EX-13 3 hfb_annrpt.txt EX-13, ANNUAL REPORT TO SHAREHOLDERS HOME FEDERAL BANCORP ANNUAL REPORT 2003 [PHOTO OMITTED] (A collage of square pictures showing customer and bank related items is omitted.) 1 Letter To Shareholders 4 Selected Consolidated Financial Data 5 Quarterly Results Of Operations 6 Management's Discussion & Analysis 20 Consolidated Balance Sheets 21 Consolidated Statements Of Income 22 Consolidated Statements Of Shareholders' Equity 23 Consolidated Statement Of Cash Flows 24 Notes To Consolidated Financial Statements 41 Independent Auditors' Report 42 Board Of Directors & Officers Of Home Federal Bancorp Executive Officers Of HomeFederal Bank To our shareholders: For many Americans, 2003 - a year marked by ongoing international conflict and continuing economic uncertainty at home - will be a time not soon forgotten. It was a time marked by contrasts, in which encouraging results generated through implementation of our strategies for growth were occasionally offset by irregular changes in economic indicators and activities. For HomeFederal, the low interest rate environment that prevailed throughout 2003 and its restricting effects on net interest margins contributed to a decrease in net income. Earnings were $9,643,000, or $2.26 basic and $2.15 diluted earnings per common share, compared to $10,501,000 or $2.41 basic and $2.30 diluted earnings per common share in 2002. Operating expenses were higher than in the previous year, largely due to increased costs that impact all businesses, such as the ever-increasing costs of health insurance, technology expenses, regulatory compliance and retirement costs. In our industry, higher levels of business also generate higher expenses, and our operating expenses rose in response to increased loan activity during the first three quarters of the year. Symbolic of this year of contrasts, refinancing activity decreased dramatically during the final three months of 2003, and operating expenses for the fourth quarter fell back to a level parallel with the fourth quarter of the previous year. In such a low rate environment, fee income and savings deposits tend to decrease as consumers seek lower borrowing rates and higher yields on investments. For financial institutions like HomeFederal, whose regulated products are replicated by an increasing number of nonregulated financial providers, strategies for growth must necessarily be based on service advantages rather than product advantages. During 2003 we continued to benefit from the unwavering commitment to customer service that has long made HomeFederal a respected and profitable institution. Over the past fifteen years we have capitalized on our specialized style of personalized financial service to customers throughout greater Indianapolis by offering a wide array of commercial products and services. Building on these efforts, we opened our first full-service branch in Greenwood, on the city's southern border. The response from the community has been very gratifying, leading us to make plans for a second Indianapolis facility on Southport Road. This full-service branch, to be located in the heart of a rapidly-developing suburban sector on the city's south side, is scheduled to open for business in the fall of 2004. Throughout the year, we expanded our initiatives in commercial services, an important cornerstone of our strategies for growth as a commercial bank. In the first segment of a two-tier program, we introduced a comprehensive program of cash management strategies designed especially for small businesses. This year, we will initiate the second tier - a new lockbox service designed to help high-volume commercial customers better manage their receivables through an automated payment system. We have been actively presenting these new commercial services to current and potential customers, often through direct visits, and have been very encouraged by the results. We know that -- in situations ranging from presentations by our officers to prospective business clients to the most basic transactions at our branches -- there is no better way to convey our style of business than through effective personal interaction with our customers. During the past year we devoted considerable time to identifying the qualities that differentiate HomeFederal from other financial institutions - the qualities that, taken together, constitute our brand. As in our broader experience, it could be observed that our brand, too, is a study in contrasts. While we are dedicated to offering the most contemporary financial products and services to meet the ever-changing needs of our customers, we are equally dedicated to maintaining the traditional levels of professionalism and personalized service that have been a HomeFederal hallmark for generations. We believe our success in meeting the needs of our customers through individualized attention to their particular needs is not only our greatest asset, but also our greatest source of opportunity for future growth and success. Accordingly, we have worked to underscore our unique commitment to personalized service through broad-scale marketing campaigns, individual advertising programs, and enhanced employee training and recognition initiatives. These programs will be maintained and expanded in the future, in concert with our ongoing development of new products and services designed to meet the needs of a growing base of diverse customers in our expanding service area. Entering our ninety-sixth year in business, we mark with regret the retirement of a distinguished colleague. Gerald Armstrong, professional banker, community leader and friend to all who worked with him, served with distinction as executive vice president and was instrumental in helping shape the modern-day HomeFederal. We extend our best wishes to him for a productive and rewarding retirement. As others step in to continue the excellent work of earlier members of the HomeFederal team, we rededicate ourselves to the essential tenets of our brand: the best products and services for contemporary needs, blended unfailingly with dedicated, personalized customer service. No matter how unpredictable daily events or economic conditions may be, we firmly believe that placing our customers' needs first - and consistently responding to them with well-planned products and courteous professionalism -- embodies a proven business model that will never go out of style. Sincerely, John K. Keach, Jr. Chairman of the Board and Chief Executive Officer SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA (in thousands except per share data) Twelve Six Months Months Ended Ended Year Ended ------------------------------------------------------------------------------------------------------------------------------------ Dec 2003 Dec 2002 June 2002 June 2001 June 2000 June 1999 ------------------------------------------------------------------------------------------------------------------------------------ Selected Balance Sheet Data: Total assets $ 853,328 $ 886,505 $ 856,012 $ 863,393 $ 832,154 $ 744,509 Cash and cash equivalents 34,178 53,692 44,478 35,424 21,196 32,906 Loans available for sale 6,272 30,560 6,302 12,383 2,376 5,102 Securities available for sale 123,638 114,440 114,989 80,316 99,364 73,521 Securities held to maturity 1,828 3,026 3,493 7,296 7,776 4,987 Loans receivable, net 630,672 628,883 631,815 674,552 652,007 586,918 Deposits 588,915 609,358 577,480 576,543 572,893 579,882 Borrowings 169,162 187,744 188,680 207,608 184,433 90,410 Shareholders' equity 84,022 77,794 77,086 72,044 69,486 69,635 Selected Operations Data: Interest income $ 45,602 $ 26,240 $ 56,298 $ 64,757 $ 57,809 $ 54,211 Interest expense 22,264 13,145 30,635 39,516 32,169 30,135 ------------ ------------ ------------ ------------ ------------ ----------- Net interest income 23,338 13,095 25,663 25,241 25,640 24,076 Provision for loan losses 1,268 1,221 1,423 1,680 1,441 1,124 ------------ ------------ ------------ ------------ ------------ ----------- Net interest income after provision for loan losses 22,070 11,874 24,240 23,561 24,199 22,952 Gain on sale of loans 7,492 3,740 4,456 1,975 720 3,380 Gain (loss) on sale of securities (83) 4 92 (196) (116) 2 Other income 7,679 3,125 7,841 7,241 7,060 6,622 Other expense 22,495 10,375 20,045 17,513 16,446 15,851 ------------ ------------ ------------ ------------ ------------ ----------- Income before income taxes 14,663 8,368 16,584 15,068 15,417 17,105 Income tax provision 5,020 3,071 6,245 5,519 5,979 6,628 ------------ ------------ ------------ ------------ ------------ ----------- Net Income $ 9,643 $ 5,297 $ 10,339 $ 9,549 $ 9,438 $ 10,477 ============ ============ ============ ============ ============ =========== Basic earnings per common share $ 2.26 $ 1.23 $ 2.34 $ 2.13 $ 1.97 $ 2.06 Diluted earnings per common share $ 2.15 $ 1.17 $ 2.25 $ 2.07 $ 1.88 $ 1.95 Cash dividends per share $ 0.70 $ 0.31 $ 0.58 $ 0.55 $ 0.54 $ 0.45 Selected Financial and Statistical Data: Return on average assets (2) 1.10% 1.21% 1.20% 1.12% 1.20% 1.42% Return on average shareholders' equity (2) 11.95% 13.59% 13.73% 13.76% 13.84% 15.13% Interest rate spread during the period (2) 2.84% 3.19% 3.20% 3.13% 3.46% 3.36% Net interest margin on average earning assets (2) 2.91% 3.26% 3.27% 3.22% 3.56% 3.53% Average shareholders' equity to average assets 9.20% 8.93% 8.76% 8.15% 8.70% 9.41% Efficiency ratio (1) 67.03% 57.01% 57.02% 50.75% 49.50% 50.00% Nonperforming loans to total loans 0.60% 0.71% 0.57% 1.02% 0.46% 0.60% Nonperforming assets to total assets 0.66% 0.70% 0.70% 0.99% 0.52% 0.75% Loss allowance to nonperforming loans 193.11% 151.12% 171.34% 78.70% 162.05% 121.82% Loss allowance to total loans 1.16% 1.08% 1.01% 0.82% 0.75% 0.73% Dividend payout ratio 31.08% 25.12% 24.45% 25.53% 27.11% 21.49% Loan servicing portfolio $ 611,636 $ 564,856 $ 551,402 $ 484,628 $ 451,768 $ 461,462 Allowance for loan losses $ 7,506 $ 7,172 $ 6,451 $ 5,690 $ 4,949 $ 4,349 Number of full service offices 18 17 17 17 16 16 __________________ (1) Operating expenses as a percentage of the sum of net interest income and non-interest income, excluding real estate income and expenses, securities gains and losses, gains and losses on sale of loans, amortization of intangibles, OMSR amortization, impairment of OMSR and non-recurring items. (2) For comparative purposes, the December 2002 ratios have been annualized.
QUARTERLY RESULTS OF OPERATIONS (in thousands except share data) The following table presents certain selected unaudited data relating to results of operations for the three month periods ending on the dates indicated. Three Months Ended --------------------------------------------------------------------------- Fiscal Year Ended December 31, 2003 March 31, 2003 June 30, 2003 Sept 30, 2003 Dec 31, 2003 ----------------------------------------------------------------------------------------------------------------------------- Total interest income $ 12,058 $ 11,542 $ 11,160 $ 10,842 Total interest expense 6,016 5,674 5,429 5,145 ----------------- ----------------- ----------------- ----------------- Net interest income 6,042 5,868 5,731 5,697 Provision for loan losses 210 450 286 322 ----------------- ----------------- ----------------- ----------------- Net interest income after provision for loan losses 5,832 5,418 5,445 5,375 Gain on sale of loans 2,144 2,155 2,479 714 Other income 1,993 1,658 2,103 1,842 Other expense 5,282 5,639 5,937 5,637 ----------------- ----------------- ----------------- ----------------- Income before income taxes 4,687 3,592 4,090 2,294 Income tax provision 1,733 1,318 1,462 507 ----------------- ----------------- ----------------- ----------------- Net Income $ 2,954 $ 2,274 $ 2,628 $ 1,787 ================= ================= ================= ================= Basic earnings per common share $ 0.70 $ 0.53 $ 0.62 $ 0.42 ================= ================= ================= ================= Diluted earnings per common share $ 0.66 $ 0.50 $ 0.59 $ 0.40 ================= ================= ================= ================= Dividends per share $ 0.163 $ 0.163 $ 0.188 $ 0.188 Stock sales price range: High (1) $ 25.12 $ 27.57 $ 27.00 $ 29.35 Low $ 22.95 $ 24.26 $ 25.15 $ 26.45 Three Months Ended -------------------------------------- Six Months Ended December 31, 2002 Sept 30, 2002 Dec 31, 2002 ---------------------------------------------------------------------------------------- Total interest income $ 13,277 $ 12,963 Total interest expense 6,703 6,442 ----------------- ----------------- Net interest income 6,574 6,521 Provision for loan losses 460 761 ----------------- ----------------- Net interest income after provision for loan losses 6,114 5,760 Gain on sale of loans 1,386 2,354 Other income 1,457 1,672 Other expense 4,807 5,568 ----------------- ----------------- Income before income taxes 4,150 4,218 Income tax provision 1,559 1,512 ----------------- ----------------- Net Income $ 2,591 $ 2,706 ================= ================= Basic earnings per common share $ 0.60 $ 0.63 ================= ================= Diluted earnings per common share $ 0.57 $ 0.60 ================= ================= Dividends per share $ 0.150 $ 0.163 Stock sales price range: High (1) $ 24.30 $ 25.14 Low $ 21.60 $ 21.76 Three Months Ended --------------------------------------------------------------------------- Fiscal Year Ended June 30, 2002 Sept 30, 2001 Dec 31, 2001 March 31, 2002 June 30, 2002 ----------------------------------------------------------------------------------------------------------------------------- Total interest income $ 15,168 $ 14,370 $ 13,290 $ 13,470 Total interest expense 8,968 7,879 6,946 6,842 ----------------- ----------------- ----------------- ----------------- Net interest income 6,200 6,491 6,344 6,628 Provision for loan losses 306 415 509 193 ----------------- ----------------- ----------------- ----------------- Net interest income after provision for loan losses 5,894 6,076 5,835 6,435 Gain on sale of loans 873 1,930 1,018 635 Other income 1,574 1,820 2,494 2,045 Other expense 4,591 5,277 5,158 5,019 ----------------- ----------------- ----------------- ----------------- Income before income taxes 3,750 4,549 4,189 4,096 Income tax provision 1,386 1,779 1,596 1,484 ----------------- ----------------- ----------------- ----------------- Net Income $ 2,364 $ 2,770 $ 2,593 $ 2,612 ================= ================= ================= ================= Basic earnings per common share $ 0.53 $ 0.62 $ 0.59 $ 0.60 ================= ================= ================= ================= Diluted earnings per common share $ 0.51 $ 0.61 $ 0.56 $ 0.57 ================= ================= ================= ================= Dividends per share $ 0.138 $ 0.138 $ 0.150 $ 0.150 Stock sales price range: High (1) $ 22.22 $ 19.75 $ 22.00 $ 25.00 Low $ 16.00 $ 16.80 $ 18.60 $ 21.68 (1) The Company's common stock trades on the NASDAQ National Market under the symbol "HOMF." As of December 31, 2003, the Company had 470 holders of record of its shares.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This Annual Report contains statements, which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Annual Report and include statements regarding the intent, belief, outlook, estimate or expectations of the Company (as defined below), its directors or its officers primarily with respect to future events and the future financial performance of the Company. Readers of this Annual Report are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward looking statements as a result of various factors. The accompanying information contained in this Annual Report identifies important factors that could cause such differences. These factors include changes in interest rates, loss of deposits and loan demand to other financial institutions, substantial changes in financial markets, changes in real estate values and the real estate market, regulatory changes, changes in the financial condition of issuers of the Company's investments and borrowers, changes in the economic condition of the Company's market area, increases in compensation and employee expenses, or unanticipated results in pending legal proceedings. The following financial information presents an analysis of the asset and liability structure of Home Federal Bancorp and a discussion of the results of operations for each of the periods presented in the Annual Report as well as a discussion of Home Federal Bancorp's sources of liquidity and capital resources. HOLDING COMPANY BUSINESS Home Federal Bancorp (the "Company") is organized as a bank holding company authorized to engage in activities permissible for a financial holding company and owns all of the outstanding capital stock of HomeFederal Bank (the "Bank"). The business of the Bank and therefore, the Company, is providing consumer and business banking services to certain markets in the south-central portions of the State of Indiana. The Bank does business through 18 full service banking offices. GENERAL The Bank's earnings in recent years reflect the fundamental changes that have occurred in the regulatory, economic and competitive environment in which commercial banks operate. The Bank's earnings are primarily dependent upon its net interest income. Interest income is a function of the average balances of loans and investments outstanding during a given period and the average yields earned on such loans and investments. Interest expense is a function of the average amount of deposits and borrowings outstanding during the same period and the average rates paid on such deposits and borrowings. Net interest income is the difference between interest income and interest expense. The Bank is subject to interest rate risk to the degree that its interest-bearing liabilities, primarily deposits and borrowings with short- and medium-term maturities, mature or reprice more rapidly, or on a different basis, than its interest-earning assets. While having liabilities that mature or reprice more frequently on average than assets will be beneficial in times of declining interest rates, such an asset/liability structure will result in lower net income or net losses during periods of rising interest rates, unless offset by other factors such as non-interest income. The Bank's net income is also affected by such factors as fee income and gains or losses on sale of loans. MD&A OVERVIEW In reviewing the Company's performance in 2003 the driving force was the low interest rate environment and the record setting year for loan refinances. The refinancing activity in 2003 not only affected the residential loan portfolio but also the commercial portfolio and the investment portfolio. Each of these portfolios experienced prepayments, calls, or refinancing activity that caused the yield on these assets to decline significantly during the year. The low rates also caused the deposit and borrowing costs of the Company to decline, but not as fast as the interest earning assets did. This situation occurred for two primary reasons. First, the Company was asset sensitive meaning that it had more assets maturing or repricing in 2003 than liabilities. Second, competition prevents repricing the deposit base of the Bank any lower and still retain customers. Because the yields on assets declined more rapidly than the cost of liabilities the Company experienced a tightening of its net interest margin that caused net interest income to decline in 2003 over 2002. The other result of the refinancing activity was a record year for the Company with respect to gain on sale of loans. The Company earned approximately $7.5 million from selling loans in 2003, $2.0 million more that the year before. It is management's opinion that rates will not decline further in 2004 and therefore this level of income for gain on sale of loans will be significantly lower in 2004. It is our opinion that loan refinancing activity in 2004 could be half of the level of refinancing activity experienced in 2003 thus reducing the gain on sale of loans by about the same percentage. If however, mortgage loan rates decline below levels experienced in 2003 then the Company could experience another wave of refinancings that would cause the income from gain on sale of loans to remain at the level experienced in 2003. A strategy to improving the Company's net interest margin will be to replace wholesale funding sources, such as Federal Home Loan Advances, brokered certificates of deposit, and public funds with core retail