10-K 1 form10-k.txt FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 Commission File Number: 0-19212 JEFFERSONVILLE BANCORP (Exact name of Registrant as specified in its charter) New York 22-2385448 (State or other jurisdiction of (I.R.S. employer identification no.) P.O. Box 398, Jeffersonville, New York 12748 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (845) 482-4000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of exchange on which registered NONE NONE Securities registered pursuant to Section 12 (g) of the Act: Title of Class: Common Stock, $0.50 Par Value Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [ X ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [ X ] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] As of June 30, 2005, the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was $88,276,000 based on the closing price of $23.20 as reported on the National Association of Securities Dealers Automated Quotation System National Market System. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at March 15, 2006 Common Stock, $0.50 par value per share 4,434,321 shares DOCUMENTS INCORPORATED BY REFERENCE Document Parts Into Which Incorporated Annual Report to Stockholders for the Fiscal Parts I, II, and IV Year Ended December 31, 2005 (Annual Report) Proxy Statement for the Annual Meeting of Part III Items 10, 11, 12, Stockholders to be held April 25, 2006 13 and 14 (Proxy Statement) JEFFERSONVILLE BANCORP INDEX TO FORM 10-K PART I Page ITEM 1. Business.........................................................1 ITEM 1A. Risk Factors.....................................................5 ITEM 1B. Unresolved Staff Comments........................................6 ITEM 2. Properties.......................................................6 ITEM 3. Legal Proceedings................................................7 ITEM 4. Submission of Matters to a Vote of Security Holders..............7 PART II ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuers Purchasing of Equity Securities..................................8 ITEM 6. Selected Financial Data..........................................9 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................10 ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk...............................................24 ITEM 8. Financial Statements and Supplementary Data.....................25 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..........................25 ITEM 9A. Controls and Procedures.........................................25 ITEM 9B. Other Information...............................................25 PART III ITEM 10. Directors and Executive Officers of the Registrant..............26 ITEM 11. Executive Compensation..........................................26 ITEM 12. Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters ................26 ITEM 13. Certain Relationships and Related Transactions..................26 ITEM 14. Principal Accountant and Fees and Services......................26 PART IV ITEM 15. Exhibits, Financial Statement Schedules.........................27 Signatures......................................................28 PART I Item 1. Business GENERAL Jeffersonville Bancorp (the "Company") was organized as a New York corporation on January 12, 1982, for the purpose of becoming a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). Effective June 30, 1982, the Company became the registered bank holding company for The First National Bank of Jeffersonville, a bank chartered in 1913 and organized under the national banking laws of the United States (the "Bank"). The Company is engaged in the business of managing or controlling its subsidiary bank and such other business related to banking as may be authorized under the BHC Act. At December 31, 2005 and 2004, the Company had total assets of $387.3 million and $365.5 million, securities available for sale of $89.0 million and $100.7 million, securities held to maturity of $8.2 million and $6.0 million and net loans receivable of $240.6 million and $220.6, respectively. At December 31, 2005 and 2004, total deposits were $312.1 million and $293.1 million, respectively. At December 31, 2005 and 2004, stockholders' equity was $42.5 million and $39.6 million, respectively. The Bank is based in Sullivan County, New York. In addition to its main office and operations center in Jeffersonville, the Bank has nine additional branch office locations in Eldred, Liberty, Loch Sheldrake, Monticello, Livingston Manor, Narrowsburg, Callicoon, Wurtsboro and one in a Wal*Mart store in Monticello. The Bank is a full service banking institution employing approximately 135 people and serving all of Sullivan County, New York as well as some areas of adjacent counties in New York and Pennsylvania. NARRATIVE DESCRIPTION OF BUSINESS Through its community bank subsidiary, The First National Bank of Jeffersonville, the Company provides traditional banking related services, which constitute the Company's only business segment. Banking services consist primarily of attracting deposits from the areas served by its banking offices and using those deposits to originate a variety of commercial, consumer, and real estate loans. The Company's primary sources of liquidity are its deposit base; Federal Home Loan Bank ("FHLB") borrowings; repayments and maturities on loans; short-term assets such as federal funds and short-term interest bearing deposits in banks; and maturities and sales of securities available for sale. The Bank has one subsidiary, FNBJ Holding Corporation, which is a Real Estate Investment Trust (REIT) and is wholly-owned by the Bank. The Company's filings with the Securities and Exchange Commission, including this Annual Report on Form 10-K, are available on the Company's website, www.jeffbank.com or upon request submitted to Charles E. Burnett, P.O. Box 398, Jeffersonville, New York 12748. DEPOSIT AND LOAN PRODUCTS Deposit Products. The Bank offers a variety of deposit products typical of commercial banks and has designed product offerings responsive to the needs of both individuals and businesses. Traditional demand deposit accounts, interest-bearing transaction accounts (NOW accounts) and savings accounts are offered on a competitive basis to meet customers' basic banking needs. Money market accounts, time deposits in the form of certificates of deposit and IRA/KEOGH accounts provide customers with price competitive and flexible investment alternatives. The Bank does not have a single depositor or a small group of related depositors whose loss would have a material adverse effect upon the business of the Bank. See item 7, Distribution of Assets, Liabilities & Stockholders' Equity for average balances of deposit products at December 31, 2005, 2004 and 2003. Loan Products. The Company originates residential and commercial real estate loans, as well as commercial, consumer and agricultural loans, to borrowers in Sullivan County, New York designed to meet the banking needs of individual customers, businesses and municipalities. A substantial portion of the loan portfolio is secured by real estate properties located in that area. The ability of the Company's borrowers to make principal and interest payments is dependent upon, among other things, the level of overall economic activity and the real estate market conditions prevailing within the Company's concentrated lending area. Periodically, the Company purchases loans from other financial institutions that are in markets outside of Sullivan County. Please see item 7, Results of Operations 2005 versus 2004 for a description of the loan portfolio and recent loan loss experience. Additional information is set forth below relating to the Bank's loan products, including major loan categories, general loan terms, credit underwriting criteria, and risks particular to each category of loans. The Bank does not have a major loan concentration in any individual industry. Commercial Loans and Commercial Real Estate Loans. The Bank offers a variety of commercial credit products and services to its customers. These include secured and unsecured loan products specifically tailored to the credit needs of the customers, underwritten with terms and conditions reflective of risk profile objectives and corporate earnings requirements. These products are offered at all branch locations. All loans are governed by a commercial loan policy which was developed to provide a clear framework for determining acceptable levels of credit risk, underwriting criteria, monitoring existing credits, and managing 1 problem credit relationships. Credit risk control mechanisms have been established and are monitored closely for compliance by the internal auditor and an external loan review company. Risks particular to commercial loans include borrowers' capacities to perform according to contractual terms of loan agreements during periods of unfavorable economic conditions and changing competitive environments. Management expertise and competency are critical factors affecting the customers' performance and ultimate ability to repay their debt obligations. Commercial real estate loans are exposed to fluctuations in collateral value. Consumer Loans. The Bank also offers a variety of consumer loan products. These products include both open-end credit (home equity lines of credit, unsecured revolving lines of credit) and closed-end credit secured and unsecured direct and installment loans. Most of these loans are originated at the branch level. This delivery mechanism is supported by an automated loan platform delivery system and a decentralized underwriting process. The lending process is designed to ensure not only the efficient delivery of credit products, but also compliance with applicable consumer regulations while minimizing credit risk exposure. Credit decisions are made under the guidance of a standard consumer loan policy, with the assistance of senior credit managers. The loan policy was developed to provide definitive guidance encompassing credit underwriting, monitoring and management. The quality and condition of the consumer loan portfolio, as well as compliance with established standards, is also monitored closely. A borrower's ability to repay consumer debt is generally dependent upon the stability of the income stream necessary to service the debt. Adverse changes in economic conditions resulting in higher levels of unemployment increase the risk of consumer defaults. Risk of default is also impacted by a customer's total debt obligation. While the Bank can analyze a borrower's capacity to repay at the time a credit decision is made, subsequent extensions of credit by other financial institutions may cause the customer to become over-extended, thereby increasing the risk of default. Residential Real Estate Loans. The Company originates a variety of mortgage loan products including balloon mortgages, adjustable rate mortgages and fixed rate mortgages. All mortgage loans originated are held in the Bank's portfolio. Residential real estate loans possess risk characteristics much the same as consumer loans. Stability of the borrower's employment is a critical factor in determining the likelihood of repayment. Mortgage loans are also subject to the risk that the value of the underlying collateral will decline due to economic conditions or other factors. SUPERVISION AND REGULATION The Company is a bank holding company, registered with the Board of Governors of the Federal Reserve System ("Federal Reserve") under the Bank Holding Company Act ("BHC Act"). As such, the Federal Reserve is the Company's primary federal regulator, and the Company is subject to extensive regulation, examination, and supervision by the Federal Reserve. The Bank is a national association, chartered by the Office of the Comptroller of the Currency ("OCC"). The OCC is the Bank's primary federal regulator, and the Bank is subject to extensive regulation, examination, and supervision by the OCC. In addition, as to certain matters, the Bank is subject to regulation by the Federal Reserve and the Federal Deposit Insurance Corporation ("FDIC"). The Company is subject to capital adequacy guidelines of the Federal Reserve. The guidelines apply on a consolidated basis and require bank holding companies having the highest regulatory ratings for safety and soundness to maintain a minimum ratio of Tier 1 capital to total average assets (or "leverage ratio") of 3%. All other bank holding companies are required to maintain an additional capital cushion of 100 to 200 basis points. The Federal Reserve capital adequacy guidelines also require bank holding companies to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 4% and a minimum ratio of qualifying total capital to risk-weighted assets of 8%. As of December 31, 2005, the Company's leverage ratio was 11.5%, its ratio of Tier 1 capital to risk-weighted assets was 16.9%, and its ratio of qualifying total capital to risk-weighted assets was 18.2%. The Federal Reserve may set higher minimum capital requirements for bank holding companies whose circumstances warrant it, such as companies anticipating significant growth or facing unusual risks. The Federal Reserve has not advised the Company of any special capital requirement applicable to it. Any bank holding company whose capital does not meet the minimum capital adequacy guidelines is considered to be undercapitalized and is required to submit an acceptable plan to the Federal Reserve for achieving capital adequacy. As an example the company's ability to pay dividends to its stockholders could be restricted. In addition, the Federal Reserve has indicated that it will consider a bank holding company's capital ratios and other indications of its capital strength in evaluating any proposal to expand its banking or nonbanking activities. The Bank is subject to leverage and risk-based capital requirements and minimum capital guidelines of the OCC that are similar to those applicable to the Company. As of December 31, 2005, the Bank was in compliance with all minimum capital requirements. Any bank that is less than well-capitalized is subject to certain mandatory prompt corrective actions by its primary federal regulatory agency, as well as other discretionary actions, to resolve its capital deficiencies. The severity of the actions required to be taken increases as the bank's capital position deteriorates. A bank holding company must guarantee that a subsidiary bank will meet its capital restoration plan, up to an amount equal to 5% of the subsidiary bank's assets or the amount required to meet regulatory capital requirements, whichever is less. In addition, under Federal Reserve policy, a bank holding company is expected to serve as a source of financial strength, and to commit financial resources to support its subsidiary banks. Any capital loans made by a bank 2 holding company to a subsidiary bank are subordinate to the claims of depositors in the bank and to certain other indebtedness of the subsidiary bank. In the event of the bankruptcy of a bank holding company, any commitment by the bank holding company to a federal banking regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and would be entitled to priority of payment. The Bank also is subject to substantial regulatory restrictions on its ability to pay dividends to the Company. Under OCC regulations, the Bank may not pay a dividend, without prior OCC approval, if the total amount of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of its retained net income to date during the calendar year and its retained net income over the preceding two years. As of December 31, 2005, approximately $13.1 million was available for the payment of dividends without prior OCC approval. The Bank's ability to pay dividends also is subject to the Bank being in compliance with the regulatory capital requirements described above. The Bank is currently in compliance with these requirements. The deposits of the Bank are insured up to regulatory limits by the FDIC and, accordingly, are subject to deposit insurance assessments to maintain the insurance funds administered by the FDIC. The deposits of the Bank historically have been subject to deposit insurance assessments to maintain the Bank Insurance Fund ("BIF"). On February 8, 2006, the Federal Deposit Insurance Reform Act of 2005 was signed into law, which gives the FDIC increased flexibility in assessing premiums on banks and savings associations, including the Bank, to pay for deposit insurance and in managing its deposit insurance reserves. The reform legislation provides a limited credit to all insured institutions, based on the amount of their insured deposits at year-end 1996, to offset the premiums that they may be assessed, combines the BIF and the Savings Association Insurance Fund to form a single Deposit Insurance Fund, increases deposit insurance to $250,000 for Individual Retirement Accounts, and authorized inflation-based increases in deposit insurance on all accounts every 5 years, beginning in 2011. The FDIC also is directed to conduct studies regarding further deposit insurance reform. The Federal Deposit Insurance Act provides for additional assessments to be imposed on insured depository institutions to pay for the cost of Financing Corporation ("FICO") funding. The FICO assessments are adjusted quarterly to reflect changes in the assessment basis of the FDIC insurance funds and do not vary depending upon a depository institution's capitalization or supervisory evaluation. During 2005, FDIC-insured banks paid an average rate of approximately $0.014 per $100 for purposes of funding FICO bond obligations. The assessment rate is set at approximately $0.013 per $100 for the first quarter of 2006. Transactions between the Bank and any affiliate, which includes the Company, are governed by sections 23A and 23B of the Federal Reserve Act which are implemented in Federal Reserve Regulation W. Generally, Regulation W is intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates by limiting the extent to which a bank or its subsidiaries may engage in covered transactions with any one affiliate and with all affiliates of the bank in the aggregate, and requiring that such transactions be on terms that are consistent with safe and sound banking practices. Regulation W also regulates transactions by a bank with its financial subsidiaries, which it may operate under the expanded authority granted to national banks under the Gramm-Leach-Bliley Act ("GLB Act"). Under the GLB Act, all financial institutions, including the Company and the Bank, are required to adopt privacy policies to restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer's request, and establish procedures and practices to protect customer data from unauthorized access. The Company has developed such policies and procedures for itself and the Bank, and believes it is in compliance with all privacy provisions of the GLB Act. In addition the Fair and Accurate Credit Transactions Act ("FACT Act") includes many provisions concerning national credit reporting standards, and permits consumers, including customers of the Company and the Bank, to opt out of information sharing among affiliated companies for marketing purposes. The FACT Act also requires banks and other financial institutions to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available. In response to periodic disclosures by companies in various industries of the loss or theft of computer-based nonpublic customer information, several bills have been introduced in Congress to establish national standards for the safeguarding of such information and the disclosure of security breaches. Under Title III of the USA PATRIOT Act, also known as the International Money Laundering Abatement and Anti-Terrorism Financing Act of 2001, all financial institutions, including the Company and the Bank, are required to take certain measures to identify their customers, prevent money laundering, monitor certain customer transactions and report suspicious activity to U.S. law enforcement agencies, and scrutinize or prohibit altogether certain transactions of special concern. Financial institutions also are required to respond to requests for information from federal banking regulatory agencies and law enforcement agencies concerning their customers and their transactions. Information-sharing among financial institutions concerning terrorist or money laundering activities is encouraged by an exemption provided from the privacy provisions of the GLB Act and other laws. Financial institutions that hold correspondent accounts for foreign banks or provide private banking services to foreign individuals are required to take measures to avoid dealing with certain foreign individuals or entities, including foreign banks with profiles that raise money laundering concerns, and are prohibited altogether from dealing with foreign "shell banks" and persons from jurisdictions of particular concern. All financial institutions also are required to adopt internal anti-money laundering programs. 