,404       203       16,152       204,089       (3,077 )     (41,925 )     175,442  
                                                     

Comprehensive Income:

             

Net Income

  —         —         —         32,949       —         —         32,949  

Unrealized Gain on Securities Available for Sale of $1,503 Net of Income Taxes and Reclassification Adjustment of $0, Net of Income Taxes

  —         —         —         —         908       —         908  

Gains or Losses and Prior Service Costs or Credits, Net of

             

Income Taxes Not Recognized as Components of Net Periodic Benefit Cost Upon Adoption of
SFAS 158

  —         —         —         —         (739 )     —         (739 )
                   

Total Comprehensive Income

                33,118  

Dividends on Common Stock - $0.800 per share

  —         —         —         (13,409 )     —         —         (13,409 )

Exercise of Stock Options

  160,902       1       1,970       —         —         —         1,971  

Purchase of Vested Stock Options

  —         —         (52 )     —         —         —         (52 )

Redemption of Common Stock

  (21,052 )     —         (536 )     —         —         —         (536 )

Payment for Fractional Shares

  (389 )     —         (11 )     —         —         —         (11 )

Tax Benefit of Option Compensation

  —         —         742       —         —         —         742  

Common Stock Issued under Deferred Compensation Plan

  —         —         (44 )     —         —         —         (44 )

Common Stock to Be Issued under Stock Incentive Plans

  —         —         1,011       (695 )     —         —         316  

Common Stock Issued under Restricted Stock Plans

  116,094       1       —         —         —         —         1  

Common Stock Cancelled under Restricted Stock Plans

  (21,586 )     —         —         —         —         —         —    

Amortization of Restricted Common Stock

  —         —         (1,366 )     2,431       —         —         1,065  

Amortization of Stock Options

  —         —         253       —         —         —         253  

Purchase of Treasury Stock

  (629,756 )     —         —         —         —         (16,765 )     (16,765 )

Reissuance of Treasury Stock

  110       —         2       —         —         1       3  
                                                     

Balance at December 31, 2006

  16,767,727     $ 205     $ 18,121     $ 225,365     $ (2,908 )   $ (58,689 )   $ 182,094  
                                                     

See Notes to Consolidated Financial Statements

 

40


Table of Contents

FIRST INDIANA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

    Years Ended December 31  
(Dollars in Thousands)   2006     2005     2004  

Cash Flows from Operating Activities

     

Net Income

  $ 32,949     $ 25,271     $ 14,678  

Income (Loss) from Discontinued Operations, Net of Taxes

    8,653       771       (1,715 )
                       

Income from Continuing Operations, Net of Taxes

    24,296       24,500       16,393  

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities

     

Gain on Sale of Loans, Investments, Premises and Equipment, and Mortgage Servicing Assets, Net

    (5,621 )     (7,317 )     (11,943 )

Amortization of Premium, Discount, and Intangibles, Net

    1,378       3,468       2,982  

Stock Option Expense

    253       —         —    

Depreciation and Amortization of Premises and Equipment

    2,539       2,664       2,655  

Amortization of Net Deferred Loan Fees

    1,313       2,684       1,737  

Provision for Loan Losses

    (1,600 )     (3,200 )     11,550  

Origination of Loans Held for Sale, Net of Principal Collected

    (259,488 )     (327,845 )     (322,393 )

Proceeds from Sale of Loans Held for Sale

    274,094       348,735       493,416  

Proceeds from Sale of Loan Servicing Assets

    —         2,392       —    

Stock Compensation

    316       624       119  

Change in:

     

Accrued Interest Receivable

    (1,236 )     (2,280 )     1,159  

Other Assets

    3,241       (1,505 )     5,685  

Accrued Interest Payable

    782       12       (338 )

Other Liabili