deposits. The Bank opened a new branch in the southern Indianapolis metropolitan market in December of 2003. A second branch in the same market is planned for 2004. The expansion into this growing market plus a new emphasis on gaining core deposits in existing markets is anticipated to increase core deposits in 2004. Both consumer and commercial core deposit growth will be the Company's focus. It is important the Company increase this source of funds in order to continue future profitable growth in coming years. Non-interest expense in 2003 increased by $1.9 million compared to 2002. Over $1.0 million of the increase came from compensation and employee benefit cost. The increases were due to increased retirement and health insurance costs as well as increased staffing costs for regulatory compliance areas and technology staffing. Some of the reductions will be offset by the costs associated with the new branches in Indianapolis and normal salary increases for 2004. Consultant fees increased by $347,000 in 2003 compared to 2002 due to outsourcing the internal audit function in 2003 and special audits of the technology systems. These expenses will stay approximately the same in 2004. Another area that will receive close scrutiny in 2004 is that of capital management. The Company has seen total shareholder equity increase while total assets have declined in the past year. The Company has had several stock repurchase plans in place over the past several years and will continue to look at these plans as one way to improve both return on equity and earnings per share in the coming year. In summary the Company faces several challenges in 2004 and subsequent years. The major challenge is to replace the anticipated reduction in gain on sale of loans with other less cyclical sources of income. The second is to grow the earning assets of the Company in such a way that net interest margins are improved. The third is to increase other sources of non-interest income while at the same time reducing the rate of increase in non-interest expense, especially those related to compensation and employee benefits. It will take more than one year to accomplish these goals but plans are in place to begin in 2004. ASSET/LIABILITY MANAGEMENT The Bank follows a program designed to decrease its vulnerability to material and prolonged increases in interest rates. This strategy includes 1) selling certain longer term, fixed rate loans from its portfolio; 2) increasing the origination of adjustable rate loans; 3) improving its interest rate gap by increasing the interest rate sensitivity by shortening the maturities of its interest-earning assets and extending the maturities of its interest-bearing liabilities; and 4) increasing its non-interest income. A significant part of the Bank's program of asset and liability management has been the increased emphasis on the origination of adjustable rate and/or short-term loans, which include adjustable rate residential mortgages and construction loans, commercial loans and consumer-related loans. The Bank continues to offer fixed rate residential mortgage loans. The Bank retains the servicing function on most of the 15-year and 30-year loans sold, thereby increasing non-interest income. The proceeds of these loan sales are used to reinvest in other interest-earning assets or to repay short-term debt. LIABILITY RELATED ACTIVITIES The Bank has taken several steps to stabilize interest costs and match the maturities of liabilities to assets. Retail deposit specials are competitively priced to attract deposits in the Bank's market area. When retail deposit funds become unavailable due to competition, the Bank employs Federal Home Loan Bank of Indianapolis ("FHLB") advances and brokered deposits to maintain the necessary liquidity to fund lending operations. In addition, the Bank utilizes FHLB advances to match maturities with select commercial loans. The Bank has endeavored to spread its maturities of FHLB advances over a five to seven year period so that only a limited amount of advances come due each year. This avoids a concentration of maturities in any one year and thus reduces the risk of having to renew all advances when rates may not be favorable. The Bank applies early withdrawal penalties to protect the maturity and cost structure of its deposits and utilizes longer term fixed rate borrowings when the cost and availability permit the proceeds of such borrowings to be invested profitably. As a result of its asset restructuring efforts, the Bank has foregone, and will likely forego in the future, certain opportunities for improving income on a short-term basis in exchange for a reduction in long-term interest rate risk. For instance, the Bank's increased emphasis on the origination of adjustable rate mortgages may cause it to sacrifice the initially higher rates of interest available to lenders on fixed rate loans. Similarly, market conditions usually have dictated that financial institutions pay substantially higher interest rates on long-term deposits than on short-term deposits. INTEREST RATE SPREAD The following table sets forth information concerning the Bank's interest-earning assets, interest-bearing liabilities, net interest income, interest rate spreads and net yield on average interest-earning assets during the periods indicated (including fees which are considered adjustments of yields). Average balance calculations were based on daily balances. (dollars in thousands)
Twelve Months Ended Six Months Ended Year Ended ---------------------------------------------------------------------------------------------- Dec 2003 Dec 2002 June 2002 ---------------------------------------------------------------------------------------------- (3) Average Average Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate ------------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets: Residential mortgage loan $ 219,059 $ 13,155 6.01% $ 244,399 $ 8,371 6.85% $ 262,194 $ 19,678 7.51% Commercial real estate mortgages 221,860 13,927 6.28% 208,117 7,126 6.85% 191,303 14,113 7.38% Home equities/ second mortgages 76,754 5,708 7.44% 82,489 3,284 7.96% 88,061 7,218 8.20% Commercial loans 93,713 5,414 5.78% 86,416 2,724 6.30% 76,947 5,271 6.85% Consumer loans 36,167 3,109 8.60% 39,414 1,792 9.09% 40,978 3,950 9.64% Securities 123,273 3,955 3.21% 117,938 2,772 4.70% 97,787 5,488 5.61% Interest-bearing deposits 30,567 334 1.09% 24,807 171 1.38% 26,991 580 2.15% ------------------------------------------------------------------------------------------- Total interest-earning assets (1) $ 801,393 $ 45,602 5.69% $ 803,580 $ 26,240 6.53% $ 784,261 $ 56,298 7.18% =========================================================================================== Interest-bearing liabilities: Deposits- Transaction account $ 296,267 $ 2,060 0.70% $ 290,629 $ 1,715 1.17% $ 283,295 $ 4,914 1.73% Certificate accounts 305,506 10,144 3.32% 303,610 5,799 3.79% 289,600 13,802 4.77% FHLB advances 163,369 9,221 5.64% 174,387 5,205 5.92% 185,453 11,106 5.99% Other borrowings 16,312 839 5.14% 11,823 426 7.15% 11,173 813 7.28% ------------------------------------------------------------------------------------------- Total interest-bearing liabilities $ 781,454 $ 22,264 2.85% $ 780,449 $ 13,145 3.34% $ 769,521 $ 30,635 3.98% =========================================================================================== Net Interest Income $ 23,338 $ 13,095 $ 25,663 ======== ======== ======== Net Interest Rate Spread 2.84% 3.19% 3.20% ===== ===== ===== Net Earning Assets $ 19,939 $ 23,131 $ 14,740 ========= ========= ========= Net Interest Margin (2) 2.91% 3.26% 3.27% ===== ===== ===== Average Interest-earning Assets to Average Interest-bearing Liabilities 102.55% 102.96% 101.92% ====== ====== ======
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[TABLE CONTINUED FROM FOLLOWING PAGE] Year Ended -------------------------------- June 2001 -------------------------------- Average Average Balance Interest Yield/Rate ----------------------------------------------------------------------- Interest-earning assets: Residential mortgage loan $ 305,512 $24,631 8.06% Commercial real estate mortgages 171,766 14,473 8.43% Home equities/ second mortgages 91,655 8,485 9.26% Commercial loans 64,431 5,696 8.84% Consumer loans 43,558 4,305 9.88% Securities 98,597 6,622 6.72% Interest-bearing deposits 9,449 545 5.77% ---------------------------- Total interest-earning assets (1) $ 784,968 $64,757 8.25% ============================ Interest-bearing liabilities: Deposits- Transaction account $ 249,647 $ 6,505 2.61% Certificate accounts 324,358 20,205 6.23% FHLB advances 187,272 11,987 6.40% Other borrowings 11,270 819 7.27% ---------------------------- Total interest-bearing liabilities $ 772,547 $39,516 5.12% ============================ Net Interest Income $25,241 ======= Net Interest Rate Spread 3.13% ======== Net Earning Assets $ 12,421 ========== Net Interest Margin (2) 3.22% ======== Average Interest-earning Assets to Average Interest-bearing Liabilities 101.61% ========== (1) Average balances are net of non-performing loans. (2) Net interest income divided by the average balance of interest-earning assets. (3) For comparative purposes, the ratios in the December 2002 average yield/rate column have been annualized.
RATE/VOLUME ANALYSIS The following table sets forth the changes in the Bank's interest income and interest expense resulting from changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities. Changes not solely attributable to volume or rate changes have been allocated in proportion to the changes due to volume or rate. (in thousands)
Year Ended Six Months Ended -------------------------------------------------------------------------- Dec 2003 vs. Dec 2002 Dec 2002 vs. Dec 2001 -------------------------------------------------------------------------- Increase/(Decrease) Increase/(Decrease) Due to Due to Total Due to Due to Total Rate Volume Change Rate Volume Change ------------------------------------------------------------------------------------------------------------------------------- Interest Income on Interest-Earning Assets: Residential mortgage loans $ (222) $ (3,901) $ (4,123) $ (1,070) $ (1,424) $ (2,494) Commercial real estate loans 2,857 (2,962) (105) 529 (559) (30) Home equities/second mortgages (513) (442) (955) (189) (366) (555) Commercial loans (314) 488 174 126 (139) (13) Consumer loans (234) (274) (508) (168) (140) (308) Securities (2,212) 434 (1,778) (288) 533 245 Interest-bearing deposits (189) 86 (103) (173) 30 (143) ----------- ----------- ------------- ---------- ---------- ---------- Total (827) (6,571) (7,398) (1,233) (2,065) (3,298) ----------- ----------- ------------- ---------- ---------- ---------- Interest Expense on Interest-Bearing Liabilities: Deposits - Transaction accounts (2,002) 598 (1,404) (1,592) 141 (1,451) Certificate accounts (1,982) 76 (1,906) (1,969) 217 (1,752) FHLB advances (561) (808) (1,369) (33) (482) (515) Other borrowings (30) 40 10 (6) 22 16 ----------- ----------- ------------- ---------- ---------- ---------- Total (4,575) (94) (4,669) (3,600) (102) (3,702) ----------- ----------- ------------- ---------- ---------- ---------- Net Change in Net Interest Income $ 3,748 $ (6,477) $ (2,729) $ 2,367 $ (1,963) $ 404 =========== =========== ============= ========== ========== ==========
Year Ended --------------------------------------- June 2002 vs. June 2001 --------------------------------------- Increase/(Decrease) Due to Due to Total Rate Volume Change -------------------------------------------------------------------------------------------- Interest Income on Interest-Earning Assets: Residential mortgage loans $ (1,623) $ (3,330) $ (4,953) Commercial real estate loans (4,188) 3,828 (360) Home equities/second mortgages (944) (323) (1,267) Commercial loans (3,104) 2,679 (425) Consumer loans (104) (251) (355) Securities (1,080) (54) (1,134) Interest-bearing deposits (18) 53 35 ----------- ----------- ------------ Total (11,061) 2,602 (8,459) ----------- ----------- ------------ Interest Expense on Interest-Bearing Liabilities: Deposits - Transaction accounts (2,665) 1,074 (1,591) Certificate accounts (4,397) (2,006) (6,403) FHLB advances (766) (115) (881) Other borrowings 1 (7) (6) ----------- ----------- ------------ Total (7,827) (1,054) (8,881) ----------- ----------- ------------ Net Change in Net Interest Income $ (3,234) $ 3,656 $ 422 =========== =========== ============
RESULTS OF OPERATIONS Comparison of Twelve Month Period Ended December 31, 2003 and Twelve Month Period Ended December 31, 2002: General On September 24, 2002, the Company announced a change in its fiscal year end from June 30 to December 31. Therefore, the current year-to-date numbers being reported will refer to the twelve month period ended December 31, 2003, while the prior year-to-date numbers being reported will refer to the twelve month period ended December 31, 2002. The Company reported net income of $9.6 million for the twelve month period ended December 31, 2003. This compared to net income of $10.5 million for the twelve month period ended December 31, 2002, representing a decrease of $858,000 or 8.2%. Net Interest Income Net interest income before provision for loan losses decreased $2.7 million or 10.5% for the twelve month period ended December 31, 2003, compared to the twelve month period ended December 31, 2002. This decrease in net interest income was due to tightening net interest margins and a decrease in total assets. Year-to-date net interest income after provision for loan losses decreased by $2.1 million, from $24.1 million one year ago to $22.1 million for the twelve month period ended December 31, 2003. The decrease in net interest income after provision for loan losses was due to the same reasons described above for net interest income before provision for loan losses. The loan loss provision decreased in 2003 compared to 2002 by $655,000. The decrease was due to the low number of loan charge offs the Bank has experienced in recent years. Even with the lower loan loss provision for the year, the allowance for loan losses increased by $334,000. For further information about the allowance for loan losses see the discussion under the Allowance for Loan Losses section. For the twelve month period ended December 31, 2003, the net interest margin declined by 35 basis points (a basis point equals 0.01%) compared to the same period a year ago. The current low interest rate environment continues to see loan and investment rates decrease more rapidly than deposit and borrowing rates. The yield on the investment portfolio has decreased because much of it was comprised of mortgage backed securities that have pre-paid ahead of schedule as well as U.S. Government agency securities that had call features exercised. In addition, the investment portfolio has increased due to increased cash flows resulting from the refinancing of adjustable rate loans held in portfolio into fixed rate loans that are sold in the secondary mortgage market. This turnover in the investment portfolio has seen higher yielding assets move into lower yielding assets that in turn tightens interest margins. On the liability side of the balance sheet, competition for retail deposits has caused rates to decrease slower than they otherwise might have given the overall rate environment, which has also kept interest margins from widening. Interest Income Total interest income for the twelve month period ended December 31, 2003, decreased $7.4 million, or 14.0%, as compared to the twelve month period ended December 31, 2002. The decrease in interest income was due primarily to the 94 basis point decrease in yield on interest earning assets for the twelve month period ended December 31, 2003 as compared to the same period a year ago. Interest Expense Total interest expense for the twelve month period ended December 31, 2003, decreased $4.7 million, or 17.3%, as compared to the twelve month period ended December 31, 2002. This decrease was due to a 58 basis point decrease in the cost of interest bearing liabilities for the twelve month period ended December 31, 2003 as compared to the same period a year ago. Other Income Other income for the current twelve month period was $15.1 million. This represented an increase of $2.0 million, or 15.5%, over the same twelve month period ended December 31, 2002. This increase was due to several factors including the increase in gain on sale of loans of $2.1 million in the current twelve month period compared to the same period one year ago. The increase was due to increased refinancing activity and loan sales. Insurance, annuity income and other fees were up $176,000 over 2002 and service fees on deposit accounts were up $316,000 over 2002. Offsetting these increases were declines in joint venture income and gains on real estate owned of $248,000 and $165,000, respectively. The decline in joint ventures was due in part to reduced activity in joint ventures as the Company continues to divest itself of these projects. The decline in real estate owned ("REO") income was due to reduced REO activity in 2003. Loan servicing income was basically unchanged as early impairment charges were recovered in part in the fourth quarter of 2003. The originated mortgage servicing rights asset is reviewed for impairment each quarter. This asset is created when mortgage loans are sold and the lender retains the servicing rights. The asset is then amortized as an expense to mortgage servicing income over the life of the loan. The impairment charge is the recognition of the change in value of mortgage servicing rights that results with changes in interest rates. Mortgage servicing portfolios typically decline in value as interest rates drop and increase in value as rates rise. The reason for this decline in value is that as rates drop, prepayment speeds increase causing the average life of the servicing portfolio to shorten. This reduces the amount of servicing income the Bank receives over time and thus reduces the value of the servicing portfolio. If rates rise the opposite occurs--prepayments slow and the average life of the mortgage servicing portfolio lengthens, increasing the amount of servicing income the Bank receives over time and the value of the servicing portfolio. In 2003 the impairment charge was $83,000 compared to the same period ending December 31, 2002 where the charge was $469,000. The amortization charge in the current period was $1.4 million compared to $905,000 for the same period a year ago. Future impairment charges will depend on future interest rate changes. If rates continue to decrease there will be more impairment charges; if they increase the impairment charges may be recovered. Other Expenses Other expenses increased $1.9 million or 9.5%, over the prior fiscal year, to $22.5 million from $20.6 million. The increases were primarily in compensation and employee benefits. Compensation and employee benefits increased $1.0 million due to various factors including increased staffing, normal salary increases, and increased funding expenses for the Bank's pension plans. Occupancy and equipment expense increased due to increased technology expenditures and the opening of a new branch in Indianapolis. RESULTS OF OPERATIONS Comparison of Six Month Period Ended December 31, 2002 and Six Month Period Ended December 31, 2001: General On September 24, 2002, the Company announced a change in its fiscal year end from June 30 to December 31. The Company reported net income of $5.3 million for the six month period ended December 31, 2002. This compared to net income of $5.1 million for the six month period ended December 31, 2001, representing an increase of $163,000 or 3.2%. Net Interest Income Net interest income before provision for loan losses increased $404,000 or 3.2% for the six month period ended December 31, 2002, compared to the six month period ended December 31, 2001. This increase was primarily the result of a $13.4 million increase in average interest earning assets compared to a $4.5 million increase in average interest bearing liabilities. Net interest income after provision for loan losses decreased by $96,000, from $11,970,000 for the six month period ended December 31, 2001 to $11,874,000 for the six month period ended December 31, 2002. The decrease in net interest income after provision for loan losses was due to an increase in the loan loss provision of $500,000 in the six month period ended December 31, 