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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2006
Commission file number: 0-26570
1ST INDEPENDENCE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 61-1284899
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8620 Biggin Hill Lane
Louisville, Kentucky 40220-4117
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502)753-0500
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of each exchange on which registered
-------------- -----------------------------------------
Common Stock, par value The NASDAQ Stock Market LLC
$0.10 per share
Securities registered pursuant to Section 12(g) of the Act:
None
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 15(d) of the Act. Yes |_| No |X|
Indicate by check mark whether the registrant (1) 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. (Check one):
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
The aggregate market value of the voting common stock held by
non-affiliates of the registrant was approximately $27,977,262 as of
June 30, 2006.
The number of shares outstanding of the registrant's common stock as of
March 15, 2007 was 1,995,594.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report on Form 10-K, to
the extent not set forth herein, is incorporated herein by reference to the
registrant's definitive proxy statement to be filed in connection with the
annual meeting of stockholders to be held May 17, 2007.
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1ST INDEPENDENCE FINANCIAL GROUP, INC.
FORM 10-K
For the Year Ended December 31, 2006
INDEX
PART I Page
Item 1. Business...................................................... 3
Item 1A. Risk Factors.................................................. 13
Item 1B. Unresolved Staff Comments..................................... 17
Item 2. Properties.................................................... 18
Item 3. Legal Proceedings............................................. 18
Item 4. Submission of Matters to a Vote of Security Holders........... 18
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities........... 19
Item 6. Selected Financial Data....................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation.................................... 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 29
Item 8. Financial Statements and Supplementary Data................... 30
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 58
Item 9A. Controls and procedures....................................... 58
Item 9B. Other Information............................................. 58
PART III
Item 10. Directors, Executive Officers and Corporate Governace......... 58
Item 11. Executive Compensation........................................ 58
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 58
Item 13. Certain Relationships and Related Transactions, and Director
Independence................................................ 58
Item 14. Principal Accounting Fees and Services........................ 58
PART IV
Item 15. Exhibits, Financial Statement Schedules....................... 59
Signatures.............................................................. 61
PART I
Item 1. Business.
General
1st Independence Financial Group, Inc. (the "Company") was organized as
a Delaware corporation in June 1995 and is a bank holding company based in
Louisville, Kentucky which owns 1st Independence Bank, Inc. (the "Bank"). During
2004, the Company merged with Independence Bancorp, New Albany, Indiana. The
Bank currently serves its customers through a network of eight branch offices
located in Harrodsburg, Lawrenceburg and Louisville (Stony Brook main office
branch and St. Matthews branch office), Kentucky and New Albany, Jeffersonville,
Marengo and Clarksville, Indiana. The Bank also operates a mortgage division,
1st Independence Mortgage, which originates one-to-four family residential
mortgage loans. 1st Independence Mortgage operates throughout the Bank's branch
network. The Bank also offers limited trust services. On November 1, 2004, the
Bank formed a title insurance company, Foundation Title Company, LLC, located in
Jeffersonville, Indiana. The Company decided to exit the title insurance
business at the end of November 2005 and sold the title insurance company at its
carrying value.
The Company provides commercial and retail banking services, with an
emphasis on commercial real estate loans, one-to-four family residential
mortgage loans via 1st Independence Mortgage, home equity loans and lines of
credit and consumer loans as well as certificates of deposit, checking accounts,
money-market accounts and savings accounts within its market area. At December
31, 2006, the Company had total assets, deposits and equity of $342.8 million,
$254.1 million, and $40.3 million, respectively. The Company's business is
conducted principally through the Bank. Unless otherwise indicated, all
references to the Company refer collectively to the Company and the Bank and its
subsidiaries.
In January 2005, the Company completed the sale of its entire interest
in its majority owned subsidiary, Citizens Financial Bank, Inc., Glasgow,
Kentucky ("Citizens) to another financial institution for $2.3 million. The sale
of Citizens reflected the Company's revised strategic plan to exit the south
central Kentucky market and to focus on the growing markets of southern Indiana,
central Kentucky, and greater Louisville, Kentucky. In accordance with Statement
of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets", the financial position and results
of operations of Citizens prior to the sale were removed from the detail line
items in the Company's financial statements and presented separately as
"subsidiary held for disposal." In a related transaction the Bank purchased in
January 2005 a commercial building located in Louisville, Kentucky, for $2.3
million from an affiliate of the financial institution which purchased Citizens.
The Bank moved its finance and accounting, loan and deposit operations, and
mortgage banking operations into the building in April 2005. The Bank also
received regulatory approval during the second quarter of 2005 to establish a
full service branch at this location which it opened in November 2005. See note
3 to the Company's consolidated financial statements, presented herein, for
additional information. Additionally, the financial tables also presented
herein, have been revised to reflect the discontinued operations of Citizens
prior to the sale.
Market Area and Competition
The competition for deposit products comes from other insured financial
institutions such as commercial banks, thrift institutions, credit unions, and
multi-state regional banks in the Company's market area of Anderson, Jefferson,
and Mercer Counties in Kentucky and Floyd, Clark and Crawford Counties in
Indiana. Deposit competition also includes a number of insurance products sold
by local agents and investment products such as mutual funds and other
securities sold by local and regional brokers. Loan competition varies depending
upon market conditions and comes from other insured financial institutions such
as commercial banks, thrift institutions, credit unions, multi-state regional
banks, and mortgage bankers.
Analysis of Loan Portfolio. The following table (in thousands except
percentages) sets forth information concerning the composition of the Company's
loan portfolio in dollar amounts and in percentages of the total loan portfolio
as of the dates indicated. Loan balances related to the discontinued operations
of Citizens have been eliminated.
December 31, September 30,
--------------------------------------------------------------------------------- ------------------
2006 2005 2004 2003 2002
-------------------- ------------------ ------------------ ------------------ ------------------
Percent of Percent of Percent of Percent of Percent of
Amount Total loans Amount Total loans Amount Total loans Amount Total loans Amount Total loans
-------- ----------- ------- ----------- ------ ----------- ------ ----------- ------ -----------
Real estate:
Commercial $ 49,943 18% $ 46,731 17% $ 35,746 15% $13,128 16% $13,005 14%
Residential 121,216 45 128,949 48 125,433 53 61,495 73 70,899 76
Construction 64,244 23 51,877 19 33,600 14 2,977 3 3,749 4
Commercial 20,393 7 23,757 9 21,040 9 3,365 4 2,181 2
Consumer
Home equity 14,026 5 16,615 6 16,672 7 1,963 2 1,630 2
Other 4,401 2 1,960 1 3,706 2 1,327 2 1,607 2
-------- --- -------- --- -------- --- ------- --- ------- ---
Total loans 274,223 100% 269,889 100% 236,197 100% 84,255 100% 93,071 100%
=== === === === ===
Less: allowance for
loan losses 3,745 2,911 2,549 391 390
-------- -------- -------- ------- -------
Loans, net $270,478 $266,978 $233,648 $83,864 $92,681
======== ======== ======== ======= =======
Loans held for sale $1,227 $1,278 $2,344 $ - $ -
====== ====== ====== ===== =======
Loan Maturity Tables
The following table (in thousands) sets forth the maturity of the
Company's loan portfolio at December 31, 2006. The table does not include
prepayments or scheduled principal repayments. Adjustable-rate mortgage loans
are shown as maturing based on contractual maturities.
Due after 1
Due within 1 through 5 Due after 5
year years years Total
---- ----- ----- -----
Real estate:
Commercial $16,156 $13,421 $ 20,366 $ 49,943
Residential 19,637 13,292 88,287 121,216
Construction 47,899 13,512 2,833 64,244
Commercial 11,156 3,760 5,477 20,393
Consumer 2,100 14,154 2,173 18,427
------- ------- -------- --------
Total $96,948 $58,139 $119,136 $274,223
======= ======= ======== ========
The following table (in thousands) sets forth as of December 31, 2006
the dollar amount of all loans that are due after December 31, 2007 and have
either fixed rates of interest or floating or adjustable interest rates.
Floating or
Fixed rates adjustable rates Total
----------- ---------------- --------
Real estate:
Commercial $ 7,745 $ 26,042 $ 33,787
Residential 28,428 73,150 101,578
Construction 1,354 14,992 16,346
Commercial 5,725 3,512 9,237
Consumer 3,194 13,133 16,327
------- -------- --------
Total $46,446 $130,829 $177,275
======= ======== ========
Commercial Real Estate Loans. The commercial real estate loans
originated are generally made to individuals, small businesses and partnerships
located in the Company's primary market area. Such loans are generally secured
by first mortgages on apartment buildings, office buildings, churches and other
properties. Adjustable-rate loans for this type of lending have a margin that is
50 to 150 basis points higher than the margin added to single-family
owner-occupied property loans. Commercial real estate loans are typically
adjustable-rate loans with terms of 25 years or less and loan-to-value ratios
typically not exceeding 80%. At December 31, 2006, commercial real estate loans
totaled approximately $49.9 million or 18% of the total loan portfolio.
Commercial real estate lending entails significant additional risks as
compared to one- to four-family residential lending. For example, such loans
typically involve large loans to single borrowers or related borrowers, the
payment experience on such loans is typically dependent on the successful
operation of the project, and these risks can be significantly affected by the
supply and demand conditions in the market for commercial property.
Loans secured by commercial real estate generally involve a greater
degree of risk than residential mortgage loans and carry larger loan balances.
This increased credit risk is a result of several factors, including the
concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on income producing properties, and the
increased difficulty of evaluating and monitoring these types of loans. If the
cash flow from the project is reduced, the borrower's ability to repay the loan
may be impaired. To minimize these risks, the Company generally limits loans of
this type to its market area and to borrowers with which it has substantial
experience and expertise in the commercial real estate market. The Company's
underwriting procedures require verification of the borrower's credit history,
income, financial statements, banking relationships, credit references, and
income projections for the property. It is their current practice to obtain
personal guarantees from all principals obtaining this type of loan. The Company
also obtains appraisals on each property.
Included in the commercial real estate loan category are agricultural
loans. At December 31, 2006, agricultural loans totaled $2.1 million, or less
than 1% of the Company's loan portfolio.
Residential Loans. The Company's residential loans consist of one- to
four-family residential mortgage loans that are secured by property located in
its primary market area. The Company generally originates one- to four-family
residential mortgage loans without private mortgage insurance in amounts up to
85% of the lesser of the appraised value or selling price of the mortgaged
property. Loans in excess of 89.9% of the value of the mortgaged property
typically carry higher rates commensurate with the higher risk associated with
this type of loan. At December 31, 2006, one-to four-family residential mortgage
loans totaled approximately $121.2 million, or 45% of the total loan portfolio.
The Company offers three types of residential adjustable rate mortgage
loans, all of which use the index value of the Weekly Average Yield on United
States Treasury Securities Adjusted to a Constant Maturity of One Year plus a
set margin added to it. The interest rates on these loans have an initial
adjustment period of between one and five years, and generally adjust annually
thereafter, with a maximum adjustment of 2% per year and a maximum increase of
5% over the life of the loan. The index margin on a non owner-occupied one- to
four-family property loan is generally 50 basis points higher than on an
owner-occupied property loan. The Company's adjustable-rate one-to- four family
and multi-family mortgage loans are for terms of up to 30 years, amortized on a
monthly basis, with principal and interest due each month. Borrowers may
refinance or prepay loans at their option without penalty. All fixed rate
one-to-four family loans with a term of ten to thirty years are originated and
sold on the secondary market through 1st Independence Mortgage. At December 31,
2006, loans held for sale totaled approximately $1.2 million.
Loan originations are generally obtained from existing and walk-in
customers, members of the local community, and referrals from realtors,
builders, depositors and borrowers within the Company's market area. Mortgage
loans originated and held by the Company in its portfolio generally include
due-on-sale clauses which gives it the contractual right to deem the loan
immediately due and payable in the event that the borrower sells or otherwise
transfers an interest in the property to a third party.
During periods of rising interest rates, the risk of default on
adjustable-rate loans may increase due to increases in interest costs to
borrowers. Further, adjustable-rate loans that provide for initial rates of
interest below the fully indexed rates may be subject to increased risk of
delinquency or default as the higher, fully indexed rate of interest
subsequently replaces the lower, initial rate.
Construction and Land Development Loans. The Company engages in
construction lending involving loans to qualified borrowers for construction of
one- to four-family dwellings, multi-family residential units, commercial
buildings and churches, and single family subdivision land development loans
with the intent of such loans converting to permanent financing upon completion
of construction. All construction and development loans are secured by a first
lien on the property under construction. Loan proceeds are disbursed in
increments as construction progresses and as inspections warrant. At December
31, 2006, construction loans totaled approximately $64.2 million, or 23%, of the
Company's total loan portfolio.
Construction/permanent loans generally have adjustable or fixed
interest rates and are underwritten in accordance with the same terms and
requirements as permanent mortgages, except the loans generally provide for
disbursement in stages during a construction period of up to twelve months,
during which the borrower is not required to make monthly principal payments.
Accrued interest must be paid at completion of construction to the first day of
the following month, and monthly payments start the first day of the following
month if the loan is converted to permanent financing. Borrowers must satisfy
all credit requirements that would apply to permanent mortgage loan financing
for the subject property and must execute a construction loan agreement.
Construction financing generally is considered to involve a higher
degree of risk of loss than long term financing on improved, occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of construction cost proves to be
inaccurate, the Company may be required to advance funds beyond the amount
originally committed to permit completion of the development. The Company has
sought to minimize this risk by requiring precise construction cost estimates,
specifications, and drawing plans from qualified borrowers in their market area
along with tighter underwriting guidelines relating to borrower cash flow and
net worth.
Commercial Loans. The Company originates fixed-rate and adjustable-rate
commercial loans secured by commercial properties. These loans are typically
originated with maximum loan-to-value ratios of 80% of the value of the
respective property. At December 31, 2006, commercial loans totaled
approximately $20.4 million, or 7%, of the total loan portfolio.
Loans secured by commercial properties generally have larger balances
and involve a greater degree of risk than one- to four-family residential
mortgage loans. Of primary concern in commercial lending are the borrower's
creditworthiness and the feasibility and cash flow potential of the project.
Payments on loans secured by income properties often depend on successful
operation and management of the properties. As a result, repayment of such loans
may be subject to a greater extent than residential real estate loans to adverse
conditions in the real estate market or the economy. To monitor cash flows on
income properties, the Company requires borrowers and loan guarantors, if any,
to provide annual financial statements on commercial loans. In reaching a
decision on whether to make a commercial loan, the Company considers the net
operating income of the property, the borrower's expertise, credit history and
profitability and the value of the underlying property. The Company generally
requires an environmental survey for all commercial loans over $500,000.
Consumer Lending. The Company originates consumer loans on either a
secured or unsecured basis with revolving home equity lines of credit composing
the majority of the consumer loan portfolio. The Company generally makes
certificate of deposit loans for terms of up to the terms of the certificate of
deposit collateralizing the loan and up to the face amount of the certificate.
The interest rate charged on these loans is typically up to 2% higher than the
rate paid on the certificate. These loans generally mature concurrently with the
certificate of deposit on demand and the account must be assigned to the Company
as collateral for the loan. At December 31, 2006, consumer loans totaled
approximately $18.4 million, or 7%, of the total loan portfolio.
Consumer loans may entail greater risk than residential loans,
particularly in the case of consumer loans that are unsecured or secured by
assets that depreciate rapidly. Repossessed collateral for a defaulted consumer
loan may not be sufficient for repayment of the outstanding loan, and the
remaining deficiency may not be collectible.
Loan Approval Authority and Underwriting. The Company has established
various lending limits for its officers and maintains a loan committee that
consists of the President and Chief Executive Officer, the Executive Vice
President and Chief Lending Officer, the Executive Vice President and Chief
Credit Officer and other officers of the Bank. The loan committee approves loans
that exceed the limits established for individual officers. In January 2005, the
loan policy was amended to provide for two classes of secured loans. Class I
loans are those secured by investment grade securities, securities listed on the
major stock exchanges, deposit accounts, life insurance cash surrender value,
and real estate mortgages meeting certain loan to value ratios. Class II loans
consist of all other asset-based lending. The loan committee may approve Class I
and Class II loans of $3,000,000 and $2,000,000, respectively. At the same time,
approval limits for unsecured loans were increased to $25,000. The Bank's
directors' loan committee, which consists of six outside Bank directors, must
approve all loans that exceed the lending limits of the loan committee.
For all loans originated by the Company, upon receipt of a completed
loan application from a prospective borrower, a credit report is generally
ordered, income and certain other information is verified and, if necessary,
additional financial information is requested. An appraisal of the real estate
intended to be used as security for the proposed loan is obtained. All
appraisals are reviewed by the Bank's loan officers designated by the Bank's
Board of Directors. An independent appraiser designated and approved by the
Bank's Board of Directors is utilized for all real estate mortgage loans. For
construction/permanent loans, the funds advanced during the construction phase
are disbursed based upon various stages of completion in accordance with the
results of inspection reports that are based upon physical inspection of the
construction by an independent contractor hired by the Bank or in some cases by
an officer of the Bank. For real estate loans, the Bank requires either title
insurance or a title opinion. Borrowers must also obtain fire and casualty,
hazard or flood insurance (for loans on property located in a flood zone, flood
insurance is required) prior to the closing of the loan.
Loan Commitments. The Company issues written commitments to prospective
borrowers on all approved commercial real estate loans in excess of $500,000.
Generally, the commitment requires acceptance within 20 days of the date of
issuance. At December 31, 2006, the Company had approximately $71 million of
commitments to cover originations and unused lines of credit.
Nonperforming and Problem Assets
Loan Delinquencies. The Company's collection procedures provide that
when a loan is 10 days past due, a notice of nonpayment is sent. Delinquent
notices are sent if the loan becomes delinquent for more than 30 days and
generally the borrower will receive a letter or be personally contacted by an
officer of the Bank. If payment is still delinquent after 60 days, the customer
will again receive a letter and/or telephone call and may receive a visit from
an officer representative of the Bank. If the delinquency continues, similar
subsequent efforts are made to eliminate the delinquency. If the loan continues
in a delinquent status for 90 days past due and no repayment plan is in effect,
management will generally initiate legal proceedings.