3 The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act, which applies to the Bank, or the BHC Act, which applies to the Company. The Company and the Bank have in place a Bank Secrecy Act and USA PATRIOT Act compliance program, and they engage in very few transactions of any kind with foreign financial institutions or foreign persons. The Sarbanes-Oxley Act ("SOA implemented a broad range of measures to increase corporate responsibility, enhance penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of corporate disclosures for companies that have securities registered under the Securities Exchange Act of 1934, including publicly-held bank holding companies such as the Company. SOA includes very specific disclosure requirements and corporate governance rules and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance, and other related rules. SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. In addition, the federal banking regulators have adopted generally similar requirements concerning the certification of financial statements by bank officials. Beginning in March 2005, home mortgage lenders, including banks, were required under the Home Mortgage Disclosure Act to make available to the public expanded information regarding the pricing of home mortgage loans, including the "rate spread" between the interest rate on loans and certain Treasury securities and other benchmarks. The availability of this information has led to increased scrutiny of higher-priced loans at all financial institution to detect illegal discriminatory practices and to the initiation of a limited number of investigations by federal banking agencies and the U.S. Department of Justice. The Company has no information that it or its affiliates are the subject of any investigation. The Bankruptcy Abuse Prevention and Consumer Protection Act amended the U.S. Bankruptcy Code, effective October 17, 2005. Under the new law, the ability of consumers to discharge their debts in bankruptcy is limited by a needs-based test, and more debtors than in the past are expected to enter into repayment programs with their creditors. The law also limits certain homestead exemptions, limits the discharge of debt incurred for the purchase of certain luxury items, and extends from 6 year to 8 years the minimum time between successive bankruptcy discharges. The Company expects no material effects from this new law. TAXATION Except for the Bank's REIT subsidiary, the Company files a calendar year consolidated federal income tax return on behalf of itself and its subsidiaries. The Company reports its income and deductions using the accrual method of accounting. The components of income tax expense are as follows for the years ended December 31: 2005 2004 2003 Current tax expenses: Federal $2,094,000 $2,115,000 $2,159,000 State 302,000 325,000 327,000 Deferred tax benefit (354,000) (223,000) (502,000) Total income tax expense $2,042,000 $2,217,000 $1,984,000 For a detailed discussion of income taxes please refer to note 9 in the Notes to Consolidated Financial Statements. MONETARY POLICY AND ECONOMIC CONDITIONS The earnings of the Company and the Bank are affected by the policies of regulatory authorities, including the Federal Reserve System. Federal Reserve System monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of the changing conditions in the national economy and in the money markets, as a result of actions by monetary and fiscal authorities, interest rates, credit availability and deposit levels may change due to circumstances beyond the control of the Company and the Bank. COMPETITION The Bank faces strong competition for local business in the communities it serves from other financial institutions. Throughout Sullivan County there are 35 branches of commercial banks, savings banks, savings and loan associations and other financial organizations. With respect to most of the services that the Bank performs, there is increasing competition from financial institutions other than commercial banks due to the relaxation of regulatory restrictions. Money market funds actively compete with banks for deposits. Savings banks, savings and loan associations and credit institutions, as well as consumer finance companies, insurance companies and pension trusts are important competitors. The Bank's ability to maintain profitability is also affected by competition for loans. NUMBER OF PERSONNEL At December 31, 2005, there were 135 persons employed by the Company and the Bank. 4 Item 1A. Risk Factors Although our common stock is traded on the NASDAQ Small Cap Market, the volume of trading in the common stock has been light. As a result, shareholders may not be able to quickly and easily sell their common stock. Although our common stock is traded on the NASDAQ Small Cap Market, and a number of brokers offer to make a market in the common stock on a regular basis, trading volume is limited. As a result, you may find it difficult to sell shares at or above the price at which you purchased them and you may lose part of your investment. Our common stock is not FDIC-insured. Shares of our common stock are not securities or savings or deposit accounts or other obligations of our subsidiary bank. Our common stock is not insured by the Federal Deposit Insurance Corporation ("FDIC") or any other governmental agency and is subject to investment risk, including the possible loss of your entire investment. Applicable laws and regulations restrict both the ability of the Bank to pay dividends to the Company, and the ability of the Company to pay dividends to you. Our principal source of income consists of dividends, if any, from the Bank. Payment of dividends by the Bank to us is subject to regulatory limitations imposed by the Office of the Comptroller of the Currency ("OCC") and the Bank must meet OCC capital requirements before and after the payment of any dividends. In addition the Bank also cannot pay a dividend, without prior OCC approval, if the total amount of all dividends declared during a calendar year, including the proposed dividend, exceeds the sum of its retained net income to date during the calendar year. The OCC has discretion to prohibit any otherwise permitted capital distribution on general safety and soundness grounds. As of December 31, 2005, approximately $13.1 million was available for the payment of dividends without prior OCC approval. Moreover, the law of the State of New York, where the Company is incorporated, requires that dividends be paid only from capital surplus so that the net assets of the Company remaining after such dividend payments are at least equal to the amounts of the Company's stated capital. Any payment of dividends in the future will continue be at the sole discretion of our board of directors and will depend on a variety of factors deemed relevant by our board of directors, including, but not limited to, earnings, capital requirements and financial condition. We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations. We are subject to extensive regulation, supervision and examination by the Board of Governors of the Federal Reserve System ("Federal Reserve"). The OCC is the Bank's primary regulator, and the Bank is subject to extensive regulation, examination, and supervision by the OCC. In addition , as to certain matters, the Bank is subject to regulation by the Federal Reserve and the FDIC. Such regulation and supervision govern the activities in which a financial institution and its holding company may engage and are intended primarily for the protection of the insurance fund and depositors and are not intended for the protection of investors in our common stock. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, may have a material impact on our operations. Changes in local economic conditions could reduce our income and growth, and could lead to higher levels of problem loans and charge-offs. We make loans, and most of our assets are located, in Sullivan County, New York as well as some adjacent areas in New York and Pennsylvania. Adverse changes in economic conditions in these markets could hurt our ability to collect loans, could reduce the demand for loans, and otherwise could negatively affect our performance and financial condition. There is no assurance that we will be able to successfully compete with others for business. We compete for loans, deposits, and investment dollars with other insured depository institutions and enterprises, such as securities firms, insurance companies, savings associations, credit unions, mortgage brokers, and private lenders, many of which have substantially greater resources. The differences in resources and regulations may make it harder for us to compete profitably, reduce the rates that we can earn on loans and investments, increase the rates we must offer on deposits and other funds, and adversely affect our overall financial condition and earnings. Our profitability depends on economic policies and factors beyond our control. Our operating income and net income depend to a great extent on "rate differentials," i.e., the difference between the interest yields we receive on loans, securities and other interest bearing assets and the interest rates we pay on interest bearing deposits and other liabilities. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities, including the Federal Reserve. 5 Rising interest rate negatively affect the fair value of our portfolio of securities available for sale. At December 31, 2005, securities available for sale constituted 23% of our total assets, or $88,984,000. As interest rates have risen, the fair value of these securities have fallen below their carrying value. If interest rates continue to rise, as is predicted, the fair value of these securities will continue to decline and the amount of unrealized losses will rise. Such unrealized losses would be recognized if the Company sells the affected securities. Our growth and expansion may be limited by many factors. We have pursued and intend to continue to pursue an internal growth strategy, the success of which will depend primarily on generating an increasing level of loans and deposits at acceptable risk and interest rate levels without corresponding increases in non interest expenses. We cannot assure you that we will be successful in continuing our growth strategies, due, in part, to delays and other impediments inherent in our highly regulated industry, limited availability of qualified personnel or unavailability of suitable branch sites. In addition, the success of our growth strategy will depend, in part, on continued favorable economic conditions in our market area. The value of residential and commercial properties underlying certain loans held by the Company would be negatively affected if Casino gambling and other projects are not completed satisfactorily. The value of residential and commercial properties in the vicinity of an arts complex have risen in anticipation of its successful completion. A similar rise in property values has been seen near properties where Casinos are expected to be constructed. Some of these properties provide the chief collateral for loans originated by the Company. If these projects are not successful, the value of these properties would be expected to decline, negatively affecting the financial condition of the Company. In addition a dam forming a large recreational lake is severely impaired and if not repaired the collateral values of both residential and commercial properties will decline. Item 1B. Unresolved Staff Comments Not Applicable. Item 2. Properties In addition to the main office of the Company and the Bank in Jeffersonville, New York, the Bank has nine branch locations and an operations center. Set forth below is a description of the offices of the Company and the Bank. MAIN OFFICE -- OWNED 4864 State Route 52 Jeffersonville, New York 12748 (845)482-4000 OPERATIONS CENTER -- OWNED 4866 State Route 52 Jeffersonville, New York 12748 (845) 482-4000 CALLICOON BRANCH -- LEASED 9 Lower Main Street Callicoon, New York 12723 (845) 887-4866 ELDRED BRANCH -- OWNED 561 Route 55 Eldred, New York 12732 (845) 557-8513 LIBERTY BRANCH -- OWNED 19 Church Street Liberty, New York 12754 (845) 292-6300 LIVINGSTON MANOR BRANCH -- OWNED 33 Main Street Livingston Manor, New York 12758 (845)439-8123 LOCH SHELDRAKE BRANCH -- OWNED 1278 State Route 52 Loch Sheldrake, New York 12759 (845) 434-1180 6 MONTICELLO BRANCH -- OWNED 19 Forestburgh Road Monticello, New York 12701 (845) 791-4000 NARROWSBURG BRANCH -- LEASED 122 Kirk Road Narrowsburg, New York 12764 (845) 252-6570 WAL*MART BRANCH -- LEASED 33 Anawana Lake Road Monticello, New York 12701 (845) 794-3988 WURTSBORO BRANCH -- LEASED 2930 State Route 209 Wurtsboro, New York 12790 (845) 888-5890 The major classifications of premises and equipment and the book value thereof were as follows at December 31, 2005: 2005 Land $ 387,000 Buildings 2,907,000 Furniture and fixtures 132,000 Equipment 3,207,000 Building and leasehold improvements 1,207,000 Construction in progress 28,000 7,868,000 Less accumulated depreciation and amortization (4,841,000) Total premises and equipment, net $ 3,027,000 Item 3. Legal Proceedings The Company and the Bank are not parties to any material legal proceedings other than ordinary routine litigation incidental to business to which the Company or any of its subsidiaries is a party or of which and of their property is subject. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 7 PART II Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company's common stock is traded on the NASDAQ Small Cap Market under the symbol JFBC. The following investment firms are known to handle Jeffersonville Bancorp stock transactions: UBS Securities, LLC, Knight Equity Markets, L.P., Citadel Derivatives Group LLC, Hill, Thompson, Magid and Co., FTN Midwest Securities Corp., and E-Trade Capital Markets. The following table shows the range of high and low sale prices for the Company's stock and cash dividends paid for the quarters indicated. Cash Sales Sales Dividends Quarter Ended Low High Paid March 31, 2004 $17.00 $20.50 $0.09 June 30, 2004 $15.75 $18.20 $0.09 September 30, 2004 $16.17 $18.00 $0.09 December 31, 2004 $16.41 $20.87 $0.13 March 31, 2005 $17.94 $20.43 $0.10 June 30, 2005 $20.15 $25.99 $0.10 September 30, 2005 $21.92 $26.15 $0.10 December 31, 2005 $21.15 $24.00 $0.14 Number of Holders of Record. At the close of business on March 6, 2006, the Company had 1,432 stockholders of record of the 4,434,321 shares of common stock then outstanding. Securities Authorized for Issuance Under Equity Compensation Plan. The Company has no equity compensation plans under which options may be issued. Payment of Dividends. Applicable laws and regulations restrict the ability of the Bank to pay dividends to the Company, and the ability of the Company to pay dividends to stockholders. Payment of dividends in the future will be at the sole discretion of the Company's board of directors and will depend on a variety of factors deemed relevant by the board of directors, including, but not limited to, earnings, capital requirements and financial condition. See "Item 1. Business -- Supervision and Regulation." 8 Item 6. Selected Financial Data FIVE-YEAR SUMMARY
2005 2004 2003 2002 2001 RESULTS OF OPERATIONS Interest income $ 22,170,000 $ 20,820,000 $ 20,082,000 $ 20,635,000 $ 20,230,000 Interest expense 5,402,000 4,051,000 4,037,000 5,331,000 7,627,000 Net interest income 16,768,000 16,769,000 16,045,000 15,304,000 12,603,000 Provision for loan losses 180,000 360,000 620,000 900,000 300,000 Net income 5,725,000 6,171,000 5,732,000 5,242,000 3,625,000 FINANCIAL CONDITION Total assets $387,343,000 $365,523,000 $352,204,000 $325,025,000 $298,110,000 Deposits 312,096,000 293,094,000 280,227,000 252,792,000 238,029,000 Gross loans 244,261,000 224,236,000 196,675,000 171,977,000 162,711,000 Stockholders' equity 42,519,000 39,646,000 35,786,000 32,497,000 27,313,000 AVERAGE BALANCES Total assets $374,413,000 $361,783,000 $340,575,000 $313,022,000 $286,823,000 Deposits 297,643,000 291,426,000 268,687,000 247,953,000 234,431,000 Gross loans 238,993,000 211,846,000 183,335,000 165,607,000 157,165,000 Stockholders' equity 41,350,000 37,149,000 33,561,000 30,271,000 28,139,000 FINANCIAL RATIOS Net income to average total assets 1.53% 1.71% 1.68% 1.67% 1.26% Net income to average stockholders' equity 13.85% 16.61% 17.08% 17.32% 12.88% Average stockholders' equity to average total assets 11.04% 10.27% 9.85% 9.67% 9.81% SHARE AND PER SHARE DATA(1) Basic earnings per share $ 1.29 $ 1.39 $ 1.29 $ 1.18 $ 0.81 Dividends per share $ 0.44 $ 0.40 $ 0.33 $ 0.30 $ 0.25 Dividend payout ratio 34.04% 28.78% 25.28% 25.39% 30.40% Book value at year end $ 9.59 $ 8.94 $ 8.07 $ 7.33 $ 6.16 Total dividends paid $ 1,949,000 $ 1,776,000 $ 1,449,000 $ 1,331,000 $ 1,102,000 Average number of shares outstanding 4,434,321 4,434,321 4,434,321 4,434,321 4,472,664 Shares outstanding at year end 4,434,321 4,434,321 4,434,321 4,434,321 4,434,321
(1) Share and per share data has been restated for a 3 for 1 stock split effected in the form of a stock dividend in 2003. 9 SUMMARY OF QUARTERLY RESULTS OF OPERATIONS FOR 2005 AND 2004
2005 March 31 June 30 September 30 December 31 Total Interest income $ 5,262,000 $ 5,391,000 $ 5,665,000 $ 5,852,000 $ 22,170,000 Interest expense (1,088,000) (1,252,000) (1,438,000) (1,624,000) (5,402,000) Net interest income 4,174,000 4,139,000 4,227,000 4,228,000 16,768,000 Provision for loan losses (60,000) (60,000) (60,000) 0 (180,000) Non-interest income 949,000 964,000 1,017,000 1,133,000 4,063,000 Non-interest expenses (3,249,000) (3,149,000) (3,278,000) (3,208,000) (12,884,000) Income before taxes 1,814,000 1,894,000 1,906,000 2,153,000 7,767,000 Income taxes (454,000) (498,000) (497,000) (593,000) (2,042,000) Net income $ 1,360,000 $ 1,396,000 $ 1,409,000 $ 1,560,000 $ 5,725,000 Basic earnings per share $ 0.31 $ 0.31 $ 0.32 $ 0.35 $ 1.29
2004 March 31 June 30 September 30 December 31 Total Interest income $ 5,137,000 $ 5,109,000 $ 5,261,000 $ 5,313,000 $ 20,820,000 Interest expense (990,000) (975,000) (1,031,000) (1,055,000) (4,051,000) Net interest income 4,147,000 4,134,000 4,230,000 4,258,000 16,769,000 Provision for loan losses (90,000) (90,000) (90,000) (90,000) (360,000) Non-interest income 860,000 1,030,000 1,046,000 936,000 3,872,000 Non-interest expenses (2,784,000) (3,064,000) (3,110,000) (2,935,000) (11,893,000) Income before taxes 2,133,000 2,010,000 2,076,000 2,169,000 8,388,000 Income taxes (573,000) (525,000) (544,000) (575,000) (2,217,000) Net income $ 1,560,000 $ 1,485,000 $ 1,532,000 $ 1,594,000 $ 6,171,000 Basic earnings per share $ 0.35 $ 0.33 $ 0.35 $ 0.36 $ 1.39