2002. The loan loss provision has increased primarily due to the deteriorating economic data regarding bankruptcies and unemployment trends in the Bank's market area. The increases in the loan loss provision have also increased the allowance for loan losses from $6,451,000 at June 30, 2002 to $7,172,000 at December 31, 2002, a $721,000 increase. For further information about the allowance for loan losses see the discussion under the Allowance for Loan Losses section. For the six month period ended December 31, 2002 compared to the same period in 2001 the net interest margin improved slightly. The low interest rate environment contributed to loan and investment rates decreasing more rapidly than deposit and borrowing rates. The yield on the investment portfolio has decreased because much of it was comprised of mortgage backed securities that have pre-paid ahead of schedule as well as U.S. Government agency securities that had call features exercised. In addition, the investment portfolio grew due to increased cash flows created by the refinancing of adjustable rate loans held in portfolio into fixed rate loans that are sold in the secondary mortgage market. This turnover in the investment portfolio has seen higher yielding assets move into lower yielding assets that in turn tightens interest margins. On the liability side of the balance sheet competition for retail deposits has caused rates to decrease slower than they otherwise might have given the overall rate environment, which has also kept interest margins from widening. Interest Income Total interest income for the six month period ended December 31, 2002, decreased $3.3 million, or 11.2%, as compared to the six month period ended December 31, 2001. The decrease in interest income was due primarily to the 95 basis point decrease in yield on interest earning assets for the six month period ended December 31, 2002 as compared to the same period in 2001. A factor offsetting the decrease in interest income was the $13.4 million increase in the average balance of the Company's interest earning assets. Interest Expense Total interest expense for the six month period ended December 31, 2002, decreased $3.7 million, or 22.0%, as compared to the six month period ended December 31, 2001. This decrease was due to a 97 basis point decrease in the cost of interest bearing liabilities for the six month period ended December 31, 2002 as compared to the same period the previous year. A factor that offsets the decrease in interest expense was the increase in average balances of deposits and borrowings of $4.5 million for the six month period ended December 31, 2002. Other Income Other income for the six month period ended December 31, 2002 was $6,869,000. This represented an increase of $672,000, or 10.8%, over the same six month period ended December 31, 2001. This increase was due to several factors including the increase in gain on sale of loans of $937,000 in the six month period ended December 31, 2002 compared to the six month period ended December 31, 2001. The increase was due to increased refinancing activity and loan sales. Offsetting this increase in other income was a $517,000 decrease in loan servicing income due primarily to an impairment charge reducing the value of originated mortgage servicing rights. In the six month period ended December 31, 2002 the impairment charge was $617,000 compared to the same period ending December 31, 2001 where the charge was $177,000. The amortization charge in the six month period ended December 31, 2002 was $478,000 compared to $302,000 for the same period ended December 2001. Future impairment charges will depend on future interest rate changes. If rates continue to decrease there will be more impairment charges; if they increase the impairment charges may be recovered. Other Expenses Other expenses increased $507,000 or 5.1%, over the six month period ended December 31, 2001, to $10.4 million from $9.9 million. The increases were primarily in compensation and employee benefits. Compensation and employee benefits increased $670,000 due to various factors including increased staffing, normal salary increases, bonus expense and increased funding expenses for the Bank's pension plans. A factor that reduced the increase in other expenses was a $156,000 reduction in service bureau expenses. The Company completed a data processing conversion in the six month period ended December 31, 2001. Data processing expenses were higher than normal during the conversion process as the Company incurred charges from both the old and new data processors for a period of time. RESULTS OF OPERATIONS Comparison of Year Ended June 30, 2002 and Year Ended June 30, 2001: General The Company reported net income of $10.3 million for the year ended June 30, 2002. This compared to net income of $9.5 million for the year ended June 30, 2001, representing an increase of $790,000 or 8.3%. Net Interest Income Net interest income before provision for loan losses increased $422,000 or 1.7% for the year ended June 30, 2002, compared to the prior year. This increase was primarily the result of rates on interest bearing liabilities declining more rapidly than the interest rates on interest earning assets, and was reflected in a 7 basis point increase in the Company's net interest rate spread. Compared to the prior year, net interest income after provision for loan losses increased by $679,000, or 2.9% to $24.2 million for the year ended June 30, 2002. In each period, the provision and allowance for loan losses were based on an analysis of individual credits, prior and current loss experience, overall growth in the portfolio, the change in the portfolio mix and current economic conditions. The loan loss provision in the fiscal year ended June 30, 2002 was $1.4 million. This charge to the provision for loan losses increased the allowance for loan losses to $6.5 million, an increase of $761,000 over the prior fiscal year balance of $5.7 million. This increase to the allowance for loan losses related to two primary factors, the deteriorating economic data regarding bankruptcies and unemployment trends in the Bank's market area and the continuing shift of the Bank's loan portfolio in the direction of increasing the commercial real estate and commercial loan portfolios, while reducing the residential loan portfolio. For further information about the allowance for loan losses see the discussion under the Allowance for Loan Losses section. Interest Income Total interest income for the year ended June 30, 2002, decreased $8.5 million, or 13.1%, as compared to the year ended June 30, 2001. The decrease in interest income was due primarily to the 107 basis point decrease in yield on interest earning assets for the twelve month period ended June 30, 2002 as compared to the same period ended June 30, 2001. Interest Expense Total interest expense for the year ended June 30, 2002, decreased $8.9 million, or 22.5%, as compared to the year ended June 30, 2001. This decrease was due to a 114 basis point decrease in the cost of interest bearing liabilities for the twelve-month period ended June 30, 2002 as compared to the same period ended June 30, 2001. An additional factor that decreased interest expense was the decline in average balances of deposits and borrowings of $3.0 million for the fiscal year ended June 30, 2002. Other Income Other income increased $3.4 million from $9.0 million in fiscal year 2001 to $12.4 million in fiscal year 2002. This increase was due primarily to an increase in the gain on sale of loans of $2.5 million. The increased gain on sale of loans was primarily due to increases in refinancing activity that occurred, as borrowers took advantage of the available lower rates. Other factors affecting the increase in other income include increases of $288,000 in gain on sale of securities, a $241,000 increase in insurance, annuity and other fees, a $164,000 increase in gain of sale on real estate owned and repossessed assets and a $195,000 increase in loan servicing income. The gain on sale of securities was the result of a $196,000 loss incurred in the fiscal year ended June 30, 2001 due to restructuring the portfolio, compared with a $92,000 gain realized in the fiscal year ended June 30, 2002. The increase in insurance, annuity and other fees came primarily from commissions earned on brokerage sales, which increased $171,000 over the previous fiscal year, as well as a $90,000 increase in fees earned from trust services. The increase in net gain on real estate owned resulted from increased activity in real estate owned and repossessed assets sales, with a total of 78 sales with proceeds of $4.5 million occurring in the June 30, 2002 fiscal year compared to 53 sales with proceeds of $1.5 million for the prior fiscal year. The increase in loan servicing income primarily resulted from a $66.8 million net increase in the servicing portfolio. Other Expenses Other expenses increased $2.5 million or 14.5%, over the June 30, 2001 fiscal year, to $20.0 million from $17.5 million. The increases came primarily from three areas, compensation and employee benefits, occupancy and equipment expenses, and miscellaneous expenses. Compensation and employee benefits increased $1.5 million principally due to funding expenses for the Bank's pension plans, health insurance costs and overtime associated with the data processing conversion. Occupancy and equipment expenses increased $320,000 or 12.7% for the fiscal year ended June 30, 2002, as compared to the prior fiscal year. These increases reflect expenses connected with rising depreciation costs associated with equipment and software purchases for the third party data processing change, as well as depreciation related to the remodeling of the main office located in Columbus, Indiana. Miscellaneous expense increases of $666,000 or 16.6% included $353,000 of expenses associated with taxes, repairs, maintenance and improvement of various real estate owned properties to place them in a condition for sale. Additional increases to miscellaneous expenses of $373,000 are associated with increases in postage, office supplies and communications charges, resulting from process changes associated with the data processing conversion. An increase of $60,000 to miscellaneous expenses is related to the Bank's charter conversion from a federal savings bank charter to a state commercial bank charter. FINANCIAL CONDITION The Company's total assets decreased $33.2 million to $853.3 million at December 31, 2003, from $886.5 million at December 31, 2002. Loans held for sale decreased $24.2 million as a result of the decrease in refinancing activity experienced in the last quarter of 2003. Additionally, cash and cash equivalents decreased $19.5 million primarily due to funding the payoff of advances from the Federal Home Loan Bank, which decreased $17.4 million during the year ended 2003. The primary decrease in liabilities occurred in deposits that decreased $20.4 million from December 31, 2002 to December 31, 2003. This decrease in deposits reflects a decrease in public funds and jumbo certificates of deposits of $14.5 million and $7.8 million, respectively. Shareholders' equity increased $6.2 million to $84.0 million. Retained earnings increased $9.6 million from net income and decreased $3.0 million for dividends paid and decreased $3.3 million from the repurchase of the Company's common stock. Common stock had a net increase of $3.4 million: a decrease of $209,000 from the repurchase of Company stock and increases of $3.1 million from options exercised and $513,000 from the related tax benefit of disqualifying dispositions of such options. The Company had accumulated other comprehensive loss, net, of $30,000, a decrease of $484,000 over the prior fiscal year. This decrease was the net result of a $686,000 decrease from unrealized losses in the available for sale portfolio and a $202,000 increase from the change in fair value of a cash flow hedge. INTEREST RATE SENSITIVITY Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Interest rate sensitivity in the Company is a result of repricing, option, and basis risks. Repricing risk represents timing mismatches in the Company's ability to alter contractual rates earned on financial assets or paid on liabilities in response to changes in market interest rates. For example, when interest-bearing liabilities reprice or mature more quickly than interest-earning assets, an increase in market rates could adversely affect net interest income. Conversely, if interest-earning assets reprice or mature more quickly than interest-bearing liabilities, a decrease in market rates could adversely affect net interest income. Option risk arises from embedded options present in many financial instruments such as loan prepayment options and deposit early withdrawal options. These provide customers opportunities to take advantage of directional changes in rates, which could have an adverse impact on the Company's net interest income. Basis risk refers to the potential for changes in the underlying relationship between market rates or indices, which subsequently result in a narrowing of the spread earned on a loan or investment relative to its cost of funds. Net interest income represents the Company's principal component of income. Consistency of the Company's net interest income is largely dependent upon the effective management of interest rate risk. The Company has established risk measures, limits and policy guidelines in its Interest Rate Risk Management Policy. The responsibility for management of interest rate risk resides with the Company's Asset/Liability Committee, ("ALCO"), with oversight by the Board of Directors. The Company uses an earnings simulation analysis that measures the sensitivity of net interest income to various interest rate movements. The base-case scenario is established using current interest rates. The comparative scenarios assume an immediate parallel shock in increments of 100 basis point rate movements. The Company did not prepare rate shocks for decreases of 200 and 300 basis points due to the unlikeliness of these rate scenarios based on the historically low current interest rate environment. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Company. Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the model. These assumptions include, but are not limited to, management's best estimates of the effect of changing interest rates on the prepayment speeds of certain assets and liabilities, projections for activity levels in each of the product lines offered by the Company and historical behavior of deposit rates and balances in relation to changes in interest rates. These assumptions are inherently uncertain, and as a result, the model cannot precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions. The Company's 12-month net interest income sensitivity profile as of fiscal year-end December 31, 2003 is as follows: --------------------------- -------------- Change in Rates % Change --------------------------- -------------- + 300 basis points (14.55) --------------------------- -------------- + 200 basis points (9.14) --------------------------- -------------- + 100 basis points (4.79) --------------------------- -------------- - 100 basis points .74 --------------------------- -------------- All of the above estimated changes in net interest income are within established policy guidelines. ASSET QUALTIY In accordance with the Company's classification of assets policy, management evaluates the loan and investment portfolio each month to identify substandard assets that may contain the potential for loss. In addition, management evaluates the adequacy of its allowance for possible loan losses. NON-PERFORMING ASSETS The following table sets forth information concerning non-performing assets of the Bank. Real estate owned includes property acquired in settlement of foreclosed loans that is carried at net realizable value. (dollars in thousands)
---------------------------------------------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 June 2001 June 2000 June 1999 ---------------------------------------------------------------------------------------------------------------------- Non-accruing loans: Residential mortgages $ 832 $ 1,749 $ 795 $ 2,613 $ 1,375 $ 1,818 Commercial real estate mortgages 247 137 96 2,783 61 6 Home equities/second mortgages 591 606 740 504 390 633 Commercial 647 566 461 226 165 718 Consumer 182 206 189 225 431 334 -------- -------- -------- -------- -------- -------- Total 2,499 3,264 2,281 6,351 2,422 3,509 --------- ---------- ---------- --------- --------- ---------- Accruing loans: Residential mortgages 1,125 1,166 1,094 - - - Commercial real estate mortgages - - - - - - Home equities/second mortgages - - - - - - Commercial 5 - - - - - Consumer - - 16 - - - -------- -------- -------- -------- -------- -------- Total 1,130 1,166 1,110 - - - --------- ---------- ---------- --------- --------- ---------- Troubled debt restructured 258 316 374 879 632 61 --------- ---------- ---------- --------- --------- ---------- Total non-performing loans 3,887 4,746 3,765 7,230 3,054 3,570 Real estate owned 1,739 1,472 2,239 1,298 1,235 2,050 --------- ---------- ---------- --------- --------- ---------- Total Non-Performing Assets $ 5,626 $ 6,218 $ 6,004 $ 8,528 $ 4,289 $ 5,620 ========= ========== ========== ========= ========= ========== Non-performing assets to total assets 0.66% 0.70% 0.70% 0.99% 0.52% 0.75% ========= ========== ========== ========= ========= ========== Non-performing loans to loans 0.60% 0.71% 0.57% 1.02% 0.46% 0.60% ========= ========== ========== ========= ========= ========== Allowance for loan losses to non-performing loans 193.11% 151.12% 171.34% 78.70% 162.05% 121.82% ========= ========== ========== ========= ========= ==========
In addition, at December 31, 2003, there were $21.7 million in current performing loans that were classified as special mention or substandard for which potential weaknesses exist, which may result in the future inclusion of such items in the non-performing category. Total non-performing assets decreased $592,000 to $5.6 million at December 31, 2003. This decrease resulted from a $859,000 decrease in non-performing loans that was offset by an increase of $267,000 in real estate owned. During fiscal year June 2002, the Company changed its method of classifying loans that are 90 days or more delinquent. In prior fiscal years, any loan that was 90 days or more delinquent was placed in a nonaccrual status. Beginning in fiscal 2002, loans that are 90 days or more delinquent, which have a mortgage insurance contract or a government agency, such as Rural Development, guaranteeing the payment of delinquent interest, are further reviewed to determine if the insurance coverage is adequate to cover both the anticipated principal loss as well as the accrued interest. If the insurance coverage is determined to be adequate the loan is then classified as nonperforming but still accruing. If management believes there is any question as to the adequacy of the insurance coverage, the loan is classified as nonaccrual. As of December 31, 2003, the Bank had $1.4 million of loans, including troubled debt restructed loans that were nonperforming but still accruing. ALLOWANCE FOR LOAN LOSSES The provision for loan losses for the fiscal year ended December 31, 2003 was $1.3 million, which resulted in an allowance for loan losses balance of $7.5 million as of December 31, 2003 as compared to $7.2 million as of December 31, 2002. The growth in the allowance for loan losses primarily reflects the changing mix of the Bank's loans from primarily residential real estate to an increasing commercial real estate and commercial loan portfolio. Commercial loans typically involve large loan balances to single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the successful operation of the related project and thus may be subject to adverse conditions in the real estate market or in the general economy. For the year ended December 31, 2003, commercial real estate loans, including commercial construction loans, increased $12.7 million or 6.5%, while commercial installment loans increased $9.0 million or 10%. See the Critical Accounting Policies, Allowance for Loan Losses section on page 25 for a description of the systematic analysis the Bank uses to determine its allowance for loan losses. The following table sets forth an analysis of the allowance for possible loan losses.