Loans are reviewed on a monthly basis by management and are generally
placed on a non-accrual status when the loan becomes more than 90 days
delinquent and, in the opinion of management, the collection of additional
interest is doubtful. Interest accrued and unpaid at the time a loan is placed
on non- accrual status is charged against interest income. Subsequent interest
payments are applied to the outstanding principal balance.
Nonperforming Assets. The following table (in thousands except
percentages) sets forth information regarding nonaccrual loans, other real
estate owned and certain other repossessed assets and loans. Nonperforming asset
balances related to the discontinued operations of Citizens have been
eliminated. Additionally, as of the dates indicated, the Company had no loans
categorized as troubled debt restructurings within the meaning of Statement of
Financial Accounting Standards ("SFAS") No. 15 and impaired loans within the
meaning of SFAS No. 114, as amended by SFAS No. 118, were approximately $3.4
million at December 31, 2006.
December, 31 September 30,
------------------------------------------ -------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Nonaccrual loans $3,698 $1,140 $893 $ - $ -
Accruing loans past due 90 days or more 31 130 332 472 334
------ ------ ----- ---- ----
Total nonperforming loans 3,729 1,270 1,225 472 334
Other real estate owned 433 - - - 233
------ ------ ------ ---- ----
Total nonperforming assets $4,162 $1,270 $1,225 $472 $567
====== ====== ====== ==== ====
Total nonperforming loans to total loans 1.36% 0.47% 0.52% 0.56% 0.36%
==== ==== ==== ==== ====
Total nonperforming assets to total assets 1.21% 0.38% 0.41% 0.36% 0.45%
==== ==== ==== ==== ====
In addition to the nonperforming loans discussed above, there were
loans for which payments were current or less than 90 days past due where
borrowers are experiencing financial difficulties. At December 31, 2006, these
loans totaled approximately $11.1 million. These loans are monitored by
management and considered in determining the level of the allowance for loan
losses. Management does not believe these loans represent a significant exposure
to loss.
Classified Assets. Federal regulations provide for a classification
system for problem assets of insured institutions that covers all problem
assets. Under this classification system, problem assets of insured institutions
are classified as "substandard," "doubtful," or "loss." An asset is considered
substandard if it is inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard assets
include those characterized by the "distinct possibility" that the insured
institution will sustain "some loss" if the deficiencies are not corrected.
Assets classified as doubtful have all of the weaknesses inherent in those
classified substandard, with the added characteristic that the weaknesses
present make "collection or liquidation in full," on the basis of currently
existing facts, conditions, and values, "highly questionable and improbable."
Assets classified as loss are those considered "uncollectible" and of such
little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted. Assets may be designated "special
mention" because of potential weaknesses that do not currently warrant
classification in one of the aforementioned categories.
When an insured institution classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
problem assets as loss, it is required either to establish a specific allowance
for losses equal to 100% of that portion of the asset so classified or to charge
off such amount. The Company's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
Federal Deposit Insurance Corporation ("FDIC") and the Kentucky Office of
Financial Institutions which may order the establishment of additional general
or specific loss allowances. A portion of general loss allowances established to
cover possible losses related to assets classified as substandard or doubtful
may be included in determining an institution's regulatory capital, while
specific valuation allowances for loan losses generally do not qualify as
regulatory capital.
Allowance for Loan Losses. It is management's policy to provide for
losses on loans in its loan portfolio. A provision for loan losses is charged to
operations based on management's evaluation of the losses that may be incurred
in the Company's loan portfolio. Such evaluation, which includes a review of all
loans of which full collectibility of interest and principal may not be
reasonably assured, considers the Company's past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, estimated value of any underlying collateral,
current economic conditions, and the relationship of the allowance for loan
losses to outstanding loans.
The following table (in thousands except percentages) sets forth
information with respect to the Company's allowance for loan losses at the dates
and for the periods indicated below. Balances related to the discontinued
operations of Citizens have been eliminated.
Three months
Year ended Year ended ended Year ended
December 31, December 31, December 31, September 30,
------------ ------------ -------------- ---------------------
2006 2005 2004 2004 2003
---- ---- ---- ---- ----
Allowance for loan losses
Balance at beginning of period $2,911 $2,549 $2,560 $ 391 $390
Allowance of acquired company - - - 1,046 -
Provision for loan losses 847 354 - 1,203 2
Net charge-offs (recoveries):
Residential 16 (11) 9 (2) 1
Commercial 1 2 - 67 -
Consumer (4) 1 2 15 -
------ ------ ------ ------ ----
Balance at end of period $3,745 $2,911 $2,549 $2,560 $391
====== ====== ====== ====== ====
Total loans outstanding $274,223 $269,889 $236,197 $213,719 $84,796
======== ======== ======== ======== =======
Average loans outstanding $276,629 $257,333 $224,201 $112,844 $84,335
======== ======== ======== ======== =======
Allowance for loan losses to
period-end loans 1.37% 1.08% 1.08% 1.20% 0.46%
===== ===== ===== ===== =====
Net loans charged off to average loans 0.00% 0.00% 0.00% 0.07% 0.00%
===== ===== ===== ===== =====
Management will continue to review the entire loan portfolio to
determine the extent, if any, to which further additional loss provisions may be
deemed necessary. There can be no assurance that the allowance for loan losses
will be adequate to cover losses that may in fact be realized in the future and
that additional provisions for losses will not be required.
Analysis of the Allowance for Loan Losses
The following table (in thousands except percentages) sets forth the
allocation of the allowance by category, which management believes can be
allocated only on an approximate basis. The allocation of the allowance to each
category is not necessarily indicative of future loss and does not restrict the
use of the allowance to absorb losses in any category. Balances related to the
discontinued operations of Citizens have been eliminated.
December 31, September 30,
--------------------------------------------------------------------------------- -----------------
2006 2005 2004 2003 2002
------------------ ------------------- ------------------- ------------------- -----------------
Percent of Percent of Percent of Percent of Percent of
Amount Total loans Amount Total loans Amount Total loans Amount Total loans Amount Total loans
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
Real estate:
Commercial $1,508 18% $ 715 17% $ 651 15% $ 61 16% $ 54 14%
Residential 832 45 581 48 255 53 285 73 298 76
Construction 358 23 153 19 358 14 14 3 16 4
Commercial 856 7 859 9 957 9 16 4 9 2
Consumer 191 7 603 7 328 9 15 4 13 4
------ --- ------ --- ------ --- ---- --- ---- ---
Total allowance for
loan losses $3,745 100% $2,911 100% $2,549 100% $391 100% $390 100%
====== === ====== === ====== === ==== === ==== ===
Return on Equity and Assets Ratios
Ratios have been adjusted to reflect the discontinued operations of
Citizens.
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Average equity to average assets 11.57% 11.59% 12.76%
Return on average equity 4.93 11.92 2.51
Return on average assets 0.57 1.38 0.32
Dividend payout ratio 31.96 16.83 0.00
Investment Activities
The Company is required under federal regulations to maintain a
sufficient amount of liquid assets that may be invested in specified short-term
securities and certain other investments. However, the Federal Deposit Insurance
Corporation ("FDIC") does not prescribe by regulation to a minimum or percentage
of liquid assets. The level of liquid assets varies depending upon several
factors, including: (i) the yields on investment alternatives, (ii) management's
judgment as to the attractiveness of the yields then available in relation to
other opportunities, (iii) expectation of future yield levels, and (iv)
management's projections as to the short-term demand for funds to be used in
loan origination and other activities. Investment securities, including
mortgage-backed securities, are classified at the time of purchase, based upon
management's intentions and abilities, as securities held to maturity or
securities available for sale. Debt securities acquired with the intent and
ability to hold to maturity are classified as held to maturity and are stated at
cost and adjusted for amortization of premium and accretion of discount, which
are computed using the level yield method and recognized as adjustments of
interest income. All other debt securities are classified as available for sale
to serve principally as a source of liquidity.
Current regulatory and accounting guidelines regarding investment
securities (including mortgage backed securities) require the Company to
categorize securities as "held to maturity," "available for sale" or "trading."
As of December 31, 2006, the Company had securities (including mortgage-backed
securities) classified as "held to maturity" and "available for sale" in the
amount of $1.9 million and $16.4 million, respectively and had no securities
classified as "trading." Securities classified as "available for sale" are
reported for financial reporting purposes at the fair market value with net
changes in the fair market value from period to period included as a separate
component of stockholders' equity, net of income taxes. At December 31, 2006,
the Company's securities available for sale had an amortized cost of $16.5
million and fair market value of $16.4 million. Changes in the fair market value
of securities available for sale do not affect the Company's net income. In
addition, changes in the fair market value of securities available for sale do
not affect the Bank's regulatory capital requirements or its loan-to-one
borrower limit.
At December 31, 2006, the Company's investment portfolio policy allowed
investments in instruments such as: (i) U.S. Treasury obligations, (ii) U.S.
federal agency or federally sponsored agency obligations, (iii) local municipal
obligations, (iv) mortgage-backed securities, (v) banker's acceptances, (vi)
certificates of deposit, (vii) equity investments, and (viii) investment grade
corporate bonds and commercial paper. The board of directors may authorize
additional investments.
As a source of liquidity and to supplement the Company's lending
activities, the Company has invested in residential mortgage-backed securities.
Mortgage-backed securities can serve as collateral for borrowings and, through
repayments, as a source of liquidity. Mortgage-backed securities represent a
participation interest in a pool of single-family or other type of mortgages.
Principal and interest payments are passed from the mortgage originators,
through intermediaries (generally quasi-governmental agencies) that pool and
repackage the participation interests in the form of securities to investors.
Mortgage-backed securities typically are issued with stated principal
amounts. The securities are backed by pools of mortgages that have loans with
interest rates that are within a set range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed rate or adjustable
rate mortgage loans. Mortgage-backed securities are generally referred to as
mortgage participation certificates or pass-through certificates. The interest
rate risk characteristics of the underlying pool of mortgages (i.e., fixed rate
or adjustable rate) and the prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security is equal to the life
of the underlying mortgages. Expected maturities will differ from contractual
maturities due to scheduled repayments and because borrowers may have the right
to call or prepay obligations with or without prepayment penalties.
Mortgage-backed securities issued by quasi-governmental agencies, make up a
majority of the pass-through certificates market.
At December 31, 2006, the Company's securities portfolio did not
contain securities of any issuer, other than those issued by U.S. government or
its agencies, with an aggregate book value in excess of 10% of the Company's
equity.
Investment Portfolio. The following table (in thousands) sets forth the
carrying value of the Company's investment securities at the dates indicated.
Balances related to the discontinued operations of Citizens have been
eliminated.
December 31,
------------------------------
2006 2005 2004
---- ---- ----
Investment securities available for sale:
Mortgage-backed $11,795 $11,556 $18,011
U.S. government and federal agencies 1,985 1,974 2,525
Municipal bonds 2,641 2,610 505
Equity - - 5,682
------- ------- -------
Total $16,421 $16,140 $26,723
======= ======= =======
Investment securities held to maturity:
Mortgage-backed $ - $ - $ 2
Municipal bonds 1,900 1,975 2,148
------- ------- -------
Total $ 1,900 $ 1,975 $ 2,150
======= ======= =======
Total investment securities $18,321 $18,115 $28,873
======= ======= =======
Investment Portfolio Maturities. The following table sets forth
information regarding the scheduled maturities, carrying values, market value
and weighted average yields for the Company's investment securities portfolio at
December 31, 2006. The following table does not take into consideration the
effects of scheduled repayments or the effects of possible prepayments.
December 31, 2006
----------------------------------------------------------------------------------------------------
More Than One to More Than Five to
One Year or Less Five Years Ten Years More Than Ten Years Total
----------------- ----------------- ------------------ -------------------- -------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
------- -------- ----------------- ------- -------- ------- -------- -------- --------
Available-for-sale securities:
Mortgage-backed securities $ 24 5.00% $ 76 7.01% $3,806 4.78% $7,889 5.32% $11,795 5.16%
U.S government and federal
agencies 986 3.07 998 5.24 - - - - 1,984 4.16
Municipal bonds 184 2.15 - - 820 3.57% 1,638 4.51 2,642 4.05
------ ---- ------ ---- ------ ---- ------ ---- ------- ----
Total $1,194 2.97% $1,074 5.37% $4,626 4.57% $9,527 5.18% $16,421 4.86%
====== ==== ====== ==== ====== ==== ====== ==== ======= ====
Held-to-maturity securities:
Mortgage-backed securities $ - -% $ - -% $ - -% $ - -% $ - -%
Municipal bonds 90 4.92 50 5.12 1,504 4.35 256 5.57 1,900 4.56
------ ---- ------ ---- ------ ---- ------ ---- ------- ----
Total $ 90 4.92% $ 50 5.12% $1,504 4.35% $ 256 5.57% $ 1,900 4.56%
====== ==== ====== ==== ====== ==== ====== ==== ======= ====
Sources of Funds
General. Deposits are the major external source of the Company's funds
for lending and other investment purposes. The Company derives funds from
amortization and prepayment of loans and, to a much lesser extent, maturities of
investment securities, borrowings, mortgage-backed securities and operations.
Scheduled loan principal repayments are a relatively stable source of funds,
while deposit inflows and outflows and loan prepayments are significantly
influenced by general interest rates and market conditions.
Deposits. Consumer and commercial deposits are attracted principally
from within the Company's primary market area through the offering of a
selection of deposit instruments including regular savings accounts, money
market accounts, and term certificate accounts. Deposit account terms vary
according to the minimum balance required, the time period the funds must remain
on deposit, and the interest rate, among other factors. At December 31, 2006,
the Company had brokered deposits totaling $23.7 million.
The following table (in thousands) sets forth the amount of the
Company's certificates of deposit of $100,000 or more by time remaining until
maturity as of December 31, 2006.
Amount
-------
3 months or less $26,206
Over 3 through 6 months 6,899
Over 6 through 12 months 22,571
Over 12 months 5,253
-------
Total $60,929
=======
The following table (in thousands except rates) sets forth the
Company's average balances and interest rates for interest-bearing demand
deposits and time deposits for the periods indicated. Balances related to the
discontinued operations of Citizens have been eliminated.
Three months
Year ended Year ended ended
December 31, 2006 December 31, 2005 December 31, 2004
------------------- ------------------- --------------------
Average Average Average Average Average Average
balance rate balance rate balance rate
------- ---- ------- ---- ------- ----
Demand and savings $ 61,710 2.96% $ 59,520 1.85% $ 48,633 1.15%
Time 187,463 4.39 177,801 3.24 155,491 2.61
-------- -------- --------
$249,173 4.04 $237,321 2.89 $204,124 2.27
======== ======== ========
Short-Term Borrowings. Deposits are the primary source of funds for the
Company's lending and investment activities and for its general business
purposes. The Company can also obtain advances from the Federal Home Loan Bank
of Cincinnati ("FHLB") and other short-term borrowings, such as federal funds
purchased and issuance of securities sold under repurchase agreements to
supplement its supply of lendable funds and to also supplement short-term
liquidity. A pledge of the Bank's stock in the FHLB and a portion of its first
mortgage loans typically secure FHLB advances. At December 31, 2006, the
Company's short-term borrowings totaled $36.5 million; of which $35.0 million
were short-term FHLB advances. See note 10 to the consolidated financial
statements for additional information.
Information regarding short-term FHLB advances follows:
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Amount outstanding:
Period end $35,000 $18,000 $22,500
Maximum month end
balance during period 35,000 28,000 22,500
Average balance during
Period 18,216 16,541 19,575
Weighted average interest rate:
Period end 5.44% 4.33% 2.42%
During the period 5.20 3.43 2.14
Personnel
As of December 31, 2006, the Company had 85 full-time equivalent
employees. None of the Company's employees are represented by a collective
bargaining group. The Company believes that its relationship with its employees
is good.
Regulation of the Company
General. The Company is a registered bank holding company subject to
regulation under the Bank Holding Company Act of 1956, as amended (the "BHC
Act"). In addition, the Company is subject to the provisions of Kentucky's
banking laws regulating bank acquisitions and various activities of controlling
bank shareholders. As a bank holding company, the Company is subject to
regulation, supervision, and examination by the Board of Governors of the
Federal Reserve System (the "FRB") and is required to file periodic reports with
the FRB. The Kentucky Office of Financial Institutions ("KOFI") may also conduct
examinations of the Company to determine whether it is in compliance with
applicable Kentucky banking laws and regulations. In addition, the FRB has
enforcement authority over the Company and any of its non-financial institution
subsidiaries. This regulation and oversight is intended primarily for the
protection of the depositors of the Bank and not for the benefit of the
Company's stockholders.
The Gramm-Leach-Bliley Act, which became effective in March 2001,
permits greater affiliation among banks, securities firms, insurance companies,
and other companies under a new type of financial services company known as a
"financial holding company." A financial holding company essentially is a bank
holding company with significantly expanded powers. Financial holding companies
are authorized by statute to engage in a number of financial activities
previously impermissible for bank holding companies, including securities
underwriting, dealing and market making; sponsoring mutual funds and investment
companies; insurance underwriting and agency; and merchant banking activities.
The act also permits the FRB and the Treasury Department to authorize additional
activities for financial holding companies if they are "financial in nature" or
"incidental" to financial activities. A bank holding company may become a
financial holding company if each of its subsidiary banks is well capitalized,
well managed, and has at least a "satisfactory" CRA rating. A financial holding
company must provide notice to the FRB within 30 days after commencing
activities previously determined by statute or by the FRB and the Department of
the Treasury to be permissible. The Company has not submitted notice to the FRB
of its intent to be deemed a financial holding company.
Regulatory Capital Requirements. The FRB has adopted capital adequacy
guidelines pursuant to which it assesses the adequacy of capital in examining
and supervising a bank holding company and in analyzing applications to it under
the Bank Holding Company Act. The FRB's capital adequacy guidelines are similar
to those imposed on the Bank. See "Regulation of the Bank - Regulatory Capital
Requirements."