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following is a discussion of the factors which significantly affected the consolidated results of operations and financial condition of Jeffersonville Bancorp ("the Parent Company") and its wholly-owned subsidiary, The First National Bank of Jeffersonville ("the Bank"). For purposes of this discussion, references to the Company include both the Bank and Parent Company, as the Bank is the Parent Company's only subsidiary. This discussion should be read in conjunction with the consolidated financial statements and notes thereto, and the other financial information appearing elsewhere in this annual report. This document contains forward-looking statements, which are based on assumptions and describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar words. The Company's ability to predict results and the actual effect of future plans or strategies is uncertain. Factors which could have a material adverse effect on operations include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market areas and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements. Actual results could differ materially from forward-looking statements. GENERAL The Parent Company is a bank holding company founded in 1982 and headquartered in Jeffersonville, New York. The Parent Company owns 100% of the outstanding shares of the Bank's common stock and derives substantially all of its income from the Bank's operations in the form of dividends paid to the Parent Company. The Bank is a New York commercial bank chartered in 1913 serving Sullivan County, New York with branch offices in Jeffersonville, Eldred, Liberty, Loch Sheldrake, Monticello (2), Livingston Manor, Narrowsburg, Callicoon and Wurtsboro. The Bank's administrative offices are located in Jeffersonville, New York. 10 The Company's mission is to serve the community banking needs of its borrowers and depositors, who predominantly are individuals, small businesses and local municipal governments. The Company believes it understands its local customer needs and provides quality service with a personal touch. The financial results of the Company are influenced by economic events that affect the communities we serve as well as national economic trends, primarily interest rates, affecting the entire banking industry. Changes in net interest income have the greatest impact on the Company's net income. National economic policies have caused interest rates to rise 14 times since June 2004. The Company's yields on interest earning assets have fallen and the costs of interest bearing liabilities have risen, creating net interest margin compression. Locally, the economy continued to exhibit strength in 2005. While the local economic forecast has been bright, it should be acknowledged that the economy in most other areas of New York State continues to be less robust. Significant improvement in the local economy continues to be demonstrated in the Sullivan County real estate market. Several new housing projects continued to progress along with a vibrant real estate market, which increase optimism in the county's future. A permanent concert facility will open on the original site of the Woodstock Festival in Bethel this year. Several Native American run casinos are still on the horizon. The success of these projects, tourism, real estate values and the availability of qualified labor is critical to the local economy and the Company. CRITICAL ACCOUNTING POLICIES Management of the Company considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the results of operations. The allowance for loan losses is maintained at a level deemed adequate by management based on an evaluation of such factors as economic conditions in the Company's market area, past loan loss experience, the financial condition of individual borrowers, and underlying collateral values based on independent appraisals. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions and values of real estate particularly in Sullivan County. Collateral underlying certain real estate loans could lose value which could lead to future additions to the allowance for loan losses. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. RECENT ACCOUNTING PRONOUNCEMENTS In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. It is not expected to have a significant effect on the consolidated financial statements. FINANCIAL CONDITION Total assets increased by $21.8 million or 6.0% to $387.3 million at December 31, 2005 from $365.5 million at December 31, 2004. The increase was primarily due to a $20.1 million or 9.1% increase in net loans from $220.6 million at December 31, 2004 to $240.6 million at December 31, 2005. A net decrease of $11.7 million in the portfolio of securities available for sale for 2005, primarily due to maturities and calls, was a funding source for new loan growth. The overall assets increase was funded by a $19.0 million increase in total deposits from $293.1 million at December 31, 2004 to $312.1 million at December 31, 2005. The deposit increase included $15.0 million of brokered deposits. Two new borrowings from the Federal Home Loan Bank (FHLB) totaling $10.0 million were added to help fund the loan growth and repay one FHLB borrowing which matured for $3.5 million. In 2005, total gross loans increased $20.0 million or 8.9% from $224.2 million to $244.3 million. Within the loan portfolio, commercial loans increased by $7.3 million to $28.6 million at December 31, 2005, residential real estate increased by $7.1 million to $89.6 million, commercial real estate loans increased $6.3 million to $81.6 million, home equity loans increased $1.6 million to $22.7 million, while consumer installment loans decreased $2.4 million to $11.7 million. The growth in commercial real estate loans reflects the Company's strategy to provide loans for local real estate projects where there is strong loan to value ratio (taking into consideration possible speculation regarding casino gambling proposals). The growth in residential mortgages reflects new products to meet the highly competitive nature of this market. As a result of casino gambling proposals and related local economic improvement, the Company anticipates continued residential and commercial real estate loan opportunities. Accordingly, additional growth is anticipated in real estate loans during 2006. The growth in the non-real estate commercial loan portfolio reflects continued business growth in the county. The overall loan portfolio is structured in accordance with management's belief that loans 11 secured by residential and commercial real estate generally result in lower loan loss levels compared to other types of loans, because of the value of the underlying collateral. In the event that the casino gambling proposals do not progress, collateral underlying certain real estate projects could lose value. There was no other real estate owned at December 31, 2005 or at December 31, 2004. Total non-performing loans increased from $2.1 million at December 31, 2004 to $2.9 million at December 31, 2005. Net loan charge-offs decreased from $284,000 in 2004 to $209,000 in 2005. At December 31, 2005, the allowance for loan losses equaled $3.6 million representing 1.48% of total gross loans outstanding and 123.7% of total non-performing loans. Total deposits increased $19.0 million to $312.1 million at December 31, 2005 from $293.1 million at December 31, 2004. Time deposits increased from $104.2 million at December 31, 2004 to $123.2 million at December 31, 2005, an increase of $19.1 million or 18.3%. The majority of this increase was due to brokered time deposits in the amount of $15.0 million or 4.8% of total deposits. These deposits were obtained to fund future anticipated growth of the loan portfolio. Increases in demand and Now and super Now accounts totaling $1.0 million were offset by reductions in saving and insured money market deposits of $1.0 million. Total stockholders' equity was $42.5 million at December 31, 2005, an increase of $2.9 million from December 31, 2004. The increase was due primarily to net income of $5.7 million partially offset by cash dividends of $1.9 million and a reduction in accumulated other comprehensive income of $903,000. RESULTS OF OPERATIONS 2005 VERSUS 2004 Net Income Net income for 2005 of $5.7 million decreased 7.2% or $446,000 from the 2004 net income of $6.2 million. The lower earnings level in 2005 reflects the interaction of a number of factors. The most significant factor which reduced 2005 net income was an increase in deposit interest expense which outpaced loan and security rate increases, squeezing the net interest spread. Net interest income remained flat from 2004 to 2005 at $16.8 million. An increase in loan interest and fees of $2.2 million to $17.6 million from $15.4 million or 13.9% were partially offset by a decrease in income on securities of $864,000 or 16.2% to $4.5 million. Interest expense on deposits increased $1.2 million or 40.5% to $4.1 million primarily due to continued rate increases by the Federal Reserve Bank. The provision for loan losses decreased 50.0% or $180,000 from $360,000 in 2004 to $180,000 in 2005. Salary and employee benefit expense increased $732,000 or 10.6% primarily due to the addition of new employees, normal salary increases and the increased costs of providing pension and health care benefits. Occupancy and equipment expense increased $178,000 or 9.9%, primarily due to an increase in software and equipment maintenance agreements and the on-line banking program. Interest Income and Interest Expense Throughout the following discussion, net interest income and its components are expressed on a tax equivalent basis which means that, where appropriate, tax exempt income is shown as if it were earned on a fully taxable basis. The largest source of income for the Company is net interest income, which represents interest earned on loans, securities and short-term investments, less interest paid on deposits and other interest bearing liabilities. Tax equivalent net interest income of $17.8 million for 2005 represented an increase of 0.4% over 2004. Net interest margin decreased 22 basis points to 5.18% in 2005 compared to 5.40% in 2004, due to overall increases in interest bearing liability yields. Total interest income for 2005 was $23.2 million, compared to $21.9 million in 2004. The increase in 2005 is the result of a 13 basis point increase in the earning asset yield combined with an increase in the average balance of interest earning assets from $329.7 million in 2004 to $342.8 million in 2005, an increase of 4.0%. Total average securities (securities available for sale and securities held to maturity) decreased $13.1 million or 11.3% in 2005 to $102.6 million. The yield on total securities decreased 11 basis points to 5.4% in 2005 from 5.5% in 2004. The decrease in total average securities during 2005 reflected the need to fund new loans. In 2005, average loans increased $27.1 million to $239.0 million from $211.8 million in 2004. Concurrently the average loan yield increased from 7.28% in 2004 to 7.35% in 2005 due to a consistent increase in time and demand loans tied to prime rate which increased in volume by 48.3% or $9.1 million. Average residential and commercial real estate loans continued to make up a major portion of the loan portfolio at 71.0% of total loans in 2005. In 2006, any increases in funding will continue to be allocated first to meet loan demand, as necessary, and then to the securities portfolios. Total interest expense in 2005 increased $1.4 million to $5.4 million from $4.1 in 2004. The average balance of interest bearing liabilities increased from $253.9 million in 2004 to $258.8 million in 2005, an increase of 1.9% as a result of $10 million increase in Federal Home Loan Bank borrowings. During 2005, the average cost of total interest bearing liabilities increased by 49 basis points from 1.60% to 2.09%. Average interest bearing deposits increased $2.8 million to reach $230.4 million in 2005, an increase of 1.2%. Interest rates on interest bearing deposits increased by 49 basis points from an average rate paid of 1.27% in 2004 to 1.76% in 2005. In 2005, average demand deposit balances increased 5.4% over 2004. 12 Provision for Loan Losses The provision for loan losses was $180,000 in 2005 as compared to $360,000 in 2004 as a result of the reduction in net loan charge offs from $284,000 in 2004 to $210,000 in 2005, offset slightly by the increase in nonaccruing loans. However, while nonaccruing loans have increased at year end 2005, as compared to 2004, the vast majority of the nonaccruing loans in 2005 were well secured with interest recognized on a cash basis. Provisions for loan losses are recorded to maintain the allowance for loan losses at a level deemed adequate by management based on an evaluation of such factors as economic conditions in the Company's market area, past loan loss experience, the financial condition of individual borrowers, and underlying collateral values based on independent appraisals. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions, particularly in Sullivan County. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. The allowance for loan losses was $3.6 million at December 31, 2005, 2004 and 2003. The allowance as a percentage of total loans was 1.48% at December 31, 2005, compared to 1.62% and 1.81% at December 31, 2004 and 2003, respectively. The allowance's coverage of non-performing loans was 123.7% at December 31, 2005 compared to 170.6% and 114.3% at December 31, 2004 and 2003 respectively. Summary of Loan Loss Experience The following table indicates the amount of charge-offs and recoveries in the loan portfolio by category. ANALYSIS OF THE CHANGES IN ALLOWANCE FOR LOAN LOSSES FOR YEARS 2001 THROUGH 2005
2005 2004 2003 2002 2001 Balance at beginning of year $3,645,000 $3,569,000 $3,068,000 $2,614,000 $2,435,000 Charge-offs: Commercial, financial and agriculture (2,000) -- (141,000) (404,000) (29,000) Real estate -- mortgage -- (3,000) (5,000) (84,000) (35,000) Installment loans (308,000) (284,000) (240,000) (108,000) (179,000) Other loans (129,000) (146,000) (102,000) (66,000) (76,000) Total charge-offs (439,000) (433,000) (488,000) (662,000) (319,000) Recoveries: Commercial, financial and agriculture 59,000 1,000 235,000 17,000 43,000 Real estate -- mortgage 8,000 22,000 7,000 97,000 38,000 Installment loans 83,000 59,000 104,000 84,000 95,000 Other loans 79,000 67,000 23,000 18,000 22,000 Total recoveries 229,000 149,000 369,000 216,000 198,000 Net charge-offs (210,000) (284,000) (119,000) (446,000) (121,000) Provision charged to operations 180,000 360,000 620,000 900,000 300,000 Balance at end of year $3,615,000 $3,645,000 $3,569,000 $3,068,000 $2,614,000 Ratio of net charge-offs to average outstanding loans 0.09% 0.13% 0.06% 0.27% 0.08%
The Company manages asset quality with a review process which includes ongoing financial analysis of credits and both internal and external loan review of existing outstanding loans and delinquencies. Management strives to identify potential non-performing loans timely; take charge-offs promptly based on a realistic assessment of probable losses; and maintain an adequate allowance for loan losses based on the inherent risk of loss in the existing portfolio. 13 No portion of the allowance for loan losses is restricted to any loan or group of loans, as the entire allowance is available to absorb charge-offs in any loan category. The amount and timing of future charge-offs and allowance allocations may vary from current estimates and will depend on local economic conditions. The following table shows the allocation of the allowance for loan losses to major portfolio categories and the percentage of each loan category to total loans outstanding. Commercial non-performing loans are evaluated individually for impairment in accordance with FAS 114. On the remaining loan portfolios, the Company applies reserve factors considering historical loan loss data and other subjective factors. DISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES AT DECEMBER 31,
2005 2004 2003 2002 2001 Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans Amount of in Each Amount of in Each Amount of in Each Amount of in Each Amount of in Each Allowance Category Allowance Category Allowance Category Allowance Category Allowance Category for Loan to Total for Loan to Total for Loan to Total for Loan to Total for Loan to Total (Dollars in Thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans Residential mortgages(1) $1,048 48.5% $1,039 48.4% $1,011 52.4% $ 890 52.2% $ 848 55.1% Commercial mortgages 351 34.9% 351 35.3% 300 30.2 300 27.3 300 21.6 Commercial loans 1,343 11.7% 1,286 9.4% 1,255 8.7 1,010 8.1 630 7.0 Installment loans 648 4.8% 753 6.3% 828 7.8 644 11.0 603 13.4 Other loans 225 0.1% 216 0.6% 175 0.9 224 1.4 233 2.9 Total $3,615 100.0% $3,645 100.0% $3,569 100.0% $3,068 100.0% $2,614 100.0%
(1) Includes home equity loans. Nonaccrual and Past Due Loans The Company places a loan on nonaccrual status when collectability of principal or interest is doubtful, or when either principal or interest is 90 days or more past due and the loan is not well secured and in the process of collection. Interest payments received on nonaccrual loans are applied as a reduction of the principal balance when concern exists as to the ultimate collection of principal. A distribution of nonaccrual loans and loans 90 days or more past due and still accruing interest is shown in the following table. DECEMBER 31, 2005
90 Days or More, Still Loan Category Nonaccrual Accruing Total Percentage(1) Percentage(2) Residential mortgages(3) $ 438,000 $-- $ 438,000 0.4% 15.0% Commercial mortgages 199,000 -- 199,000 -- 6.8 Commercial loans 2,285,000 -- 2,285,000 8.0 78.2 Installment loans -- -- -- -- -- Total $2,922,000 $-- $2,922,000 1.2% 100.0%
DECEMBER 31, 2004
90 Days or More, Still Loan Category Nonaccrual Accruing Total Percentage(1) Percentage(2) Residential mortgages(3) $491,000 $ 166,000 $ 657,000 0.6% 22.5% Commercial mortgages -- -- -- -- -- Commercial loans 233,000 1,230,000 1,463,000 6.9 50.1 Installment loans -- 16,000 16,000 0.1 0.5 Total $724,000 $1,412,000 $2,136,000 0.9% 73.1%
14 DECEMBER 31, 2003
90 Days or More, Still Loan Category Nonaccrual Accruing Total Percentage(1) Percentage(2) Residential mortgages(3) $ 411,000 $ 379,000 $ 790,000 0.8% 25.3% Commercial mortgages 514,000 1,364,000 1,878,000 3.1 60.1 Commercial loans 434,000 7,000 441,000 2.6 14.1 Installment loans -- 14,000 14,000 0.1 0.5 Total $1,359,000 $1,764,000 $3,123,000 1.6% 100.0%
DECEMBER 31, 2002
90 Days or More, Still Loan Category Nonaccrual Accruing Total Percentage(1) Percentage(2) Residential mortgages(3) $1,766,000 $57,000 $1,823,000 2.5% 56.6% Commercial mortgages 367,000 -- 367,000 0.8 11.4 Commercial loans 888,000 -- 888,000 5.1 27.6 Installment loans 141,000 -- 141,000 0.8 4.4 Total $3,162,000 $57,000 $3,219,000 1.9% 100.0%
DECEMBER 31, 2001
90 Days or More, Still Loan Category Nonaccrual Accruing Total Percentage(1) Percentage(2) Residential mortgages(3) $126,000 $539,000 $ 665,000 1.0% 40.1% Commercial mortgages 439,000 95,000 534,000 1.3 32.2 Commercial loans 269,000 167,000 436,000 2.4 26.3 Installment loans 15,000 8,000 23,000 0.1 1.4 Total $849,000 $809,000 $1,658,000 1.0% 100.0%
(1) Percentage of gross loans outstanding for each loan category. (2) Percentage of total nonaccrual and 90 day past due loans. (3) Includes home equity loans. Total nonperforming residential mortgage, commercial mortgage and commercial loans represent 0.4%, 0.2%, and 8.0% of their respective portfolio totals at December 31, 2005, compared to 0.6%, 0.0%, and 6.9% at December 31, 2004, respectively. The majority of the Company's total nonaccrual and past due loans are secured loans and, as such, management anticipates there will be limited risk of loss in their ultimate resolution. Nonaccrual loans increased $2.2 million from $724,000 at December 31, 2004 to $2.9 million at December 31, 2005. The majority of the increase arose from the transfer of $1.2 million of commercial past due loans to nonaccrual status in 2005. All nonperforming loans are well collateralized with interest being recognized as received. From time to time, loans may be renegotiated in a troubled debt restructuring when the Company determines that it will ultimately receive greater economic value under the new terms than through foreclosure, liquidation, or bankruptcy. Candidates for renegotiation must meet specific guidelines. There were no restructured loans as of December 31, 2005, 2004, and 2003. 15 Loan Portfolio Set forth below is selected information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated. LOAN PORTFOLIO COMPOSITION