--------------------------------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 June 2001 June 2000 June 1999 --------------------------------------------------------------------------------------------------------- Balance at beginning of period $ 7,172 $ 6,451 $ 5,690 $ 4,949 $ 4,349 $ 4,243 Provision for loan losses 1,268 1,221 1,423 1,680 1,441 1,124 Loan charge-offs: Residential mortgages (176) (74) (137) (81) (118) (137) Commercial real estate mortgages (60) - (86) (50) - (200) Home equities/second mortgages (163) (44) (138) (87) (104) (94) Commercial (255) (240) (38) (303) (397) (66) Consumer (425) (186) (331) (498) (318) (606) ---------- ---------- ---------- ---------- ---------- ---------- Total charge-offs (1,079) (544) (730) (1,019) (937) (1,103) ---------- ---------- ---------- ---------- ---------- ---------- Recoveries: Residential mortgages 28 18 3 3 5 - Commercial real estate mortgages - - - - - - Home equities/second mortgages - - 1 - - - Commercial 65 1 8 - - 1 Consumer 52 25 56 77 91 84 ---------- ---------- ---------- ---------- ---------- ---------- Total recoveries 145 44 68 80 96 85 ---------- ---------- ---------- ---------- ---------- ---------- Net loan recoveries (charge-offs) (934) (500) (662) (939) (841) (1,018) ---------- ---------- ---------- ---------- ---------- ---------- Balance $ 7,506 $ 7,172 $ 6,451 $ 5,690 $ 4,949 $ 4,349 ========== ========== ========== ========== ========== ========== Net charge-offs to average loans 0.14% 0.08% 0.10% 0.14% 0.14% 0.17% ========== ========== ========== ========== ========== ========== Allowance balance to total loans 1.16% 1.08% 1.01% 0.82% 0.75% 0.73% ========== ========== ========== ========== ========== ==========
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The following table indicates the portion of the loan loss reserve management has allocated to each loan type at December 31, 2003: (dollars in thousands) Loan type Allowance --------------------------------------------- ----------- Residential mortgages $ 1,535 Commercial real estate 1,839 Home equities/second mortgages 712 Commercial other 2,491 Consumer loans 929 --------------------------------------------- ----------- Total allowance for loan losses $ 7,506 ============================================= =========== LIQUIDITY AND CAPITAL RESOURCES The Bank maintains its liquid assets at a level believed adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. Cash for these purposes is generated through the sale or maturity of securities and loan prepayments and repayments, and may be generated through increases in deposits or borrowings. Loan payments are a relatively stable source of funds, while deposit flows are influenced significantly by the level of interest rates and general money market conditions. Borrowings may be used to compensate for reductions in other sources of funds such as deposits. As a member of the FHLB System, the Bank may borrow from the FHLB of Indianapolis. At December 31, 2003, the Bank had $154.3 million in borrowings from the FHLB of Indianapolis. As of that date, the Bank had commitments to fund loan originations of approximately $23.2 million and commitments to sell loans of $18.5 million. In the opinion of management, the Bank has sufficient cash flow and borrowing capacity to meet current and anticipated funding commitments. The Bank's liquidity, represented by cash and cash equivalents, is a result of its operating, investing and financing activities. During the fiscal year ended December 31, 2003, there was a net decrease of $19.5 million in cash and cash equivalents. The major uses of cash during the year were: originations of mortgages held for sale of $350.0 million; purchases of investment and mortgage-backed securities of $182.3 million; repayment of FHLB advances of $32.0 million; and decreases in deposits of $20.4 million. The major sources of cash provided during the year included $381.8 million from selling fixed rate mortgage loans primarily to Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"); maturities and sales of investment securities of $172.5 million; and proceeds from FHLB advances of $14.7 million. SIGNIFICANT COMMITMENTS In the normal course of business, the Bank is a party to various activities that contain credit and market risk that are not reflected in the financial statements. Such activities include commitments to extend credit, sell loans and standby letters of credit. For further information on off-balance sheet credit related financial obligations see note 15 to the financial statements. Commitments that are not reflected in the accompanying consolidated financial statements are summarized as follows: (in thousands) Commitments to extend credit: Commercial $63,094 Residential real estate 18,332 Revolving home equity lines of credit 72,443 Other 1,864 Standby letters of credit 1,904 Commitments to sell loans: Mortgage 11,675 Commercial 6,851 Commitments to extend credit, including loan commitments and standby letters of credit do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. OFF-BALANCE SHEET ARRANGEMENTS The term "off-balance sheet arrangement" generally means any transaction, agreement, or other contractual arrangement to which an entity unconsolidated with the Company is a party under which the company has (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets. The Company does not have any off-balance sheet arrangements with unconsolidated entities that have or are reasonably likely to have a current or future effect on the Company's financial condition, change in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. JOINT VENTURES The Company has invested in joint ventures through its subsidiaries, Home Savings Corporation ("HSC") and HomeFed Financial Corp. On December 31, 2001, the Bank changed its charter from a Federal savings bank charter to an Indiana commercial bank charter. Commercial banks are not permitted to participate in real estate development joint ventures. HSC is a partner in five real estate development joint ventures for which exit strategies are either developed, or are currently being developed. The Company, as mandated by its charter change, is in the process of divesting itself of these investments by December 31, 2004, with two one-year extensions available, subject to regulatory approval. The investments are accounted for by the equity method. DERIVIATIVE FINANCIAL INSTRUMENTS On July 1, 2000, the Company adopted Statement of Financial Accounting Standards No. 133, ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts. All derivatives, whether designated as a hedge, or not, are required to be recorded on the balance sheet at fair value. The Company designates its fixed rate and variable rate interest rate swaps as fair value and cash flow hedge instruments, respectively. If the derivative is designated as a fair value hedge, the changes in fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the changes in fair value of the derivative and of the hedged item attributable to the hedged risk are recorded in accumulated other comprehensive income (OCI), net of income taxes. The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. See Note 1 for further discussion of derivative financial instruments. IMPACT OF INFLATION The consolidated financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of commercial banks such as the Bank are monetary in nature. As a result, interest rates have a more significant impact on the Bank's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the price of goods and services. In the current interest rate environment, liquidity, maturity structure and quality of the Bank's assets and liabilities are critical to the maintenance of acceptable performance levels. NEW ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board, ("FASB") has issued Statements No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" and No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." The FASB also issued FASB Interpretation No. 45, ``Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,'' and FASB Interpretation No. 46, ``Consolidation of Variable Interest Entities - an Interpretation of Accounting Research Bulletin (ARB) No. 51." The Company adopted these new pronouncements during the twelve month period ended December 31, 2003. See Note 1 to the consolidated financial statements for further discussion of these pronouncements. Adoption of these pronouncements did not have a material effect on the Company's consolidated financial statements. CRITICAL ACCOUNTING POLICIES The notes to the consolidated financial statements contain a summary of the Company's significant accounting policies. Certain of these policies are critical to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include a determination of the allowance for loan losses and the valuation of mortgage servicing rights. Allowance for Loan Losses A loan is considered impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the loan's observable market price or the estimated fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to operating expense. Loan losses are charged against the allowance when management believes the loans are uncollectible. Subsequent recoveries, if any, are credited to the allowance. The Company maintains an allowance for loan losses to absorb probable loan losses inherent in the portfolio. The allowance for loan losses is maintained at a level management considers to be adequate to absorb probable loan losses inherent in the portfolio, based on evaluations of the collectibility and historical loss experience of loans. The allowance is based on ongoing assessments of the probable estimated losses inherent in the loan portfolio. The Company's methodology for assessing the appropriate allowance level consists of several key elements, as described below. All delinquent loans that meet regulatory requirements are included on the Asset Watch List. The Asset Watch List is reviewed quarterly by the Asset Watch Committee for any classification beyond the regulatory rating based on a loan's delinquency. Commercial and commercial real estate loans are individually risk rated per the loan policy. Homogenous loans such as consumer and residential mortgage loans are not individually risk rated by management. They are risk rated based on computer file data that management believes will provide a good basis for the loans' quality. For all loans not listed individually on the Asset Watch List, historical loss rates based on the last four years are the basis for developing expected charge-offs for each pool of loans. Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the local economy, trends in the nature and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Company's internal credit review function. A portion of the allowance is not allocated to any particular loan type and is maintained in recognition of the inherent inability to precisely determine the loss potential in any particular loan or pool of loans. Among the factors used by management in determining the unallocated portion of the allowance are current economic conditions, trends in the Company's loan portfolio delinquency, losses and recoveries; level of under performing and nonperforming loans; and concentrations of loans in any one industry. Valuation of Mortgage Servicing Rights The Company recognizes the rights to service mortgage loans as separate assets, which are included in other assets in the consolidated balance sheet. The total cost of loans when sold is allocated between loans and mortgage servicing rights ("MSR's") based on the relative fair values of each. MSR's are subsequently carried at the lower of the initial carrying value, adjusted for amortization, or fair value. MSR's are evaluated for impairment based on the fair value of those rights. The Company uses a present value cash flow valuation model to establish the fair value of the MSR's. Factors included in the calculation of fair value of the MSR's include estimating the present value of future net cash flows, market loan prepayment speeds for similar loans, discount rates, servicing costs, and other economic factors. Servicing rights are amortized over the estimated period of net servicing revenue. It is likely that these economic factors will change over the life of the MSR's, resulting in different valuations of the MSR's. The differing valuations will affect the carrying value of the MSR's on the balance sheet as well as the income recorded from loan servicing in the income statement.
CONSOLIDATED BALANCE SHEETS (in thousands except share data) ------------------------------------ Dec 2003 Dec 2002 June 2002 --------------------------------------------------------------------------------------------------------------------------- Assets: Cash $ 22,734 $ 27,404 $ 25,006 Interest-bearing deposits 11,444 26,288 19,472 ----------- ---------- ----------- Total cash and cash equivalents 34,178 53,692 44,478 ----------- ---------- ----------- Securities available for sale at fair value (amortized cost $123,243, $113,000 and $113,132)(Note 2) 123,638 114,440 114,989 Securities held to maturity at amortized cost (fair value $1,883, $3,147 and $3,619) (Note 2) 1,828 3,026 3,493 Loans held for sale (fair value $6,357, $31,055 and $6,383) (Note 4) 6,272 30,560 6,302 Loans receivable, net of allowance for loan losses of $7,506, $7,172 and $6,451 (Note 3) 630,672 628,883 631,815 Investments in joint ventures (Note 5) 5,501 6,710 8,153 Federal Home Loan Bank stock (Note 9) 9,965 9,965 9,965 Accrued interest receivable, net (Note 6) 3,733 4,289 4,431 Premises and equipment, net (Note 7) 13,987 12,973 12,192 Real estate owned 1,739 1,472 2,239 Prepaid expenses and other assets 9,061 8,259 6,768 Cash surrender value of life insurance 11,359 10,841 9,792 Goodwill, net 1,395 1,395 1,395 ----------- ---------- ----------- Total Assets $ 853,328 $ 886,505 $ 856,012 =========== ========== =========== Liabilities and Shareholders' Equity: Liabilities: Deposits (Note 8) $ 588,915 $ 609,358 $ 577,480 Federal Home Loan Bank advances (Note 9) 154,296 171,635 174,139 Senior debt (Note 10) 14,242 14,242 11,200 Other borrowings (Note 10) 624 1,867 3,341 Advance payments by borrowers for taxes and insurance 76 229 442 Accrued expenses and other liabilities 11,153 11,380 12,324 ----------- ---------- ----------- Total liabilities 769,306 808,711 778,926 ----------- ---------- ----------- Shareholders' equity (Notes 10, 11, 12, 14): No par preferred stock; Authorized: 2,000,000 shares Issued and outstanding: None No par common stock; Authorized: 15,000,000 shares Issued and outstanding: 12,616 9,184 9,086 4,312,805 shares at December 31, 2003 4,228,859 shares at December 31, 2002 4,336,515 shares at June 30, 2002 Retained earnings, restricted 71,436 68,156 67,150 Accumulated other comprehensive income, net (30) 454 850 ----------- ---------- ----------- Total shareholders' equity 84,022 77,794 77,086 ----------- ---------- ----------- Total Liabilities and Shareholders' Equity $ 853,328 $ 886,505 $ 856,012 =========== ========== ========== See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data) Twelve Six Months Months Ended Ended Year Ended ------------------------------------------------------ Dec 2003 Dec 2002 June 2002 June 2001 ------------------------------------------------------------------------------------------------------------- Interest Income: Loans receivable (Note 3) $ 41,313 $ 23,297 $ 50,230 $ 57,590 Securities available for sale and held to maturity 3,932 2,772 5,488 6,622 Other interest income 357 171 580 545 ------------ ------------ ------------ ------------ Total interest income 45,602 26,240 56,298 64,757 ------------ ------------ ------------ ------------ Interest Expense: Deposits (Note 8) 12,204 7,514 18,716 26,710 Advances from Federal Home Loan Bank (Note 9) 9,221 5,205 11,106 11,987 Other borrowings (Note 10) 839 426 813 819 ------------ ------------ ------------ ------------ Total interest expense 22,264 13,145 30,635 39,516 ------------ ------------ ------------ ------------ Net interest income 23,338 13,095 25,663 25,241 ------------ ------------ ------------ ------------ Provision for loan losses 1,268 1,221 1,423 1,680 ------------ ------------ ------------ ------------ Net interest income after provision for loan losses 22,070 11,874 24,240 23,561 ------------ ------------ ------------ ------------ Other Income: Gain on sale of loans 7,492 3,740 4,456 1,975 Gain (loss) on sale of securities available for sale (83) 4 92 (196) Income from joint ventures (Note 5) 668 141 880 811 Insurance, annuity income, other fees 1,677 717 1,400 1,159 Service fees on NOW accounts 2,715 1,316 2,241 2,316 Net gain on real estate owned 197 114 271 107 Loan servicing income, net of impairments 575 (136) 1,031 836 Miscellaneous 1,847 973 2,018 2,012 ------------ ------------ ------------ ------------ Total other income 15,088 6,869 12,389 9,020 ------------ ------------ ------------ ------------ Other Expenses: Compensation and employee benefits (Note 13) 12,520 5,745 10,813 9,270 Occupancy and equipment 3,027 1,453 2,850 2,530 Service bureau expense 957 428 1,029 938 Federal insurance premium (Note 12) 95 49 104 113 Marketing 655 223 571 549 Goodwill amortization - - - 101 Miscellaneous 5,241 2,477 4,678 4,012 ------------ ------------ ------------ ------------ Total other expenses 22,495 10,375 20,045 17,513 ------------ ------------ ------------ ------------ Income before income taxes 14,663 8,368 16,584 15,068 Income tax provision (Note 11) 5,020 3,071 6,245 5,519 ------------ ------------ ------------ ------------ Net Income $ 9,643 $ 5,297 $ 10,339 $ 9,549 ============ ============ ============ ============ Basic Earnings per Common Share $ 2.26 $ 1.23 $ 2.34 $ 2.13 Diluted Earnings per Common Share $ 2.15 $ 1.17 $ 2.25 $ 2.07 See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands except share data) ---------------------------------------------------------------------------- Accumulated Other Total Shares Common Retained Comprehensive Shareholders' Outstanding Stock Earnings Income (Loss) Equity ---------------------------------------------------------------------------------------------------------------------------- Balance at June 2000 4,734,585 $ 8,335 $ 62,251 $ (1,100) $ 69,486 Comprehensive income: Net income 9,549 9,549 Change in unrealized gain on securities available for sale, net of reclassification adjustment and tax effect 1,394 1,394 Change in fair value of cash flow hedge, net of tax (70) (70) ---------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 10,873 ---------------------------------------------------------------------------------------------------------------------------- Stock options exercised 17,848 117 117 Stock repurchased (336,729) (501) (5,575) (6,076) Tax benefit related to exercise of non-qualified stock options 82 82 Cash dividends ($.550 per share) (2,438) (2,438) ---------------------------------------------------------------------------------------------------------------------------- Balance at June 2001 4,415,704 8,033 63,787 224 72,044 Comprehensive income: Net income 10,339 10,339 Change in unrealized gain on securities available for sale, net of reclassification adjustment and tax effect 924 924 Change in fair value of cash flow hedge, net of tax (298) (298) ---------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 10,965 ---------------------------------------------------------------------------------------------------------------------------- Stock options exercised 132,961 1,311 1,311 Stock repurchased (212,150) (316) (4,448) (4,764) Tax benefit related to exercise of non-qualified stock options 58 58 Cash dividends ($.576 per share) (2,528) (2,528) ---------------------------------------------------------------------------------------------------------------------------- Balance at June 2002 4,336,515 9,086 67,150 850 77,086 Comprehensive income: Net income 5,297 5,297 Change in unrealized gain on securities available for sale, net of reclassification adjustment and tax effect (272) (272) Change in fair value of cash flow hedge, net of tax (124) (124) ---------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 4,901 ---------------------------------------------------------------------------------------------------------------------------- Stock options exercised 22,344 292 292 Stock repurchased (130,000) (194) (2,960) (3,154) Cash dividends ($.313 per share) (1,331) (1,331) ---------------------------------------------------------------------------------------------------------------------------- Balance at December 2002 4,228,859 9,184 68,156 454 77,794 Comprehensive income: Net income 9,643 9,643 Change in unrealized gain on securities available for sale, net of reclassification adjustment and tax effect (687) (687) Change in fair value of cash flow hedge, net of tax 203 203 ---------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 9,159 ---------------------------------------------------------------------------------------------------------------------------- Stock options exercised 224,346 3,128 3,128 Stock repurchased (140,400) (209) (3,366) (3,575) Tax benefit related to exercise of non-qualified stock options 513 513 Cash dividends ($.700 per share) (2,997) (2,997) ---------------------------------------------------------------------------------------------------------------------------- Balance