Restrictions on Dividends. The FRB has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the FRB's
view that a bank holding company should pay cash dividends only to the extent
that the holding company's net income for the past year is sufficient to cover
both the cash dividends and a rate of earnings retention that is consistent with
the holding company's capital needs, asset quality and overall financial
condition. The FRB also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Accordingly, the Company's ability to pay dividends is dependent on the Bank's
ability to pay dividends to the Company. Furthermore, under the federal prompt
corrective action regulations, the FRB may prohibit a bank holding company from
paying any dividends if the holding company's bank subsidiary is classified as
"undercapitalized."
Acquisition of Banks. The BHC Act also requires a bank holding company
to obtain prior approval from the FRB before acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any bank which is
not already majority owned or controlled by that bank holding company.
Acquisition of any additional banks would require prior approval from both the
FRB and the KOFI.
Non-Banking Activities. A bank holding company is generally prohibited
from engaging in, or acquiring, direct or indirect control of more than 5% of
the voting securities of any company engaged in non-banking activities. One of
the principal exceptions to this prohibition is for activities found by the FRB
to be so closely related to banking or managing or controlling banks as to be a
proper incident thereto. Some of the principal activities that the FRB has
determined by regulation to be so closely related to banking are: (i) making or
servicing loans; (ii) performing certain data processing services; (iii)
providing discount brokerage services; (iv) acting as fiduciary, investment or
financial advisor; (v) leasing personal or real property; (vi) making
investments in corporations or projects designed primarily to promote community
welfare; and (vii) acquiring a savings and loan association.
Regulation of the Bank
General. Set forth below is a brief description of certain laws that
relate to the regulation of the Bank. The description does not purport to be
complete and is qualified in its entirety by reference to applicable laws. The
Bank is a Kentucky state-chartered stock-form commercial bank and its deposit
accounts are insured under the Deposit Insurance Fund ("DIF"). The Bank is
subject to extensive regulation and supervision by the KOFI as its chartering
agency, and by the FDIC, as its deposit insurer. The Bank must file reports with
the KOFI and the FDIC concerning its activities and financial condition, in
addition to obtaining regulatory approvals prior to entering into certain
transactions such as mergers with, or acquisitions of, other depository
institutions. The deposits of the Bank are insured by the FDIC to the maximum
extent provided by law.
Federal and Kentucky banking laws and regulations control, among other
things, the Bank's required reserves, investments, loans, mergers and
consolidations, issuance of securities, payment of dividends and other aspects
of the Bank's operations. The regulatory structure also gives the respective
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including polices with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Supervision, regulation and examination
of the Bank by the bank regulatory agencies are intended primarily for the
protection of depositors rather than for holders of the Company's stock or for
the Company as the holder of the stock of the Bank.
Insurance of Deposit Accounts. The FDIC has adopted a risk-based
insurance assessment system. The FDIC assigns an institution to one of three
capital categories, consisting of (1) well capitalized, (2) adequately
capitalized, or (3) undercapitalized, and one of three supervisory subcategories
within each capital group, based on the institution's financial information, as
of the reporting period ending seven months before the assessment period. The
supervisory subgroup to which an institution is assigned is based on the
supervisory evaluation provided to the FDIC by the institution's primary federal
regulator, and information which the FDIC determines to be relevant to the
institution's financial condition and the risk posed to the deposit insurance
funds. An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned. Assessment rates are determined
semiannually by the FDIC.
Under the Federal Deposit Insurance Act, insurance of deposits may be
terminated by the FDIC upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order, or
condition imposed by the FDIC. The Bank does not know of any practice,
condition, or violation that might lead to the termination of deposit insurance.
Regulatory Capital Requirements. The FDIC has adopted regulations
requiring institutions under their respective jurisdictions to maintain
specified minimum ratios of capital to total assets and capital to risk-weighted
assets. Specifically, all savings institutions and banks must maintain the
following ratios: (1) Tier 1 or core capital equal to at least 4% (3% if the
institution has received the highest rating on its most recent examination) of
total adjusted assets; and (2) total capital (defined as Tier 1 capital plus
supplementary Tier 2 capital) equal to 8% of total risk-weighted assets. At
December 31, 2006, the Bank was in compliance with the capital requirements of
the FDIC.
Dividend and Other Capital Distribution Limitations. The KOFI imposes
restrictions on the ability of Kentucky commercial banks to pay dividends and to
make other capital distributions. In general, banks are prohibited from paying
any dividends or other capital distributions if, after the distribution, they
would be undercapitalized under applicable federal law.
In addition, under applicable provisions of Kentucky law, the prior
approval of the KOFI is required if the total of all dividends declared by the
Bank in any calendar year exceeds its respective net profits, as defined, for
that year combined with its retained net profits for the preceding two calendar
years, less any required transfers to surplus or a fund for the retirement of
any preferred stock. At January 1, 2007, the Bank could pay dividends to the
Company of approximately $7,883,000, without regulatory approval.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Cincinnati, which is one of twelve (12) regional federal home loan banks that
administer the home financing credit function of savings associations. Each FHLB
serves as a reserve or central bank for its members within its assigned region.
It is funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLB System. It makes loans to members (i.e., advances) in
accordance with policies and procedures established by the Board of Directors of
the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Cincinnati in an amount equal to at least 1% of aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year.
Federal Reserve System. The FRB requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW, and Super NOW checking accounts)
and non-personal time deposits. At December 31, 2006, the Bank was in compliance
with these FRB requirements.
Transactions with Affiliates
Under current federal law, transactions between depository
institutions, such as the Bank, and their affiliates are governed by Sections
23A and 23B of the Federal Reserve Act. An affiliate is any company or entity
that controls, is controlled by, or is under common control with the financial
institution, other than a subsidiary. Generally, a bank's subsidiaries are not
treated as affiliates unless they are engaged in activities as principal that
are not permissible for national banks. In a holding company context, at a
minimum, the parent holding company of a bank, and any companies that are
controlled by such parent holding company, are affiliates of the bank.
Generally, Section 23A limits the extent to which the bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such bank's capital stock and surplus, and contains an aggregate limit
on all such transactions with all affiliates to an amount equal to 20% of such
capital stock and surplus. The term "covered transaction" includes the making of
loans or other extensions of credit to an affiliate; the purchase of assets from
an affiliate; the purchase of, or an investment in, the securities of an
affiliate; the acceptance of securities of an affiliate as collateral for a loan
or extension of credit to any person; or issuance of a guarantee, acceptance, or
letter of credit on behalf of an affiliate. Section 23A also establishes
specific collateral requirements for loans or extensions of credit to, or
guarantees, or acceptances on letters of credit issued on behalf of an
affiliate. Section 23B requires that covered transactions and a broad list of
other specified transactions be on terms substantially the same as or no less
favorable to, the bank or its subsidiary as similar transactions with
non-affiliates.
The Sarbanes-Oxley Act of 2002 generally prohibits loans by the Company
to its executive officers and directors. However, the Sarbanes-Oxley Act
contains a specific exemption for loans made by the Bank to its executive
officers and directors in compliance with federal banking laws. Section 22(h) of
the Federal Reserve Act governs a bank's loans to directors, executive officers,
and principal shareholders. Under Section 22(h), loans to directors, executive
officers, and shareholders who control, directly or indirectly, 10% or more of
voting securities of a bank, and certain related interests of any of the
foregoing, may not exceed, together with all other outstanding loans to such
persons and affiliated entities, the bank's total capital and surplus. Section
22(h) also prohibits loans above amounts prescribed by the appropriate federal
banking agency to directors, executive officers, and shareholders who control 10
% of more of voting securities of a bank, and their respective related
interests, unless such loan is approved in advance by a majority of the board of
directors of the bank. Any "interested" director may not participate in the
voting. The loan amount (which includes all other outstanding loans to such
person) as to which such prior board of director approval is required, is the
greater of $25,000 or 5% of capital and surplus or any loans over $500,000.
Further, pursuant to Section 22(h), loans to directors, executive officers, and
principal shareholders must be made on terms substantially the same as those
offered in comparable transactions to other persons. There is an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
executive officers over other employees. Section 22(g) of the Federal Reserve
Act places additional limitations on loans to executive officers.
Available Information
The Company files annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments to those reports with the
United States Securities and Exchange Commission (the "SEC") pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934. Such reports can be read
and copied at the public reference facilities maintained by the SEC at the
Public Reference Room, 100 F Street, NE, Washington, D. C. 20549. Information
regarding the operation of the Public Reference Room may be obtained by calling
the SEC at 1-800-732-0330. These reports are also available at the SEC's website
at www.sec.gov. You also may obtain electronic or paper copies of our reports
free of charge by contacting John F. Barron, Senior Vice President and
Controller, 1st Independence Financial Group, Inc., 8620 Biggin Hill Lane,
Louisville, Kentucky 40220-4117.
Item 1A. Risk Factors.
Risks Related to our Business
We are subject to extensive regulation that could limit or restrict our
activities and impose financial requirements or limitations on the conduct of
our business, which limitations or restrictions could adversely affect our
profitability.
As a bank holding company, we are primarily regulated by the Board of
Governors of the Federal Reserve System. Our subsidiary is primarily
regulated by the FDIC and the Kentucky Office of Financial Institutions.
Our compliance with Federal Reserve Board, FDIC and Kentucky banking
regulations is costly. A failure to comply with the banking regulations may
limit our growth and restrict certain of our activities, including payment
of dividends, mergers and acquisitions, investments, loans and interest
rates charged, interest rates paid on deposits and locations of offices. We
are also subject to the capital requirements of our regulators.
The laws and regulations applicable to the banking industry could change at
any time, and we cannot predict the effects of these changes on our
business and profitability. Because government regulation greatly affects
our business and financial results, our cost of compliance could adversely
affect our ability to operate profitably and a failure to comply could
limit our ability to implement our business strategy. See the caption
entitled "Regulatory Matters" included in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section of this
report, which is Part II, Item 7 of this report, for further information.
Our business strategy includes the continuation of growth plans, and our
financial condition and results of operations could be negatively affected if we
fail to grow.
We have grown rapidly in terms of branch expansion, total assets, net
loans, and deposits. We may not be able to continue to grow at the same
rate that we have grown in the past. We currently serve our customers
through a network of eight banking offices, consisting of two full-service
banking locations in Louisville, Kentucky, and one full-service banking
location in each of New Albany, Jeffersonville, and Clarksville, Indiana.
We also have one full-service banking location in Harrodsburg, Kentucky,
Lawrenceburg, Kentucky, and Marengo, Indiana. Our business strategy calls
for continued expansion and the opening of additional branches during the
next three to five years. We have not yet attempted to establish branches
in any of the other counties in Kentucky or southern Indiana. Our branch
expansion strategy entails other risks, including:
o the entrance into new markets where we lack experience;
o the experience of unexpected competition;
o the introduction of new products and services into our business
with which we have no prior experience;
o the time and costs of evaluating new markets, hiring experienced
local management and opening new offices;
o the ability to implement and improve our operational, credit,
financial, management and other internal risk controls and
processes and our reporting systems and procedures;
o the ability to manage a growing number of client relationships;
o the ability to recruit and retain additional experienced bankers to
accommodate growth;
o the ability to maintain controls and procedures sufficient to
accommodate an increase in expected loan volume andinfrastructure;
o the diversion of our management's attention from our existing
businesses as a result of our growth strategy;
o the additional expenditures our asset growth may require to expand
our administrative and operational infrastructure; and
o the ability to maintain cost controls and asset quality while
attracting additional loans and deposits on favorable terms.
The occurrence of any of these factors could have an adverse effect on our
financial condition. We can provide no assurance that we will be able to
overcome the risks associated with growth or any other problems encountered
in executing our growth strategy.
Our recent results do not indicate our future results, and may not provide
guidance to assess the risk of an investment in our common stock.
We are unlikely to sustain our historical rate of growth, and may not even
be able to expand our business at all. Further, our recent growth may
distort some of our historical financial ratios and statistics. In the
future, we may not have the ability to find suitable expansion
opportunities. Various factors, such as economic conditions, regulatory and
legislative considerations and competition, may also impede or prohibit our
ability to expand our market presence. If we are not able to successfully
grow and expand our business, our financial condition and results of
operations could be adversely affected.
Our business would be harmed if we lost the services of any of our senior
management team and are unable to recruit or retain suitable replacements.
We believe that our success to date and our prospects for future success
depend significantly on the efforts of our senior management team, which
includes N. William White, our President and Chief Executive Officer, R.
Michael Wilbourn, our Executive Vice President and Chief Financial Officer,
Gregory A. DeMuth, our Executive Vice President and Chief Lending Officer
of the Bank, David M. Hall, our Executive Vice President-Retail Banking of
the Bank, Kathy L. Beach, our Executive Vice President and Chief Operations
Officer, Alan D. Shepard, our Executive Vice President and Chief Credit
Officer of the Bank and certain of our senior bankers. We have $0.5 million
of key-man life insurance on both Mr. White and Mr. Wilbourn. There is no
assurance, however, that $0.5 million would be enough to compensate us for
the loss of Mr. White or Mr. Wilbourn. We do not have key-man insurance on
any other officer of the Company or the Bank. In addition to their skills
and experience as bankers, these persons provide us with extensive
community ties upon which our competitive strategy is based.
A significant portion of our loan portfolio is secured by real estate, and
events that negatively impact the real estate market could hurt our business.
A significant portion of our loan portfolio is secured by real estate. The
real estate collateral in each case provides an alternate source of
repayment in the event of default by the borrower and may deteriorate in
value during the time the credit is extended. A weakening of the real
estate market in our market areas could result in an increase in the number
of borrowers who default on their loans and a reduction in the value of the
collateral securing their loans, which in turn could have an adverse effect
on our profitability and asset quality. If we are required to liquidate the
collateral securing a loan to satisfy the debt during a period of reduced
real estate values, our earnings and capital could be adversely affected.
Acts of nature, including hurricanes, tornados, earthquakes, fires and
floods, which may cause uninsured damage and other loss of value to real
estate that secures these loans, may also negatively impact our financial
condition. Additionally, a slowdown in real estate activity in the markets
we serve may also negatively impact our financial condition.
An economic downturn, either nationally or in the local market area, could
adversely affect our financial condition, results of operations and cash flows.
Deterioration in local, regional, national or global economic conditions
could result in, among other things, an increase in loan delinquencies, a
change in the housing turnover rate or a reduction in the level of
available wholesale deposits. If the communities in which we operate do not
grow, or if the prevailing local or national economic conditions are
unfavorable, our business strategy may not succeed. A weakening of the
employment market in our primary market area could result in an increase in
the number of borrowers who default on their loans. Further, the banking
industry is affected by general economic conditions such as inflation,
interest rates, recession, unemployment and other factors beyond our
control. Moreover, we cannot give any assurance that we will benefit from
any market growth or favorable economic conditions in our primary market
areas even if they do occur.
Our cost of funds for banking operations may increase as a result of general
economic conditions, interest rates and competitive pressures.
In the past, the Bank has relied heavily on brokered certificates of
deposits and borrowings for the funds necessary for banking operations. As
a general matter, deposits are a cheaper source of funds than brokered
certificates of deposit or borrowings, because interest rates paid for
deposits are typically less than interest rates charged for brokered
certificates of deposit or borrowings. Our business strategy includes
funding more of our operations with deposits; however, we cannot provide
any assurances that we will be able attract sufficient deposits.
Competition from other financial institutions and others may adversely affect
our profitability.
The banking business generally, and because of its desirability and the
opportunities for growth, the Louisville, Kentucky and southern Indiana
market area in particular, is highly competitive, and we experience strong
competition from many other financial institutions. We compete with
commercial banks, credit unions, savings and loan associations, mortgage
banking firms, consumer finance companies, securities brokerage firms,
insurance companies, money market funds and other financial institutions,
which operate in our primary market area and elsewhere.
We compete with these institutions to make loans and to attract new
customers and in pricing loans and deposits. Many of our competitors are
well-established and much larger financial institutions and can offer
customers more attractive pricing terms. While we believe we can and do
successfully compete with these other financial institutions in our
markets, we may face a competitive disadvantage as a result of our smaller
size.
We also compete with private lenders, mezzanine and venture capital firms
and angel investors in some of our lending divisions, including our
community redevelopment lending and mezzanine financing divisions. Many of
these competitors are subject to minimal or no regulation and may be able
to make accommodations for customers that we are unable to make.
We are currently subject to claims regarding the merger of Independence Bancorp
with Harrodsburg First Financial Bancorp, Inc. that could result in substantial
defense, judgment or settlement costs.
On or about May 28, 2004, a complaint was filed in the Circuit Court of
Anderson County in the Commonwealth of Kentucky by Larry Sutherland, Judy
Sutherland, John Henry Disponett, Brenda Disponett, Todd Hyatt, Lois Ann
Disponett, Sue Saufley, and Hugh Coomer. Soon thereafter, an amended
complaint was filed which added Lois Hawkins and Norma K. Barnett as
plaintiffs. The lawsuit arises from offers to purchase securities made by
us in connection with an offer to purchase up to 300,000 shares of our
stock in a tender offer on or about May 28, 2003. The Plaintiffs allege
that we made certain material misrepresentations in connection with certain
statements made in the tender offer. The Plaintiffs are seeking to recover
compensatory and punitive damages in connection with the shares they sold
in the tender offer and their attorneys' fees.
On April 14, 2006 a partial summary judgment was entered against the
plaintiffs. In the partial summary judgment, the Circuit Court held that
the only remedy available to the plaintiffs is the return of the stock upon
the tender of the consideration received by the Plaintiffs in exchange for
the stock. Subsequent to the partial summary judgment, the plaintiffs
amended their complaint to allege certain additional material
misrepresentations had been made by the Company. This matter is currently
scheduled for trial in July 2007. If we are ultimately unsuccessful in this
litigation, it may have a negative effect on our results of operations or
cash flows.
Risks Related to Our Industry
Our profitability is vulnerable to interest rate fluctuations.