At December 31, 2005 2004 2003 2002 2001 (Dollars in Thousands) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent REAL ESTATE LOANS Residential $ 89,599 36.7% $ 82,482 36.8% $ 77,284 39.3% $ 70,645 41.1% $ 63,363 38.9% Commercial 81,587 33.4 75,266 33.6 59,682 30.3% 44,594 25.9 39,509 24.3 Home equity 22,697 9.3 21,127 9.4 18,337 9.3% 14,825 8.6 12,756 7.8 Farm land 3,443 1.4 3,721 1.7 2,872 1.5% 1,828 1.1 2,009 1.2 Construction 5,956 2.4 4,524 2.0 4,102 2.1% 3,414 2.0 5,570 3.4 $203,282 83.2 $187,120 83.4 $162,277 82.5% $135,306 78.7 $123,207 75.7 OTHER LOANS Commercial loans $ 28,643 11.7% $ 21,317 9.5% $ 17,157 8.7% $ 17,445 10.1% $ 18,111 11.1% Consumer installment loans 11,673 4.8 14,116 6.3 15,350 7.8% 17,314 10.1 19,222 11.8 Other consumer loans 128 0.1 1,345 0.6 1,488 0.8% 1,537 0.9 1,504 0.9 Agricultural loans 535 0.2 338 0.2 403 0.2% 375 0.2 667 0.4 40,979 16.8 37,116 16.6 34,398 17.5% 36,671 21.3 39,504 24.3 Total loans 244,261 100.0% 224,236 100.0% 196,675 100.0% 171,977 100.0% 162,711 100.0% Allowance for loan loss (3,615) (3,645) (3,569) (3,068) (2,614) Total loans, net $240,646 $220,591 $193,106 $168,909 $160,097
The following table indicates the amount of loans in portfolio categories according to their period to maturity. The table also indicates the dollar amount of these loans that have predetermined or fixed rates versus variable or adjustable rates. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES AT DECEMBER 31, 2005
One Year One Year Through After or Less Five Years Five Years Total Commercial and agricultural $16,271 $ 9,451 $3,456 $29,178 Real estate construction 1,216 4,678 62 5,956 Total $17,487 $14,129 $3,518 $35,134 Interest sensitivity of loans: Predetermined rate $ 2,229 $12,339 $3,518 $18,086 Variable rate 15,258 1790 0 17,048 Total $17,487 $14,129 $3,518 $35,134
Other Real Estate Owned Other real estate owned represents properties acquired through foreclosure and is recorded on an individual-asset basis at the lower of (1) fair value less estimated costs to sell or (2) cost, which represents the loan balance at initial foreclosure. When a property is acquired, the excess of the loan balance over the fair value of the property is charged to the allowance for loan losses. Subsequent write downs to reflect further declines in fair value are included in non-interest expense. The following are the changes in other real estate owned during the last two years: Years Ended December 31, 2005 2004 Beginning balance $-- $43,000 Additions (includes costs capitalized) -- -- Sales -- (43,000) Write downs -- -- Ending balance $-- $ -- 16 Non-Interest Income and Expense Non-interest income primarily consists of service charges, commissions and fees for various banking services, and securities gains and losses. Total non-interest income of $4.1 million in 2005 was an increase of 4.8% or $186,000 over 2004. The increase is primarily attributable to the sale of the final three Grandview Palace units, eliminating all company owned real estate, and a $234,000 gain on the sale of the credit card portfolio. The elimination of the one time gain on the sale of the credit card portfolio would have resulted in a decrease of $48,000 from 2004 to 2005. Non-interest expense increased by $986,000 or 8.3% to $12.9 million in 2005. Salaries and employee benefit expense increased 10.6% to $7.6 million in 2005. This increase was caused by increased expenses for normal salary increases and increased costs of providing pension and healthcare benefits. Occupancy and equipment expense increased by $178,000 or 9.9% to $2.0 million in 2005, primarily due to an increase in equipment maintenance agreements and the addition of the on-line banking system. Other non-interest expense increased by $76,000 or 2.4% in 2005 to $3.3 million from $3.2 million in 2004. The increase was primarily due to professional fees incurred due to the implementation of the Sarbanes-Oxley Act. These costs amounted to $248,000 in 2005, an increase of $118,000 over 2004. Income Tax Expense Income tax expense totaled $2.0 million in 2005 versus $2.2 million in 2004. The effective tax rate approximated 26.3% in 2005 and 26.4% in 2004. These relatively low effective tax rates reflect the favorable tax treatment received on tax-exempt interest income and net earnings from bank-owned life insurance. The proposed 2006 New York State budget bill contains a provision that world disallow the exclusion of dividends paid by a real estate investment trust subsidiary ("REIT"). The bill, if enacted as proposed would be effective for taxable years beginning on or after January 1, 2006, and the Company would lose the tax benefit associated with the REIT. Further, Article 32 of the New York State Tax law, which sets forth the taxation of financial institutions, expired at year end 2005. The reenactment of Article 32 is also included in the proposed 2006 New York State budget bill. Until there is resolution to the proposal, the Company may have to increase the 2006 tax provision by approximately $37,000 per quarter as compared to 2005 and may have to begin recording the increased provision in the first quarter of 2006. Additionally, the proposed legislation would reduce the statutory tax rate on the taxable income base from 7.5% to 6.75%. RESULTS OF OPERATIONS 2004 VERSUS 2003 Net Income Net income for 2004 of $6.2 million increased 7.7% or $439,000 from the 2003 net income of $5.7 million. The higher level of earnings in 2004 reflects the interaction of a number of factors. The most significant factor which increased 2004 net income was the increase in loan interest and fees of $1.2 million to $15.4 million from $14.2 million or 8.4%. The increase in interest income on loans was partially offset by a decrease in interest income on securities which went down from $5.8 million in 2003 to $5.4 million in 2004. The provision for loan losses decreased 41.9% or $260,000 from $620,000 in 2003 to $360,000 in 2004. Salary and employee benefit expense increased $356,000 or 5.4% primarily due to the addition of new employees, normal salary increases and the increased costs of providing pension and health care benefits. Occupancy and equipment expense decreased $394,000 or 17.9%, primarily due to increase focus on reducing building and equipment maintenance expenses. Interest Income and Interest Expense Throughout the following discussion, net interest income and its components are expressed on a tax equivalent basis which means that, where appropriate, tax exempt income is shown as if it were earned on a fully taxable basis. The largest source of income for the Company is net interest income, which represents interest earned on loans, securities and short-term investments, less interest paid on deposits and other interest bearing liabilities. Tax equivalent net interest income of $17.8 million for 2004 represented an increase of 4.7% compared to $17.0 million for 2003. Net interest margin decreased to 5.40% in 2004 compared to 5.56% in 2003, due to overall decreases in earning asset yields. Total interest income for 2004 was $21.9 million, compared to $21.1 million in 2003. The increase in 2004 is the result of a 25 basis point decrease in the earning asset yield which was offset by an increase in the average balance of interest earning assets from $306.3 million in 2003 to $329.7 million in 2004, an increase of 7.6%. Total average securities (securities available for sale and securities held to maturity) decreased $5.4 million or 4.4% in 2004 to $115.7 million. The yield on total securities decreased to 5.5% in 2004 from 5.6% in 2003. The decrease in total average securities during 2004 reflected the need to fund new loans. In 2004, average loans increased $28.5 million to $211.8 million from $183.3 million in 2003. Concurrently the average loan yield decreased from 7.76% in 2003 to 7.28% in 2004 due to a consistent decline in interest rates coupled with a significant volume of refinanced mortgage loans. Average residential and commercial real estate loans continued to make up a major portion of the loan portfolio at 72.3% of total loans in 2004. In 2005, any increases in funding will continue to be allocated first to meet loan demand, as necessary, and then to the securities portfolios. 17 Total interest expense in 2004 was consistent with 2003. The average balance of interest bearing liabilities increased from $248.3 million in 2003 to $253.9 million in 2004, an increase of 2.2%. During 2004, the average cost of total interest bearing liabilities decreased by 2 basis points. Average interest bearing deposits increased $13.9 million to reach $227.6 million in 2004, an increase of 6.5%. Overall interest rates paid on all deposit accounts only dropped one basis point from 2003 to 2004. Interest rates on interest bearing deposits decreased from an average rate paid of 1.30% in 2003 to 1.27% in 2004. In 2004, average demand deposit balances increased 16.1% over 2003. Provision for Loan Losses The provision for loan losses was $360,000 in 2004 as compared to $620,000 in 2003 as a result of improved asset quality. The provision for loan losses was reduced in 2004 due to the reduction in non-performing loans as well as a continuation of the relatively low level of net loan charge-offs. Total non-performing loans decreased from $3.1 million at December 31, 2003 to $2.1 million at December 31, 2004. Net loan charge-offs increased from $119,000 in 2003 to $284,000 in 2004 while gross charge-offs decreased from $488,000 in 2003 to $433,000 in 2004. Non-Interest Income and Expense Non-interest income primarily consists of service charges, commissions and fees for various banking services, and securities gains and losses. Total non-interest income of $3.9 million in 2004 was a decrease of 2.1% or $83,000 over 2003. The decrease is attributable to lower securities gains, a decrease in income from the cash surrender value of bank owned life insurance partially offset by higher service charges for checking accounts and an increase in other non-interest income. Non-interest expense increased by $229,000 or 2.0% to $11.9 million in 2004. Salaries and employee benefit expense increased 5.4% to $6.9 million in 2004. This increase was caused by increased expenses for normal salary increases and increased costs of providing pension and healthcare benefits. Occupancy and equipment expense decreased 17.9% to $1.8 million in 2004, due to increases in insurance premiums, offset by tighter control over maintenance expense. Net other real estate owned (income) expense decreased $88,000 to ($5,000) in 2004 from $83,000 of expense in 2004 primarily due to reduced maintenance expenses at Grandview Palace. Other non-interest expense increased by $355,000 or 12.5% in 2004 to $3.2 million from $2.8 million in 2003. Income Tax Expense Income tax expense totaled $2.2 million in 2004 versus $2.0 million in 2003. The effective tax rate approximated 26.4% in 2004 and 25.7% in 2003. These relatively low effective tax rates reflects the favorable tax treatment received on tax-exempt interest income and net earnings from bank-owned life insurance. OFF-BALANCE SHEET ARRANGEMENTS In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used by us for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage customers' requests for funding. See note 16 of Notes to Consolidated Financial Statements contained elsewhere within this report for further information concerning off-balance sheet arrangements. LIQUIDITY Liquidity is the ability to provide sufficient cash flow to meet financial commitments such as additional loan demand and withdrawals of existing deposits. The Company's primary sources of liquidity are its deposit base; FHLB borrowings; repayments and maturities on loans; short-term assets such as federal funds and short-term interest bearing deposits in banks; and maturities and sales of securities available for sale. These sources are available in amounts sufficient to provide liquidity to meet the Company's ongoing funding requirements. The Bank's membership in the FHLB of New York enhances liquidity in the form of overnight and 30 day lines of credit of approximately $36.7 million, which may be used to meet unforeseen liquidity demands. There were no overnight borrowings at December 31, 2005. Five separate FHLB term advances totaling $25.0 million at December 31, 2005 were being used to fund loan growth and to leverage our excess capital position. 18 In 2005, cash generated from operating activities amounted to $7.6 million and cash generated from financing activities amounted to $15.6 million. These amounts were offset by a use of cash in investing activities of $13.0 million, resulting in a net increase in cash and cash equivalents of $10.2 million. See the Consolidated Statements of Cash Flows for additional information. The following table reflects the Maturities of Time Deposits of $100,000 or more: MATURITY SCHEDULE OF TIME DEPOSITS OF $100,000 OR MORE AT DECEMBER 31, 2005 Deposits Due three months or less $ 9,665,000 Over three months through six months 3,386,000 Over six months through twelve months 14,344,000 Over twelve months 16,441,000 Total $43,836,000 Management anticipates much of these maturing deposits to rollover at maturity, and that liquidity will be adequate to meet funding requirements. CAPITAL ADEQUACY One of management's primary objectives is to maintain a strong capital position to merit the confidence of depositors, the investing public, bank regulators and stockholders. A strong capital position should help the Company withstand unforeseen adverse developments and take advantage of profitable investment opportunities when they arise. Stockholders' equity increased $2.9 million or 7.2% in 2005 following an increase of 10.8% in 2004. The Company retained $3.8 million from 2005 earnings, while accumulated other comprehensive loss decreased stockholders' equity by $903,000. In accordance with regulatory capital rules, the adjustment for the after tax net unrealized gain or loss on securities available for sale is not considered in the computation of regulatory capital ratios. Under the Federal Reserve Bank's risk-based capital rules at December 31, 2005, the Company's Tier I risk-based capital was 16.9% and total risk-based capital was 18.2% of risk-weighted assets. These risk-based capital ratios are well above the minimum regulatory requirements of 4.0% for Tier I capital and 8.0% for total capital. The Company's leverage ratio (Tier I capital to average assets) of 11.5% is well above the 4.0% minimum regulatory requirement. The following table shows the Company's actual capital measurements compared to the minimum regulatory requirements.
As of December 31, 2005 2004 TIER I CAPITAL Stockholders' equity, excluding the after-tax net unrealized gain on securities available for sale $ 42,984,000 $ 39,370,000 TIER II CAPITAL Allowance for loan losses(1) 3,156,000 2,891,000 Total risk-based capital $ 46,140,000 $ 42,261,000 Risk-weighted assets(2) $253,911,000 $232,679,000 Average assets $374,413,000 $361,783,000 RATIOS Tier I risk-based capital (minimum 4.0%) 16.9% 16.9% Total risk-based capital (minimum 8.0%) 18.2% 18.2% Leverage (minimum 4.0%) 11.5% 10.9%
(1) The allowance for loan losses is limited to 1.25% of risk-weighted assets for the purpose of this calculation. (2) Risk-weighted assets have been reduced for the portion allowance for loan losses excluded from total risk-based capital. CONTRACTUAL OBLIGATIONS The Company is contractually obligated to make the following payments on long-term debt and leases as of December 31, 2005:
Less Than 1 to 3 3 to 5 More Than 1 Year Years Years 5 Years Total Federal Home Loan Bank borrowings $ -- $20,000,000 $5,000,000 $-- $25,000,000 Operating leases 85,000 131,000 48,000 -- 264,000 Total $85,000 $20,131,000 $5,048,000 $-- $25,264,000
In regard to short-term borrowings, see note 8 of Notes to Consolidated Financial Statements. 19 DISTRIBUTION OF ASSETS, LIABILITIES & STOCKHOLDERS' EQUITY: INTEREST RATES & INTEREST DIFFERENTIAL The following schedule presents the condensed average consolidated balance sheets for 2005, 2004 and 2003. The total dollar amount of interest income from earning assets and the resultant yields are calculated on a tax equivalent basis. The interest paid on interest-bearing liabilities, expressed in dollars and rates, are also presented. CONSOLIDATED AVERAGE BALANCE SHEET 2005
Percentage of Total Average Average Interest Average Balance Assets Earned/Paid Yield/Rate ASSETS Securities available for sale and held to maturity:(1) Taxable securities $ 54,542,000 14.57% $ 2,618,000 4.80% Tax exempt securities 48,082,000 12.84 2,944,000 6.12% Total securities 102,624,000 27.41 5,562,000 5.42% Short-term investments 1,224,000 0.33 39,000 3.19% Loans Real estate mortgages 169,585,000 45.29 12,005,000 7.08% Home equity loans 21,708,000 5.80 1,326,000 6.11% Time and demand loans 27,965,000 7.47 2,179,000 7.79% Installment and other loans 19,735,000 5.27 2,059,000 10.45% Total loans(2) 238,993,000 63.83 17,569,000 7.35% Total interest earning assets 342,841,000 91.57 23,170,000 6.76% Allowance for loan losses (3,663,000) (0.98) Unrealized gains and losses on portfolio 52,000 0.01 Cash and due from banks (demand) 13,027,000 3.48 Fixed assets (net) 2,967,000 0.79 Bank owned life insurance 12,972,000 3.46 Other assets 6,217,000 1.66 Total assets $374,413,000 100.00% LIABILITIES AND STOCKHOLDERS' EQUITY NOW and Super NOW deposits $ 36,743,000 9.81% 118,000 0.32% Savings and insured money market deposits 88,083,000 23.53 947,000 1.08 Time deposits 105,585,000 28.20 2,994,000 2.84 Total interest bearing deposits 230,411,000 61.54 4,059,000 1.76 Federal funds purchased and other short-term debt 3,436,000 0.92 120,000 3.49 Long-term debt 24,914,000 6.65 1,223,000 4.91 Total interest bearing liabilities 258,761,000 69.11 5,402,000 2.09 Demand deposits 67,232,000 17.96 Other liabilities 7,070,000 1.89 Total liabilities 333,063,000 88.96 Stockholders' equity 41,350,000 11.04 Total liabilities and stockholders' equity $374,413,000 100.00% Net interest income $17,768,000 Net interest spread 4.67% Net interest margin(3) 5.18%
(1) Yields on securities available for sale are based on amortized cost. (2) For purpose of this schedule, interest in nonaccruing loans has been included only to the extent reflected in the consolidated income statement. However, the nonaccrual loan balances are included in the average amount outstanding. (3) Computed by dividing net interest income by total interest earning assets. 20 DISTRIBUTION OF ASSETS, LIABILITIES & STOCKHOLDERS' EQUITY: INTEREST RATES & INTEREST DIFFERENTIAL CONSOLIDATED AVERAGE BALANCE SHEET 2004
Percentage of Total Average Average Interest Average Balance Assets Earned/Paid Yield/Rate ASSETS Securities available for sale and held to maturity:(1) Taxable securities $ 66,265,000 18.32% $ 3,366,000 5.08% Tax exempt securities 49,467,000 13.67 3,043,000 6.15% Total securities 115,732,000 31.99 6,409,000 5.54% Short-term investments 2,079,000 0.57 25,000 1.20% Loans Real estate mortgages 153,147,000 42.33 10,920,000 7.13% Home equity loans 19,689,000 5.44 1,207,000 6.13% Time and demand loans 18,855,000 5.21 1,255,000 6.66% Installment and other loans 20,155,000 5.57 2,039,000 10.12% Total loans(2) 211,846,000 58.56 15,421,000 7.28% Total interest earning assets 329,657,000 91.12 21,855,000 6.63% Allowance for loan losses (3,554,000) (0.98) Unrealized gains and losses on portfolio 390,000 0.11 Cash and due from banks (demand) 12,816,000 3.54 Fixed assets (net) 3,037,000 0.84 Bank owned life insurance 12,488,000 3.45 Other assets 6,949,000 1.92 Total assets $361,783,000 100.00% LIABILITIES AND STOCKHOLDERS' EQUITY NOW and Super NOW deposits $ 38,887,000 10.75% 102,000 0.26% Savings and insured money market deposits 85,134,000 23.53 550,000 0.65% Time deposits 103,625,000 28.64 2,237,000 2.16% Total interest bearing deposits 227,646,000 62.92 2,889,000 1.27% Federal funds purchased and other short-term debt 1,411,000 0.39 23,000 1.63% Long-term debt 24,836,000 6.86 1,139,000 4.59% Total interest bearing liabilities 253,893,000 70.18 4,051,000 1.60% Demand deposits 63,780,000 17.63 Other liabilities 6,961,000 1.92 Total liabilities 324,634,000 89.73 Stockholders' equity 37,149,000 10.27 Total liabilities and stockholders' equity $361,783,000 100.00% Net interest income $17,804,000 Net interest spread 5.03% Net interest margin(3) 5.40%