at December 2003 4,312,805 $ 12,616 $ 71,436 $ (30) $ 84,022 ============================================================================================================================ See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Twelve Six Months Months Ended Ended Year Ended ------------------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 ------------------------------------------------------- Cash Flows From Operating Activities: Net income $ 9,643 $ 5,297 $ 10,339 $ 9,549 Adjustments to reconcile net income to net cash from operating activities: Accretion of discounts, amortization and depreciation 2,212 924 1,197 768 Provision for loan losses 1,268 1,221 1,423 1,680 Net gain from sale of loans (7,492) (3,740) (4,456) (1,975) Net (gain) loss from sale of securities available for sale 83 (4) (92) 196 Income from joint ventures and net gain from real estate owned (865) (255) (1,151) (918) Net loan fees deferred (recognized) (22) 36 61 (56) Proceeds from sale of loans held for sale 381,764 210,692 256,579 131,580 Origination of loans held for sale (349,984) (231,210) (246,042) (139,612) Decrease (increase) in accrued interest and other assets (2,805) (1,893) (7,377) 218 Increase in other liabilities (177) (1,281) 5,270 1,786 ----------- ---------- ---------- ---------- Net Cash From Operating Activities 33,625 (20,213) 15,751 3,216 ----------- ---------- ---------- ---------- Cash Flows From Investing Activities: Net principal received (disbursed) on loans 7,570 9,059 45,525 (15,034) Proceeds from: Maturities/Repayments of: Securities held to maturity 1,304 472 1,822 1,498 Securities available for sale 131,136 38,395 27,772 8,417 Sales of: Securities available for sale 40,078 7,360 20,237 74,471 Real estate owned and other asset sales 2,328 1,305 4,545 1,505 Purchases of: Loans (10,605) (7,384) (4,272) (9,135) Securities available for sale (182,214) (45,822) (79,349) (61,853) Securities held to maturity (100) - - (1,010) Federal Home Loan Bank stock - - (99) (829) Investment in joint ventures, net 1,877 1,584 2,802 1,069 Investment in cash surrender value of life insurance - (785) - (2,500) Acquisition of property and equipment (2,557) (1,506) (1,766) (4,097) ----------- ---------- ---------- ---------- Net Cash From Investing Activities (11,183) 2,678 17,217 (7,498) ----------- ---------- ---------- ---------- Cash Flows From Financing Activities: Net increase (decrease) in deposits (20,443) 31,878 937 3,650 Proceeds from advances from Federal Home Loan Bank 14,700 17,600 29,700 154,400 Repayment of advances from Federal Home Loan Bank (32,039) (20,104) (47,628) (137,819) Proceeds from senior debt - 3,042 - 5,500 Repayment of senior debt - - - (505) Net increase (decrease) from overnight borrowings (1,243) (1,474) (1,000) 1,599 Common stock options exercised, net of fractional shares paid 3,641 292 1,369 198 Repurchase of common stock (3,575) (3,154) (4,764) (6,075) Payment of dividends on common stock (2,997) (1,331) (2,528) (2,438) ----------- ---------- ---------- ---------- Net Cash From Financing Activities (41,956) 26,749 (23,914) 18,510 ----------- ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents (19,514) 9,214 9,054 14,228 Cash and cash equivalents, beginning of period 53,692 44,478 35,424 21,196 ----------- ---------- ---------- ---------- Cash and Cash Equivalents, End of Period $ 34,178 $ 53,692 $ 44,478 $ 35,424 =========== ========== ========== ========== Supplemental Information: Cash paid for interest $ 22,398 $ 13,032 $ 31,191 $ 38,825 Cash paid for income taxes $ 5,840 $ 3,570 $ 6,574 $ 6,853 Assets acquired through foreclosure $ 3,606 $ 1,104 $ 4,342 $ 1,427 See notes to consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For The Twelve Months Ended December 31, 2003 And The Six Months Ended December 31, 2002 And For Each Of The Years In The Two Year Period Ended June 30, 2002 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting policies of Home Federal Bancorp (the "Company") conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. A summary of the more significant accounting policies follows: Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, HomeFed Financial Corp. and HomeFederal Bank (the "Bank") and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. On September 24, 2002, the Company changed its fiscal year end from June 30 to December 31. Description of Business The Company is a bank holding company. The Bank provides financial services to south-central Indiana through its main office in Columbus and 17 other full service banking offices. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Estimates most susceptible to change in the near term include the allowance for loan losses, the valuation of mortgage servicing rights, the valuation of investments in joint ventures and the fair value of securities. Cash and Cash Equivalents All highly liquid investments with an original maturity of three months or less are considered to be cash equivalents. Securities Securities are required to be classified as held to maturity, available for sale or trading. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity. Debt and equity securities not classified as either held to maturity or trading securities are classified as available for sale. Only those securities classified as held to maturity are reported at amortized cost, with those available for sale and trading reported at fair value with unrealized gains and losses included in shareholders' equity or income, respectively. Premiums and discounts are amortized over the contractual lives of the related securities using the level yield method. Gain or loss on sale of securities is based on the specific identification method. Loans Held for Sale Loans held for sale consist of fixed rate mortgage loans conforming to established guidelines and held for sale to the secondary market. Mortgage loans held for sale are carried at the lower of cost or fair value determined on an aggregate basis. Gains and losses on the sale of these mortgage loans are included in other income. Mortgage Servicing Rights The Company recognizes the rights to service mortgage loans as separate assets, which are included in other assets in the consolidated balance sheet. The total cost of loans when sold is allocated between loans and mortgage servicing rights, ("MSR's"), based on the relative fair values of each. MSR's are subsequently carried at the lower of the initial carrying value, adjusted for amortization, or fair value. MSR's are evaluated for impairment based on the fair value of those rights. The Company uses a present value cash flow valuation model to establish the fair value of the MSR's. Factors included in the calculation of fair value of the MSR's include estimating the present value of future net cash flows, market loan prepayment speeds for similar loans, discount rates, servicing costs, and other economic factors. Servicing rights are amortized over the estimated period of net servicing revenue. It is likely that these economic factors will change over the life of the MSR's, resulting in different valuations of the MSR's. The differing valuations will affect the carrying value of the MSR's on the balance sheet as well as the income recorded from loan servicing in the income statement. Loans Interest on real estate, commercial and installment loans is accrued over the term of the loans on a level yield basis. The recognition of interest income is discontinued when, in management's judgment, the interest will not be collectible in the normal course of business. Loan Origination Fees Nonrefundable origination fees, net of certain direct origination costs, are deferred and recognized as a yield adjustment over the life of the underlying loan. Any unamortized fees on loans sold are credited to gain on sale of loans at the time of sale. Uncollected Interest An allowance for the loss of uncollected interest is generally provided on loans which are more than 90 days past due. The only loans which are 90 days past due and do not have an allowance for the loss of interest, are loans where the Bank is guaranteed reimbursement of interest by either a mortgage insurance contract or by a government agency such as Rural Development. If neither of these criteria is met an allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments returns to normal, in which case the loan is returned to accrual status. Allowance for Loan Losses A loan is considered impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the loan's observable market price or the estimated fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to operating expense. Loan losses are charged against the allowance when management believes the loans are uncollectible. Subsequent recoveries, if any, are credited to the allowance. The Company maintains an allowance for loan losses to absorb probable loan losses inherent in the portfolio. The allowance for loan losses is maintained at a level management considers to be adequate to absorb probable loan losses inherent in the portfolio, based on evaluations of the collectibility and historical loss experience of loans. The allowance is based on ongoing assessments of the probable estimated losses inherent in the loan portfolio. The Company's methodology for assessing the appropriate allowance level consists of several key elements, as described below. All delinquent loans that meet regulatory requirements are included on the Asset Watch List. The Asset Watch List is reviewed quarterly by the Asset Watch Committee for any classification beyond the regulatory rating based on the loans' delinquency. Commercial and commercial real estate loans are individually risk rated per the loan policy. Homogeneous loans such as consumer and residential mortgage loans are not individually risk rated by management. They are risk rated based on computer file data that management believes will provide a good basis for the loans' quality. For all loans not listed individually on the Asset Watch List, historical loss rates based on the last four years are the basis for developing expected charge-offs for each pool of loans. Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the local economy, trends in the nature and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Company's internal credit review function. A portion of the allowance is not allocated to any particular loan type and is maintained in recognition of the inherent inability to precisely determine the loss potential in any particular loan or pool of loans. Among the factors used by management in determining the unallocated portion of the allowance are current economic conditions; trends in the Company's loan portfolio delinquency, losses and recoveries; level of under performing and nonperforming loans; and concentrations of loans in any one industry. Real Estate Owned Real estate owned represents real estate acquired through foreclosure or deed in lieu of foreclosure and is recorded at the lower of fair value or carrying amount. When property is acquired, it is recorded at net realizable value at the date of acquisition, with any resulting write-down charged against the allowance for loan losses. Any subsequent deterioration of the property is charged directly to real estate owned expense. Costs relating to the development and improvement of real estate owned are capitalized, whereas costs relating to holding and maintaining the properties are charged to expense. Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation. Depreciation is computed on the straight-line method over estimated useful lives that range from three to thirty-nine years. Derivative Financial Instruments On July 1, 2000, the Company adopted Statement of Financial Accounting Standards No. 133, ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts. All derivatives, whether designated as a hedge, or not, are required to be recorded on the balance sheet at fair value. The Company designates its fixed rate and variable rate interest rate swaps as fair value and cash flow hedge instruments, respectively. If the derivative is designated as a fair value hedge, the changes in fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the changes in fair value of the derivative and of the hedged item attributable to the hedged risk are recorded in accumulated other comprehensive income (OCI), net of income taxes. The adoption of this standard resulted in a fair value hedge asset of $271,000 being recorded on July 1, 2000 and an offsetting contra asset for the same amount being applied as a reduction to commercial real estate loans. The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. The Company has entered into interest rate swap agreements as a means of managing its interest rate exposure on certain fixed rate commercial loans and variable rate debt obligations. As of December 31, 2003, the notional amount of the Company's two outstanding interest rate swaps on commercial loans was $5.1 million with maturities in 2008 and 2009, as discussed in Note 3. The notional amount of the Company's two outstanding interest rate swaps on debt obligations was $9.2 million with maturities in 2004 and 2006, as discussed in Note 10. As of December 31, 2003, the fair value of the fair value hedge liability was adjusted to $620,000. As of December 31, 2003, the fair value of the cash flow hedge liability was $480,000. The total income statement impact resulting from the fair value and cash flow hedges was zero, as management has determined there to be no ineffectiveness in accordance with SFAS 133. Goodwill On July 1, 2001, the Company early adopted, as permitted, Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets." In accordance with SFAS 142, the Company ceased annual goodwill amortization of approximately $101,000. The new rules also require an initial goodwill impairment assessment in the year of adoption and at least annual impairment tests thereafter. Management determined that there was no impairment charge resulting from the adoption of SFAS 142 and its annual impairment test. Income Taxes The Company and its wholly owned subsidiaries file consolidated income tax returns. Deferred income tax assets and liabilities reflect the impact of temporary differences between amounts of assets and liabilities recorded for financial reporting purposes and basis of such assets and liabilities as measured by tax laws and regulations. Earnings per Common Share Earnings per share of common stock are based on the weighted average number of basic shares and dilutive shares outstanding during the year. The following is a reconciliation of the weighted average common shares for the basic and diluted earnings per share computations:
Twelve Six Months Months Ended Ended Year Ended ------------------------------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 ----------------------------------------------------------------------------------------------------------- Basic Earnings per Share: Weighted average common shares 4,267,257 4,300,578 4,409,829 4,485,583 =============== =============== =============== =============== Diluted Earnings per Share: Weighted average common shares 4,267,257 4,300,578 4,409,829 4,485,583 Dilutive effect of stock options 216,088 214,551 178,765 137,836 --------------- --------------- --------------- --------------- Weighted average common and incremental shares 4,483,345 4,515,129 4,588,594 4,623,419 =============== =============== =============== ===============
Comprehensive Income The following is a summary of the Company's comprehensive income: (dollars in thousands) Twelve Six Months Months Ended Ended Year Ended ----------------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 ----------------------------------------------------------------------------------------------------- Net Income $ 9,643 $ 5,297 $10,339 $ 9,549 Other comprehensive income: Unrealized holding gains (losses) from securities available for sale (1,127) (418) 1,482 2,128 Reclassification adjustment for (gains) losses realized in income 83 (4) (92) 196 Unrealized gains (losses) from cash flow hedge 336 (205) (494) (117) -------- ------- ------- ------- Net unrealized gains (losses) (708) (627) 896 2,207 Tax effect 224 231 (270) (883) -------- ------- ------- ------- Other comprehensive income, net of tax (484) (396) 626 1,324 -------- ------- ------- ------- Comprehensive Income $ 9,159 $ 4,901 $10,965 $10,873 ======== ======= ======= =======
Segments In accordance with Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information," management has concluded that the Company is comprised of a single operating segment, community banking activities, and has disclosed all required information relating to its one operating segment. Management considers parent company activity to represent an overhead function rather than an operating segment. The Company operates in one geographical area and does not have a single external customer from which it derives 10 percent or more of its revenue. Stock Based Compensation The Company has stock-based employee compensation plans, which are described more fully in Note 14. The company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of SFAS Statement No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation.
Twelve Six Months Months Ended Ended Year Ended ------------------------------------------------------------------------------ (dollars in thousands, except share data) Dec 2003 Dec 2002 June 2002 June 2001 --------------------------------------------------------------------------------------------------------------------------- Net income, as reported $ 9,643 $ 5,297 $10,339 $ 9,549 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (206) (63) (401) (296) ------- ------- ------- ------- Pro forma net income $ 9,437 $ 5,234 $ 9,938 $ 9,253 ======= ======== ======= ======= Earnings per share: Basic---as reported $ 2.26 $ 1.23 $ 2.34 $ 2.13 Basic---pro forma $ 2.21 $ 1.22 $ 2.25 $ 2.06 Diluted---as reported $ 2.15 $ 1.17 $ 2.25 $ 2.07 Diluted---pro forma $ 2.10 $ 1.16 $ 2.17 $ 2.00
The pro forma amounts are not representative of the effects on reported net income for future years. Changes in Presentation Certain amounts and items appearing in the prior periods' financial statements have been reclassified to conform to the current presentation. New Accounting Pronouncements Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities," was issued in June 2002. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. Management does not believe this statement had a material effect on its consolidated financial statements. As of December 31, 2003, there were no such exit or disposal activities. Statement of Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation--Transition and Disclosure, an amendment of FASB Statement No. 123," was issued in December 2002 and is effective for fiscal years ending after December 15, 2002. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results. Management has included the new disclosure requirements in its consolidated financial statements. Statement of Financial Accounting Standards No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," was issued in April 2003 and is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. In addition, except as stated below, all provisions of SFAS 149 are to be applied prospectively. The provisions of SFAS 149 that relate to Statement 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, will continue to be applied in accordance with their respective effective dates. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." Management has determined the adoption of SFAS 149 did not have a material effect on its consolidated financial statements. Statement of Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity," was issued in May 2003 and is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). The requirements of SFAS 150 apply to issuers' classification and measurement of freestanding financial instruments, including those that comprise more than one option or forward contract. SFAS 150 does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety. Management has determined the adoption of SFAS 150 did not have a material effect on its consolidated financial statements. In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.'' FIN 45 requires that certain guarantees must be recognized at fair value. FIN 45 also requires disclosure of detailed information about each guarantee or group of guarantees. The disclosure requirements are effective for financial statements ending after December 15, 2002. The recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. Management has determined the adoption of FIN 45 did not have a material effect on its consolidated financial statements. In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities - an Interpretation of Accounting Research Bulletin (ARB) No. 51." FIN 46 requires the primary beneficiary to consolidate a variable interest entity ("VIE") if it has a variable interest that will absorb a majority of the entity's expected losses if they occur, receive a majority of the entity's expected residual returns if they occur, or both. FIN 46 applies immediately to VIEs created after January 31, 2003, and to VIEs in which the entity obtains an interest after that date. Management has determined the adoption of FIN 46 did not have a material effect on its consolidated financial statements.