Most of our assets and liabilities are monetary in nature, and thus subject
us to significant risks from changes in interest rates. Consequently, our
results of operations can be significantly affected by changes in interest
rates and our ability to manage interest rate risk. Changes in market
interest rates, or changes in the relationships between short-term and
long-term market interest rates, or changes in the relationship between
different interest rate indices can affect the interest rates charged on
interest-earning assets differently than the interest paid on
interest-bearing liabilities. This difference could result in an increase
in interest expense relative to interest income or a decrease in interest
rate spread. In addition to affecting our profitability, changes in
interest rates can impact the valuation of our assets and liabilities. A
discussion of how we measure our exposure to interest rate changes is
provided in Part II, Item 7 of this report.
We could suffer loan losses from a decline in credit quality.
We could sustain losses if borrowers, guarantors or related parties fail to
perform in accordance with the terms of their loans. We have adopted
underwriting and credit monitoring procedures and policies, including the
establishment and review of the allowance for credit losses, that we
believe are appropriate to minimize this risk by assessing the likelihood
of nonperformance, tracking loan performance and diversifying our credit
portfolio. These policies and procedures, however, may not prevent
unexpected losses that could materially adversely affect our results of
operations and financial condition.
If our allowance for loan losses is not sufficient to cover actual loan losses,
our earnings could decrease.
We manage our credit exposure through careful monitoring of loan applicants
and loan concentrations in particular industries, and through loan approval
and review procedures. We have established an evaluation process designed
to determine the adequacy of our allowance for loan losses. While this
evaluation process uses historical and other objective information, the
classification of loans and the establishment of loan losses is an estimate
based on experience, judgment and expectations regarding our borrowers, the
economies in which we and our borrowers operate, as well as the judgment of
our regulators.
There is no precise method of predicting loan losses, so we cannot assure
you that our loan loss allowance will be sufficient to absorb future loan
losses or prevent a material adverse effect on our business, financial
condition or results of operations.
Failure to achieve and maintain effective internal controls in accordance with
Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on
our ability to report our financial results timely and accurately and on our
stock price.
Section 404 of the Sarbanes-Oxley Act requires annual assessments of the
effectiveness of our internal control over financial reporting and a report
by our independent registered public accounting firm regarding their
opinion of the effectiveness of our internal control over financial
reporting based upon their audit. We are required to complete our initial
assessment by the filing of our Form 10-K for the year ended December 31,
2007 and to obtain the opinion of our independent registered public
accounting firm by the filing of our Form 10-K for the year ended December
31, 2008. During the course of our assessment, we may identify deficiencies
in our internal controls over financial reporting which we may not be able
to remediate in time to meet this deadline. A failure to maintain adequate
internal controls may result in material misstatements in our financial
statements and a failure to meet our reporting obligations. As a result
investors may lose confidence in our reported financial information and our
stock price could decline.
Our operations could be interrupted if our network or computer systems fail or
experience a security breach.
Our computer systems and network infrastructure could be vulnerable to
unforeseen problems. Our operations are dependent upon our ability to
protect our computer equipment against damage from fire, power loss,
telecommunications failure or a similar catastrophic event. Any damage or
failure that causes an interruption in our operations could result in a
loss of customers and thereby have a material adverse effect on our
business, operating results and financial condition.
Risks Relating to an Investment in Our Common Stock
Additional growth may require us to raise additional capital in the future, but
that capital may not be available when it is needed, which could adversely
affect our financial condition and results of operations.
We are required by federal and state regulatory authorities to maintain
adequate levels of capital to support our operations. We anticipate that
our current capital resources will satisfy our capital requirements for the
foreseeable future. We may at some point, however, need to raise additional
capital to support our continued growth. Our ability to raise capital, if
needed, will depend on conditions in the capital markets at that time,
which are outside our control, and on our financial performance.
Accordingly, we cannot assure you of our ability to raise capital, if
needed, on terms acceptable to us. If we cannot raise capital when needed,
our ability to implement our business strategy could be materially
impaired.
Our stock price may fluctuate and be volatile.
The prices at which our common stock has traded may not be indicative of
future market prices. The trading price of our common stock has, in the
past, and could continue in the future to fluctuate significantly.
Volatility in our stock price could result from the following factors,
among others:
o variations in quarterly operating results;
o changes in financial estimates by securities analysts;
o the operating and stock price performance of other companies in the
banking industry; and
o general stock market or economic conditions.
The stock market in recent years has experienced price and volume
fluctuations that have often been unrelated or disproportionate to the
operating performance of affected companies.
Our ability to pay dividends is limited, and we may be unable to pay future
dividends if we decide to do so.
Our ability to continue our current dividends is limited by regulatory
restrictions, by the bank's ability to pay dividends to us based on its
capital position and profitability, and by our need to maintain sufficient
capital to support the bank's operations. The ability of the bank to pay
dividends to us is limited by its obligations to maintain sufficient
capital and by other restrictions on its dividends that are applicable to
banks that are regulated by the FDIC. If the bank does not satisfy these
regulatory requirements it will be unable to pay dividends to us and we
will be unable to pay dividends on our common stock to you.
The holders of our junior subordinated debentures have rights that are senior
to those of our common shareholders.
As of December 31, 2006 we had $9.3 million of trust preferred securities
outstanding. Payments of the principal and interest on the trust preferred
securities are conditionally guaranteed by us. Further, the junior
subordinated debentures are senior to our shares of common stock. We have
the right to defer payment of interest on the junior subordinated
debentures for a period not exceeding 20 consecutive quarters. If we defer,
or fail to make, interest payments on the junior subordinated debentures,
we will be prohibited, subject to certain exceptions, from paying cash
dividends on our common stock until we pay all deferred interest and resume
interest payments on the junior subordinated debentures.
We have implemented anti-takeover devices that could make it more difficult for
another company to purchase us, even though such a purchase may increase
shareholder value.
In many cases, shareholders would receive a premium for their shares if we
were purchased by another company. However, state and federal law and our
certificate of incorporation and bylaws make it difficult for anyone to
purchase us without approval of our board of directors. For example, our
articles of incorporation divide the board of directors into three classes
of directors serving staggered three-year terms with approximately
one-third of the board of directors elected at each annual meeting of
shareholders. The classification of directors makes it more difficult for
shareholders to change the composition of the board of directors. As a
result, at least two annual meetings of shareholders would be required for
the shareholders to change a majority of the directors, whether or not a
change in the board of directors would be beneficial and whether or not a
majority of shareholders believe that such a change would be desirable. In
addition, our certificate of incorporation provides that in no event shall
any record owner of any outstanding common stock which is beneficially
owned, directly or indirectly, by a person who beneficially owns in excess
of 10% of the then outstanding shares of common stock be entitled or
permitted to any vote with respect to the shares held in excess of the 10%
limit. Consequently, a takeover attempt may prove difficult, and
shareholders may not realize the highest possible price for their
securities.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
The Company's corporate office is located at 8620 Biggin Hill Lane in
Louisville, Kentucky where the Company's finance and accounting, loan and
deposit operations, mortgage operations and a full service banking office (Stony
Brook Branch) are located. The Company conducts its banking business through
eight full service banking offices located in Harrodsburg, Lawrenceburg and two
locations in Louisville, Kentucky (St. Matthews Branch and Stony Brook Branch)
and Jeffersonville, New Albany, Marengo and Clarksville, Indiana. 1st
Independence Mortgage conducts its business throughout the Bank's branch
network.
The location of the Company's properties, the approximate square
footage and whether owned or leased is described in the following table:
Location Nature Square Feet Status
-------- ------ ----------- ------
Harrodsburg, Kentucky Branch banking facility 12,636 Owned
104 South Chiles Street
Lawrenceburg, Kentucky Branch banking facility 2,550 Owned
1015 Crossroad Drive
Louisville, Kentucky Corporate office (including 14,190 Owned
(Stony Brook Branch) finance and accounting, loan
8620 Biggin Hill Lane and deposit operations),
mortgage operations and
branch banking facility
Louisville, Kentucky Branch banking facility 3,606 Leased
(St. Matthews Branch)
4220 Shelbyville Road
Clarksville, Indiana Branch banking facility 2,817 Leased
1325 Veterans Parkway
Jeffersonville, Indiana Branch banking facility 3,562 Leased
1711 East 10th Street
Marengo, Indiana Branch banking facility 5,856 Owned
309 South Bradley Street
New Albany, Indiana Branch banking facility 11,200 Leased
3801 Charlestown Road
See note 8 to the Company's consolidated financial statements herein
for additional information. The New Albany, Indiana branch is leased from
Chalfant Industries, Inc., a company owned by the Company's Chairman of the
Board of Directors.
Item 3. Legal Proceedings.
The Company, from time to time, is a party to ordinary routine
litigation, which arises in the normal course of business, such as claims to
enforce liens, condemnation proceedings on properties in which the Company holds
security interests, claims involving the making and servicing of real property
loans, and other issues incident to its business. Except as discussed below,
there were no potentially material lawsuits or other legal proceedings pending
or known to be contemplated against the Company at December 31, 2006.
On or about May 28, 2004, a complaint was filed in the Circuit Court of
Anderson County in the Commonwealth of Kentucky by Larry Sutherland, Judy
Sutherland, John Henry Disponett, Brenda Disponett, Todd Hyatt, Lois Ann
Disponett, Sue Saufley, and Hugh Coomer. Soon thereafter, an amended complaint
was filed which added Lois Hawkins and Norma K. Barnett as plaintiffs. The
lawsuit arises from offers to purchase securities made by the Company in
connection with an offer to purchase up to 300,000 shares of its stock in a
tender offer on or about May 28, 2003. The Plaintiffs allege that the Company
made certain material misrepresentations in connection with certain statements
made in the tender offer. The Plaintiffs are seeking to recover compensatory and
punitive damages in connection with the shares it sold in the tender offer and
their attorneys' fees. On April 14, 2006 a partial summary judgment was entered
against the plaintiffs. In the partial summary judgment, the Circuit Court held
that the only remedy available to the plaintiffs is the return of the stock upon
the tender of the consideration received by the plaintiffs in exchange for the
stock. Subsequent to the partial summary judgment, the plaintiffs amended their
complaint to allege certain additional material misrepresentations had been made
by the Company. This matter is currently scheduled for trial in July 2007. Based
upon the advice of counsel, management records an estimate of the amount of
ultimate expected loss for litigation, if any. Management, after discussion with
legal counsel, believes the ultimate result of this litigation will not have a
material adverse effect on the Company's financial position, results of
operations or cash flows. However, events could occur that could cause any
estimate of ultimate loss to differ materially in the near term.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the
fourth quarter ended December 31, 2006.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
Since its issuance in October 1995, the Company's common stock has
traded on the NASDAQ Global Market System. The Company's trading symbol is FIFG.
The quarterly high and low sales prices for the Company's common stock as
reported by NASDAQ and any dividends declared during the quarter are set forth
in the table below.
Quarter Ended
----------------------------------------------------
2006 3/31 6/30 9/30 12/31
---- ---- ---- ---- -----
High $19.00 $18.80 $18.00 $17.90
Low 17.49 16.20 15.67 16.40
Cash dividend declared
per share 0.08 0.08 0.08 0.08
Quarter Ended
----------------------------------------------------
2005 3/31 6/30 9/30 12/31
---- ---- ---- ---- -----
High $19.99 $23.05 $20.50 $20.00
Low 18.21 17.41 19.00 18.00
Cash dividend declared
per share 0.16 0.08 0.08 0.08
The number of shareholders of record of common stock as of December 31,
2006, was approximately 410. This does not reflect the number of persons or
entities who held stock in nominee or "street" name through various brokerage
firms. At December 31, 2006, there were 1,995,594 shares outstanding. The
Company's ability to pay dividends to stockholders is dependent upon the
dividends it receives from the Bank. The payment of cash dividends by the Bank
is limited by regulations of the FDIC. See "Regulations of the Bank - Dividend
and Other Capital Distribution Limitations."
Set forth below is information as of December 31, 2006 with respect to
compensation plans under which equity securities of the Company are authorized
for issuance.
Equity Compensation Plan Information
(c)
(a) (b) Number of securities
Number of securities Weighted-average remaining available for
to be issued upon exercise price future issuance under
exercise of of outstanding equity compensation plan
outstanding options, options, warrants [excluding securities
warrants and rights and rights reflected in column (a)]
---------------------- ------------------- ------------------------
Equity compensation plans approved
by stockholders:
2004 Omnibus Stock Option Plan 51,550 $ 11.83 223,450
1996 Stock Option Plan 81,000 16.50 30,000 (1)
Restricted Stock Plan - - 76,500
Equity compensation plans not
approved by stockholders n/a n/a n/a
------- ------- -------
Total 132,550 $ 14.69 329,950
======= ======= =======
(1) No longer eligible for grant as of January 28, 2007.
Performance Graph
The following Performance Graph and related information shall not be
deemed "soliciting material" or to be "filed" with the Securities and Exchange
Commission, nor shall such information be incorporated by reference into any
future filing under the Securities Act of 1933 or Securities Exchange Act of
1934, each as amended, except to the extent that the Company specifically
incorporates it by reference into such filing.
Comparative Stock Performance Graph
The following performance graph compares the performance of the
Company's Common Stock to the NASDAQ Market Index (U.S.) and the NASDAQ
Financial Stocks Index for the five year period ended December 31, 2006. The
graph assumes an investment of $100 in each of the Company's Common Stock, the
NASDAQ Market Index (U.S.) and the NASDAQ Financial Stocks Index on December 31,
2001 and that all dividends were reinvested.
[GRAPHIC OMITTED]
12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
-------- -------- --------- -------- -------- --------
1st Independence Financial Group, Inc. $100.00 $121.29 $221.53 $187.85 $186.96 $168.82
NASDAQ Market Index (U.S.) 100.00 69.13 103.36 112.49 114.88 126.22
NASDAQ Financial Stocks Index 100.00 102.98 139.28 162.56 166.42 191.34
Item 6. Selected Financial Data.
Selected Consolidated Financial Data
(in thousands except per share data)
Three months ended
Year ended December 31, December 31, Year ended September 30,
--------------------- ------------- ----------------------------------
Results of operations: 2006 2005 2004 2004 2003 2002
---------- --------- ----------- --------- ---------- ---------
Net interest income $ 10,623 $ 10,252 $ 2,330 $ 4,678 $ 3,422 $ 3,592
Provision for loan losses 847 354 - 1,203 3 -
Noninterest income 1,791 6,957 538 682 652 337
Noninterest expense 8,839 10,093 2,537 6,026 2,715 2,476
Net income (loss) 1,940 4,481 240 (1,093) 1,307 670
Per Share Data:
Income (loss) from continuing operations
Basic $ 1.00 $ 2.38 $ 0.13 $ (0.84) $ 0.94 $ 0.77
Diluted 0.99 2.33 0.12 (0.84) 0.94 0.77
Income from subsidiary held for disposal
Basic 0.00 0.00 0.00 0.02 0.20 (0.42)
Diluted 0.00 0.00 0.00 0.02 0.20 (0.42)
Net income (loss)
Basic 1.00 2.37 0.13 (0.83) 1.05 0.54
Diluted 0.99 2.32 0.13 (0.83) 1.05 0.54
Weighted average shares outstanding
Basic 1,941 1,889 1,864 1,318 1,244 1,243
Diluted 1,957 1,929 1,917 1,318 1,245 1,243
Book value - end of period $ 20.20 $ 19.61 $ 19.68 $ 19.38 $ 16.98 $ 16.47
Market value - end of period 16.40 18.50 18.98 20.00 19.42 11.61
Cash dividends declared 0.32 0.40 0.00 0.38 0.60 0.60
Dividend payout ratio 31.96% 16.83% 0.00% (47.30)% 54.94% 110.75%
At December 31, At September 30,
------------------------------------ ----------------------------------
Balance Sheet Data: 2006 2005 2004 2004 2003 2002
---------- --------- ----------- --------- ---------- ---------
Total assets $342,806 $336,187 $337,191 $320,032 $173,764 $153,052
Securities 18,321 18,115 28,873 29,478 31,892 14,564
Loans, excluding held for sale 274,223 269,889 236,197 213,719 84,796 93,510
Allowance for loan losses 3,745 2,911 2,549 2,560 391 390
Deposits 254,077 264,323 223,308 219,817 106,692 98,049
Short-term borrowings 36,526 18,747 23,233 7,121 - 4,000
Long-term borrowings 10,279 13,279 14,247 14,234 6,155 1,000
Stockholders' equity 40,303 38,261 37,706 37,081 20,772 22,066
Shares outstanding at end of period 1,996 1,951 1,916 1,913 1,223 1,340
Three months ended
Year ended December 31, December 31, Year ended September 30,
----------------------- ----------- ----------------------------------
Financial Performance Ratios: 2006 2005 2004 2004 2003 2002
---------- --------- ----------- --------- ---------- ---------
Return on average assets 0.57% 1.38% 0.32% (0.68)% 0.91% 0.76%
Return on average stockholders' equity 4.93 11.92 2.51 (4.58) 5.65 4.32
Net interest margin 3.40 3.44 3.45 3.13 2.82 3.05
Efficiency ratio (1) 71.20 81.88 88.46 112.28 67.35 63.02
Asset Quality Ratios (2):
Nonperforming loans to total loans 1.36% 0.47% 0.52% 0.57% 0.48% 0.36%
Nonperforming assets to total assets 1.21 0.38 0.41 0.44 0.31 0.45
Net charge-offs (recoveries) to
average loans 0.00 0.00 0.00 0.07 0.00 0.02
Allowance for loans losses to total
loans (excluding held for sale) 1.37 1.08 1.08 1.20 0.46 0.42
Allowance for loans losses to
nonperforming loans (3) 100.43 229.21 208.08 210.01 95.13 116.77
Liquidity and Capital Ratios:
Loans to deposits 107.93% 102.11% 105.77% 97.23% 79.48% 95.37%
Average stockholders' equity
to average total assets 11.57 11.59 12.76 14.79 16.08 17.70
Tangible equity to assets (4) 8.47 8.01 7.81 8.01 11.75 14.42
Leverage ratio 11.60 10.20 9.60 9.90 11.40 11.70
Tier 1 risk-based capital ratio 14.60 13.10 13.30 13.90 20.60 20.60
Total risk-based capital ratio 15.90 15.10 15.60 16.20 21.10 21.10
(1) Efficiency ratio is noninterest expense divided by net interest income plus noninterest income (excluding securities
gains and losses).