(1) Yields on securities available for sale are based on amortized cost. (2) For purpose of this schedule, interest in nonaccruing loans has been included only to the extent reflected in the consolidated income statement. However, the nonaccrual loan balances are included in the average amount outstanding. (3) Computed by dividing net interest income by total interest earning assets. 21 DISTRIBUTION OF ASSETS, LIABILITIES & STOCKHOLDERS' EQUITY: INTEREST RATES & INTEREST DIFFERENTIAL CONSOLIDATED AVERAGE BALANCE SHEET 2003
Percentage of Total Average Average Interest Average Balance Assets Earned/Paid Yield/Rate ASSETS Securities available for sale and held to maturity:(1) Taxable securities $ 75,504,000 22.17% $ 3,893,000 5.16% Tax exempt securities 45,579,000 13.38 2,913,000 6.39% Total securities 121,083,000 35.55 6,806,000 5.62% Short-term investments 1,871,000 0.55 23,000 1.23% Loans Real estate mortgages 131,978,000 38.75 10,108,000 7.66% Home equity loans 16,826,000 4.94 1,073,000 6.38% Time and demand loans 14,387,000 4.22 947,000 6.58% Installment and other loans 20,144,000 5.92 2,098,000 10.42% Total loans(2) 183,335,000 53.83 14,226,000 7.76% Total interest earning assets 306,289,000 89.93 21,055,000 6.87% Allowance for loan losses (3,149,000) (0.92) Unrealized gains and losses on portfolio 1,924,000 0.57 Cash and due from banks (demand) 12,436,000 3.65 Fixed assets (net) 3,206,000 0.94 Bank owned life insurance 12,005,000 3.52 Other assets 7,864,000 2.31 Total assets $340,575,000 100.00% LIABILITIES AND STOCKHOLDERS' EQUITY NOW and Super NOW deposits $ 37,363,000 10.97% 169,000 0.45% Savings and insured money market deposits 86,323,000 25.34 542,000 0.63 Time deposits 90,067,000 26.45 2,067,000 2.29 Total interest bearing deposits 213,753,000 62.76 2,778,000 1.30 Federal funds purchased and other short-term debt 4,808,000 1.41 56,000 1.16 Long-term debt 29,753,000 8.74 1,203,000 4.04 Total interest bearing liabilities 248,314,000 72.91 4,037,000 1.63 Demand deposits 54,934,000 16.13 Other liabilities 3,766,000 1.11 Total liabilities 307,014,000 90.15 Stockholders' equity 33,561,000 9.85 Total liabilities and stockholders' equity $340,575,000 100.00% Net interest income $17,018,000 Net interest spread 5.24% Net interest margin(3) 5.56%
(1) Yields on securities available for sale are based on amortized cost. (2) For purpose of this schedule, interest in nonaccruing loans has been included only to the extent reflected in the consolidated income statement. However, the nonaccrual loan balances are included in the average amount outstanding. (3) Computed by dividing net interest income by total interest earning assets. 22 The following schedule sets forth, for each major category of interest earning assets and interest bearing liabilities, the dollar amount of interest income (calculated on a tax equivalent basis) and interest expense, and changes therein for 2005 as compared to 2004, and 2004 as compared to 2003. The increase and decrease in interest income and expense due to both rate and volume have been allocated to the two categories of variances (volume and rate) based on percentage relationships of such variance to each other. VOLUME AND RATE ANALYSIS
2005 Compared to 2004 2004 Compared to 2003 Increase (Decrease) Increase (Decrease) Due to Change In Due to Change In Volume Rate Total Volume Rate Total INTEREST INCOME Investment securities and securities available for sale $ (726,000) $ (121,000) $ (847,000) $ (301,000) $ (96,000) $ (397,000) Short-term investments (10,000) 24,000 14,000 3,000 (1,000) 2,000 Loans 1,976,000 172,000 2,148,000 2,212,000 (1,017,000) 1,195,000 Total interest income 1,240,000 75,000 1,315,000 1,914,000 (1,114,000) 800,000 INTEREST EXPENSE NOW and Super NOW deposits (6,000) 22,000 16,000 7,000 (74,000) (67,000) Savings and insured money market deposits 19,000 378,000 397,000 (75,000) 83,000 8,000 Time deposits 42,000 715,000 757,000 311,000 (141,000) 170,000 Federal funds purchased and other short-term debt 33,000 63,000 96,000 (39,000) 6,000 (33,000) Long-term debt 4,000 81,000 85,000 (199,000) 135,000 (64,000) Total interest expense 92,000 1,259,000 1,351,000 5,000 9,000 14,000 Net interest income $1,148,000 $(1,184,000) $ (36,000) $1,909,000 $ 1,123,000 $ 786,000
INFLATION The Company's operating results are affected by inflation to the extent that interest rates, loan demand and deposit levels adjust to inflation and impact net interest income. Management can best counter the effect of inflation over the long term by managing net interest income and controlling expenses. SECURITIES AVAILABLE FOR SALE AND INVESTMENT SECURITIES ANALYSIS* SUMMARY OF INVESTMENT SECURITIES
At December 31, 2005 2004 2003 Carrying Value Fair Value Carrying Value Fair Value Carrying Value Fair Value Government Sponsored Enterprises $45,323,000 $44,011,000 $ 51,351,000 $ 50,461,000 $ 59,837,000 $ 59,415,000 Municipal securities 48,394,000 48,861,000 48,596,000 49,875,000 50,248,000 51,748,000 Mortgage backed securities and collateralized mortgage obligations 3,416,000 3,323,000 5,585,000 5,590,000 9,434,000 9,596,000 Other securities -- -- -- -- -- -- $97,133,000 $96,195,000 $105,532,000 $105,926,000 $119,519,000 $120,759,000
23 ANALYSIS BY TYPE AND BY PERIOD TO MATURITY
Under 1 Year 1-5 Years 5-10 Years After 10 Years December 31, 2005 Balance Rate Balance Rate Balance Rate Balance Rate Total Government Sponsored Enterprises $ 5,971,000 5.55% $ 4,000,000 3.93% $13,352,000 4.74% $22,000,000 5.22% $45,323,000 Municipal securities -- tax exempt(1) 1,584,000 4.75 8,988,000 4.253 27,573,000 4.009 2,054,000 4.146 40,199,000 Municipal securities -- taxable 4,346,000 3.24 3,146,000 4.834 703,000 4.456 0 0 8,195,000 Mortgage backed securities and collateralized mortgage obligations 1,620,000 5.29 1,796,000 5.098 0 0 0 0 3,416,000 $13,521,000 4.68% $17,930,000 4.37% $41,628,000 4.25% $24,054,000 5.13% $97,133,000
* The analysis shown above combines the Company's Securities Available for Sale portfolio and the Investment Securities portfolio, excluding equity securities. All securities are included above at their amortized cost. (1) Yields on tax exempt securities have not been stated on a tax equivalent basis. Item 7A. Quantitative and Qualitative Disclosures about Market Risk INTEREST RATE RISK Measuring and managing interest rate risk is a dynamic process that the Bank's management must continually perform to meet the objectives of maintaining stable net interest income and net interest margin. This means that prior to setting the term or interest rate on loans or deposits, or before purchasing investment securities or borrowing funds, management must understand the impact that alternative interest rates will have on the Bank's interest rate risk profile. This is accomplished through simulation modeling. Simulation modeling is the process of "shocking" the current balance sheet under a variety of interest rate scenarios and then measuring the impact of interest rate changes on both projected earning ands the economic value of the Bank's equity. The estimates underlying the sensitivity analysis are based upon numerous assumptions including, but not limited to; the nature and timing of interest rate changes, prepayments on loan and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement rates on asset and liability cash flows. While assumptions are developed based on available information and current economic and general market conditions, management cannot make any assurance as to the ultimate accuracy of these assumptions including competitive influences and customer behavior. Accordingly, actual results will differ from those predicted by simulation modeling. The following table shows the projected changes in net interest income from an instantaneous shift in all market interest rates. The projected changes in net interest income are totals for the 12-month period beginning January 1, 2006 and ending December 31, 2006 under instantaneous shock scenarios. INTEREST RATE SENSITIVITY TABLE
Projected Change in Projected Projected Net Interest Projected Dollar Percentage Income as a Annualized Change in Change in Percent of Total Net Interest Net Interest Net Interest Stockholders' Interest Rate Shock(1) Prime Rate Income Income Income Equity 3.00% 10.25% $15,207,000 $ (82,000) (0.5)% (0.2)% 2.00% 9.25% $15,275,000 $ (14,000) (0.1)% -- 1.00% 8.25% $15,321,000 $ 32,000 0.2% (0.1)% No change 7.25% $15,289,000 (1.00)% 6.25% $14,980,000 $ (309,000) (2.0)% (0.7)% (2.00)% 5.25% $13,901,000 $(1,388,000) (9.1)% (3.3)% (3.00)% 4.25% $12,488,000 $(2,801,000) (18.3)% (6.6)%
(1) Under an instantaneous interest rate shock, interest rates are modeled to change at once. This is a very conservative modeling technique that illustrates immediate rather than gradual increases or decreases in interest rates. 24 Many assumptions are embedded within our interest rate risk model. These assumptions are approved by the Asset and Liability Committee and are based upon both management's experience and projections provided by investment securities companies. Assuming our prepayment and other assumptions are accurate and assuming we take reasonable actions to preserve net interest income, we project that net interest income would decline by $14,000 or -0.1% of total stockholders' equity in a +2.00% instantaneous interest rate shock and decline by $1,388 million or -9.01% of stockholders' equity in a -2.00% instantaneous interest rate shock. This is within our Asset and Liability Policy guideline which limits the maximum projected decrease in net interest income in a +2.00% or -2.00% instantaneous interest rate shock to +/-12% of the Company's total equity capital. Our strategy for managing interest rate risk is impacted by general market conditions and customer demand. Generally we try to limit the volume and term of fixed-rate assets and fixed-rate liabilities, so that we can adjust it and pricing of assets and liabilities to mitigate net interest income volatility. The Bank purchases investments for the securities portfolio and borrowings from the FHLB of NY to offset interest rate risk taken in the loan portfolio. The Banks also offers adjustable rate loan and deposit products that change as interest rates change. Approximately 12% of the Bank's assets at December 31, 2005 were invested in adjustable rate loans. Item 8. Financial Statements and Supplementary Data Consolidated financial statements and supplementary data are found on pages 3 to 27 of this report. Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure None. Item 9A. Controls and Procedures EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's principal executive officer and principal financial officer have evaluated the disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act as of December 31, 2005. Based on this evaluation, the principal executive officer and principal financial officer have concluded that the disclosure controls and procedures effectively ensure that information required to be disclosed in the Company's filings and submissions with the Securities and Exchange Commission under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission. In addition, the Company has reviewed its internal controls and there have been no significant changes in its internal controls over financial reporting or in other factors during the Company's most recent fiscal quarter that have or are likely to materially affect internal control over financial reporting. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) or 15d-15(f). The Company's internal control system was designed to provide reasonable assurance to the Company's management and board of directors regarding the preparation and fair presentation of published financial statements. Under the supervision and with the participation of the Company's management, including its principal executive officer and principal financial officer, an evaluation of the effectiveness of internal controls over financial reporting was conducted, based on the framework in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation under the framework in Internal Control -- Integrated Framework, management concluded that the internal controls over financial reporting were effective as of December 31, 2005. Management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, and independent registered public accounting firm, as stated in their report, which is included in Item 8 herein. Item 9B. Other Information Nothing to disclose. 25 PART III Item 10. Directors and Executive Officers of the Registrant See "Nomination of Directors and Election of Directors" on page 3 contained in the proxy statement ("Proxy Statement") for the Company's 2006 annual meeting which will be filed with the Securities and Exchange Commission within 120 days of the Company's 2005 fiscal year end, which is incorporated herein by reference. Item 11. Executive Compensation See "Executive Compensation" on page 13 of the Proxy Statement, which is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters See "Executive Compensation" on page 13 of the Proxy Statement, which is incorporated herein by reference. See "Security Ownership of Certain Beneficial Owners and of Management" on page 11 of the Proxy Statement, which is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions See "Director and Executive Officer Information" on pages 5-7, "Transactions with Management" on page 18 and "Remuneration of Management and Others" on pages 8, 13-16 and 18 of the Proxy Statement, which are incorporated herein by reference. Item 14. Principal Accountant Fees and Services See "Audit Fees" on page 17 of the Proxy Statement, which is incorporated herein by reference. 26 PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. Consolidated financial statements and schedules of the Company and Bank. Independent Registered Public Accounting Firm's Report Consolidated Balance Sheets -- December 31, 2005 and 2004 Consolidated Statements of Income Years Ended December 31, 2005, 2004 and 2003 Consolidated Statements of Changes in Stockholders' Equity Years Ended December 31, 2005, 2004 and 2003 Consolidated Statements of Cash Flows Years Ended December 31, 2005, 2004 and 2003 Notes to Consolidated Financial Statements (a) 2. All schedules are omitted since the required information is either not applicable, not required or contained in the respective consolidated financial statements or in the notes thereto. (a) 3. Exhibits (numbered in accordance with Item 601 of Regulation S-K). 3.1 Certificate of Incorporation of the Company (Incorporation by Reference to Exhibit 3.1, 3.2, 3.3 and 3.4 to Form 8 Registration Statement, effective June 29, 1991) 3.2 The Bylaws of the Company (Incorporated by Reference to Exhibit 3.5 and 3.6 to Form 8 Registration Statement, effective June 29, 1991) 4.1 Instruments defining the Rights of Security Holders. (Incorporated by Reference to Exhibit 4 to Form 8 Registration Statement, effective June 29, 1991) 21.1 Subsidiaries of the Company 31.1 Section 302 Certification of Chief Executive Officer 31.2 Section 302 Certification of Chief Financial Officer 32.1 906 certification of Chief Executive Officer 32.2 906 certification of Chief Financial Officer (b) Exhibits to this Form 10-K are attached or incorporated herein by reference. (c) Not applicable 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 15, 2006 By: /s/ Raymond Walter By: /s/ Charles E. Burnett Chief Executive Officer Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE /s/ Arthur E. Keesler Chairman-Director March 15, 2006 Arthur E. Keesler /s/ Wayne V. Zanetti Vice President March 15, 2006 Wayne V. Zanetti /s/ John K. Gempler Secretary-Director March 15, 2006 John K. Gempler /s/ Edward T. Sykes Director March 15, 2006 Edward T. Sykes /s/ Raymond Walter Chief Executive Officer March 15, 2006 Raymond Walter President-Director /s/ Earle A. Wilde Director March 15, 2006 Earle A. Wilde /s/ James F. Roche Director March 15, 2006 James F. Roche /s/ John W. Galligan Director March 15, 2006 John W. Galligan /s/ Kenneth C. Klein Director March 15, 2006 Kenneth C. Klein /s/ Gibson E. McKean Director March 15, 2006 Gibson E. McKean /s/ Douglas A. Heinle Director March 15, 2006 Douglas A. Heinle
28 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM [LOGO] KPMG The Board of Directors and Shareholders Jeffersonville Bancorp: We have audited the accompanying consolidated balance sheets of Jeffersonville Bancorp and subsidiary as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jeffersonville Bancorp and subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2006 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP Albany, New York March 15, 2006 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM [LOGO] KPMG The Board of Directors and Shareholders Jeffersonville Bancorp: We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting that Jeffersonville Bancorp (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in a reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Jeffersonville Bancorp maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Jeffersonville Bancorp and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 15, 2006, expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Albany, New York March 15, 2006 F-2 CONSOLIDATED BALANCE SHEETS December 31, 2005 2004 ASSETS Cash and due from banks (note 2) $ 24,192,000 $ 14,040,000 Securities available for sale, at fair value (notes 3 and 7) 88,984,000 100,705,000 Securities held to maturity (estimated fair value of $8,233 at December 31, 2005 and $5,998 at December 31, 2004) (note 3) 8,195,000 5,957,000 Loans, net of allowance for loan losses of $3,615 at December 31, 2005 and $3,645 at December 31, 2004 (notes 4, 7, and 8) 240,646,000 220,591,000 Accrued interest receivable 2,040,000 2,085,000 Premises and equipment, net (note 5) 3,027,000 2,869,000 Federal Home Loan Bank stock (notes 7 and 8) 2,496,000 2,175,000 Cash surrender value of bank-owned life insurance 13,217,000 12,747,000 Other assets 4,546,000 4,354,000 Total assets $387,343,000 $365,523,000 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits: Demand deposits $ 65,266,000 $ 65,208,000 NOW and Super NOW accounts 37,501,000 36,594,000 Savings and money market deposits 86,094,000 87,115,000 Time deposits (note 6) 123,235,000 104,177,000 Total deposits 312,096,000 293,094,000 Federal Home Loan Bank borrowings (note 7) 25,000,000 18,500,000 Short-term borrowings (note 8) 427,000 8,424,000 Accrued expenses and other liabilities 7,301,000 5,859,000 Total liabilities 344,824,000 325,877,000 Commitments and contingent liabilities (note 16) Stockholders' equity (notes 11, 12, and 13): Series A preferred stock, no par value 2,000,000 shares authorized none issued -- -- Common stock, $0.50 par value 11,250,000 shares authorized 4,767,786 shares issued at December 31, 2005 and at December 31, 2004 2,384,000 2,384,000 Paid-in capital 6,483,000 6,483,000 Treasury stock, at cost 333,465 shares at December 31, 2005 and at December 31, 2004 (1,108,000) (1,108,000) Retained earnings 36,118,000 32,342,000 Accumulated other comprehensive loss, net of taxes of $905 at December 31, 2005 and $297 at December 31, 2004 (1,358,000) (455,000) Total stockholders' equity 42,519,000 39,646,000 Total liabilities and stockholders' equity $387,343,000 $365,523,000 See accompanying notes to consolidated financial statements. F-3 CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2005 2004 2003 INTEREST AND DIVIDEND INCOME Loan interest and fees $17,570,000 $15,421,000 $14,226,000 Securities: Taxable 2,627,000 3,365,000 3,893,000 Non-taxable 1,943,000 2,009,000 1,940,000 Federal funds sold 30,000 25,000 23,000 Total interest and dividend income 22,170,000 20,820,000 20,082,000 INTEREST EXPENSE Deposits 4,060,000 2,889,000 2,778,000 Federal Home Loan Bank borrowings 1,223,000 1,139,000 1,203,000 Other interest expense 119,000 23,000 56,000 Total interest expense 5,402,000 4,051,000 4,037,000 Net interest income 16,768,000 16,769,000 16,045,000 Provision for loan losses (note 4) 180,000 360,000 620,000 Net interest income after provision for loan losses 16,588,000 16,409,000 15,425,000 NON-INTEREST INCOME Service charges 1,894,000 2,198,000 2,054,000 Earnings from cash surrender value of bank-owned life insurance 470,000 479,000 534,000 Net security gains (note 3) 6,000 14,000 307,000 Gain on sale of credit card portfolio 234,000 -- -- Other real estate owned income (expense), net 141,000 5,000 (83,000) Other non-interest income 1,318,000 1,181,000 1,060,000 Total non-interest income 4,063,000 3,877,000 3,872,000 NON-INTEREST EXPENSES Salaries and employee benefits 7,636,000 6,904,000 6,548,000 Occupancy and equipment expenses 1,981,000 1,803,000 2,197,000 Other non-interest expenses (note 10) 3,267,000 3,191,000 2,836,000 Total non-interest expenses 12,884,000 11,898,000 11,581,000 Income before income tax expense 7,767,000 8,388,000 7,716,000 Income tax expense (note 9) 2,042,000 2,217,000 1,984,000 Net income $ 5,725,000 $ 6,171,000 $ 5,732,000 Basic earnings per common share $ 1.29 $ 1.39 $ 1.29