2. SECURITIES Securities are summarized as follows: (in thousands) December 31, 2003 December 31, 2002 --------------------------------------------------------------------------------------- Gross Unrealized Gross Unrealized Amortized ---------------- Fair Amortized ---------------- Fair Cost Gains Losses Value Cost Gains Losses Value ---------------------------------------------------------------------------------------------------------------------- Held to Maturity: Municipal bonds $ 1,250 $ 20 $ - $ 1,270 $ 1,985 $ 55 $ - $ 2,040 Certificate of deposit 100 - - 100 100 - - 100 Collateralized mortgage obligations - - - - 14 - - 14 Mortgage backed securities 478 35 - 513 927 66 - 993 --------------------------------------------------------------------------------------- Total Held to Maturity $ 1,828 $ 55 $ - $ 1,883 $ 3,026 $ 121 $ - $ 3,147 ======================================================================================= Available for Sale: Agency bonds $ 51,442 $ 300 $ (30) $ 51,712 $ 42,386 $ 313 $ (2) $ 42,697 Asset backed securities - - - - 5,970 86 - 6,056 Municipal bonds 14,636 142 (2) 14,776 - - - - Collateralized mortgage obligations 27,095 108 (131) 27,072 39,316 714 - 40,030 Mortgage backed securities 22,889 234 (171) 22,952 12,048 574 - 12,622 Corporate debt 3,428 34 (77) 3,385 8,448 82 (209) 8,321 Equity mutual funds 3,678 - (12) 3,666 4,757 13 (131) 4,639 Equity securities 75 - - 75 75 - - 75 --------------------------------------------------------------------------------------- Total Available for Sale $l23,243 $ 818 $(423) $123,638 $113,000 $1,782 $(342) $114,440 =======================================================================================
June 30, 2002 ------------------------------------------------- Gross Unrealized Amortized ---------------- Fair Cost Gains Losses Value -------------------------------------------------------------------------------- Held to Maturity: Municipal bonds $ 2,210 $ 61 $ - $ 2,271 Certificate of deposit 100 - - 100 Collateralized mortgage obligations 128 2 - 130 Mortgage backed securities 1,055 63 - 1,118 ------------------------------------------------- Total Held to Maturity $ 3,493 $ 126 $ - $ 3,619 ================================================= Available for Sale: Agency bonds $ 14,358 $ 198 $ - $ 14,556 Asset backed securities 5,965 89 - 6,054 Municipal bonds - - - - Collateralized mortgage obligations 60,431 1,016 (5) 61,442 Mortgage backed securities 16,744 553 - 17,297 Corporate debt 10,876 230 (129) 10,977 Equity mutual funds 4,683 9 (104) 4,588 Equity securities 75 - - 75 ------------------------------------------------- Total Available for Sale $113,132 $2,095 $(238) $114,989 ================================================= Certain securities, with amortized cost and fair value of $2.5 million at December 31, 2003, amortized cost and fair value of $2.0 million at December 31, 2002 and amortized cost of $2.9 million and fair value of $3.0 million at June 30, 2002, were pledged as collateral for the Bank's treasury, tax and loan account at the Federal Reserve and for certain trust, IRA and KEOGH accounts.
The amortized cost and fair value of securities at December 31, 2003, by contractual maturity are summarized as follows: (in thousands) Held to Maturity Available for Sale --------------------------------------------------------- Amortized Fair Market Amortized Fair Market Cost Value Yield Cost Value Yield --------------------------------------------------------------------------------------------------- Agency bonds: Due in one year or less $ - $ - - $ 4,009 $ 4,016 1.21% Due after 1 year through 5 years - - - 47,183 47,445 2.89% Due after 10 years - - - 250 251 2.26% Municipal bonds: Due after 1 year through 5 years 475 487 6.05% 4,880 4,906 3.46% Due after 5 years through 10 years 535 541 7.45% 9,756 9,870 4.89% Due after 10 years 240 242 7.79% - - - Certificate of deposit: Due in one year or less 100 100 1.10% - - - Collateralized mortgage obligations - - - 27,095 27,072 3.57% Mortgage backed securities 478 513 7.47% 22,889 22,952 4.22% Corporate debt: Due in one year or less - - - 1,505 1,539 6.13% Due after 10 years - - - 1,923 1,846 2.29% Equity mutual funds - - - 3,678 3,666 2.15% Equity securities - - - 75 75 - ------------------------------------------------------- Total $ 1,828 $ 1,883 6.79% $ 123,243 $123,638 3.42% =======================================================
Activities related to the sales of securities available for sale and called securities are summarized as follows: (in thousands) Twelve Six Months Months Ended Ended Year Ended --------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 --------------------------------------------------------------------- Proceeds from sales $40,078 $7,360 $20,237 $74,471 Gross gains on sales 37 5 92 205 Gross losses on sales 120 1 - 401 The majority of unrealized losses in the portfolio resulted from increases in market interest rates and not from deterioration in the creditworthiness of the issuer. The total number of security positions in the investment portfolio that were in an unrealized loss position at December 31, 2003 is 29. The Company defines securities in a continuous unrealized loss position as a security that has been so classified for a period greater than 31 consecutive days as of December 31, 2003. Investments that have been in a continuous unrealized loss position are summarized as follows: (in thousands)
Less than Twelve Months Twelve Months Or Longer Total ------------------------------------------------------------------------------------- Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Losses Value Losses Value Losses -------------------------------------------------------------------------------------------------------------------------------- Agency bonds $ 5,830 (30) $ - - $ 5,830 (30) Collateralized mortgage obligations 12,454 (131) - - 12,454 (131) Mortgage backed securities 13,015 (171) - - 13,015 (171) Corporate debt - - 1,846 (77) 1,846 (77) Equity mutual funds 3,572 (12) - - 3,572 (12) ------------------------------------------------------------------------------------- Total Temporarily Impaired Securities $ 34,871 (344) $ 1,846 (77) $36,717 (421) =====================================================================================
3. LOANS RECEIVEBLE Loans receivable are summarized as follows: (in thousands) ----------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 ------------------------------------------------------------------------------- First mortgage loans: Residential single family $178,159 $195,255 $214,565 Commercial and multi-family 171,397 183,369 172,495 Property under construction 94,431 63,017 54,639 Unimproved land 3,201 2,795 4,712 Home equity 35,515 40,998 45,541 Second mortgage 44,529 39,276 40,278 Commerical 99,085 90,063 86,435 Mobile home 4,365 5,834 6,625 Automobile 23,244 25,149 25,355 Consumer 4,221 4,681 4,535 Savings account 2,736 3,018 3,092 ---------- --------- --------- Gross loans receivable 660,883 653,455 658,272 Allowance for loan losses (7,506) (7,172) (6,451) Deferred loan fees (555) (544) (508) Undisbursed loan proceeds (22,150) (16,856) (19,498) ---------- --------- --------- Loans Receivable, Net $630,672 $628,883 $631,815 ========== ========= ========= The Bank originates both adjustable and fixed rate loans. The adjustable rate loans have interest rate adjustment limitations and are indexed to various indices. Adjustable residential mortgages are generally indexed to the one year Treasury constant maturity rate; adjustable consumer loans are generally indexed to the prime rate; adjustable commercial loans are generally indexed to either the prime rate or the one, three or five year Treasury constant maturity rate. Future market factors may affect the correlation of the interest rates the Bank pays on the short-term deposits that have been primarily utilized to fund these loans. The principal balance of loans on nonaccrual status totaled approximately $2.5 million at December 31, 2003, $3.3 million at December 31, 2002 and $2.3 million at June 30, 2002. The Bank would have recorded interest income of $461,000 for the year ended December 31, 2003, $168,000 for the six month period ended December 31, 2002 and $503,000 and $432,000 for the fiscal years ended June 30, 2002 and 2001, respectively, if loans on non-accrual status had been current in accordance with their original terms. Actual interest received was $253,000, $83,000, $431,000 and $220,000 for the fiscal year ended December 31, 2003, for the six months ended December 31, 2002, and the fiscal years ended June 30, 2002 and 2001, respectively. The Bank agreed to modify the terms of certain loans to customers who were experiencing financial difficulties. Modifications included forgiveness of interest, reduced interest rates and/or extensions of the loan term. The principal balance at December 31, 2003, December 31, 2002 and June 30, 2002, on these restructured loans were $298,000, $266,000 and $324,000, respectively. The Bank's primary lending area is south-central Indiana. Virtually all of the Bank's loans originated and purchased are to borrowers located within the state of Indiana. The Bank originates and purchases commercial real estate loans, which totaled $171.4 million, $183.4 million and $172.5 million at December 31, 2003 and 2002, and June 30, 2002, respectively. These loans are considered by management to be of somewhat greater risk of uncollectibility due to the dependency on income production or future development of the real estate. Of the commercial real estate loans, $22.0, $22.8 million and $29.6 million were collateralized by multi-family residential property at December 31, 2003 and 2002, and June 30, 2002, respectively. Effective July 1, 1998 and January 2, 1999, the company entered into two interest rate swap agreements with KeyBank on two commercial loans. In the first agreement the company will receive variable rate payments at thirty-day London inter bank offering rate ("LIBOR") index and make fixed rate payments at 6.28%. The notional amount on the swap was $3.2 million as of December 31, 2003. The thirty-day LIBOR was 1.12% at December 31, 2003. The termination date of the first swap agreement is July 1, 2008. In the second agreement the company will receive variable rate payments at thirty day LIBOR and make fixed rate payments at 6.24%. The notional amount of the swap was $1.9 million as of December 31, 2003. The termination date of the second swap agreement is January 2, 2009. The two interest rate swaps are settled on a net basis. The company is exposed to losses, in the event of nonperformance by KeyBank, for the net interest rate differential when floating rates exceed the fixed maximum rate. However, the company does not anticipate nonperformance by the counter party. Under the capital standards provisions of FIRREA, the loans-to-one-borrower limitation is generally 15% of unimpaired capital and surplus, which, for the Bank, was approximately $14.5 million, $14.1 million and $13.6 million at December 31, 2003 and 2002, and June 30, 2002, respectively. As of December 31, 2003 and 2002, and June 30, 2002, the Bank was in compliance with this limitation. Aggregate loans to officers and directors included above were $11.6 million, $13.2 million and $13.0 million as of December 31, 2003 and 2002, and June 30, 2002, respectively. Such loans are made in the ordinary course of business and are made on substantially the same terms as those prevailing at the time for comparable transactions with other borrowers. For the fiscal year ended December 31, 2003, loans of $2.7 million were disbursed to officers and directors and repayments of $4.3 million were received from officers and directors. An analysis of the allowance for loan losses is as follows: (in thousands) Twelve Six Months Months Ended Ended Year Ended -------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 -------------------------------------------------------------------------------- Beginning balance $ 7,172 $ 6,451 $ 5,690 $ 4,949 Provision for loan losses 1,268 1,221 1,423 1,680 Charge-offs (1,079) (544) (730) (1,019) Recoveries 145 44 68 80 -------- ---------- -------- -------- Ending Balance $ 7,506 $ 7,172 $ 6,451 $ 5,690 ======== ========== ======== ======== The following is a summary of information pertaining to impaired loans: (in thousands) -------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 -------------------------------------------------------------------------------- Impaired loans with a valuation reserve $ 57 $ 234 $ - Impaired loans with no valuation reserve 8,982 6,063 580 ------ ------ ------ Total Impaired Loans $9,039 $6,297 $ 580 ====== ====== ====== Valuation reserve on average impaired loans $ 27 $ 111 $ - Average impaired loans $6,866 $5,534 $2,602 4. MORTGAGE BANKING ACTIVITIES At December 31, 2003 and 2002, and June 30, 2002, the Bank was servicing loans for others amounting to $611.6 million, $564.9 million and $551.4 million, respectively. Net gain on sales of loans, exclusive of gain attributable to retained MSR's was $5.1 million for the fiscal year ended December 31, 2003, $2.6 million, $2.8 million and $1.4 million for the six month period ended December 31, 2002, and the fiscal years ended June 30, 2002 and 2001, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. Loan servicing income includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. The Bank is obligated to repurchase certain loans sold to and serviced for others that become delinquent as defined by the various agreements. At December 31, 2003 and 2002, and June 30, 2002, these obligations were limited to approximately $0, $53,000 and $90,000, respectively. The following analysis reflects the changes in mortgage servicing rights retained: (in thousands) --------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 --------------------------------------------------------------------------- Beginning carrying value $ 2,508 $ 2,511 $ 1,617 Additions 2,356 1,092 1,651 Amortization (1,398) (478) (729) Net change in valuation allowance (83) (617) (28) ------- ------- ------- Ending Carrying Value $ 3,383 $ 2,508 $ 2,511 ======= ======= ======= The carrying value approximates fair value at December 31, 2003 and 2002, and June 30, 2002. Fair value is estimated by discounting the net servicing income to be received over the estimated servicing term using a current market rate. The significant risk characteristics of the underlying loans used to stratify MSRs for impairment measurement were term and rate of note. The valuation allowance as of December 31, 2003 and 2002, and June 30, 2002 was $1,069,000, $986,000 and $368,000, respectively. The estimated annual amortization expense for the next five years is $865,000, $800,000, $646,000, $456,000, and $272,000. 5. INVESTMENTS IN JOINT VENTURES The Company has invested in joint ventures through its subsidiaries, Home Savings Corporation ("HSC") and HomeFed Financial Corp. On December 31, 2001, the Bank changed its charter from a Federal savings bank charter to an Indiana commercial bank charter. Commercial banks are not permitted to participate in real estate development joint ventures at December 31, 2003. HSC is a partner in five real estate development joint ventures for which exit strategies are either developed, or are currently being developed. The Company, as mandated by the regulators, is in the process of divesting itself of these investments by December 31, 2004, with two one-year extensions available, subject to regulatory approval. The Company is not required to divest itself of its investment in Family Financial Life. The investments are accounted for by the equity method. The Company's interest in these investments is as follows: (in thousands) ----------------------------------------------------------------------- Equity Period Ended As Of Interest Dec 2003 Dec 2002 June 2002 ------------------------------------------------------------------------ Family Financial Life 14% $ 774 $ 774 $ 774 Heritage Woods 33% 46 53 53 Home-Breeden 50% 1,600 1,809 2,126 Coventry Associates 65% - - 20 Crystal Lake 50% - 300 307 Broadmoor North/Heathfield 35% 1,227 1,394 1,415 Sycamore Springs 33% 1,581 1,880 2,925 Bloomington Technology 50% 273 500 533 ------- ------- ------ Total Investment $ 5,501 $6,710 $8,153 ======= ====== ======
Summarized condensed unaudited financial statements for these joint ventures are as follows: (in thousands) -------------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 -------------------------------------------------------------------------------------- Balance Sheets: Cash $ 2,932 $ 2,634 $ 2,883 Investments 2,372 4,020 3,727 Property and equipment, net 619 673 671 Inventory of developed lots 6,359 7,828 8,866 Other assets 556 489 547 ------- ------- ------- Total Assets $12,838 $15,644 $16,694 ======= ======= ======= Notes payable $ 4,783 $ 5,656 $ 6,999 Insurance liabilities 791 1,296 1,407 Other liabilities 277 321 286 ------- ------- ------- Total liabilities 5,851 7,273 8,692 ------- ------- ------- Shareholders' equity 6,987 8,371 8,002 ------- ------- ------- Total Liabilities and Shareholders' Equity $12,838 $15,644 $16,694 ======= ======= =======
Twelve Six Months Months Ended Ended Year Ended ----------------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 ------------------------------------------------------------------------------ Income Statements Income: Insurance premiums and commissions $1,353 $2,062 $2,153 $2,479 Investment income 201 283 445 416 Net lot sales 2,189 671 1,809 767 Other income 136 1 165 109 ------- ------- ------- ------- Total income 3,879 3,017 4,572 3,771 ------- ------- ------- ------- Expenses: Commissions 883 987 1,239 1,100 Insurance benefits 394 479 367 326 Interest expense 148 77 497 208 Other expense 920 1,110 1,337 1,315 ------- ------- ------- ------- Total expense 2,345 2,653 3,440 2,949 ------- ------- ------- ------- Net Income $1,534 $ 364 $1,132 $ 822 ======= ======= ======= ======= The notes payable included $4.2 million, $5.2 million and $6.6 million due to HSC and $335,000, $149,000 and $135,000 due to the Bank at December 31, 2003 and 2002, and June 30, 2002, respectively. At December 31, 2003 and 2002, and June 30, 2002, open commitments to these joint ventures included letters of credit totaling $191,000, $609,000 and $609,000, respectively. 6. ACCRUED INTEREST RECEIVABLE Accrued interest receivable consists of the following: (in thousands) -------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 -------------------------------------------------------------------------------- Loans, less allowance of $183, $185 and $165 $2,838 $3,488 $3,575 Securities 881 770 846 Interest-bearing deposits 14 31 10 ------ ------ ------ Total Accrued Interest Receivable $3,733 $4,289 $4,431 ====== ====== ====== 7. PREMISES AND EQUIPMENT Premises and equipment consists of the following: (in thousands) -------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 -------------------------------------------------------------------------------- Land $ 2,230 $ 2,230 $ 1,561 Buildings and improvements 15,342 13,893 13,805 Furniture and equipment 7,895 7,875 7,240 -------- ---------- ---------- Total 25,467 23,998 22,606 Accumulated depreciation (11,480) (11,025) (10,414) -------- ---------- ---------- Total Premises and Equipment $13,987 $12,973 $12,192 ======== ========== ========== Depreciation expense included in operations for the fiscal year ended December 31, 2003, six months ended December 31, 2002, and the years ended June 30, 2002 and June 30, 2001 totaled $1.5 million, $725,000, $1.5 million and $1.3 million, respectively.