(2) At period end, except for net charge-offs to average loans.
(3) Nonperforming loans consist of nonaccrual loans, loans contractually past due 90 days or more and restructured loans.
(4) Calculated by dividing stockholders' equity less goodwill and core deposit intangibles by total assets.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation.
The following is a discussion of the consolidated financial condition
and results of operations of the Company for the periods presented, and certain
factors that may affect the Company's prospective financial condition. This
section should be read in conjunction with the consolidated financial statements
and the notes thereto appearing elsewhere or incorporated by reference in this
Annual Report on Form 10-K including note 1 which describes the Company's
significant accounting policies including its use of estimates. See the caption
entitled "Critical Accounting Policies and Estimates" in this section for
further information. The following discussion contains statements which are
forward-looking rather than historical fact. Forward-looking statements, which
are based on certain assumptions and describe future plans, strategies, and
expectations of the Company, are generally identified by use of the words
"plan," "believe," "expect," "intend," "anticipate," "estimate," "project," or
similar expressions. These forward-looking statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and involve risks and uncertainties that could render them materially different,
including, but not limited to, changes in general economic conditions; interest
rates, deposit flows, loan demand, real estate values, competition and demand
for financial services and loan, deposit, and investment products in the
Company's local markets; changes in the quality and composition of the loan or
investment portfolios; changes in accounting principles, policies, or
guidelines; changes in legislation and regulation; changes in the monetary and
fiscal policies of the U.S. Government, including policies of the U.S. Treasury
and the Federal Reserve Board; war or terrorist activities; and other economic,
competitive, governmental, regulatory, geopolitical, and technological factors
affecting the Company's operations, pricing, and services, and other risks as
detailed in the Company's various Securities and Exchange Commission filings.
Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this filing.
Except as required by applicable law or regulation, the Company undertakes no
obligation to update these forward-looking statements to reflect events or
circumstances that occur after the date on which such statements were made.
General
The Company provides commercial and retail banking services, including
commercial real estate loans, one-to-four family residential mortgage loans via
1st Independence Mortgage, home equity loans and lines of credit and consumer
loans as well as certificates of deposit, checking accounts, money-market
accounts and savings accounts within its market area. At December 31, 2006, the
Company had total assets, deposits and stockholders' equity of $342.8 million,
$254.1 million, and $40.3 million, respectively. The Company's business is
conducted principally through the Bank. Unless otherwise indicated, all
references to the Company refer collectively to the Company and the Bank.
The Company is currently a defendant in a lawsuit that asserts that the
Company made certain material misrepresentations in connection with its offer to
purchase up to 300,000 shares of stock in a tender offer in May 2003. The
plaintiffs are seeking to recover damages in connection with the shares they
sold in the tender offer and attorneys fees. This matter is currently scheduled
for trial in July 2007. Based upon the advice of counsel, management records an
estimate of the amount of ultimate expected loss for litigation, if any.
Management has not recorded a loss provision for this litigation as, after
discussion with legal counsel, management believes the ultimate result of this
litigation will not have a material adverse effect on the Company's financial
position, results of operations or cash flows. Events could occur that could
cause the estimate of ultimate loss to differ materially in the near term.
In January 2005, the Company sold its interest in Citizens Financial
Bank, Inc., Glasgow, Kentucky ("Citizens") to another financial institution for
$2.3 million. The sale of Citizens reflected the Company's revised strategic
plan to exit the south central Kentucky market and to focus on the growing
markets of southern Indiana, central Kentucky, and greater Louisville, Kentucky.
The Bank also purchased property and a building, located in Louisville,
Kentucky, that was previously used as an operations center and retail branch of
an affiliate of the financial institution that purchased Citizens. The purchase
price of the building and property was $2.3 million. The Bank moved its finance
and accounting, loan and deposit operations, and mortgage banking operations
into the building in April 2005. The Bank also received regulatory approval
during the second quarter of 2005 to establish a full service branch at this
location and subsequently opened the branch in November 2005.
Critical Accounting Policies and Estimates
The discussion and analysis of the Company's financial condition and
results of operations is based upon the Company's consolidated financial
statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period.
On an ongoing basis, management evaluates the Company's accounting
polices and estimates it uses to prepare the consolidated financial statements.
In general, management's estimates are based on historical experience, on
information from regulators and third party professionals and other assumptions
believed to be reasonable under the circumstances. Actual results could differ
from those estimates.
The following critical accounting policies affect the Company's more
significant judgements and estimates used to prepare the consolidated financial
statements:
Other Than Temporary Impairment of Securities. Securities are
evaluated periodically to determine whether a decline in their value is other
than temporary. Management utilizes criteria such as the magnitude and duration
of the decline, in addition to the reasons underlying the decline, to determine
whether the loss in value is other than temporary. The term "other than
temporary" is not intended to indicate that the decline is permanent. It
indicates that the prospects for a near term recovery of value are not
necessarily favorable, or that there is a lack of evidence to support fair
values equal to, or greater than, the carrying value of the investment. Once a
decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized.
Allowance for Loan Losses. Determining the amount of the allowance for
loan losses necessarily involves a high degree of judgment. To assess the
adequacy of the allowance, management uses historical information as well as the
prevailing business environment, as it is affected by changing economic
conditions and various external factors, which may impact the portfolio in ways
currently unforeseen. The allowance is increased by provisions for loan losses
and by recoveries of loans previously charged-off and reduced by loans
charged-off. For a full discussion of the methodology of assessing the adequacy
of the allowance for loan losses, see the "Provision for Loan Losses" section
elsewhere within this Management's Discussion and Analysis of Financial
Condition and Results of Operations and note 5 to the Company's consolidated
financial statements.
Goodwill. Acquisitions accounted for under the purchase method of
accounting require that assets acquired and liabilities assumed be recorded at
their fair value which is an estimate determined by the use of internal or other
valuation techniques. These valuation estimates result in goodwill and other
intangible assets with goodwill representing the excess of the purchase price
over the fair value of acquired tangible assets and liabilities and identifiable
intangible assets. Goodwill is subject to an annual impairment test and is
evaluated using various fair value techniques. See note 7 to the Company's
consolidated financial statements for further information.
Overview
Net income for the year ended December 31, 2006 was $1,940,000 or $0.99
per diluted share compared to net income of $4,481,000 or $2.32 per diluted
share for the year ended December 31, 2005. The decreases in net income and net
income per diluted share for the year ended December 31, 2006 were primarily due
to after tax securities gains of $3,308,000 taken in the first quarter of 2005
and the increase of $325,000 after taxes in the provision for loan losses in the
year 2006 compared to the year 2005. Partially offsetting these factors was an
increase in net interest income of $245,000 after taxes and an after tax charge
of $235,000 recorded in the first quarter of 2005 for severance expenses related
to the retirement of the Company's former Chairman and Chief Executive Officer.
Other factors were decreased incentive expense, employee benefit expense,
marketing expense, professional fees and other noninterest expense items.
Partially offsetting these factors were increased net occupancy expense and data
processing expense.
Net income for the year ended December 31, 2005 was $4,481,000 or $2.32
per diluted share compared to a loss of ($1,036,000) or ($0.69) per diluted
share for the twelve months ended December 31, 2004. The Company changed its
fiscal year from September 30 to December 31, effective December 31, 2004.
Accordingly, results of operations and related statistical information set forth
in this Management's Discussion and Analysis of Financial Condition and Results
of Operations for the twelve months ended December 31, 2004 is unaudited and is
derived by taking the (audited) twelve months ended September 30, 2004 amount
and adding the (audited) three months ended December 31, 2004 amount and
subtracting the (unaudited) three months ended December 31, 2003 amount. The
increases in net income and net income per diluted share for the year ended
December 31, 2005 were primarily due to after tax securities gains of $3,308,000
taken in the first quarter of 2005 which was previously mentioned and the
significance of the Company's July 2004 merger with Independence Bancorp (the
"Merger") to the Company's operations including an after tax charge of
approximately $526,000 recorded in the second quarter of 2004 in connection with
the termination of a data processing contract. Other factors which contributed
to the increase were a decrease of $560,000, after taxes, in the provision for
loan losses taken in the twelve months ended December 31, 2005 compared to the
same period in 2004, an after tax charge of $158,000 relating to the Bank's
termination of its pension plan in the third quarter of 2004, a $356,000
goodwill writeoff recorded in the third quarter of 2004 in regards to the
Citizens disposal and certain merger-related expenses also taken in the third
quarter of 2004. Partially offsetting these factors was the after tax charge of
$235,000 recorded in the first quarter 2005 for severance expenses related to
the retirement of the Company's former Chairman and CEO which was previously
mentioned.
Results of Operations
Net Interest Income
Net interest income is the most significant component of the Company's
revenues. Net interest income is the difference between interest income on
interest-earning assets (primarily loans and investment securities) and interest
expense on interest-bearing liabilities (deposits and borrowed funds). Net
interest income depends on the volume and rate earned on interest-earning assets
and the volume and rate paid on interest-bearing liabilities.
Net interest income was $10.6 million for the year ended December 31,
2006, an increase of $0.3 million or 4% from $10.3 million for the year ended
December 31, 2005. Net interest spread and net interest margin were 2.98% and
3.40%, respectively, for the year ended December 31, 2006, compared to 3.14% and
3.44% for the year ended December 31, 2005. The decrease in net interest spread
and net interest margin for the year 2006 compared to the year 2005 was
primarily due to the reversal of $57,000 of interest income on a $2.6 million
loan which was placed on nonaccrual in August 2006 and a faster increase in
interest rates on interest-bearing liabilities, including the effect of the
increasing rate on the $4.1 million of variable rate subordinated debentures,
compared to the rates on interest-earning assets. Partially offsetting these
factors were increases in the volume of net earning assets. Changes in volume
resulted in an increase in net interest income of $0.7 million for the year of
2006 compared to the year 2005, and changes in interest rates and the mix
resulted in a decrease in net interest income of $0.4 million for the year 2006
versus the year 2005.
Net interest income was $10.3 million for the year ended December 31,
2005, an increase of $4.1 million or 67% from $6.2 million for the twelve months
ended December 31, 2004. Net interest spread and net interest margin were 3.14%
and 3.44%, respectively, for the year ended December 31, 2005, compared to 3.07%
and 3.30% for the twelve months ended December 31, 2004. The increase in the net
interest margin was due to an increase in the volume of net interest bearing
assets, primarily resulting from the Merger and due to loan growth since the
Merger. Changes in volume resulted in an increase in net interest income in 2005
of $4.4 million and changes in interest rates and the mix resulted in a decrease
in net interest income of $0.3 million versus the comparable periods in 2004.
For a detailed analysis of interest income and interest expense, see
"Average Balance Sheets" and "Rate/Volume Analysis" below.
Average Balance Sheets
The following table set forth certain information relating to the
Company for the periods indicated. The average yields and costs are derived by
dividing income or expense by the average balance of assets or liabilities,
respectively, for the periods presented.
Year ended December 31, Year ended December 31, Twelve months ended December 31,
2006 2005 (1) 2004 (1)
---------------------------- ---------------------------- ----------------------------
Average Average Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost
--------- ------- --------- -------- ------ -------- -------- ------- -------
(in thousands except percentages)
Earning assets:
Loan, net of unearned incom $277,974 $20,798 7.48% $259,119 $17,009 6.56% $148,072 $ 9,158 6.17%
Investment securities and other (2) 34,060 1,640 4.82 38,827 1,437 3.70 37,569 1,238 3.29
-------- ------- -------- ------ ------- -------
Total earning assets 312,034 22,438 7.19 297,946 18,446 6.19 185,641 10,396 5.58
------- ------ -------
Less allowance for loan losses 3,157 2,747 1,404
-------- -------- --------
308,877 295,199 184,237
Assets of discontinued operations 41,923
Non-earning assets:
Cash and due from banks 5,462 4,604 4,320
Premises and equipment, net 8,259 7,856 3,726
Other assets 17,584 16,431 11,172
-------- -------- --------
Total assets $340,182 $324,090 $245,378
======== ======== ========
Interest bearing liabilities:
Deposits $249,173 10,060 4.04 $237,321 6,852 2.89 $150,147 3,556 2.36
Borrowings 31,433 1,755 5.58 31,302 1,342 4.29 18,398 690 3.75
-------- ------- -------- ------ -------- -------
Total interest bearing
liabilities 280,606 11,815 4.21 268,623 8,194 3.05 168,545 4,246 2.51
------- ------ -------
Liabilities of discontinued operations 37,631
Non-earning liabilities:
Non-interest bearing deposits 18,539 16,016 6,916
Other liabilities 1,674 1,861 2,228
-------- -------- --------
Total liabilities 300,819 286,500 215,320
Minority interests - 13 1,770
Stockholders' equity 39,363 37,577 28,288
-------- -------- --------
Total liabilities and
stockholders' equity $340,182 $324,090 $245,378
======== ======== ========
Net interest income $10,623 $10,252 $ 6,150
======= ======= =======
Net interest spread (3) 2.98% 3.14% 3.07%
====== ====== ======
Net interest margin (4) 3.40% 3.44% 3.30%
====== ====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities 111.20% 110.92% 110.14%
====== ====== ======
(1) Average balances and interest income and interest expense related to the
discontinued operations of Citizens have been eliminated.
(2) Includes interest-earning overnight deposits and term deposits with
the FHLB.
(3) Net interest spread represents the difference between the average yield
on earning assets and the average cost of interest bearing liabilities.
(4) Net interest margin represents net interest income as a percentage of
average earning assets.
Rate/Volume Analysis
The following table below sets forth certain information regarding
changes in interest income and interest expense of the Company for the periods
indicated. For each category of earning assets and interest bearing liabilities,
information is provided on changes attributable to (i) changes in volume (change
in average volume multiplied by old rate); and (ii) changes in rates (change in
rate multiplied by old average volume). Changes in rate/volume (change in rate
multiplied by the change in volume) have been allocated to the changes due to
volume and rate in proportion to the absolute value of the changes due to volume
and rate prior to the allocation.
Year ended December 31, Year ended December 31,
2006 vs. 2005 (1) 2005 vs. 2004 (1)
------------------------------------ ------------------------------------
Increase (decrease) due to change in Increase (decrease) due to change in
------------------------------------ ------------------------------------
Volume Rate Net Volume Rate Net
--------- --------- --------- ---------- --------- ----------
(in thousands)
Interest income
Loans $1,294 $2,495 $3,789 $7,241 $ 610 $7,851
Investment securities and other (2) (192) 395 203 42 157 199
------ ------ ------ ------ ------ ------
Total interest income 1,102 2,890 3,992 7,283 767 8,050
------ ------ ------ ------ ------ ------
Interest expense
Deposits 358 2,850 3,208 2,377 919 3,296
Borrowings 6 407 413 539 113 652
------ ------ ------ ------ ------ ------
Total interest expense 364 3,257 3,621 2,916 1,032 3,948
------ ------ ------ ------ ------ ------
Net interest income $ 738 $ (367) $ 371 $4,367 $ (265) $4,102
====== ====== ====== ====== ====== ======
(1) Average balances and changes in interest income and interest expense
related to the discontinued operations of Citizens have been eliminated.
(2) Includes interest-earning overnight deposits and term deposits with
the FHLB.
Provision for Loan Losses
The provision for loan losses was $847,000 for the year ended December
31, 2006, compared to $354,000 for the year 2005. Nonperforming loans were $3.7
million at December 31, 2006 and $1.3 million at December 31, 2005, or 1.36% and
0.47%, respectively, of total loans. The increase in the level of nonperforming
loans was primarily due to the result of one loan of $2.6 million that was
placed on nonaccrual status in August 2006 in addition to several other smaller
loans totaling $0.9 million placed on nonaccrual status during the third quarter
of 2006 and a $0.4 million increase in loans delinquent over 90 days but still
accruing at December 31, 2006 compared to the amount at December 31, 2005. A
softening in the 1-4 family residential real estate and real estate construction
markets contributed to the increase in nonperforming loans. The allowance for
loan losses was $3.7 million and $2.9 million at December 31, 2006 and December
31, 2005, or 1.37% and 1.08%, respectively, of total loans.
The provision for loan losses was $354,000 for the year ended December
31, 2005, compared to $1,203,000 for the twelve months ended December 31, 2004.
Nonperforming loans were $1.3 million at December 31, 2005 and $1.2 million at
December 31, 2004, or 0.47% and 0.52%, respectively, of total loans. The
allowance for loan losses was $2.9 million and $2.5 million at December 31, 2005
and December 31, 2004, or 1.08% and 1.08%, respectively, of total loans. The
higher amount of provision for loan losses in 2004 compared to 2005 was
primarily attributable to the changes in the loan mix as a result of the Merger,
as described below.
The Company maintains the allowance for loan losses at a level that it
considers to be adequate to provide for credit losses inherent in its loan
portfolio. Management determines the level of the allowance by performing a
quarterly analysis that considers concentrations of credit, past loss
experience, current economic conditions, the amount and composition of the loan
portfolio (including nonperforming and potential problem loans), estimated fair
value of underlying collateral, loan commitments outstanding, and other
information relevant to assessing the risk of loss inherent in the loan
portfolio. As a result of management's analysis, a range of the potential amount
of the allowance for loan losses is determined.
Prior to the acquisition of Independence Bancorp in July 2004, the
Company operated as a thrift and provided primarily residential real estate loan
products in its markets in central Kentucky. As a result of the Merger and the
Bank's conversion to a state-chartered commercial bank, management made the
decision to no longer originate long-term residential real estate loans for its
loan portfolio. The Company's loan growth since the Merger has primarily
consisted of shorter-term construction loans, commercial real estate loans,
other commercial loans and other loan types traditional to the banking industry.
The Company therefore has different risk characteristics including but not
limited to higher individual loan amounts and increased exposure to economic
conditions.
The Company will continue to monitor the adequacy of the allowance for
loan losses and make additions to the allowance in accordance with the analysis
referred to above. Because of uncertainties inherent in estimating the
appropriate level of the allowance for loan losses, actual results may differ
from management's estimate of credit losses and the related allowance.