See accompanying notes to consolidated financial statements. F-4 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated Other Total Years Ended December 31, Common Paid-in Treasury Retained Comprehensive Stockholders' 2005, 2004, and 2003 Stock Capital Stock Earnings (Loss) Income Equity BALANCE AT DECEMBER 31, 2002 $ 795,000 $ 8,072,000 $(1,108,000) $23,664,000 $ 1,074,000 $32,497,000 Net income -- -- -- 5,732,000 -- 5,732,000 Other comprehensive loss -- -- -- -- (994,000) (994,000) Comprehensive income 4,738,000 Cash dividends ($0.33 per share) -- -- -- (1,449,000) -- (1,449,000) 3 for 1 stock split (3,178,524 shares) 1,589,000 (1,589,000) -- -- -- -- BALANCE AT DECEMBER 31, 2003 2,384,000 6,483,000 (1,108,000) 27,947,000 80,000 35,786,000 Net income -- -- -- 6,171,000 -- 6,171,000 Other comprehensive loss -- -- -- -- (535,000) (535,000) Comprehensive income 5,636,000 Cash dividends ($0.40 per share) -- -- -- (1,776,000) -- (1,776,000) BALANCE AT DECEMBER 31, 2004 2,384,000 6,483,000 (1,108,000) 32,342,000 (455,000) 39,646,000 Net income -- -- -- 5,725,000 -- 5,725,000 Other comprehensive loss -- -- -- -- (903,000) (903,000) Comprehensive income 4,822,000 Cash dividends ($0.44 per share) -- -- -- (1,949,000) -- (1,949,000) BALANCE AT DECEMBER 31, 2005 $2,384,000 $ 6,483,000 $(1,108,000) $36,118,000 $(1,358,000) $42,519,000
See accompanying notes to consolidated financial statements. F-5 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2005 2004 2003 OPERATING ACTIVITIES Net income $ 5,725,000 $ 6,171,000 $ 5,732,000 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 180,000 360,000 620,000 Write down of other real estate owned -- -- 29,000 Net gain on sales of other real estate owned (125,000) (6,000) (108,000) Depreciation and amortization 632,000 640,000 730,000 Net loss (gain) on disposal of premises and equipment 3,000 (9,000) 29,000 Increase in cash surrender value of bank-owned life insurance (470,000) (479,000) (534,000) Deferred income tax benefit (354,000) (223,000) (502,000) Net security gains (6,000) (14,000) (307,000) Increase (decrease) in accrued interest receivable 45,000 216,000 (172,000) (Increase) decrease in other assets 511,000 209,000 471,000 Increase in accrued expenses and other liabilities 1,442,000 490,000 554,000 Net cash provided by operating activities 7,583,000 7,355,000 6,542,000 INVESTING ACTIVITIES Proceeds from maturities and calls: Securities available for sale 10,626,000 20,527,000 56,207,000 Securities held to maturity 4,431,000 3,182,000 1,741,000 Proceeds from sales of securities available for sale 4,782,000 -- 20,343,000 Purchases: Securities available for sale (4,933,000) (6,479,000) (75,858,000) Securities held to maturity (6,669,000) (3,223,000) (2,984,000) Proceeds from sale of credit card portfolio 1,468,000 -- -- Disbursements for loan originations, net of principal collections (21,703,000) (27,845,000) (24,993,000) Proceeds from call of Federal Home Loan Bank stock 4,826,000 1,375,000 1,525,000 Purchase of Federal Home Loan Bank stock (5,147,000) (1,950,000) (1,225,000) Net purchases of premises and equipment (793,000) (437,000) (592,000) Proceeds from sales of other real estate owned 125,000 49,000 338,000 Net cash used in investing activities (12,987,000) (14,801,000) (25,498,000) FINANCING ACTIVITIES Net increase in deposits 19,002,000 12,867,000 27,435,000 Proceeds from Federal Home Loan Bank borrowings 10,000,000 -- 5,000,000 Repayments of Federal Home Loan Bank borrowings (3,500,000) (8,500,000) (8,000,000) Net (decrease) increase in short-term borrowings (7,997,000) 2,903,000 (912,000) Cash dividends paid (1,949,000) (1,776,000) (1,449,000) Net cash provided by financing activities 15,556,000 5,494,000 22,074,000 Net increase (decrease) in cash and cash equivalents 10,152,000 (1,952,000) 3,118,000 Cash and cash equivalents at beginning of year 14,040,000 15,992,000 12,874,000 Cash and cash equivalents at end of year $ 24,192,000 $ 14,040,000 $ 15,992,000 SUPPLEMENTAL INFORMATION: Cash paid for: Interest $ 5,173,000 $ 4,043,000 $ 4,183,000 Income taxes 1,668,000 2,070,000 2,128,000 Transfer of loans to other real estate owned -- -- 176,000
See accompanying notes to consolidated financial statements. F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies BASIS OF PRESENTATION The consolidated financial statements of Jeffersonville Bancorp (the Parent Company) include its wholly owned subsidiary, The First National Bank of Jeffersonville (the Bank). Collectively, these entities are referred to herein as the "Company". All significant intercompany transactions have been eliminated in consolidation. The Parent Company is a bank holding company whose principal activity is the ownership of all outstanding shares of the Bank's stock. The Bank is a commercial bank providing community banking services to individuals, small businesses and local municipal governments in Sullivan County, New York. Management makes operating decisions and assesses performance based on an ongoing review of the Bank's community banking operations, which constitute the Company's only operating segment for financial reporting purposes. The consolidated financial statements have been prepared, in all material respects, in conformity with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to near-term change include the allowance for loan losses which is described below. Actual results could differ from these estimates. For purposes of the consolidated statements of cash flows, the Company considers cash and due from banks and federal funds sold, if any, to be cash equivalents. Reclassifications are made to prior years' consolidated financial statements whenever necessary to conform to the current year's presentation. INVESTMENT SECURITIES Management determines the appropriate classification of securities at the time of purchase. If management has the positive intent and ability to hold debt securities to maturity, they are classified as securities held to maturity and are stated at amortized cost. If securities are purchased for the purpose of selling them in the near term, they are classified as trading securities and are reported at fair value with unrealized gains and losses reflected in current earnings. All other debt and marketable equity securities are classified as securities available for sale and are reported at fair value. Net unrealized gains or losses on securities available for sale are reported (net of income taxes) in stockholders' equity as accumulated other comprehensive income (loss). Nonmarketable equity securities are carried at cost. At December 31, 2005 and 2004, the Company had no trading securities. Gains and losses on sales of securities are based on the net proceeds and the amortized cost of the securities sold, using the specific identification method. The amortization of premium and accretion of discount on debt securities is calculated using the level-yield interest method over the period to the earlier of the call date or maturity date. Unrealized losses on securities that reflect a decline in value which is other than temporary, if any, are charged to income. LOANS Loans are stated at unpaid principal balances, less unearned discounts and the allowance for loan losses. Unearned discounts on certain installment loans are accreted into income using a level-yield interest method. Interest income is recognized on the accrual basis of accounting. When, in the opinion of management, the collection of interest or principal is in doubt, the loan is classified as nonaccrual. Generally, loans past due more than 90 days are classified as nonaccrual. Thereafter, no interest is recognized as income until received in cash or until such time as the borrower demonstrates the ability to make scheduled payments of interest and principal. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the collectibility of all or a portion of the principal is unlikely. Recoveries of loans previously charged-off are credited to the allowance when realized. The Company identifies impaired loans and measures loan impairment in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118. Under SFAS No. 114, a loan is considered to be impaired when, based on current information and events, it is probable that the creditor will be unable to collect all principal and interest contractually due. SFAS No. 114 applies to loans that are individually evaluated for collectibility in accordance with the Company's ongoing loan review procedure, principally commercial mortgage loans and commercial loans. Smaller balance, homogeneous loans which are collectively evaluated, such as consumer and smaller balance residential mortgage loans are specifically excluded from the classification of impaired loans. Creditors are permitted to measure impaired loans based on (i) the present value of expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price or (iii) the fair value of the collateral if the loan is collateral dependent. If the approach used results in a measurement that is less than an impaired loan's recorded investment, an impairment loss is recognized as part of the allowance for loan losses. F-7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The allowance for loan losses is maintained at a level deemed adequate by management based on an evaluation of such factors as economic conditions in the Company's market area, past loan loss experience, the financial condition of individual borrowers, and underlying collateral values based on independent appraisals. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions, particularly in Sullivan County. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided over the estimated useful lives of the assets using straight-line or accelerated methods. FEDERAL HOME LOAN BANK STOCK As a member institution of the Federal Home Loan Bank (FHLB), the Bank is required to hold a certain amount of FHLB stock. This stock is considered to be a nonmarketable equity security and, accordingly, is carried at cost. OTHER REAL ESTATE OWNED Other real estate owned consists of properties acquired through foreclosure and is stated on an individual-asset basis at the lower of (i) fair value less estimated costs to sell or (ii) cost which represents the fair value at initial foreclosure. When a property is acquired, the excess of the loan balance over the fair value of the property is charged to the allowance for loan losses. If necessary, subsequent write downs to reflect further declines in fair value are included in non-interest expenses. Fair value estimates are based on independent appraisals and other available information. While management estimates losses on other real estate owned using the best available information, such as independent appraisals, future write downs may be necessary based on changes in real estate market conditions, particularly in Sullivan County, and the results of regulatory examinations. BANK-OWNED LIFE INSURANCE The investment in bank-owned life insurance, which covers certain officers of the Bank, is carried at the policies' cash surrender value. Increases in the cash surrender value of bank-owned life insurance, net of premiums paid, are included in non-interest income. INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance when management determines that it is more likely than not that all or a portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. EARNINGS PER COMMON SHARE Basic earnings per share (EPS) is computed by dividing income available to common stockholders (net income less dividends on preferred stock, if any) by the weighted average number of common shares outstanding for the period. Entities with complex capital structures must also present diluted EPS which reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common shares. The Company does not have a complex capital structure and, accordingly, has presented only basic EPS. Basic earnings per common share was computed based on average outstanding common shares of 4,434,321 in 2005, 2004, and 2003. Income available to common stockholders equaled net income for each of these years. RECENT ACCOUNTING PRONOUNCEMENTS In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. It is not expected to have a significant effect on the consolidated financial statements. F-8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Cash and Due From Banks The Bank is required to maintain certain reserves in the form of vault cash and/or deposits with the Federal Reserve Bank. The amount of this reserve requirement, which is included in cash and due from banks, was $6,288,000 at December 31, 2005 and $6,418,000 at December 31, 2004. 3. Investment Securities The amortized cost and estimated fair value of securities available for sale are as follows:
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value DECEMBER 31, 2005 Government sponsored enterprises $ 45,323,000 $ 2,000 $(1,314,000) $ 44,011,000 Obligations of states and political subdivisions 40,199,000 736,000 (307,000) 40,628,000 Mortgage-backed securities and collateralized mortgage obligations 3,416,000 37,000 (130,000) 3,323,000 Total debt securities 88,938,000 775,000 (1,751,000) 87,962,000 Equity securities 820,000 202,000 -- 1,022,000 Total securities available for sale $ 89,758,000 $ 977,000 $(1,751,000) $ 88,984,000
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value DECEMBER 31, 2004 Government sponsored enterprises $ 51,351,000 $ 103,000 $ (993,000) $ 50,461,000 Obligations of states and political subdivisions 42,639,000 1,371,000 (133,000) 43,877,000 Mortgage-backed securities and collateralized mortgage obligations 5,585,000 100,000 (95,000) 5,590,000 Total debt securities 99,575,000 1,574,000 (1,221,000) 99,928,000 Equity securities 653,000 124,000 -- 777,000 Total securities available for sale $100,228,000 $1,698,000 $(1,221,000) $100,705,000
Proceeds from sales of securities available for sale during 2005 were $4,782,000. No securities available for sale were sold in 2004, while proceeds from sales during 2003 were $20,343,000. Gross gains and gross losses realized on sales and calls of securities were as follows: 2005 2004 2003 Gross realized gains $ 42,000 $14,000 $344,000 Gross realized losses (36,000) -- (37,000) Net security gains (losses) $ 6,000 $14,000 $307,000 F-9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amortized cost and estimated fair value of debt securities available for sale at December 31, 2005, by remaining period to contractual maturity, are shown in the following table. Actual maturities will differ from contractual maturities because of security prepayments and the right of certain issuers to call or prepay their obligations. Amortized Estimated Cost Fair Value Within one year $ 9,174,000 $ 9,034,000 One to five years 14,784,000 14,779,000 Five to ten years 40,926,000 40,865,000 Over ten years 24,054,000 23,284,000 Total $88,938,000 $87,962,000 Securities included in government sponsored enterprises are securities of the Federal Home Loan Bank, FNMA and FHLMC. These securities are not backed by the full faith of the U.S. government. Substantially all mortgage-backed securities and collateralized mortgage obligations are securities guaranteed by Freddie Mac or Fannie Mae, which are U.S. government-sponsored entities. Securities available for sale with an estimated fair value of $43,130,000, and $45,507,000 at December 31, 2005 and 2004 respectively, were pledged to secure public funds on deposit and for other purposes. The amortized cost and estimated fair value of securities held to maturity are as follows:
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value DECEMBER 31, 2005 Obligations of states and political subdivisions $8,195,000 $121,000 $(83,000) $8,233,000 DECEMBER 31, 2004 Obligations of states and political subdivisions $5,957,000 $ 95,000 $(54,000) $5,998,000
There were no sales of securities held to maturity in 2005, 2004, or 2003. The amortized cost and estimated fair value of these securities at December 31, 2005, by remaining period to contractual maturity, are shown in the following table. Actual maturities will differ from contractual maturities because certain issuers have the right to call or prepay their obligations. Amortized Estimated Cost Fair Value Within one year $4,346,000 $4,330,000 One to five years 3,146,000 3,218,000 Five to ten years 703,000 685,000 Total $8,195,000 $8,233,000 F-10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005 were as follows:
Less Than 12 Months 12 Months or More Total Estimated Unrealized Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses Fair Value Losses AVAILABLE FOR SALE Government sponsored enterprises $25,438,000 $1,054,000 $17,570,000 $ 261,000 $43,008,000 $1,315,000 Obligations of states and political subdivisions 4,689,000 188,000 7,272,000 118,000 11,961,000 306,000 Mortgage-backed securities and collateralized mortgage obligations 2,008,000 130,000 -- -- 2,008,000 130,000 $32,135,000 $1,372,000 $24,842,000 $ 379,000 $56,977,000 $1,751,000 HELD TO MATURITY Obligations of states and political subdivisions $ -- $ -- $ 4,205,000 $ 83,000 $ 4,205,000 $ 83,000