8. DEPOSITS Deposits are summarized as follows: (in thousands) Dec 2003 Dec 2002 June 2002 ------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Amount Rate Amount Rate Amount Rate ---------------------------------------------------------------------------------------------------- Non-interest bearing $ 55,535 $ 51,720 $ 49,884 NOW accounts 67,533 0.37% 73,690 0.77% 67,362 0.93% Statement savings 50,269 0.30% 47,809 0.75% 48,382 1.05% Money market savings 112,797 0.74% 120,944 1.53% 121,978 1.57% -------- ----- -------- ----- -------- ----- Total transaction accounts 286,134 0.43% 294,163 0.94% 287,606 1.06% -------- ----- -------- ----- -------- ----- Certificates of deposit: Less than one year 51,516 1.42% 45,039 1.93% 27,175 2.25% 12-23 months 38,270 1.62% 48,920 2.46% 58,959 3.01% 24-35 months 96,665 2.85% 108,069 3.69% 107,408 5.05% 36-59 months 30,655 4.49% 43,765 4.85% 27,559 4.86% 60-120 months 85,675 4.96% 69,402 5.15% 68,773 5.32% -------- ----- -------- ----- -------- ----- Total certificate accounts 302,781 3.21% 315,195 3.73% 289,874 4.42% -------- ----- -------- ----- -------- ----- Total Deposits $588,915 1.86% $609,358 2.39% $577,480 2.74% ======== ===== ======== ===== ======== =====
At December 31, 2003 and 2002, and June 30, 2002, certificates of deposit in amounts of $100,000 or more totaled $102.4 million, $106.4 million and $76.9 million, respectively.
A summary of certificate accounts by scheduled maturities at December 31, 2003 is as follows: (in thousands) 2004 2005 2006 2007 2008 Thereafter Total ------------------------------------------------------------------------------------------------- 1.99% or less $ 74,060 $14,502 $ 1,119 $ - $ - $ - $ 89,681 2.00% - 2.99% 24,596 21,096 1,607 313 300 - 47,912 3.00% - 3.99% 49,152 1,509 1,620 1,372 4,485 1,715 59,853 4.00% - 4.99% 9,710 9,511 9,913 11,236 3,798 10,979 55,147 5.00% - 5.99% 4,326 4,081 7,501 22,537 2,193 1,612 42,250 Over 6.00% 2,033 4,023 471 782 217 412 7,938 --------------------------------------------------------------------- Total Certificate Amounts $163,877 $54,722 $22,231 $36,240 $10,993 $ 14,718 $302,781 =====================================================================
A summary of interest expense on deposits is as follows: (in thousands) Twelve Six Months Months Ended Ended Year Ended ---------- ---------- ---------------------- Dec 2003 Dec 2002 June 2002 June 2001 ---------- ---------- --------- --------- NOW accounts $ 176 $ 120 $ 379 $ 533 Statement savings 243 222 589 848 Money market savings 1,277 1,138 3,282 5,907 Certificates of deposit 10,508 6,034 14,466 19,422 ------- ------ ------- ------- Total Interest Expense $12,204 $7,514 $18,716 $26,710 ======= ====== ======= ======= 9. FEDERAL HOME LOAN BANK ADVANCES The Bank was eligible to receive advances from the FHLB up to $162.4 million, $207.6 million and $198.6 million at December 31, 2003 and 2002, and June 30, 2002. The Bank has pledged qualifying mortgage loans and Federal Home Loan Bank stock as collateral on the following advances from the Federal Home Loan Bank: (in thousands) -------------------------------------------------- Weighted Year Ending Maturity Average December Amount Rate -------------------------------------------------- 2004 $ 37,200 5.35% 2005 39,650 5.50% 2006 32,603 5.49% 2007 9,250 5.04% 2008 11,850 4.26% Thereafter 23,743 5.23% -------- ----- Total FHLB Advances $154,296 5.30% ======== ===== 10. OTHER BORROWINGS Senior Debt The Company has a revolving note with LaSalle Bank N.A. whereby the Company may borrow $17.5 million. The note accrues interest at a variable rate based on the ninety-day LIBOR index, on the date of the draw, plus 150 basis points. The ninety-day LIBOR index was 1.15% at December 31, 2003. Interest payments are due ninety days after the date of any principal draws made on the loan and every ninety days thereafter. Maturities of senior debt based on minimum scheduled payments as of December 31, 2003 are: 2004 - $4.6 million and 2006 - $7.6 million. The Company used the funds to buy back shares of the Company's common stock. The assets of the Company collateralize the note. Under terms of the agreement, the Company is bound by certain restrictive debt covenants relating to earnings, net worth and various financial ratios. As of December 31, 2003, the Company was in compliance with the debt covenants. As of December 31, 2003, the company has two swap agreements with LaSalle Bank N.A. In the first agreement the Company will make fixed rate payments at 5.6% and receive variable rate payments at the three-month LIBOR on a notional amount of $4.6 million. The maturity date of the first swap agreement is May 1, 2004. In the second agreement the Company will make fixed rate payments at 5.77% and receive variable rate payments at the three-month LIBOR on a notional amount of $4.6 million. The maturity date of the second swap agreement is February 1, 2006. The two interest rate swaps are settled on a net basis. The Company is exposed to credit loss, in the event of nonperformance by LaSalle Bank N.A., for the net interest rate differential when floating rates exceed the fixed maximum rate. However, the Company does not anticipate nonperformance by the counter party. Other Borrowings In addition to the other borrowings scheduled below, the Bank also has a $5.0 million overdraft line of credit with the Federal Home Loan Bank, none of which was used, as of December 31, 2003 or 2002, or June 30, 2002. (in thousands) -------------------------------------------------------------------------------- Period Ended Dec 2003 Dec 2002 June 2002 -------------------------------------------------------------------------------- Official check overnight remittance $ 624 $ 1,867 $ 3,341 -------- -------- -------- Total Other Borrowings $ 624 $ 1,867 $ 3,341 ======== ======== ======== 11. INCOME TAXES An analysis of the income tax provision is as follows: (in thousands) Twelve Six Months Months Ended Ended Year Ended --------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 ----------------------------------------------------------------------------- Current: Federal $ 3,020 $ 3,621 $ 5,869 $ 4,929 State 549 702 1,200 1,022 Deferred 1,451 (1,252) (824) (432) ------- ------- -------- ------- Income Tax Provision $ 5,020 $ 3,071 $ 6,245 $ 5,519 ======= ======= ======== ======= The difference between the financial statement provision and amounts computed by using the statutory rate of 34% is reconciled as follows: (in thousands)
-------------------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 June 2001 -------------------------------------------------------------------------------------------- Income tax provision at federal statutory rate $ 4,986 $ 2,845 $ 5,639 $ 5,123 State tax, net of federal tax benefit 568 286 722 640 Tax exempt interest (180) (57) (112) (125) Increase in cash surrender value of life insurance (176) (90) (176) (125) Other (178) 87 172 6 ------- ------- ------- ------- Income Tax Provision $ 5,020 $ 3,071 $ 6,245 $ 5,519 ======= ======= ======= =======
The Company is allowed to deduct an addition to a reserve for bad debts in determining taxable income. This addition differs from the provision for loan losses for financial reporting purposes. No deferred taxes have been provided on the income tax bad debt reserves which total $6.0 million, for years prior to 1988. This tax reserve for bad debts is included in taxable income of later years only if the bad debt reserves are subsequently used for purposes other than to absorb bad debt losses. Because the Company does not intend to use the reserves for purposes other than to absorb losses, deferred income taxes of $2.4 million were not provided at December 31, 2003 and 2002, and June 30, 2002, respectively. Pursuant to Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes," the Company has recognized the deferred tax consequences of differences between the financial statement and income tax treatment of allowances for loan losses arising after June 30, 1987. In August 1996, the "Small Business Job Protection Act of 1996" was passed into law. One provision of this act repeals the special bad debt reserve method for thrift institutions provided for in Section 593 of the Internal Revenue Code. The provision requires thrifts to recapture any reserves accumulated after 1987 but forgives taxes owed on reserves accumulated prior to 1988. The six year recovery period for the excess reserves began in taxable year 1999. The adoption of the act did not have a material adverse effect on the Company's consolidated financial position or results of operations. The Company's deferred income tax assets and liabilities are as follows: (in thousands)
----------------------------------------------------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 ----------------------------------------------------------------------------------------------- Deferred tax assets: Bad debt reserves, net $2,265 $ 2,478 $ 2,394 Difference in basis of fixed assets - 131 - Other 190 323 195 Deferred compensation 1,377 1,153 1,032 ------- ------- ------ Total deferred tax assets 3,832 4,085 3,621 ------- ------- ------ Deferred tax liabilities: Difference in basis of fixed assets 101 - 205 FHLB dividend 177 185 194 Unrealized gain on securities available for sale 136 494 639 Deferred fees 308 365 361 Originated mortgage servicing rights 1,087 23 537 Other - - 146 ------- ------- ------ Total deferred tax liabilities 1,809 1,067 2,082 ------- ------- ------- Net Deferred Tax Asset $ 2,023 $ 3,018 $ 1,539 ======= ======= =======
12. REGULATORY MATTERS The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures that have been established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table), of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2003, the Company and the Bank met all capital adequacy requirements to which they were subject. As of December 31, 2003 and 2002, and June 30, 2002, the most recent notifications from the Federal Reserve categorized the Company and the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized" the Company must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed either entity's category.
Summary of capital amounts and ratios as of December 31, 2003 and 2002, and June 30, 2002: (dollars in thousands) To Be Categorized As "Well Capitalized" Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ----------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------------------------------------------------------- As of December 31, 2003 Total risk-based capital (to risk-weighted assets) HomeFederal Bank $ 96,739 14.35% $ 53,927 8.0% $ 67,409 10.0% Home Federal Bancorp Consolidated $ 90,164 13.36% $ 54,003 8.0% $ 67,504 10.0% Tier 1 risk-based capital (to risk-weighted assets) HomeFederal Bank $ 89,233 13.24% $ 26,964 4.0% $ 40,446 6.0% Home Federal Bancorp Consolidated $ 82,658 12.24% $ 27,002 4.0% $ 40,503 6.0% Tier 1 leverage capital (to average assets) HomeFederal Bank $ 89,233 10.36% $ 34,437 4.0% $ 43,046 5.0% Home Federal Bancorp Consolidated $ 82,658 9.61% $ 34,418 4.0% $ 43,022 5.0% To Be Categorized As "Well Capitalized" Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ----------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------------------------------------------------------- As of December 31, 2002 Total risk-based capital (to risk-weighted assets) HomeFederal Bank $ 93,862 13.96% $ 53,795 8.0% $ 67,243 10.0% Home Federal Bancorp Consolidated $ 83,118 12.34% $ 53,883 8.0% $ 67,354 10.0% Tier 1 risk-based capital (to risk-weighted assets) HomeFederal Bank $ 86,690 12.89% $ 26,897 4.0% $ 40,346 6.0% Home Federal Bancorp Consolidated $ 75,946 11.28% $ 26,941 4.0% $ 40,412 6.0% Tier 1 leverage capital (to average assets) HomeFederal Bank $ 86,690 9.80% $ 35,370 4.0% $ 44,213 5.0% Home Federal Bancorp Consolidated $ 75,946 8.56% $ 35,505 4.0% $ 44,382 5.0% To Be Categorized As "Well Capitalized" Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ------------------------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio ------------------------------------------------------------------------------------------------------------------------------ As of June 30, 2002 Total risk-based capital (to risk-weighted assets) HomeFederal Bank $ 90,347 13.62% $ 53,062 8.00% $ 66,327 10.00% Home Federal Bancorp Consolidated $ 81,293 12.23% $ 53,196 8.00% $ 66,494 10.00% Tier 1 risk-based capital (to risk-weighted assets) HomeFederal Bank $ 83,896 12.65% $ 26,531 4.00% $ 39,796 6.00% Home Federal Bancorp Consolidated $ 74,842 11.26% $ 26,598 4.00% $ 39,897 6.00% Tier 1 leverage capital (to average assets) HomeFederal Bank $ 83,896 9.91% $ 33,877 4.00% $ 42,346 5.00% Home Federal Bancorp Consolidated $ 74,842 8.81% $ 33,992 4.00% $ 42,490 5.00%
Dividend Restrictions The principal source of income and funds for the Company are dividends from the Bank. The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2003, approximately $21.9 million of retained earnings were available for dividend declaration without prior regulatory approval. 13. EMPLOYEE BENEFIT PLANS Multi-employer Pension Plan The Bank participates in a noncontributory multi-employer pension plan covering all qualified employees. The plan is administered by the trustees of the Financial Institutions Retirement Fund. There is no separate valuation of the plan benefits nor segregation of plan assets specifically for the Bank, because the plan is a multi-employer plan and separate actuarial valuations are not made with respect to each employer. However, as of June 30, 2003, the latest actuarial valuation, the total plan assets exceeded the actuarially determined value of accrued benefits. The Bank had contribution expenses of $815,000 for the twelve months ended December 2003, $237,000 for six months ended December 2002, and $404,000 and $206,000, for the fiscal years ended June 2002 and June 2001, respectively. Cash contributions to the multi-employer pension plan for these same periods were $471,000, $163,000, $435,000 and $209,000, respectively. Supplemental Retirement Program The Bank has entered into supplemental retirement agreements for certain officers. These agreements are unfunded. However, the Bank has entered into life insurance contracts to fund these agreements. Benefits under these arrangements are generally paid over a 15 year period. The following table sets forth the Plan's funded status and amount recognized in the Bank's consolidated statements of income for the twelve months ended December 31, 2003, six months ended December 31, 2002 and for the fiscal years ended June 30, 2002 and 2001:
------------------------------------------------------------------- Dec 2003 Dec 2002 June 2002 June 2001 ---------------------------------------------------------------------------------------------------------------------------- Economic assumptions: Discount rate 6.5% 6.5% 8.5% 9.7% Salary rate 4.0% 4.0% 4.0% 4.0% Components of net periodic pension expense: Interest cost on projected benefit obligation $ 176,676 $ 137,121 $ 200,196 $ 124,181 Service cost 64,914 11,292 34,995 64,516 Prior service cost 129,705 96,489 234,860 39,475 --------------- --------------- --------------- -------------- Net periodic pension expense $ 371,295 $ 244,902 $ 470,051 $ 228,172 =============== =============== =============== ==============
A summary of the Plan's funded status at December 31, 2003 and 2002, and June 30, 2002, 2001 is as follows: -------------------------------------------------- Dec 2003 Dec 2002 June 2002 ------------------------------------------------------------------------------------------------------------------ Projected benefit obligation at beginning of year $ 2,770,882 $ 2,552,969 $ 2,410,778 Interest cost 176,676 137,121 200,196 Service cost 64,914 11,292 34,995 Amendment to plan - - - Actuarial loss 110,988 116,000 - Benefits paid during year (121,060) (46,500) (93,000) --------------- --------------- --------------- Projected benefit obligation at end of year (unfunded status) 3,002,400 2,770,882 2,552,969 Unrecognized net loss (932,859) (951,576) (932,065) --------------- --------------- --------------- Accrued pension liability $ 2,069,541 $ 1,819,306 $ 1,620,904 =============== =============== ===============