Noninterest Income
Noninterest income was $1.8 million for the year ended December 31,
2006, compared to $7.0 million for the year 2005. The significant decrease in
noninterest income for the year 2006 compared to the year 2005 resulted
primarily from a $5.0 million gain on sale of Federal Home Loan Mortgage
Corporation ("FHLMC") preferred stock recorded in the first quarter of 2005. The
gain on loan sales decreased for the year 2006 compared to the year 2005 due to
a slow down in secondary market mortgage activity and lower margins in 2006. The
gain on loan sales was $892,000 for the year 2006 compared to $1,041,000 for the
year 2005. Service charge income was $518,000 for the year 2006 compared to
$391,000 for the year 2005. The Company continues to evaluate its deposit
product offerings with the intention of continuing to expand its offerings to
the consumer and business depositor. During March 2005, the Bank began offering
products which include overdraft privileges on certain individual deposit
products and cash management services for business depositors. Both of these
products are fee-based and should result in further increases in service charge
income. Other factors which primarily offset each other was a reduction of the
loss on sale of premises and equipment which decreased from $156,000 in 2005 to
$32,000 in 2006 which offset a loss of $120,000 in 2006 relating to other real
estate owned compared to no activity in 2005. Factors contributing to the
decrease in other noninterest income for the year 2006 was the Company's
decision to exit the title insurance business at the end of November 2005 and a
decrease in fees due to reduced activity relating to secondary market mortgage
lending and a one time gain of $32,000 on long-term portfolio loans sold in the
first quarter of 2005. The Company's title insurance company had approximately
$264,000 of title insurance revenue for the year ended December 31, 2005.
Noninterest income was $7.0 million for the year ended December 31,
2005, compared to $1.2 million for the twelve months ended December 31, 2004.
Significant increases in noninterest income for the year ended December 31, 2005
resulted from the $5.0 million gain on sale of FHLMC preferred stock recorded in
the first quarter of 2005 which was previously mentioned and gains on loan
sales. The gains on loan sales represented a new source of noninterest income to
the Company after the Merger as the Company did not previously engage in
significant secondary market sales prior to the Merger. Service charge income
was $391,000 for the year ended December 31, 2005, compared to $195,000 for the
twelve months ended December 31, 2004. The increase was primarily attributable
to the Merger. Traditionally, the Company did not have significant service
charge income since the vast majority of their deposit accounts were consumer
accounts. Contributing to the increase in other noninterest income were the
effects of the Merger and approximately $264,000 of title insurance revenue for
the year ended December 31, 2005 from the Company's title insurance company
which began operations in November 2004. As previously mentioned, the Company
decided to exit the title insurance business at the end of November 2005 and
sold the title insurance company at its carrying value.
Noninterest Expense
Noninterest expense was $8.8 million for the year ended December 31,
2006 compared to $10.1 million for the year ended 2005. Contributing to the
decrease was a decrease in salaries and employee benefits due to the $356,000
which the Company accrued during the first quarter of 2005 for the severance
expense relating to the retirement of the Company's former Chairman and Chief
Executive Officer, a reduction in the commissions related to reduced activity in
mortgage loan sales, a reduction in incentive accruals and a decrease in
employee benefit expense due to a plan revision and a lower amount of ESOP
contributions. Additional factors contributing to the decrease were reduced
marketing expense and a reduction in professional fees in the year 2006 compared
to the year 2005 due to a reduced amount of services required. Other factors
included a higher level of other noninterest expenses in the first quarter of
2005 primarily related to integration items associated with the Merger, the
Citizens disposal in January 2005 and the expenses relating to the title
insurance company that was sold which was previously mentioned. Partially
offsetting those factors was an increase in net occupancy expense due to the
Bank's purchase of a building, located in Louisville, Kentucky to accommodate
expansion. In April 2005, the Bank moved its finance and accounting, loan and
deposit operations, and mortgage banking operations into the building and in
November 2005 established a full service branch at this location. An additional
factor offsetting the overall decrease in noninterest expense was an increase in
data processing expense which was primarily due to the growth of the Bank's
services and its commitment to upgrade systems productivity and the effects of a
refund received in the first quarter of 2005 from a previous third party data
processing company of the Bank.
Noninterest expense was $10.1 million for the year ended December 31,
2005 compared to $7.8 million for the twelve months ended December 31, 2004. All
categories of noninterest expense for the year ended December 31, 2005 increased
significantly over the comparable period in 2004 as a result of the Merger which
was effective on July 9, 2004 except for other noninterest expense which was
flat due to several items recorded in 2004 that did not recur in 2005. In
addition, contributing to the increase in salaries and employee benefits was
$356,000 which the Company accrued during the first quarter of 2005 for the
severance expense relating to the retirement of the Company's former Chairman
and CEO. Factors limiting the increase were $797,000 of charges recorded in the
second quarter of 2004 in connection with the termination of a data processing
contract, $239,000 relating to the Bank's termination of its pension plan in the
third quarter of 2004, and items effecting other noninterest expense were a
$356,000 goodwill writeoff recorded in the third quarter of 2004 in regards to
the Citizens disposal and certain merger-related expenses also taken in the
third quarter of 2004.
Income Tax Expense (Benefit)
The effective income tax rate on income from continuing operations was
28.9% for the year ended December 31, 2006 compared to 33.6% for the year 2005.
The decrease in the effective tax rate is primarily due to an increase in the
percentage of tax exempt interest income compared to income from continuing
operations.
The effective income tax rate on income (loss) from continuing
operations was 33.6% for the year ended December 31, 2005 compared to (41.8%)
for the twelve months ended December 31, 2004. The change in the effective
income tax rate was primarily due to the change in income from continuing
operations.
Financial Condition
The Company's total assets were $342.8 million at December 31, 2006
compared to $336.2 million at December 31, 2005, an increase of $6.6 million or
2.0%. Net loans increased $3.5 million, cash and cash equivalents increased $2.0
million, interest receivable and other assets increased $1.0 million,
investments increased $0.2 million while Federal Home Loan Bank ("FHLB") stock
went down $0.4 million and all other assets increased $0.3 million.
Net loans were $270.5 million at December 31, 2006, compared to $267.0
million at December 31, 2005, an increase of $3.5 million or 1.3%. The increases
in loans were in the real estate construction and real estate commercial loan
portfolios, which increased $12.4 million or 24% and $3.2 million or 7%,
respectively. The increases were primarily a result of lending activity in the
Kentucky markets. All loan categories increased or remained the same as a
percentage of total loans, except residential real estate loans, which decreased
from approximately 48% to 45% of total loans and commercial loans which
decreased from 9% to 7% of total loans. The decrease in residential real estate
loans as a percentage of total loans is primarily due to those loans now being
sold in the secondary market through 1st Independence Mortgage, a division of
the Bank, rather than being retained for the Company's loan portfolio. The
Company continues to identify opportunities to cross sell its other products,
including home equity and consumer loans for its loan portfolio resulting from
customer relationships established through the origination of loans by 1st
Independence Mortgage.
Deposits decreased $10.2 million or 3.9% to $254.1 million at December
31, 2006 compared to $264.3 million at December 31, 2005. This decrease was
largely attributable to a decrease in time deposits of $39.8 million which more
than offset increases in savings, NOW and money market deposits of $26.9 million
and demand deposits of $2.7 million. The decrease in time deposits was primarily
due to a $35.9 million decrease in brokered deposits. The increase in savings,
NOW and money market deposits resulted primarily from the effects of a general
marketing campaign during the first nine months of 2005 focusing on existing
products and print advertisements only.
Short-term borrowings increased $17.8 million or 94.8% to $36.5 million
at December 31, 2006, compared to $18.7 million at December 31, 2005. The
Company uses short-term borrowings, primarily short-term FHLB advances, to fund
short-term liquidity needs and manage net interest margin.
Liquidity
Liquidity to meet borrowers' credit and depositors' withdrawal demands
is provided by maturing assets, short-term liquid assets that can be converted
to cash and the ability to attract funds from depositors. Additional sources of
liquidity include brokered deposits, advances from the FHLB and other short-term
borrowings, such as federal funds purchased and securities sold under repurchase
agreements.
At December 31, 2006 and December 31, 2005, brokered deposits were
$23.7 million and $59.6 million, respectively. The weighted average cost and
maturity of brokered deposits were 4.86% and six months at December 31, 2006
compared to 3.90% and nine months at December 31, 2005. The Company plans to
continue using brokered deposits for the foreseeable future to support loan
demand in its market area when pricing for brokered deposits is more favorable
than short-term borrowings.
At December 31, 2006 and December 31, 2005, the Bank had total FHLB
advances outstanding of $36.0 million and $22.0, respectively. Additionally, the
Bank had $25.0 million of unused commitments under its line of credit with the
FHLB and sufficient collateral to borrow an additional $48.1 million.
The Company's liquidity depends primarily on dividends paid to it as
sole shareholder of the Bank. As discussed in note 13 to the consolidated
financial statements, the Bank may pay $7.9 million in dividends to the Company
without regulatory approval, subject to the ongoing capital requirements of the
Bank.
The Company has $9.3 million of subordinated debentures outstanding,
which are included in long-term debt in the accompanying consolidated balance
sheets. Approximately $4.1 million of the debentures are variable rate
obligations with interest rates that reprice quarterly, and are tied to the
three-month London Interbank Offering Rate ("LIBOR") plus 3.15%. At December 31,
2006, the rate on these debentures was 8.52%. The remaining $5.2 million of
debentures carry a fixed interest rate of 6.4% until March 26, 2008 when the
debentures become variable rate obligations that reprice quarterly at the
three-month LIBOR plus 3.15%. At the rates that were in effect at December 31,
2006, the Company's cash requirement to service interest on the debentures for
2007 was $686,000.
Sources and Uses of Cash
The Company derives most of its cash flow from the Bank's activities.
Cash flow of the Bank is provided primarily through financing activities, which
include net increases in deposits and short-term borrowings. These funds are
used to fund investing activities, which include making loans and increasing the
investment portfolio.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in financial
transactions that contain credit, interest rate, and liquidity risk that are not
recorded in the financial statements. Such transactions include traditional
off-balance sheet credit-related financial instruments, and commitments under
long-term debt and operating lease agreements.
The Company provides customers with off-balance sheet credit support
through loan commitments, unused lines of credit, letters of credit, and
commitments to sell loans. A summary of these financial instruments at December
31, 2006 follows:
Less than 1 to 3 3 - 5 Over 5
Total one year years years years
----- -------- ----- ----- -----
(in thousands)
Off- balance sheet items:
Commitments to make loans $21,385 $21,385 $ - $ - $ -
Unused lines of credit 43,983 25,075 8,263 5,356 5,289
Performance letters of credit 2,405 1,202 1,153 50 -
Mortgage banking rate-lock 5,773 5,773 - - -
Since many of the commitments and unused lines of credit are expected
to expire or be only partially used, the total amount of commitments does not
necessarily represent future cash requirements.
Contractual Obligations
The Company is required to make future payments on long-term debt,
which includes long-term FHLB advances and subordinated debentures. In addition
to owned banking facilities, the Company has entered into long-term leases to
support its activities. A summary of these aggregate contractual obligations at
December 31, 2006 follows:
Payments Due by Period
------------------------------------------------
Less than 1 to 3 3 -5 Over 5
Total one year years years years
----- -------- ----- ----- -----
(in thousands)
Aggregate contractual obligations:
FHLB borrowings $ 1,000 $ - $ - $1,000 $ -
Subordinated debentures 9,279 - - - 9,279
Operating lease commitments 2,878 290 483 520 1,585
------- ---- ---- ------ -------
Total $13,157 $290 $483 $1,520 $10,864
======= ==== ==== ====== =======
Asset/Liability Management
The Bank, like many other financial institutions, is vulnerable to an
increase in interest rates to the extent interest-bearing liabilities mature or
reprice more rapidly than interest-earning assets. Historically, the lending
activities of commercial banks emphasized the origination of short to
intermediate term variable rate loans that are more closely matched with the
deposit maturities and repricing of interest-bearing liabilities which occur
closer to the same general time period. While having interest-bearing
liabilities that reprice more frequently than interest-earning assets is
generally beneficial to net interest income during periods of declining interest
rates, it is generally detrimental during periods of rising interest rates.
To reduce the effect of interest rate changes on net interest income,
the Bank has adopted various strategies to improve matching interest-earning
asset maturities to interest-bearing liability maturities. The principal
elements of these strategies include; originating variable rate commercial loans
that include interest rate floors; originating one-to-four family residential
mortgage loans with adjustable rate features, or fixed rate loans with short
maturities; maintaining interest-bearing demand deposits, federal funds sold,
and U.S. government securities with short to intermediate term maturities;
maintaining an investment portfolio that provides stable cash flows, thereby
providing investable funds in varying interest rate cycles; lengthening the
maturities of our time deposits and borrowings when it would be cost effective;
and attracting low cost checking and transaction accounts, which tend to be less
interest rate sensitive when interest rates increase.
The Bank measures its exposure to changes in interest rates using an
overnight upward and downward shift (shock) in the Treasury yield curve. As of
December 31, 2006, if interest rates increased 200 basis points and decreased
200 points, respectively, the Bank's net interest income would increase by 0.4%
and decrease by 0.9%, respectively. The risk position of the Bank is within the
Bank's policy limits.
Regulatory Matters
On July 20, 2006, the Bank received its most recent Community
Reinvestment Act ("CRA") Performance Evaluation prepared as of May 15, 2006. The
Bank was assigned a "Needs to Improve" rating due in part to the Bank's low
level of residential lending to low and moderate income borrowers within the
Louisville, Kentucky Metropolitan Statistical Area. Management has taken
appropriate steps to improve the residential lending issues cited by the Federal
Deposit Insurance Corporation ("FDIC") during the CRA Performance Evaluation. By
statute, a bank with a "less than satisfactory" CRA rating has limitations on
certain future business activities until the CRA rating improves. Management
does not believe these limitations will have any material affect on the Bank's
current business plan.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Information required by this item is included in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operation" under
the caption "Asset/Liability Management."
Item 8. Financial Statements and Supplementary Data.
The following report of independent registered public accounting firm
and the consolidated financial statements of the Company are included below:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
1st Independence Financial Group, Inc.