At December 31, 2004 there was $385,000 in unrealized losses on available for sale securities with an estimated fair value of $23,675,000 that had been in a continuous unrealized loss position for less than 12 months. There was $836,000 in unrealized losses on available for sale securities with an estimated fair value of $23,725,000 for those securities that have been in a continuous unrealized loss position 12 months or more. At December 31, 2004 there were $1,000 in unrealized losses on held to maturity securities with an estimated fair value of $612,000 that had been in a continuous unrealized loss position for less than 12 months and $53,000 in unrealized losses on held to maturity securities with an estimated fair value of $912,000 that have been in a continuous unrealized loss position for 12 months or more. The unrealized losses on securities at December 31, 2005 and 2004 were caused by increases in market interest rates. The contractual terms of the government sponsored enterprise securities and the obligations of states and political subdivisions require the issuer to settle the securities at par upon maturity of the investment. The contractual cash flows of the mortgage backed securities and collateralized mortgage obligations are guaranteed by various government agencies or government sponsored enterprises such as GNMA, FNMA, and FHLMC. Because the Company has the ability and intent to hold these securities until a market price recovery or possibly to maturity, these investments are not considered other-than-temporarily impaired at December 31, 2005 and 2004. F-11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. Loans The major classifications of loans are as follows at December 31: 2005 2004 REAL ESTATE LOANS Residential $ 89,598,000 $ 82,482,000 Commercial 81,587,000 75,266,000 Home equity 22,697,000 21,127,000 Farm land 3,443,000 3,721,000 Construction 5,956,000 4,524,000 203,281,000 187,120,000 OTHER LOANS Commercial loans 28,644,000 21,317,000 Consumer installment loans 11,673,000 14,116,000 Other consumer loans 128,000 1,345,000 Agricultural loans 535,000 338,000 40,980,000 37,116,000 Total loans 244,261,000 224,236,000 Allowance for loan losses (3,615,000) (3,645,000) Total loans, net $240,646,000 $220,591,000 The Company originates residential and commercial real estate loans, as well as commercial, consumer and agricultural loans, to borrowers in Sullivan County, New York. A substantial portion of the loan portfolio is secured by real estate properties located in that area. The ability of the Company's borrowers to make principal and interest payments is dependent upon, among other things, the level of overall economic activity and the real estate market conditions prevailing within the Company's concentrated lending area. Included in other consumer loans is a credit card portfolio whose balance was $1,225,000 at December 31, 2004. This portfolio was sold in November 2005 for $1,468,000 when its carrying value was $1,234,000. Nonperforming loans are summarized as follows at December 31: 2005 2004 2003 Nonaccrual loans $2,922,000 $ 724,000 $1,359,000 Loans past due 90 days or more and still accruing interest -- 1,412,000 1,764,000 Total nonperforming loans $2,922,000 $2,136,000 $3,123,000 Nonaccrual loans had the following effect on interest income for the years ended December 31: 2005 2004 2003 Interest contractually due at original rates $ 169,000 $ 90,000 $166,000 Interest income recognized (134,000) (29,000) (37,000) Interest income not recognized $ 35,000 $ 61,000 $129,000 F-12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Changes in the allowance for loan losses are summarized as follows for the years ended December 31: 2005 2004 2003 Balance at beginning of the year $3,645,000 $3,569,000 $3,068,000 Provision for loan losses 180,000 360,000 620,000 Loans charged-off (440,000) (433,000) (488,000) Recoveries 230,000 149,000 369,000 Balance at end of year $3,615,000 $3,645,000 $3,569,000 As of December 31, 2005 and 2004, there were no loans which were considered to be impaired under SFAS No. 114. There are no commitments to lend additional funds on the above noted non-performing loans. 5. Premises and Equipment The major classifications of premises and equipment were as follows at December 31: 2005 2004 Land $ 387,000 $ 387,000 Buildings 2,907,000 2,790,000 Furniture and fixtures 132,000 116,000 Equipment 3,207,000 2,739,000 Building and leasehold improvements 1,207,000 1,099,000 Construction in progress 28,000 -- 7,868,000 7,131,000 Less accumulated depreciation and amortization (4,841,000) (4,262,000) Total premises and equipment, net $ 3,027,000 $ 2,869,000 Depreciation and amortization expense was $632,000, $640,000, and $730,000 in 2005, 2004, and 2003, respectively. 6. Time Deposits The following is a summary of time deposits at December 31, 2005 by remaining period to contractual maturity: Within one year $ 77,834,000 One to two years 26,608,000 Two to three years 9,978,000 Three to four years 3,032,000 Four to five years 5,780,000 Over five years 3,000 Total time deposits $123,235,000 Time deposits of $100,000 or more totaled $43,836,000, $24,532,000 and $22,863,000 at December 31, 2005, 2004 and 2003 respectively. Interest expense related to time deposits over $100,000 was $812,000, $514,000, and $441,000 for 2005, 2004, and 2003, respectively. Total time deposits include brokered time deposits obtained from the national market, which during 2005 averaged $1,110,000 and amounted to $15,034,000, or 4.82% of total deposits at December 31, 2005. There were no brokered deposits in 2004 or 2003. The rates of interest paid on time deposits obtained from the national market averaged 4.56% during 2005. F-13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. Federal Home Loan Bank Borrowings The following is a summary of FHLB advances outstanding at December 31:
2005 2004 Amount Rate Amount Rate Fixed rate advances maturing in 2005 $ -- $ 3,500,000 4.86% Fixed rate advances maturing in 2007 5,000,000 4.12% -- Fixed rate advances maturing in 2008 15,000,000 4.80% 10,000,000 5.02% Fixed rate advances maturing in 2009 5,000,000 5.45% 5,000,000 5.45% Total FHLB advances $25,000,000 4.79% $18,500,000 5.11%
Borrowings are secured by the Bank's investment in FHLB stock and by a blanket security agreement. This agreement requires the Bank to maintain as collateral certain qualifying assets (principally residential mortgage loans) not otherwise pledged. The carrying value of the total qualifying residential mortgage loan and security collateral at December 31, 2005 and 2004 were $26.5 million and $10.6 million respectively, which satisfied the collateral requirements of the FHLB. 8. Short-Term Borrowings Short-term borrowings at December 31, 2005 and 2004 are primarily comprised of overnight FHLB borrowings. The Bank, as a member of the FHLB, has access to a line of credit program with a maximum borrowing capacity of $36.7 million and $35.5 million as of December 31, 2005 and 2004, respectively. There were no borrowings under the overnight program at December 31, 2005; at December 31, 2004 borrowings totaled $8.0 million at a rate of 2.38%. The Bank has pledged mortgage loans and FHLB stock as collateral on these borrowings. During 2005, the maximum month-end balance was $10.0 million, the average balance was $4.7 million, and the average interest rate was 3.39%. During 2004, the maximum month-end balance was $8.0 million, the average balance was $1.1 million, and the average interest rate was 1.72%. Short-term borrowings at December 31, 2005 and 2004 also included $427,000 and $424,000, respectively of treasury, tax and loan notes. 9. Income Taxes The components of income tax expense are as follows for the years ended December 31: 2005 2004 2003 CURRENT TAX EXPENSES Federal $2,094,000 $2,115,000 $2,159,000 State 302,000 325,000 327,000 Deferred tax benefit (354,000) (223,000) (502,000) Total income tax expense $2,042,000 $2,217,000 $1,984,000 Not included in the above table is net deferred income tax benefit of $607,000, $354,000, and $685,000, in 2005, 2004, and 2003, respectively, associated with the unrealized gain or loss on securities available for sale and a minimum pension liability, which are recorded directly in stockholders' equity as components of other comprehensive loss. F-14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The reasons for the differences between income tax expense and taxes computed by applying the statutory Federal tax rate of 34% to income before income taxes are as follows:
2005 2004 2003 Tax at statutory rate $2,641,000 $2,852,000 $2,623,000 State taxes, net of Federal tax benefit 158,000 186,000 152,000 Tax-exempt interest (661,000) (683,000) (660,000) Interest expense allocated to tax-exempt securities 47,000 38,000 37,000 Net earnings from cash surrender value of bank-owned life insurance (160,000) (168,000) (182,000) Other adjustments 17,000 (8,000) 14,000 Income tax expense $2,042,000 $2,217,000 $1,984,000
The tax effects of temporary differences and tax credits that give rise to deferred tax assets and liabilities at December 31 are presented below:
2005 2004 DEFERRED TAX ASSETS Allowance for loan losses in excess of tax bad debt reserve $1,259,000 $1,271,000 Interest on nonaccrual loans 1,000 2,000 Retirement benefits 1,456,000 1,166,000 Deferred compensation 106,000 84,000 Depreciation 420,000 328,000 Other real estate owned -- 90,000 Total deferred tax assets 3,242,000 2,941,000 DEFERRED TAX LIABILITIES Prepaid expenses (281,000) (329,000) Other taxable temporary differences -- (5,000) Total deferred tax liabilities (281,000) (334,000) Net deferred tax asset $2,961,000 $2,607,000
In addition to the deferred tax assets and liabilities described above, the Company also has a deferred tax asset of $310,000 at December 31, 2005 related to the net unrealized loss on securities available for sale as of December 31, 2005 and a deferred tax asset of $595,000 related to a minimum pension liability as of December 31, 2005. In addition to the deferred tax assets described above, the Company also has a deferred tax liability of $195,000 at December 31, 2004 related to the net unrealized gain on securities available for sale as of December 31, 2004 and a deferred tax asset of $492,000 related to a minimum pension liability as of December 31, 2004. In assessing the realizability of the Company's total deferred tax assets, management considers whether it is more likely than not that some portion or all of those assets will not be realized. Based upon management's consideration of historical and anticipated future pre-tax income, as well as the reversal period for the items giving rise to the deferred tax assets and liabilities, a valuation allowance for deferred tax assets was not considered necessary at December 31, 2005 and 2004. The proposed 2006 New York State budget bill contains a provision that world disallow the exclusion of dividends paid by a real estate investment trust subsidiary ("REIT"). The bill, if enacted as proposed would be effective for taxable years beginning on or after January 1, 2006, and the Company would lose the tax benefit associated with the REIT. Further, Article 32 of the New York State Tax law, which sets forth the taxation of financial institutions, expired at year end 2005. The reenactment of Article 32 is also included in the proposed 2006 New York State budget bill. Until there is resolution to the proposal, the Company may have to increase the 2006 tax provision by approximately $37,000 per quarter as compared to 2005 and may have to begin recording the increased provision in the first quarter of 2006. Additionally, the proposed legislation would reduce the statutory tax rate on the taxable income base from 7.5% to 6.75%. F-15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. Other Non-interest Expenses The major components of other non-interest expenses are as follows for the years ended December 31:
2005 2004 2003 Stationary and supplies $ 237,000 $ 287,000 $ 348,000 Director expenses 286,000 277,000 227,000 ATM and credit card processing fees 582,000 582,000 469,000 Professional services 639,000 581,000 406,000 Other expenses 1,523,000 1,464,000 1,386,000 Other non-interest expenses $3,267,000 $3,191,000 $2,836,000
11. Regulatory Capital Requirements National banks are required to maintain minimum levels of regulatory capital in accordance with regulations of the Office of the Comptroller of the Currency (OCC). The Federal Reserve Board (FRB) imposes similar requirements for consolidated capital of bank holding companies. The OCC and FRB regulations require a minimum leverage ratio of Tier 1 capital to total adjusted assets of 4.0%, and minimum ratios of Tier I and total capital to risk-weighted assets of 4.0% and 8.0%, respectively. Under its prompt corrective action regulations, the OCC is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized bank. Such actions could have a direct material effect on a bank's financial statements. The regulations establish a framework for the classification of banks into five categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Generally, a bank is considered well capitalized if it has a leverage (Tier I) capital ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0%, and a total risk-based capital ratio of at least 10.0%. The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about capital components, risk weightings and other factors. Management believes that, as of December 31, 2005 and 2004, the Bank and the Parent Company met all capital adequacy requirements to which they are subject. Further, the most recent OCC notification categorized the Bank as a well-capitalized bank under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed the Bank's capital classification. F-16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of the actual capital amounts and ratios as of December 31, 2005 and 2004 for the Bank and the Parent Company (consolidated), compared to the required ratios for minimum capital adequacy and for classification as well-capitalized:
Actual Required Ratios Minimum Classification Capital as Well Amount Ratio Adequacy Capitalized DECEMBER 31, 2005 BANK Leverage (Tier 1) capital $41,113,000 10.8% 4.0% 5.0% Risk-based capital: Tier 1 41,113,000 16.3 4.0 6.0 Total 44,269,000 17.5 8.0 10.0 CONSOLIDATED Leverage (Tier 1) capital $42,984,000 11.5% 4.0% Risk-based capital: Tier 1 42,984,000 16.9 4.0 Total 46,140,000 18.2 8.0 DECEMBER 31, 2004 BANK Leverage (Tier 1) capital $36,981,000 10.2% 4.0% 5.0% Risk-based capital: Tier 1 36,981,000 16.0 4.0 6.0 Total 39,872,000 17.3 8.0 10.0 CONSOLIDATED Leverage (Tier 1) capital $39,370,000 10.9% 4.0% Risk-based capital: Tier 1 39,370,000 16.9 4.0 Total 42,261,000 18.2 8.0
12. Stockholders' Equity DIVIDEND RESTRICTIONS Dividends paid by the Bank are the primary source of funds available to the Parent Company for payment of dividends to its stockholders and for other working capital needs. Applicable Federal statutes, regulations and guidelines impose restrictions on the amount of dividends that may be declared by the Bank. Under these restrictions, the dividends declared and paid by the Bank to the Parent Company may not exceed the total amount of the Bank's net profit retained in the current year plus its retained net profits, as defined, from the two preceding years. The Bank's retained net profits (after dividend payments to the Parent Company) for 2005 and 2004 totaled $13,057,000 and $13,282,000, respectively. PREFERRED STOCK PURCHASE RIGHTS On July 9, 1996, the board of directors declared a dividend distribution of one purchase right ("Right") for each outstanding share of Parent Company common stock ("Common Stock"), to stockholders of record at the close of business on July 9, 1996. The Rights have a 10-year term. The Rights become exercisable (i) 10 days following a public announcement that a person or group has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding shares of Common Stock, or (ii) 10 days following the commencement of a tender offer or exchange offer that, if successful, would result in an acquiring person or group beneficially owning 30% or more of the outstanding Common Stock (unless such tender or exchange offer is predicated upon the redemption of the Rights). When the Rights become exercisable, a holder is entitled to purchase one one-hundredth of a share, subject to adjustment, of Series A Preferred Stock of the Parent Company or, upon the occurrence of certain events described below, Common Stock of the Parent Company or common stock of an entity that acquires the Company. The purchase price per one one-hundredth of a share of Series A Preferred Stock (Purchase Price) will equal the board of directors' judgment as to the "long-term investment value" of one share of Common Stock at the end of the 10-year term of the Rights. F-17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Upon the occurrence of certain events (including certain acquisitions of more than 20% of the Common Stock by a person or group), each holder of an unexercised Right will be entitled to receive Common Stock having a value equal to twice the Purchase Price of the Right. Upon the occurrence of certain other events (including acquisition of the Parent Company in a merger or other business combination in which the Parent Company is not the surviving corporation), each holder of an unexercised Right will be entitled to receive common stock of the acquiring person having a value equal to twice the Purchase Price of the Right. The Parent Company may redeem the Rights (to the extent not exercised) at any time, in whole but not in part, at a price of $0.01 per Right. 13. Comprehensive (Loss) Income Comprehensive (loss) income represents the sum of net income and items of "other comprehensive (loss) income" which are reported directly in stockholders' equity, such as the net unrealized gain or loss on securities available for sale and minimum pension liability adjustments. The Company has reported its comprehensive (loss) income for 2005, 2004, and 2003 in the consolidated statements of changes in stockholders' equity. The Company's other comprehensive loss consisted of the following components for the years ended December 31:
2005 2004 2003 Net unrealized holding losses arising during the year, net of taxes of $502,000 in 2005, $327,000 in 2004, and $688,000 in 2003 $(744,000) $(490,000) $(998,000) Reclassification adjustment for net realized gains included in income, net of taxes of $2,000 in 2005, $6,000 in 2004, and $125,000 in 2003 (4,000) (8,000) (182,000) Minimum pension liability adjustment, net of taxes of $103,000 in 2005, $21,000 in 2004, and ($128,000) in 2003 (155,000) (37,000) 186,000 Other comprehensive loss $(903,000) $(535,000) $(994,000)
The Company has accumulated other comprehensive losses related to the net unrealized loss on securities available for sale and minimum pension liability of $465,000 and $893,000, respectively, as of December 31, 2005. As of December 31, 2004, the Company recorded an accumulated other comprehensive income on the net unrealized gain on securities available for sale of $282,000 and a $737,000 loss related to the minimum pension liability. 14. Related Party Transactions Certain directors and executive officers of the Company, as well as certain affiliates of these directors and officers, have engaged in loan transactions with the Company. Such loans were made in the ordinary course of business at the Company's normal terms, including interest rates and collateral requirements, and do not represent more than normal risk of collection. Outstanding loans to these related parties are summarized as follows at December 31: 2005 2004 Directors $2,301,000 $1,102,000 Executive offices (nondirectors) 373,000 216,000 $2,674,000 $1,318,000 During 2005, total advances to these directors and officers were $3,493,000 and total payments made on these loans were $2,137,000. These directors and officers had unused lines of credit with the Company of $892,000 and $730,000 at December 31, 2005 and 2004, respectively. F-18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. Employee Benefit Plans PENSION AND OTHER POSTRETIREMENT BENEFITS The Company has a noncontributory defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee's average compensation during the five consecutive years in the last ten years of employment affording the highest such average. The Company's funding policy is to contribute annually an amount sufficient to satisfy the minimum funding requirements of ERISA, but not greater than the maximum amount that can be deducted for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date, but also for benefits expected to be earned in the future. The Company also sponsors a postretirement medical, dental and life insurance benefit plan for retirees in the pension plan. Effective in 2005, employees attaining age 55 or later, and whose age plus service is greater than or equal to 85 are eligible for medical benefits. The retirees pay a percentage of the medical benefit costs. Both of the plans are unfunded. The Company accounts for the cost of these postretirement benefits in accordance with SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. Accordingly, the cost of these benefits is recognized on an accrual basis as employees perform services to earn the benefits. The Company adopted SFAS No. 106 as of January 1, 1993 and elected to amortize the accumulated benefit obligation at that date (transition obligation) into expense over the allowed period of 20 years. In December 2004, the Medicare Prescription Drug, Improvement and Modernization Act of 2004 (Medicare Act) was signed into law. The Medicare Act introduced both a Medicare prescription-drug benefit and a federal subsidy to sponsors of retiree health-care plans that provide a benefit at least "actuarially equivalent" to the Medicare benefit. These provisions of the Medicare Act will affect accounting measurements under SFAS No. 106. Accordingly, the FASB staff has issued guidance allowing companies to recognize or defer recognizing the effects of the Medicare Act in annual financial statements for fiscal years ending after enactment of the Medicare Act. The Company has elected to defer recognizing the effects of the Medicare Act in its December 31, 2005 consolidated financial statements. Accordingly, the reported measures of the accumulated postretirement benefit obligation and net periodic postretirement benefit cost do not include the effects of the Medicare Act. When issued, the specific authoritative literature on accounting for the federal subsidy could require the Company to revise its previously reported information. The Company expects to contribute $328,000 to its pension plan and $69,000 to its other postretirement benefit plan in 2006. The pension benefits expected to be paid in each year from 2006-2010 are $246,000, $254,000, $255,000, $339,000, and $342,000, respectively. The aggregate pension benefits expected to be paid in the five years from 2011-2015 are $2,478,000. The expected benefits are based on the same assumptions used to measure the Company's benefit obligation at September 30, 2005 and include estimated future employee service. The other postretirement benefits expected to be paid in each year from 2006-2010 are $101,000, $109,000, $114,000, $129,000 and $146,000, respectively. The aggregate other postretirement benefits expected to be paid in the five years from 2011-2015 are $1,127,000. The expected benefits are based on the same assumptions used to measure the Company's benefit obligation at December 31, 2005 and include estimated future employee service. F-19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of changes in the benefit obligations and plan assets for the pension plan as of a September 30th measurement date and the other postretirement benefit plan as of a December 31st measurement date, together with a reconciliation of each plan's funded status to the amounts recognized in the consolidated balance sheets:
Pension Benefits Postretirement Benefits 2005 2004 2005 2004 CHANGES IN BENEFIT OBLIGATION Beginning of year $ 6,988,000 $ 6,049,000 $ 3,104,000 $ 3,604,000 Service cost 298,000 266,000 166,000 242,000 Interest cost 408,000 375,000 176,000 209,000 Actuarial (gain) loss 846,000 547,000 (216,000) (7,000) Benefits paid (250,000) (249,000) (56,000) (49,000) Plan Amendments -- -- -- (906,000) Contributions by plan participants -- -- 16,000 11,000 End of year 8,290,000 6,988,000 3,190,000 3,104,000 CHANGES IN FAIR VALUE OF PLAN ASSETS Beginning of year 4,877,000 4,222,000 -- -- Actual return on plan assets 414,000 416,000 -- -- Employer contributions 341,000 488,000 16,000 38,000 Contributions by plan participants -- -- 39,000 10,000 Benefits paid (250,000) (249,000) (55,000) (48,000) End of year 5,382,000 4,877,000 -- -- Unfunded status at end of year (2,908,000) (2,111,000) (3,190,000) (3,104,000) Unrecognized net transition asset (2,000) (6,000) -- -- Unrecognized net actuarial loss 3,183,000 2,520,000 1,101,000 1,370,000 Unrecognized prior service cost (benefit) 212,000 236,000 (714,000) (758,000) Net amount recognized $ 485,000 $ 639,000 $(2,803,000) $(2,492,000) AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET CONSIST OF Prepaid (accrued) benefit cost $ 485,000 $ 639,000 $(2,803,000) $(2,492,000) Additional minimum liability (1,699,000) (1,465,000) -- -- Intangible asset 212,000 236,000 -- -- Accumulated other comprehensive loss (pre-tax basis) 1,487,000 1,229,000 -- -- Net amount recognized $ 485,000 $ 639,000 $(2,803,000) $(2,492,000)
The accumulated benefit obligation for the pension plan was $6,597,000 and $5,705,000 at September 30, 2005 and 2004, respectively. F-20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of the net periodic benefit cost for these plans were as follows:
Pension Benefits 2005 2004 2003 Service cost $ 298,000 $ 266,000 $ 253,000 Interest cost 408,000 375,000 339,000 Expected return on plan assets (366,000) (321,000) (278,000) Amortization of prior service cost 25,000 25,000 25,000 Amortization of transition asset (4,000) (4,000) (4,000) Recognized net actuarial loss 134,000 135,000 110,000 Net periodic benefit cost $ 495,000 $ 476,000 $ 445,000
Postretirement Benefits 2005 2004 2003 Service cost $166,000 $242,000 $151,000 Interest cost 176,000 209,000 146,000 Amortization of transition obligation -- 18,000 18,000 Amortization of prior services cost (45,000) -- -- Recognized net actuarial loss 53,000 60,000 8,000 Net periodic benefit cost $350,000 $529,000 $323,000
Assumptions used to determine benefit obligations for the pension plan as of a September 30th measurement date and for the other postretirement benefits plan as of a December 31st measurement date were as follows:
Pension Benefits Postretirement Benefits 2005 2004 2005 2004 Discount rate 5.35% 5.75% 5.35% 5.75% Rate of compensation increase 4.00 3.75 -- --
Assumptions used to determine net periodic benefit cost were as follows:
Pension Benefits Postretirement Benefits 2005 2004 2005 2004 Discount rate 5.75% 5.85% 5.75% 5.85% Expected long-term rate of return on plan assets 7.50 7.50 -- -- Rate of compensation increase 3.75 3.85 -- --
The Company's expected long-term rate of return on plan assets reflects long-term earnings expectations and was determined based on historical returns earned by existing plan assets adjusted to reflect expectations of future returns as applied to plan's targeted allocation of assets. In 2004, the postretirement plan was amended from retiree eligibility at age 60 with a minimum of 10 years of service to age 60 with a minimum of 10 years of service and whose age plus service is greater than or equal to 85. This changed from the requirement that employees must retire after age 60 with at least 10 years of service to be eligible for medical benefits. In addition, retiree contributions for ages 65 and over changed to retiree pays 25% of the special Medicare Supplement premium if single coverage is selected and 40% of the special Medicare Supplement premium otherwise, from the previous provision of retiree pays 25% of the active premium or the special Medicare Supplement premium for any coverage selected. The assumed health care cost trend rate for retirees under age 65 which was used to determine the benefit obligation for the other postretirement benefits plan at December 31, 2005 was 9.0%, declining gradually to 5.0% in 2010 and remaining at that level F-21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS thereafter. The assumed health care cost trend rate for retirees over age 65 which was also used to determine the benefit obligation for the other postretirement benefits plan at December 31, 2005 was 8.0%, declining gradually to 4.0% in 2010 and remaining at that level thereafter. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the benefit obligation at December 31, 2005 by approximately $645,000 and the net periodic benefit cost for the year by approximately $84,000; a one percentage point decrease would decrease the benefit obligation and benefit cost by approximately $495,000 and $63,000, respectively. The Company's pension plan asset allocation at October 3, 2005 and September 30, 2004, by asset category is as follows: 2005 2004 ASSET CATEGORY Equity securities 63% 50% Debt securities 32 37 Other 5 13 Total 100% 100% Plan assets were in transit as of the end of the plan year as a new discretionary trustee, Citizens Bank, was employed on October 1, 2005. Plan assets are invested in eleven diversified investment funds of Citizens Bank. The investment funds include six equity funds, four bond funds and one money market fund. Citizens Bank has been given discretion by the Company to determine the appropriate strategic asset allocation as governed by the Company's Discretionary Asset Management Investment Policy Statement which provides specific targeted asset allocations for each investment fund as follows: Allocation Range CITIZENS BANK INVESTMENT FUNDS Large Cap Domestic Equity 30% - 40% Mid Cap Domestic Equity 5% - 15% Small Cap Domestic Equity 0% - 10% International Equity 5% - 20% Real Estate 0% - 10% Core Investment Grade Bonds 15% - 30% Mortgages 0% - 15% Money Market 0% - 10% The actual asset allocations at December 31, 2005 are consistent with the table above. DIRECTORS SURVIVAL INSURANCE The Company maintains a separate insurance program for Directors not insurable under the post-retirement plan. The benefits accrued under this plan totaled $273,000 at December 31, 2005 and $215,000 at December 31, 2004 and are unfunded. The Company recorded an expense of $58,000, $18,000 and $17,000 relating to this plan during the years ended December 31, 2005, 2004 and 2003 respectively. TAX-DEFERRED SAVINGS PLAN The Company maintains a qualified 401(k) plan for all employees, which permits tax-deferred employee contributions up to 75% of salary and provides for matching contributions by the Company. The Company matches 100% of employee contributions up to 4% of the employee's salary and 25% of the next 2% of the employee's salary. The Company incurred annual expenses of $161,000, $133,000 and $144,000 in 2005, 2004 and 2003 respectively SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN In 2003, the Company established a Supplemental Executive Retirement Plan for certain executive officers primarily to restore benefits cutback in certain employee benefit plans due to Internal Revenue Service regulations. The benefits accrued under this plan totaled $596,000 at December 31, 2005 and $186,000 at December 31, 2004, and are unfunded. The Company recorded an expense of $410,000, $83,000 and $103,000 relating to this plan during the years ended December 31, 2005, 2004 and 2003 respectively. DIRECTOR RETIREMENT PLAN In 2003, the Company established a Director Retirement Plan in order to provide certain retirement benefits to participating directors. Generally, each participating director receives an annual retirement benefit of eighty percent of their average annual cash compensation during the three calendar years preceding their retirement date, as defined in the plan. This annual retirement benefit is payable until death and may not exceed $40,000 per year. The benefits accrued under this plan totaled $339,000 and $187,000 at December 31, 2005 and 2004 respectively, and are unfunded. The Company recorded an expense of $152,000, $107,000 and $80,000 relating to this plan during the years ended December 31, 2005, 2004 and 2003 respectively. F-22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. Commitments and Contingent Liabilities LEGAL PROCEEDINGS The Parent Company and the Bank are, from time to time, defendants in legal proceedings relating to the conduct of their business. In the best judgment of management, the consolidated financial position of the Company will not be affected materially by the outcome of any pending legal proceedings. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS The Company is a party to certain financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These are limited to commitments to extend credit and standby letters of credit which involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The contract amounts of these instruments reflect the extent of the Company's involvement in particular classes of financial instruments. The Company's maximum exposure to credit loss in the event of nonperformance by the other party to these instruments represents the contract amounts, assuming that they are fully funded at a later date and any collateral proves to be worthless. The Company uses the same credit policies in making commitments as it does for on-balance-sheet extensions of credit. Contract amounts of financial instruments that represent agreements to extend credit are as follows at December 31:
2005 2004 Loan origination commitments and unused lines of credit: Mortgage loans $13,655,000 $ 9,211,000 Commercial loans 12,540,000 15,430,000 Credit card lines -- 4,998,000 Home equity lines 11,661,000 9,727,000 Other revolving credit 3,875,000 4,587,000 41,731,000 43,953,000 Standby letters of credit 1,691,000 808,000 $43,422,000 $44,761,000
These agreements to extend credit have been granted to customers within the Company's lending area described in note 4 and relate primarily to fixed-rate loans. Loan origination commitments and lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These agreements generally have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Since commitments and lines of credit may expire without being fully drawn upon, the total contract amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral, if any, required by the Company upon the extension of credit is based on management's credit evaluation of the customer. Mortgage commitments are secured by a first lien on real estate. Collateral on extensions of credit for commercial loans varies but may include accounts receivable, equipment, inventory, livestock, and income-producing commercial property. FASB Interpretation No. 45 (FIN No. 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others; an Interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34, requires certain disclosures and liability-recognition for the fair value at issuance of guarantees that fall within its scope. Under FIN No. 45, the Company does not issue any guarantees that would require liability-recognition or disclosure, other than its standby letters of credit. The Company has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled $1,691,000 and $808,000 at December 31, 2005 and 2004, respectively, and represent the maximum potential future payments the Company could be required to make. Typically, these instruments have terms of twelve months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Company policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral. The fair value of the Company's standby letters of credit at December 31, 2005 and 2004 was not significant. F-23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. Fair Values of Financial Instruments SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Company disclose estimated fair values for its on- and off-balance-sheet financial instruments. SFAS No. 107 defines fair value as the amount at which a financial instrument could be exchanged in a current transaction between parties other than in a forced sale or liquidation. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holding of a particular financial instrument, nor do they reflect possible tax ramifications or transaction costs. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected net cash flows, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business or the value of nonfinancial assets and liabilities. In addition, there are significant unrecognized intangible assets that are not included in these fair value estimates, such as the value of "core deposits" and the Company's branch network. The following is a summary of the net carrying values and estimated fair values of the Company's financial assets and liabilities (none of which were held for trading purposes) at December 31:
2005 2004 Net Net Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value FINANCIAL ASSETS Cash and due from banks $ 24,192,000 $ 24,192,000 $ 14,040,000 $ 14,040,000 Securities available for sale 88,984,000 88,984,000 100,705,000 100,705,000 Securities held to maturity 8,195,000 8,233,000 5,957,000 5,998,000 Loans, net 240,646,000 239,105,000 220,591,000 222,140,000 Accrued interest receivable 2,040,000 2,040,000 2,085,000 2,085,000 FHLB stock 2,496,000 2,496,000 2,175,000 2,175,000 FINANCIAL LIABILITIES Demand deposits (non-interest bearing) 65,266,000 65,266,000 65,208,000 65,208,000 Interest-bearing deposits 246,830,000 246,830,000 227,886,000 227,886,000 FHLB advances 25,000,000 24,908,000 18,500,000 19,159,000 Short-term borrowings 427,000 427,000 8,424,000 8,424,000 Accrued interest payable 450,000 450,000 232,000 232,000
The specific estimation methods and assumptions used can have a substantial impact on the estimated fair values. The following is a summary of the significant methods and assumptions used by the Company to estimate the fair values shown in the preceding table: SECURITIES The carrying values for securities maturing within 90 days approximate fair values because there is little interest rate or credit risk associated with these instruments. The fair values of longer-term securities are estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair values of certain state and municipal securities are not readily available through market sources; accordingly, fair value estimates are based on quoted market prices of similar instruments, adjusted for any significant differences between the quoted instruments and the instruments being valued. LOANS Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, consumer, real estate and other loans. Each loan category is further segregated into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair values of performing loans are calculated by discounting scheduled cash flows through estimated maturity using estimated market discount rates that reflect the credit and interest rate risks inherent in the loans. Estimated maturities are based on contractual terms and repricing opportunities. F-24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair values of nonperforming loans are based on recent external appraisals and discounted cash flow analyses. Estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information. DEPOSIT LIABILITIES The fair values of deposits with no stated maturity (such as checking, savings and money market deposits) equal the carrying amounts payable on demand. The fair values of time deposits are based on the discounted value of contractual cash flows (but are not less than the net amount at which depositors could settle their accounts). The discount rates are estimated based on the rates currently offered for time deposits with similar remaining maturities. FHLB ADVANCES The fair value was estimated by discounting scheduled cash flows through maturity using current market rates. OTHER FINANCIAL INSTRUMENTS The fair values of cash and cash equivalents, FHLB stock, accrued interest receivable, accrued interest payable and short-term debt approximated their carrying values at December 31, 2005 and 2004. The fair values of the agreements to extend credit described in note 16 are estimated based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value estimates also consider the difference between current market interest rates and the committed rates. At December 31, 2005 and 2004, the fair values of these financial instruments approximated the related carrying values which were not significant. 18. Condensed Parent Company Financial Statements The following are the condensed parent company only financial statements for Jeffersonville Bancorp: BALANCE SHEETS
December 31, 2005 2004 ASSETS Cash $ 88,000 $ 292,000 Securities available for sale 982,000 736,000 Investment in subsidiary 40,094,000 37,137,000 Premises and equipment, net 901,000 963,000 Other assets 457,000 570,000 Total assets $42,522,000 $39,698,000 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 3,000 $ 52,000 Stockholders' equity 42,519,000 39,646,000 Total liabilities and stockholders' equity $42,522,000 $39,698,000
F-25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS STATEMENTS OF INCOME
Years Ended December 31, 2005 2004 2003 Dividend income from subsidiary $1,800,000 $1,800,000 $ 700,000 Dividend income on securities available for sale 29,000 23,000 48,000 Rental income from subsidiary 235,000 313,000 313,000 Other non-interest income 11,000 7,000 -- 2,075,000 2,143,000 1,061,000 Occupancy and equipment expenses 116,000 110,000 108,000 Other non-interest expenses 108,000 134,000 154,000 224,000 244,000 262,000 Income before income taxes and undistributed income of subsidiary 1,851,000 1,899,000 799,000 Income tax expense 33,000 38,000 38,000 Income before undistributed income of subsidiary 1,818,000 1,861,000 761,000 Equity in undistributed income of subsidiary 3,907,000 4,310,000 4,971,000 Net income $5,725,000 $6,171,000 $5,732,000
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2005 2004 2003 OPERATING ACTIVITIES Net income $ 5,725,000 $ 6,171,000 $ 5,732,000 Equity in undistributed income of subsidiary (3,907,000) (4,310,000) (4,971,000) Depreciation and amortization 62,000 61,000 62,000 Other adjustments, net 32,000 34,000 (2,000) Net cash provided by operating activities 1,912,000 1,956,000 821,000 INVESTING ACTIVITIES Proceeds from calls of securities available for sale 3,000 150,000 598,000 Purchase of securities available for sale (170,000) (150,000) (376,000) Cash provided by investing activities (167,000) -- 222,000 FINANCING ACTIVITIES Cash dividends paid (1,949,000) (1,776,000) (1,449,000) Net cash used in financing activities (1,949,000) (1,776,000) (1,449,000) Net (decrease) increase in cash (204,000) 180,000 (406,000) Cash at beginning of year 292,000 112,000 518,000 Cash at end of year $ 88,000 $ 292,000 $ 112,000
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