Prior service cost is amortized over the estimated remaining service lives of the employees of approximately seven years. 401(k) Plan The Bank has an employee thrift plan established for substantially all full-time employees. The Bank has elected to make matching contributions equal to 50% of the employee contributions up to a maximum of 1.5% of an individual's total eligible salary. The Bank contributed $120,000 $54,000, $109,000 and $99,000 during the year ended December 31, 2003, six months ended December 31, 2002 and fiscal years ended June 30, 2002 and 2001, respectively. 14. STOCK OPTIONS The Company has stock option plans for the benefit of officers, other key employees and directors. As of December 31, 2003, the plans were authorized to grant additional options to purchase 310,631 shares of the Company's common stock. The option price is not to be less than the fair market value of the common stock on the date the option is granted, and the stock options are exercisable at any time within the maximum term of 10 years and one day from the grant date. The options are nontransferable and are forfeited upon termination of employment. The following is the stock option activity for the twelve month period ended December 31, 2003 and the six month period ended December 31, 2002, and for each of the years in the two year period ended June 30, 2002, and the stock options outstanding at the end of the respective periods: ----------------------------- Weighted Average Exercise Options Shares Price -------------------------------------------------------------------------------- Outstanding June 30, 2000 908,596 $17.52 Granted 105,655 15.87 Forfeited (3,001) 23.06 Exercised (17,848) 6.56 --------- Outstanding June 30, 2001 993,402 17.52 Granted 164,655 18.73 Forfeited (14,687) 20.30 Exercised (132,961) 9.86 --------- Outstanding June 30, 2002 1,010,409 18.68 Granted 22,224 22.65 Forfeited (3,987) 24.46 Exercised (22,344) 13.05 --------- Outstanding December 31, 2002 1,006,302 18.87 --------- Granted 8,724 27.23 Forfeited (19,412) 23.03 Exercised (224,346) 13.94 --------- Outstanding December 31, 2003 771,268 20.30 ========= The following table is an analysis of the remaining weighted average life as of December 31, 2003 of the outstanding options within various exercise price ranges: ------------------------------------------------------------------------ Exercise Price Number of Options Average Life ------------------------------------------------------------------------ $10.620 - $16.250 244,137 3.9 $17.575 - $23.000 240,959 6.9 $23.063 - $27.400 286,172 5.5 ------- Total 771,268 5.4 ======= The weighted average fair value of options granted was $5.91 for the fiscal year ended December 31, 2003, $5.18 for the six month period ended December 31, 2002, and $4.58 and $3.59 for the fiscal years ended June 30, 2002 and June 30, 2001, respectively. The fair value of the option grants is estimated on the date of grant using an option pricing model with the following assumptions: dividend yield ranging from 1.32% to 3.58%, risk-free interest rates ranging from 2.66% to 8.04%, expected volatility ranging from 24.13% to 34.86% and expected life of 5.04 to 5.80 years. Shareholder Rights Plan The Company has adopted a Shareholder Rights Plan and declared a dividend distribution at the rate of one Right for each share of common stock held of record as of the close of business on November 22, 1994, and for each share of common stock issued thereafter up to the Distribution Date (defined below). Each Right entitles holders of common stock to buy one share of common stock of the Company at an exercise price of $80. The Rights would be exercisable, and would detach from the common stock (the "Distribution Date") only if a person or group (i) were to acquire 15 percent or more of the outstanding shares of common stock of the Company; (ii) were to announce a tender or exchange offer that, if consummated, would result in a person or group beneficially owning 30 percent or more of the outstanding shares of common stock of the Company; or (iii) were declared by the Board to be an Adverse Person (as defined in the Plan) if such person or group beneficially owns 10 percent or more of the outstanding shares of common stock in the Company. In the event of any occurrence triggering the Distribution Date, each Right may be exercised by the holder (other than such an acquiring person or group) to purchase shares of common stock of the Company (or, in certain circumstances, common stock of the acquiring person) at a 50% discount to market price. The Company is entitled to redeem the Rights at $.01 per Right at any time. The Rights will expire at the close of business on November 22, 2004. 15. COMMITMENTS Financial Instruments with Off-Balance Sheet Risk In the normal course of business, the Bank makes various commitments to extend credit that are not reflected in the accompanying consolidated financial statements. At December 31, 2003 and 2002, and June 30, 2002, the Bank had loan commitments approximating $23.2, $35.5 million and $29.9 million, respectively, excluding undisbursed portions of loans in process. Loan commitments at December 31, 2003, included commitments to originate fixed rate loans with interest rates ranging from 4.5% to 7.5% totaling $7.3 million and adjustable rate loan commitments with interest rates ranging from 3.3% to 9.5% totaling $15.9 million. Commitments, which are disbursed subject to certain limitations, extend over various periods of time. Generally, unused commitments are cancelled upon expiration of the commitment term as outlined in each individual contract. Outstanding letters of credit were $1.9 million, $2.5 million and $2.4 million at December 31, 2003 and 2002, and June 30, 2002, respectively. Additionally, the Bank had approximately $11.7 million in commitments to sell fixed rate residential loans and $6.8 million in commitments to sell adjustable rate commercial loans at December 31, 2003. The Bank's exposure to credit loss in the event of nonperformance by the other parties to the financial instruments for commitments to extend credit is represented by the contract amount of those instruments. The Bank uses the same credit policies and collateral requirements in making commitments as it does for on-balance sheet instruments. Employment Agreements The Company has entered into employment agreements with certain executive officers. Under certain circumstances provided in the agreements, the Company may be obligated to continue the officer's salary for a period of up to three years.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS The disclosure of the estimated fair value of financial instruments is as follows: (in thousands) December 2003 December 2002 June 2002 -------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Carrying Fair Value Value Value Value Value Value ----------------------------------------------------------------------------------------------------------------------------------- Assets: Cash $ 22,734 $ 22,734 $ 27,404 $ 27,404 $ 25,006 $ 25,006 Interest-bearing deposits 11,444 11,444 26,288 26,288 19,472 19,472 Securities available for sale 123,638 123,638 114,440 114,440 114,989 114,989 Securities held to maturity 1,828 1,883 3,026 3,147 3,493 3,619 Loans held for sale 6,272 6,357 30,560 31,055 6,302 6,383 Loans, net 630,672 648,987 628,883 653,007 631,815 649,880 Accrued interest receivable 3,733 3,733 4,289 4,289 4,431 4,431 Federal Home Loan Bank stock 9,965 9,965 9,965 9,965 9,965 9,965 Cash surrender value of life insurance 11,359 11,359 10,841 10,841 9,792 9,792 Liabilities: Deposits 588,915 597,911 609,358 621,187 577,480 583,881 Federal Home Loan Bank advances 154,296 161,387 171,635 180,429 174,139 182,626 Senior debt 14,242 14,792 14,242 15,161 11,200 11,200 Other borrowings 624 624 1,867 1,867 3,341 3,341 Advance payments by borrowers for taxes and insurance 76 76 229 229 442 442 Accrued interest payable 900 900 1,035 1,035 924 924 Commitments - - - - - - Financial Instruments: Interest rate swaps (1,099) (1,099) (1,592) (1,592) (1,038) (1,038)
The Company, using available market information and appropriate valuation methodologies, has determined the estimated fair values of financial instruments. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Cash, Interest-bearing Deposits, Accrued Interest Receivable, Cash Surrender Value of Life Insurance, Advance Payments by Borrowers for Taxes and Insurance, Accrued Interest Payable and Other Borrowings The carrying amount as reported in the Consolidated Balance Sheets is a reasonable estimate of fair value. Securities Held to Maturity and Available for Sale Fair values are based on quoted market prices and dealer quotes. Loans Held for Sale and Loans, net The fair value is estimated by discounting the future cash flows using the current rates for loans of similar credit risk and maturities. Federal Home Loan Bank Stock The fair value is estimated to be the carrying value, which is par. Deposits The fair value of demand deposits, savings accounts and money market deposit accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using rates currently offered for deposits of similar remaining maturities. Federal Home Loan Bank Advances The fair value is estimated by discounting future cash flows using rates currently available to the Company for advances of similar maturities. Senior Debt Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Interest Rate Swaps The fair value is derived from proprietary models based upon well-recognized financial principles which management believes provide a reasonable approximation of the fair value of the interest rate swap transactions. Commitments The commitments to originate and purchase loans have terms that are consistent with current market conditions. Accordingly, the Company estimated that the face amounts of these commitments approximate carrying values. The fair value estimates presented herein are based on information available to management at December 31, 2003 and 2002, and June 30, 2002. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
17. PARENT COMPANY FINANCIAL STATEMENTS The condensed financial statements of Home Federal Bancorp are as follows: (in thousands) -------------------------------------- Dec 2003 Dec 2002 June 2002 -------------------------------------------------------------------------------------------------------------- Condensed Balance Sheets (Parent Company only) Assets: Cash $ 6,857 $ 2,930 $ 1,421 Investment in subsidiary 91,667 89,835 87,280 Other 285 447 361 ----------- ------------ ----------- Total Assets $ 98,809 $ 93,212 $ 89,062 =========== ============ =========== Liabilities: Senior debt $ 14,242 $ 14,242 $ 11,200 Other 545 1,176 776 ----------- ------------ ----------- Total liabilities 14,787 15,418 11,976 ----------- ------------ ----------- Shareholders' equity 84,022 77,794 77,086 ----------- ------------ ----------- Total Liabilities and Shareholders' Equity $ 98,809 $ 93,212 $ 89,062 =========== ============ ===========
--------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 June 2001 --------------------------------------------------------------------------------------------------------------------------- Condensed Statements of Income (Parent Company only) Dividends from subsidiary $ 7,750 $ 2,914 $ 6,379 $ 5,574 Other 560 271 629 556 ----------- ------------ ----------- ----------- Total income 8,310 3,185 7,008 6,130 ----------- ------------ ----------- ----------- Interest on senior debt 838 425 812 807 Other expenses 751 574 895 925 ----------- ------------ ----------- ----------- Total expenses 1,589 999 1,707 1,732 ----------- ------------ ----------- ----------- Income before taxes and change in undistributed earnings of subisidiary 6,721 2,186 5,301 4,398 Applicable income tax credit (403) (284) (419) (433) ----------- ------------ ----------- ----------- Income before change in undistributed earnings of subsidiary 7,124 2,470 5,720 4,831 Increase in undistributed earnings of subsidiary 2,519 2,827 4,619 4,718 ----------- ------------ ----------- ----------- Net Income $ 9,643 $ 5,297 $ 10,339 $ 9,549 =========== ============ =========== =========== --------------------------------------------------- Period Ended As Of Dec 2003 Dec 2002 June 2002 June 2001 --------------------------------------------------------------------------------------------------------------------------- Condensed Statements of Cash Flows (Parent Company only) Operating Activities: Net income $ 9,643 $ 5,297 $ 10,339 $ 9,549 Adjustments to reconcile net income to net cash provided by operating activities: Decrease (increase) in other assets 162 (86) (29) (87) Increase (decrease) in accrued expenses and other liabilities (428) 276 44 245 Increase in undistributed earnings of subsidiary (2,519) (2,827) (4,619) (4,718) ----------- ------------ ----------- ----------- Net cash provided by operating activities 6,858 2,660 5,735 4,989 ----------- ------------ ----------- ----------- Investing Activities: Net cash used in investment in HomeFed Financial Corp. - - (768) - ----------- ------------ ----------- ----------- Financing Activities: Repayment of senior debt - - - (505) Funds provided by senior debt - 3,042 - 5,500 Payment of dividends (2,997) (1,331) (2,528) (2,438) Repurchase shares of common stock (3,575) (3,154) (4,764) (6,076) Exercise of stock options, net of fractional shares paid 3,641 292 1,369 199 ----------- ------------ ----------- ----------- Net cash used in financing activities (2,931) (1,151) (5,923) (3,320) ----------- ------------ ----------- ----------- Net (decrease)/increase in cash 3,927 1,509 (956) 1,669 Cash at beginning of period 2,930 1,421 2,377 708 ----------- ------------ ----------- ----------- Cash at End of Period $ 6,857 $ 2,930 $ 1,421 $ 2,377 =========== ============ =========== ===========
INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Home Federal Bancorp Columbus, Indiana We have audited the accompanying consolidated balance sheets of Home Federal Bancorp and its subsidiaries (the "Company") as of December 31, 2003 December 31, 2002, and June 30, 2002, and the related consolidated statements of income, shareholders' equity and cash flows for the year ended December 31, 2003, the six month period ended December 31, 2002 and for each of the two years in the period ended June 30, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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, such financial consolidated statements present fairly, in all material respects, the financial position of the Company at December 31, 2003 and 2002, and June 30, 2002, and the results of its operations and its cash flows for the year ended December 31, 2003, the six month period ended December 31, 2002 and for each of the two years in the period ended June 30, 2002 in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Indianapolis, Indiana January 23, 2004 Board of Directors & Officers of Home Federal Bancorp Board of Directors Officers John K. Keach, Jr. John K. Keach, Jr. Chairman of the Board, President and Chairman of the Board, President and Chief Executive Officer, Chief Executive Officer Home Federal Bancorp Charles R. Farber John T. Beatty Executive Vice President President, Beatty Insurance, Inc. Lawrence E. Welker Executive Vice President, Harold Force Chief Financial Officer, President, Treasurer and Secretary Force Construction Company, Inc. S. Elaine Pollert David W. Laitinen, MD Executive Vice President Orthopedic Surgeon John M. Miller President, Best Beers, Inc. Executive Officers of HomeFederal Bank Harvard W. Nolting, Jr. John K. Keach, Jr. Retired from Nolting Chairman of the Board, Foods, Inc. President and Chief Executive Officer Gregory J. Pence President, Charles R. Faber Kiel Bros. Oil Company, Inc. and Executive Vice President KP Oil Company, Inc. Lawrence E. Welker John K. Keach, Sr. Executive Vice President, Chairman Emeritus Chief Financial Officer, Retired Treasurer and Secretary The Directors of Home S. Elaine Pollert Federal Bancorp also Executive Vice President serve as Directors of HomeFederal Bank. Melissa A. McGill Senior Vice President Controller Shareholder Information Stock Listing The common stock of Home Federal Bancorp is traded on the National Association of Securities Dealers Automated Quotation System, National Market System, under the symbol HOMF. Home Federal Bancorp stock appears in The Wall Street Journal under the abbreviation HomFedBcpIN, and in other publications under the abbreviation HFdBcp. Transfer Agent & Registrar To change name, address or ownership of stock, to report lost certificates, or to consolidate accounts, contact: LaSalle Bank N.A. c/o Corporate Trust Operations 135 South LaSalle Street, Room 1960 Chicago, Illinois 60603 (800) 246-5761 General Counsel Barnes & Thornburg 11 South Meridian Street Indianapolis, IN 46204 Shareholder & General Inquiries Home Federal Bancorp is required to file an Annual Report on Form 10-K for its fiscal year ended December 31, 2003, with the Securities and Exchange Commission. For copies of the Annual Report and Home Federal Bancorp's Quarterly Reports, contact: Cora Laymon Home Federal Bancorp 222 West Second Street P.O. Box 648 Seymour, IN 47274 (812) 522-1592 (877) 626-7000 For financial information and security analyst inquiries, please contact: Lawrence E. Welker Home Federal Bancorp 222 West Second Street P.O. Box 648 Seymour, IN 47274 (812) 522-1592 (877) 626-7000 For an online annual report or shareholder inquiries on the Web, visit us at: www.homf.com Office Locations Seymour 22 W. Second Street 1117 E. Tipton Street Picture omitted Columbus 501 Washington Street A map of the state of Indiana, showing 1020 Washington Street HomeFederal's office locations is on 3805 25th Street the left side of the page. 2751 Brentwood Drive 4330 W. Jonathan Moore Pike Hope 8475 N. State Road 9 Austin 67 W. Main Street North Vernon 111 N. State Street 1540 N. State Street Osgood 820 S. Buckeye Street Batesville 114 State Road 46 East Madison 201 Clifty Drive Brownstown 101 N. Main Steet Salem 1208 S. Jackson Street Greensburg 115 E. North Street Greenwood 8740 W. Emerson Avenue Southport Road Coming Fall 2004 Visit our Web site at www.homf.com or call us toll-free at (877) 626-7000.