Louisville, Kentucky
We have audited the accompanying consolidated balance sheets of 1st Independence
Financial Group, Inc. (Company) as of December 31, 2006 and 2005, and the
related consolidated statements of income, comprehensive income, changes in
stockholders' equity and cash flows for the years ended December 31, 2006 and
2005, and the three-month period ended December 31, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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 the Company as of
December 31, 2006 and 2005, and the results of its operations and its cash flows
for the years ended December 31, 2006 and 2005, and the three-month period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
/s/ BKD, LLP
Louisville, Kentucky
March 23, 2007
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Consolidated Balance Sheets
(in thousands except share data)
December 31, December 31,
2006 2005
--------------- ---------------
Assets
Cash and and due from banks $ 16,678 $ 4,327
Interest-bearing demand deposits 6,370 5,886
Federal funds sold 531 11,350
-------------- -------------
Cash and cash equivalents 23,579 21,563
Inerest-bearing deposits 100 100
Available-for-sale securities at fair value 16,421 16,140
Held-to-maturity securities, fair value of $1,930 and
$1,974 at December 31, 2006 and 2005, respectively 1,900 1,975
Loans held for sale 1,227 1,278
Loans, net of allowance for loan losses of $3,745 and
$2,911 at December 31, 2006 and 2005, respectively 270,478 266,978
Premises and equipment, net 8,322 8,215
Federal Home Loan Bank (FHLB) stock 2,313 2,688
Bank owned life insurance 3,435 3,235
Goodwill 11,142 11,142
Interest receivable and other assets 3,889 2,873
------------- -------------
Total assets $342,806 $336,187
============= =============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand $ 18,261 $ 15,570
Savings, NOW and money market 78,083 51,167
Time 157,733 197,586
------------- -------------
Total depositsotal deposits 254,077 264,323
Short-term borrowings 36,526 18,747
Long-term debt 10,279 13,279
Interest payable and other liabilities 1,621 1,577
------------- -------------
Total liabilitiesl liabilities 302,503 297,926
------------- -------------
Commitments and contingencies - -
Stockholders' equity
Preferred stock, $0.10 par value, 500,000 shares authorized, no
shares issued or outstanding - -
Common stock, $0.10 par value, 5,000,000 shares authorized,
1,995,594 shares and 1,951,408 shares outstanding at
December 31, 2006 and 2005, respectively 296 292
Additional paid-in capital 39,775 39,236
Retained earnings 15,169 13,849
Unearned ESOP compensation (291) (380)
Unearned compensation on restricted stock - (24)
Accumulated other comprehensive income (loss) (71) (137)
Treasury stock, at cost, common,
969,835 shares and 969,835 shares at December 31, 2006 and
and 2005, respectively (14,575) (14,575)
------------- -------------
Total stockholders' equity 40,303 38,261
------------- -------------
Total liabilities and stockholders' equity $342,806 $336,187
============= =============
See notes to consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Consolidated Statements of Income
(in thousands except per share data)
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---------- ----------- -----------
Interest and dividend income
Loans, including fees $20,798 $17,009 $3,456
Securities
Taxable 649 693 201
Tax exempt 183 125 27
Federal funds sold 368 332 36
Dividends 158 143 54
Deposits with financial institutions 282 144 16
--------- --------- ---------
Total interest and dividend income 22,438 18,446 3,790
--------- --------- ---------
Interest expense
Deposits 10,060 6,852 1,166
FHLB advances 1,023 727 153
Other 732 615 141
--------- --------- ---------
Total interest expense 11,815 8,194 1,460
--------- --------- ---------
Net interest income 10,623 10,252 2,330
Provision for loan losses 847 354 -
--------- --------- ---------
Net interest income after provision for loan losses 9,776 9,898 2,330
--------- --------- ---------
Noninterest income
Service charges 518 391 82
Gain on loan sales 892 1,041 293
(Loss) on sale of premises and equipment (32) (156) -
(Loss) on other real estate owned (120) - -
Increase in cash value of life insurance 199 188 45
Net realized gains on sales of
available-for-sale securities - 4,883 -
Other 334 610 118
--------- --------- ---------
Total noninterest income 1,791 6,957 538
--------- --------- ---------
Noninterest expense
Salaries and employee benefits 4,162 4,850 1,292
Net occupancy expense 1,586 1,431 248
Data processing fees 759 630 164
Professional fees 590 785 218
Marketing expense 104 362 24
Other 1,638 2,035 591
--------- --------- ---------
Total noninterest expense 8,839 10,093 2,537
--------- --------- ---------
Income from continuing operations before income
taxes and minority interest 2,728 6,762 331
Income tax expense from continuing operations 788 2,273 95
--------- --------- ---------
Income from continuing operations before minority
interest and discontinued operations 1,940 4,489 236
Income from subsidiary held for disposal - 6 24
Income tax expense from subsidiary held for disposal - 2 17
--------- --------- ---------
Income before minority interest 1,940 4,493 243
Minority interest in (income) of consolidated subsidiary
and subsidiary held for disposal - (12) (3)
--------- --------- ---------
Net income $ 1,940 $ 4,481 $ 240
========= ========= =========
Income per share from continuing operations
Basic $1.00 $2.38 $0.13
Diluted 0.99 2.33 0.12
Income per share from subsidiary held for disposal
Basic $0.00 $0.00 $0.00
Diluted 0.00 0.00 0.00
Net income per share
Basic $1.00 $2.37 $0.13
Diluted 0.99 2.32 0.13
Weighted average shares outstanding
Basic 1,941 1,889 1,864
Diluted 1,957 1,929 1,917
See notes to consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Consolidated Statements of Comprehensive Income
(in thousands)
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---------- ---------- -----------
Net income $1,940 $4,481 $240
Other comprehensive income (loss), net of tax
Change in unrealized gains and losses on available-for-sale
securities 66 (686) 305
Less reclassification adjustment for realized gains (losses)
included in net income - 3,223 -
-------- -------- --------
Other comprehensive income (loss) 66 (3,909) 305
-------- -------- --------
Comprehensive income $2,006 $ 572 $545
======== ======== ========
See notes to consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Consolidated Statements of Changes in Stockholders' Equity
(in thousands except share and per share data)
Common Stock Accumulated
---------------- Additional Unearned Other Total
Number of Paid-in Retained ESOP Unearned Comprehensive Treasury Stockholders'
Shares Amount Capital Earnings Compensation Compensation Income (Loss) Stock Equity
--------- ------ ---------- -------- ------------ ------------ ------------ -------- -------------
Balance September 30, 2004 1,913,368 $288 $38,535 $ 9,882 $(516) $ - $ 3,467 $(14,575) $37,081
Net income - - - 240 - - - - 240
Change in other comprehensive
income, net of tax - - - - - - 305 - 305
Exercise of stock options 3,000 1 29 - - - - - 30
ESOP shares released - - 24 - 26 - - - 50
--------- ---- ------- ------- ----- ---- ------- -------- -------
Balance December 31, 2004 1,916,368 $289 $38,588 $10,122 $(490) $ - $ 3,772 $(14,575) $37,706
Net income - - - 4,481 - - - - 4,481
Cash dividends declared,
$0.40 per share - - - (754) - - - - (754)
Change in other comprehensive
income (loss), net of tax - - - - - - (3,909) - (3,909)
Exercise of stock options 54,500 5 877 - - - - - 882
Retirement of stock received
as part of exercise of
stock options (20,960) (2) (411) - - - - - (413)
Issuance of restricted stock 2,000 - 38 - - (38) - - -
Forfeiture of restricted stock (500) - (9) - - 9 - - -
Amortization of unearned
compensation - - - - - 5 - - 5
ESOP shares released - - 153 - 110 - - - 263
--------- ---- ------- ------- ----- ---- ------- -------- -------
Balance December 31, 2005 1,951,408 $292 $39,236 $13,849 $(380) $(24) $ (137) $(14,575) $38,261
Net income - - - 1,940 - - - - 1,940
Cash dividends declared,
$0.32 per share - - - (620) - - - - (620)
Change in other comprehensive
income (loss), net of tax - - - - - - 66 - 66
Exercise of stock options 51,500 5 736 - - - - - 741
Retirement of stock received
as part of exercise of
stock options (14,314) (1) (246) - - - - - (247)
Issuance of restricted stock 7,000 1 (1) - - - - - -
Accrual of compensation expense
for stock options - - 40 - - - - - 40
Amortization of unearned
compensation - - 19 - - - - - 19
ESOP shares released - - 14 - 89 - - - 103
Other - (1) (23) - - 24 - - -
--------- ---- ------- ------- ----- ---- ------- -------- -------
Balance December 31, 2006 1,995,594 $296 $39,775 $15,169 $(291) $ - $ (71) $(14,575) $40,303
========= ==== ======= ======= ===== ==== ======= ======== =======
See notes to consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Consolidated Statements of Cash Flows
(in thousands)
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
----------- ----------- ------------
Cash Flows from Operating Activities:
Net income $ 1,940 $ 4,481 $ 240
Adjustments to reconcile net income to net cash provided by
operations:
Depreciation 716 613 106
Goodwill impairment - - 47
Provision for loan losses 847 354 -
Gain on loan sales (892) (1,041) (293)
Origination of loans held for sale (46,830) (60,408) (18,247)
Proceeds from loans held for sale 47,773 62,515 18,382
Compensation expense on stock options 40 - -
ESOP compensation 103 210 50
Amortization of unearned compensation on restricted stock 19 5 -
Amortization of premiums and discounts on securities 32 117 43
Deferred income taxes (395) 3 68
FHLB stock dividend (122) (100) (21)
Amortization of loan fees (358) (330) (53)
Amortization of intangibles, net 259 336 98
Net realized (gains) losses on available-for-sale securities - (4,883) -
Loss on sale of premises and equipment 32 156 -
Minority interest in income of consolidated subsidiary and
subsidiary held for disposal - 12 2
Increase in cash value of life insurance (199) (188) (45)
(Income) from subsidiary held for disposal - (4) (7)
Changes in:
(Increase) decrease in interest receivable and other assets (70) (594) 618
Increase (decrease) in interest payable and other liabilities 120 507 (177)
------- ------- ------------
Net cash provided by operating activities 3,015 1,761 811
------- ------- ------------
Cash Flows from Investing Activities:
Purchase of interest-bearing deposits (100) - -
Proceeds from maturities of interest-bearing deposits 100 - -
Purchases of available-for-sale securities (2,538) (7,319) -
Proceeds from maturities of available-for-sale securities 2,321 5,474 1,031
Proceeds from the sales of available-for-sale securities - 11,267 -
Proceeds from maturities of held-to-maturity securities 68 165 -
Net (increase) in loans (4,901) (33,578) (23,105)
Purchases of premises and equipment (855) (3,635) (454)
Proceeds from sales of premises and equipment - 24 -
Proceeds from sale of FHLB stock 498 - -
Proceeds, net from sale of subsidiaries - 2,260 -
------- ------- ------------
Net cash (used in) investing activities (5,407) (25,342) (22,528)
------- ------- ------------
Cash Flows from Financing Activities:
Net (decrease) increase in deposits (10,245) 40,968 3,457
Net increase (decrease) in short-term borrowings 17,779 (4,486) 16,112
Repayment of long-term debt (3,000) (1,000) -
Proceeds from exercise of stock options 494 470 30
Cash dividends paid (620) (754) -
------- ------- ------------
Net cash provided by financing activities 4,408 35,198 19,599
------- ------- ------------
Net increase (decrease) in cash and cash equivalents 2,016 11,617 (2,118)
Cash and cash equivalents at beginning of period 21,563 9,946 12,064
------- ------- ------------
Cash and cash equivalents at end of period $23,579 $21,563 $ 9,946
======= ======= ============
Supplemental Cash Flow Information:
Interest paid $11,664 $ 7,800 $ 1,380
Income taxes paid 1,248 1,965 -
Net increase in cash and cash equivalents of
discontinued operations
Net cash (used in) provided by operating activities - (5) 105
Net cash provided by investing activities - 1,647 3,224
Net cash (used in) financing activities - (361) (3,114)
------- ------- ------------
Net increase in cash and cash equivalents of discontinued operations - 1,281 215
------- ------- ------------
Real estate acquired in settlement of loans 710 33 -
See notes to consolidated financial statements.
1st INDEPENDENCE FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Summary of Significant Accounting Policies
Nature of Operations
1st Independence Financial Group, Inc. (the "Company") is a holding company
whose principal activity is the ownership and management of its wholly owned
subsidiary, 1st Independence Bank, Inc. (the "Bank") and 1st Independence
Mortgage, a division of the Bank. The Bank is primarily engaged in providing a
full range of banking and financial services to individual and corporate
customers in Indiana and Kentucky. The Bank is subject to competition from other
financial institutions and is subject to the regulation of certain federal and
state agencies and undergoes periodic examinations by those regulatory
authorities. 1st Independence Mortgage engages in mortgage banking operations.
The Bank sold its majority ownership in Foundation Title Company, LLC at the end
of November 2005 after deciding to exit the title insurance business. As
discussed in note 3, on January 28, 2005 the Company completed the sale of its
entire interest in its majority owned subsidiary, Citizens Financial Bank, Inc.
("Citizens").
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
the Bank. All significant inter-company accounts and transactions have been
eliminated in consolidation. The financial position and results of operations of
Citizens were removed from the detail line items in the Company's financial
statements and presented separately as "subsidiary held for disposal."
The Company changed its fiscal year-end from September 30 to December 31 in
2004. References to periods refer to the one year periods ended December 31,
2006 and 2005 and the three month period ended December 31, 2004, as
appropriate.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses. In connection with
the determination of the allowance for loan losses, management obtains
independent appraisals for significant properties.
Cash Equivalents
The Company considers all liquid investments with original maturities of three
months or less to be cash equivalents.
Securities
Available-for-sale securities, which include any security for which the Company
has no immediate plan to sell, but which may be sold in the future, are carried
at fair value. Unrealized gains and losses are recorded, net of related income
tax effects, in other comprehensive income.
Held-to-maturity securities, which include any security for which the Company
has the positive intent and ability to hold until maturity, are carried at
historical cost adjusted for amortization of premiums and accretion of
discounts.
Amortization of premiums and accretion of discounts are recorded as interest
income from securities. Realized gains and losses are recorded as net security
gains (losses). Gains and losses on sales of securities are determined on the
specific-identification method.
Mortgage Banking Activities
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of aggregate cost or market value. To deliver closed loans
to the secondary market and to control its interest rate risk prior to sale, the
Company enters into "best efforts" contracts. The aggregate market value of
mortgage loans held for sale considers the price of the sales contracts. No
servicing is retained on loans sold into the secondary market.
Loans
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or payoffs are reported at their outstanding principal
balances adjusted for any charge-offs, the allowance for loan losses, any
deferred fees or costs on originated loans and unamortized premiums or discounts
on purchased loans. Interest income is reported on the interest method and
includes amortization of net deferred loan fees and costs over the loan term.
Generally, loans are placed on nonaccrual status at 90 days past due and
interest is considered a loss unless the loan is well-secured and in the process
of collection.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to income. Loan losses are
charged against the allowance when management believes the uncollectibility of a
loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revisions as more information becomes available.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record and the amount of the
shortfall in relation to the principal and interest owed. Impairment is measured
on a loan-by-loan basis for commercial and construction loans by either the
present value of expected future cash flows discounted at the loan's effective
interest rate, the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Company does not separately identify individual
consumer and residential loans for impairment.
Premises and Equipment
Depreciable assets and leasehold improvements are stated at cost less
accumulated depreciation. Depreciation is charged to expense using the
straight-line method over the estimated useful lives of the assets which
generally range from 5 to 39 years for buildings and related components and from
3 to 10 years for furniture, fixtures and equipment.
Federal Home Loan Bank Stock
Federal Home Loan Bank ("FHLB") stock is a required investment for institutions
that are members of the FHLB system. The required investment in the common stock
is based on a predetermined formula and is carried at cost.
Bank Owned Life Insurance
The Bank has purchased life insurance policies on certain key executives.
Company owned life insurance is recorded at its cash surrender value or the
amount that can be realized.
Goodwill
Goodwill is tested annually for impairment. If the implied fair value of
goodwill is lower than its carrying amount, goodwill impairment is indicated and
goodwill is written down to its implied fair value. Subsequent increases in
goodwill value are not recognized in the consolidated financial statements.
Treasury Stock
Treasury stock is stated at cost. Cost is determined by the average cost method.
Stock Options
The Company has two stock-based employee compensation plans ("Plans"), which are
described more fully in note 16. Prior to January 1, 2006, as permitted by
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), the Company followed the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations in accounting for its stock option plans
under the intrinsic value based method. Accordingly, no stock-based compensation
expense was recognized for the year ended December 31, 2005 or the three months
ended December 31, 2004 for stock options issued under the plans as all stock
options granted under the plans had an exercise price equal to the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and basic and diluted net income per share
had compensation expense been determined based on the fair value of the stock
options at the grant date consistent with the provisions of SFAS No. 123 (in
thousands except per share data):
Three months
Year ended ended
December 31, December 31,
2005 2004
---- ----
Net income as reported $4,481 $240
Less total stock-based employee
compensation expense (including
forfeitures of $65 and $0) determined
under fair value method for all awards,
net of related tax effects (47) 4
------ ----
Pro forma net income $4,528 $236
====== ====
Basic net income per share
As reported $2.37 $0.13
Pro forma 2.40 0.13
Diluted net income per share
As reported $2.32 $0.13
Pro forma 2.35 0.12
The weighted average fair value of stock options granted in 2006 and 2005 was
$4.87 and $6.65, respectively, and was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions:
Year ended Year ended
December 31, December 31,
2006 2005
---- ----
Risk-free interest rate 4.72% 4.17%
Dividend yield 1.80% 1.69%
Volatility factor 22% 27%
Expected term of options (in years) 7 10
There were no stock options granted in the three months ended December 31, 2004.
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No.123R, "Share-Based Payment"
("SFAS 123R"). This Statement requires expensing of stock options and other
share-based payments over the related vesting period and supersedes FASB's
earlier rule (the original SFAS 123) that had allowed companies to choose
between expensing stock options and showing pro forma disclosure only. SFAS 123R
permits companies to adopt its requirements using either a "modified
prospective" method, or a "modified retrospective" method. Under the "modified
prospective" method, compensation cost is recognized in the financial statements
beginning with the effective date, based on the requirements of SFAS 123R for
all share-based payments granted after that date, and based on the requirements
of SFAS 123 for all unvested awards granted prior to the effective date of SFAS
123R. Under the "modified retrospective" method, the requirements are the same
as under the "modified prospective" method but this method also permits entities
to restate financial statements of previous periods based on proforma
disclosures made in accordance with SFAS 123. Beginning in January 2006, the
Company adopted the Statement as required and elected the "modified prospective"
method and thus has not restated prior financial statements. For the year ended
December 31, 2006, the Company recorded $40,000 in employee stock-based
compensation expense, which is included in salaries and employee benefits. As of
December 31, 2006, there was $22,000 of unrecognized stock-compensation expense
for previously granted unvested options that will be recognized over a
weighted-average period of 1.4 years.
Income Taxes
Deferred tax assets and liabilities are recognized for the tax effects of
differences between the consolidated financial statement and tax basis of assets
and liabilities. A valuation allowance is established to reduce deferred tax
assets if it is more likely than not that a deferred tax asset will not be
realized. The Company files consolidated income tax returns with 1st
Independence Bank.
Employee Stock Ownership Plan ("ESOP")
The cost of shares issued to the ESOP, but not yet allocated to participants, is
shown as a reduction to stockholders' equity. Compensation expense is based on
the market price of shares as they are committed to be released to participant
accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends
on unearned ESOP shares reduce debt and accrued interest. Effective January 1,
2006, the ESOP was combined with the Company's 401(k) plan and now a portion of
the released shares are used as the Company's 401(k) match.
Net Income Per Share
Net income per share has been computed based upon the weighted-average common
shares outstanding during each year. Unearned ESOP shares have been excluded
from the computation of average shares outstanding.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes unrealized gains and losses on securities
available for sale, which are recognized as a separate component of equity.
Other comprehensive income (loss) includes $9,794 of unrealized gains related to
Citizens for the three month period ending December 31, 2004, for which deferred
taxes were provided.
Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No.123R, "Share-Based Payment"
("SFAS 123R"). This Statement required expensing of stock options and other
share-based payments over the related vesting period beginning in 2005, and
superseded FASB's earlier rule (the original SFAS 123) that had allowed
companies to choose between expensing stock options and showing pro forma
disclosure only. The Statement required that public entities apply SFAS 123R as
of the first interim or annual reporting period that began after June 15, 2005.
However, in April 2005 the United States Securities and Exchange Commission
issued a rule that revised the required date of adoption under SFAS 123R. The
new rule allowed for public entities to adopt the provisions of SFAS 123R at the
beginning of the first fiscal year beginning after June 15, 2005. The Company
adopted the Statement in the first quarter of 2006 as required and the effects
of initial adoption were immaterial. See the previous section entitled, "Stock
Options" in this footnote for additional information.
In July 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN 48"). The
Interpretation clarifies the accounting for uncertainty in income taxes
recognized in accordance with FASB Statement No. 109, "Accounting for Income
Taxes". FIN 48 also prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The evaluation of a tax position in
accordance with this Interpretation is a two-step process. The first step is a
recognition process to determine whether it is more likely than not that a tax
position will be sustained upon examination, including resolution of any related
appeals or litigation processes, based on the technical merits of the position.
The second step is a measurement process whereby a tax position that meets the
more likely than not recognition threshold is calculated to determine the amount
of benefit to recognize in the financial statements. FIN 48 is effective for
fiscal years beginning after December 15, 2006 and the cumulative effect of
applying the provisions of this statement will be recognized as an adjustment to
the beginning balance of retained earnings. The Company is currently evaluating
the potential impact this Statement may have on the Company's financial position
and results of operations, but does not believe the impact of the adoption will
be material.
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, "Fair Value Measurements" ("SFAS 157"), which provides guidance on how
to measure assets and liabilities that use fair value. SFAS 157 will apply
whenever another US GAAP standard requires (or permits) assets or liabilities to
be measured at fair value but does not expand the use of fair value to any new
circumstances. This Statement also will require additional disclosures in both
annual and quarterly reports. SFAS 157 will be effective for financial
statements issued for fiscal years beginning after November 15, 2007, and will
be adopted by the Company beginning in the first quarter of 2008. The Company is
currently evaluating the potential impact this Statement may have on the
Company's financial position and results of operations, but does not believe the
impact of the adoption will be material.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108 was
issued in order to eliminate the diversity of practice in how public companies
quantify misstatements of financial statements, including misstatements that
were not material to prior years' financial statements. The Company initially
adopted the provisions of SAB 108 in connection with the preparation of our
annual financial statements for the year ending December 31, 2006 as required
and the impact on the Company's financial position and results of operations was
immaterial.
Reclassifications
Certain prior year amounts have been reclassified to conform with current
classifications. These reclassifications had no effect on net income.
2. Restrictions on Cash and Due from Banks
The Bank is required by law to maintain average reserve balances, in the form of
vault cash and non-interest bearing balances with the Federal Reserve Bank,
against a percentage of certain deposit liabilities. The reserve required was
approximately $2,252,000 and $869,000 at December 31, 2006 and 2005,
respectively.
3. Completion of Subsidiary Disposal
On January 28, 2005 the Company completed the sale of its entire interest in its
majority owned subsidiary, Citizens Financial Bank, Inc., to Porter Bancorp,
Inc. for $2.3 million, pursuant to a Stock Purchase Agreement, dated as of
October 22, 2004, between Porter Bancorp, Inc. and the Company. In accordance
with Financial Accounting Standard No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", the financial position and results of operations
of Citizens prior to the sale were removed from the detail line items in the
Company's financial statements and presented separately as "subsidiary held for
disposal." Recorded goodwill related to the Company's investment in Citizens in
the amount of $356,000 was written off as impaired in the fourth quarter of
2004.
In a related transaction, on January 28, 2005, the Company's subsidiary bank,
1st Independence Bank, Inc., purchased a commercial building located in
Louisville, Kentucky, for $2.3 million from Ascencia Bank, Inc., an affiliate of
Porter Bancorp, Inc.
The following is a condensed balance sheet as of December 31, 2004 and a
condensed statement of income for the three month period ended December 31, 2004
for Citizens (in thousands):
December 31,
2004
-----------
Assets
Cash and cash equivalents $ 1,796
Available-for-sale securities 5,777
Loans, net of allowance for loan losses of $596 28,930
Premises and equipment, net 209
Other real estate owned 404
Other assets 1,030
-------
Total assets $38,146
=======
Liabilities
Deposits $31,829
Federal funds purchased 254
FHLB advances 1,949
Other liabilities 97
-------
Total liabilities 34,129
Stockholders' equity 4,017
-------
Total liabilities and stockholders' equity $38,146
=======
Three months ended
December 31,
2004
----
Interest income $554
Interest expense 236
----
Net interest income 318
Provision for loan losses 13
Noninterest income 56
Noninterest expense 337
Income tax expense 17
----
Net income $ 7
====
4. Securities
The amortized cost and approximate fair value of securities are as follows (in
thousands):
Gross Gross
Amortized Unrealized Unrealized Approximate
Cost Gains (Losses) Fair Value
----------- ------------ ------------ -------------
Available-for-sale securities
December 31, 2006
U.S. government agencies $ 1,999 $ - $ (14) $ 1,985
State and municipal 2,638 20 (17) 2,641
Mortgage-backed 11,892 30 (127) 11,795
------- --- ----- -------
$16,529 $50 $(158) $16,421
======= === ===== =======
December 31, 2005
U.S. government agencies $ 1,999 $ 1 $ (26) $ 1,974
State and municipal 2,643 26 (59) 2,610
Mortgage-backed 11,705 16 (165) 11,556
------- --- ----- -------
$16,347 $43 $(250) $16,140
======= === ===== =======
Held-to-maturity securities
December 31, 2006
State and municipal $ 1,900 $54 $ (24) $ 1,930
Mortgage-backed - - - -
------- --- ----- -------
$ 1,900 $54 $ (24) $ 1,930
======= === ===== =======
December 31, 2005
State and municipal $ 1,975 $40 $ (41) $ 1,974
Mortgage-backed - - - -
------- --- ----- -------
$ 1,975 $40 $ (41) $ 1,974
======= === ===== =======
The amortized cost and approximate fair value of available-for-sale securities
and held-to-maturity securities at December 31, 2006, by contractual maturity,
are shown below (in thousands). Expected maturities will differ from contractual
maturities because issuers may have the right to call or prepay obligations with
or without call or prepayment penalties.
Available for Sale Held to Maturity
---------------------------- ---------------------------
Amortized Approximate Amortized Approximate
Cost Fair Value Cost Fair Value
----------- ------------- ------------ -------------
Due within one year $ 1,185 $ 1,170 $ 90 $ 90
Due after one year through five years 999 998 50 51
Due after five years through ten years 833 822 1,504 1,531
Due after ten years 1,620 1,636 256 258
Mortgage-backed securities 11,892 11,795 - -
------- ------- ------ ------
$16,529 $16,421 $1,900 $1,930
======= ======= ====== ======
The approximate fair value of available-for-sale securities pledged as
collateral to secure public deposits and for other purposes, was $3,332,000 and
$2,365,000 at December 31, 2006 and 2005, respectively.
Gross gains of $5,012,000 and gross losses of $129,000 resulting from sales of
available-for-sale securities were realized for the year ended December 31,
2005. There were no sales of securities for the year ended December 31, 2006 or
for the three months ended December 31, 2004.
The following table is a summary of investment securities with gross unrealized
losses at December 31, 2006 and December 31, 2005, aggregated by investment
category and length of time that individual securities have been in a continuous
unrealized loss position (in thousands):
Less than 12 months 12 months or longer Total
------------------- ------------------- -----------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
---------- ---------- ---------- ---------- ---------- ----------
December 31, 2006
U.S. government agencies $ 998 $ (1) $ 987 $ (13) $ 1,985 $ (14)
State and municipal - - 2,757 (41) 2,757 (41)
Mortgage-backed 1,373 (5) 8,386 (122) 9,759 (127)
------ ----- ------- ----- ------- -----
Total temporarily impaired $2,371 $ (6) $12,130 $(176) $14,501 $(182)
====== ===== ======= ===== ======= =====
December 31, 2005
U.S. government agencies $ 974 $ (26) $ - $ - $ 974 $ (26)
State and municipal 2,098 (56) 794 (44) 2,892 (100)
Mortgage-backed 10,573 (165) - - 10,573 (165)
------- ----- ------- ----- ------- -----
Total temporarily impaired $13,645 $(247) $ 794 $ (44) $14,439 $(291)
======= ===== ======= ===== ======= =====
These declines primarily resulted from recent increases in market interest rates
and failure of certain investments to maintain consistent credit quality
ratings.
Based on evaluation of available evidence, including recent changes in market
interest rates, credit rating information and information obtained from
regulatory filings, management believes the declines in fair value for these
securities are temporary.
Should the impairment of any of these securities become other than temporary,
the cost basis of the investment will be reduced and the resulting loss
recognized in net income in the period the other-than-temporary impairment is
identified.
5. Loans and Allowance for Loan Losses
The composition of the loan portfolio at each of the dates indicated was as
follows (in thousands):
December 31, December 31,
2006 2005
---- ----
Residential real estate $121,216 $128,949
Commercial real estate 49,943 46,731
Commercial 20,393 23,757
Construction 64,244 51,877
Consumer 4,401 1,960
Home equity 14,026 16,615
-------- --------
Total loans 274,223 269,889
Less allowance for loan losses 3,745 2,911
-------- --------
Net loans $270,478 $266,978
======== ========
Activity in the allowance for loan losses was as follows (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Balance at the beginning of period $2,911 $2,549 $2,560
Provision for loan losses 847 354 -
Loans charged off (17) (11) (46)
Recoveries on loans 4 19 35
------ ------ ------
Balance at end of period $3,745 $2,911 $2,549
====== ====== ======
Impaired loans were as follows (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Impaired loans at end of period $3,398 $514 $565
Impaired loans at end of period with
allowance allocated 3,351 448 181
Allowance allocated for impaired loans 610 128 102
Average impaired loans during the period 3,372 511 568
Interest income recognized during the period 114 19 8
Interest income received during the period 114 18 5
Nonperforming loans were as follows (in thousands):
December 31, December 31,
2006 2005
---- ----
Loans past due 90 days or more
and still on accrual $ 31 $ 130
Nonaccrual loans 3,698 1,140
------ ------
Total nonperforming loans $3,729 $1,270
====== ======
Loans held for sale activity is as follows (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Balance at the beginning of period $ 1,278 $ 2,344 $ 2,186
Origination of loans held for sale 46,830 60,408 18,247
Sales proceeds (47,773) (62,515) (18,382)
Gain on sales of loans 892 1,041 293
------- ------- -------
Balance at end of period $ 1,227 $ 1,278 $ 2,344
======= ======= =======
In conjunction with the mortgage banking activities, the Company enters into
commitments to originate and commitments to sell loans, both of which are
considered derivatives. The Company's commitments are generally for fixed rate
mortgage loans, lasting 45 days and are at market rates when initiated. The
Company had commitments to originate $5,773,000 and $2,669,000 in loans as of
December 31, 2006 and 2005, respectively, which it intends to sell.
6. Premises and Equipment
A summary of premises and equipment follows (in thousands):
December 31, December 31,
2006 2005
---- ----
Land $ 1,487 $1,387
Buildings and improvements 6,473 5,714
Furniture, fixtures and equipment 2,598 2,460
Construction in progress 63 151
------- ------
10,621 9,712
Less accumulated depreciation 2,299 1,497
------- ------
Net premises and equipment $ 8,322 $8,215
======= ======
Depreciation expense was $716,000, $613,000 and $106,000 for the year ended
December 31, 2006, the year ended December 31, 2005 and the three months ended
December 31, 2004, respectively.
7. Goodwill and Intangible Assets
The change in the carrying amount of goodwill is as follows (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Balance at the beginning of period $11,142 $11,142 $11,188
Impairment - - (46)
------- ------- -------
Balance at end of period $11,142 $11,142 $11,142
======= ======= =======
The Company also has a core deposit intangible of $258,000 that was recorded in
2004 relating to an acquisition. The amount is being amortized over eight years
using an accelerated method. Net core deposit intangible is as follows (in
thousands):
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Core deposit intangible $258 $258 $258
Less accumulated amortization 125 78 24
---- ---- ----
Net core deposit intangible $133 $180 $234
==== ==== ====
Estimated amortization expense for each of the next five years follows (in
thousands):
2007 $40
2008 33
2009 26
2010 19
2011 11
8. Leases
A lease was entered into in December 2000 to lease an office facility which is
now the Bank's New Albany, Indiana branch from an entity owned by the Company's
Chairman of the Board of Directors under an operating lease for 15 years. Base
monthly rentals are $10,000, with increases in January 2006 and 2011 equal to
the percentage increase in the U. S. Consumer Price Index - All Urban Consumers
("CPI-U") for the prior five-year period. The Company may purchase the facility
at any time for $1,187,000, plus an increase equal to the percentage increase in
the CPI-U from January 1, 2001, until the month of purchase.
A lease was entered into in December 2001 to lease an office building for the
Bank's Jeffersonville, Indiana branch. This three year operating lease was from
January 1, 2002, through year-end 2004 with three three-year renewal options. In
March 2005, the Bank exercised its option to purchase the facility for $322,000.
A lease was entered into in August 2002 to lease an office facility for the
Bank's mortgage banking operations. This three year operating lease was from
August 1, 2002, to July 31, 2005, with a two-year renewal option. Monthly
payments were $2,200, $2,300 and $2,400 through July 2003, 2004 and 2005,
respectively. The Bank moved its mortgage banking operations to a building that
was purchased in 2005 by the Bank and did not renew this lease.
A lease was entered into in April 2003 to lease an office building for the
Bank's St. Matthews, Kentucky branch. This 15-year operating lease is from May
1, 2003, through April 30, 2018, with a five-year renewal option. Monthly
payments are $4,000, $4,500, $5,000, $6,500 and $8,000 through April 2005, 2007,
2009, 2013 and 2018, respectively.
A lease was entered into in May 2004 to lease an office facility for the Bank's
Clarksville, Indiana branch from an entity owned by the Company's Chairman of
the Board of Directors under an operating lease starting in October 2004 for 15
years. In March 2006 that entity sold the office facility to an unrelated third
party which assumed the lease arrangement. The lease contains a provision for
additional rent in addition to the base rent for common area expenses. This
common area expense rent adjusts annually based upon the actual expenses paid by
the landlord. Monthly payments are $4,550, $5,155 and $5,855 through September
2009, 2014 and 2019, respectively.
Rent expense for operating leases was $260,000, $267,000 and $64,000 for the
year ended December 31, 2006, the year ended December 31, 2005 and the three
months ended December 31, 2004, respectively. Rent expense paid to related
parties was $140,000, $181,000 and $44,000 for the year ended December 31, 2006,
the year ended December 31, 2005 and the three months ended December 31, 2004,
respectively. Rent commitments under noncancelable operating leases at December
31, 2006 were as follows, before considering renewal options (in thousands):
2007 $ 290
2008 235
2009 248
2010 260
2011 260
Thereafter 1,585
------
$2,878
======
9. Interest-bearing deposits
Interest-bearing time deposits in denominations of $100,000 or more were
$60,929,000, $68,962,000 and $60,030,000 on December 31, 2006, December 31, 2005
and December 31, 2004, respectively. Time deposits include $23,724,000,
$59,618,000 and $35,525,000 of brokered deposits at December 31, 2006, December
31, 2005 and December 31, 2004, respectively.
At December 31, 2006, the scheduled maturities of time deposits are as follows
(in thousands):
2007 $139,442
2008 14,067
2009 2,188
2010 884
2011 1,027
Thereafter 125
--------
$157,733
========
10. Short-term Borrowings
Short-term borrowings were as follows (in thousands):
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Securities sold under agreements to repurchase $ 1,526 $ 747 $ 733
Single maturity FHLB advance with variable
rate of 5.44% and maturity date of March
21, 2007 15,000 - -
Single maturity FHLB advance with variable
rate of 5.44% and maturity date of March
21, 2007 15,000 - -
Single maturity FHLB advance with variable
rate of 5.44% and maturity date of February
16, 2007 5,000 - -
Single maturity FHLB advance with variable
rate of 4.33% and maturity date of March
22, 2006 - 18,000 -
Single maturity FHLB advances with variable
rate of 2.42% and maturity dates of January
14, 2005, through February 18, 2005 - - 22,500
------- ------- -------
$36,526 $18,747 $23,233
======= ======= =======
Securities sold under agreements to repurchase consist of obligations of the
Bank to other parties. The obligations are secured by the underlying securities
and such collateral is held by First Tennessee Bank. The maximum amount of
outstanding agreements at any month end during the year ended December 31, 2006,
the year ended December 31, 2005 and the three months ending December 31, 2004,
totaled $1,526,000, $747,000 and $733,000, respectively, and the average of such
agreements totaled $912,000, $514,000 and $574,000 for the year ended December
31, 2006, the year ended December 31, 2005 and the three months ended December
31, 2004, respectively. The agreements at December 31, 2006, mature within one
to three days.
The Company had a $2.5 million line of credit with an unaffiliated institution
that the Company elected to cancel in January 2006. The Company had never
borrowed against the line of credit.
11. Long-term Debt
Long-term debt was as follows (in thousands):
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
FHLB advance with fixed rate of 5.20% with
maturity date of March 7, 2011 $ 1,000 $ 1,000 $ 1,000
FHLB advance with fixed rate of 1.95% with
maturity date of June 9, 2006 - 3,000 3,000
FHLB advance with fixed rate of 2.32% with
maturity date of September 12, 2005 - - 968
Subordinated debentures 9,279 9,279 9,279
------- ------- -------
$10,279 $13,279 $14,247
======= ======= =======
The FHLB advances shown here and in note 10 are secured by mortgage loans; the
minimum balance required was approximately $45,000,000, $27,800,000 and
$37,125,000 at December 31, 2006, December 31, 2005 and December 31, 2004,
respectively. The advances are subject to restrictions or penalties in the event
of prepayment.
Aggregate annual maturities of FHLB borrowings at December 31, 2006, were (in
thousands):
2011 $ 1,000
The subordinated debentures relate to transactions entered into as part of the
formation of two separate trusts in 2003. One trust (Harrodsburg Statutory Trust
I) was formed by the Company and the other trust (Independence Bancorp Statutory
Trust I) was formed by Independence Bancorp and acquired by the Company as part
of the acquisition of Independence. Both trusts were formed to issue trust
preferred securities as part of pooled offerings. The Company issued $5,155,000
of subordinated debentures and Independence issued $4,124,000 of subordinated
debentures to the respective trusts in exchange for the proceeds of the
offerings. Issuance costs are being amortized over the life of the preferred
securities. Distributions on each issue are paid quarterly on March 26, June 26,
September 26 and December 26 of each year.
The subordinated debentures, which mature March 26, 2033, are redeemable prior
to the maturity date at the option of the Company on or after March 26, 2008 at
their principal amount plus accrued interest. As defined in the trust
indentures, the prepayment would require prior approval of the Board of
Governors of the Federal Reserve System. The Company also has the option to
defer interest payments on the subordinated debentures from time to time for a
period not to exceed twenty consecutive quarters. If payments are deferred, the
Company is prohibited from paying dividends to its common stockholders.
The $5,155,000 subordinated debentures bear interest at 6.4% through March 26,
2008 and thereafter a variable rate with repricing quarterly based on the
three-month London Interbank Offering Rate ("LIBOR") plus 3.15%. The $4,124,000
subordinated debentures bear interest at a variable rate repricing quarterly
based on the three-month LIBOR plus 3.15%. At December 31, 2006 that rate was
8.52%.
12. Income Taxes
The provision for income taxes includes these components (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Current $1,183 $2,270 $27
Deferred (395) 3 68
------ ------ ---
Income tax expense $ 788 $2,273 $95
====== ====== ===
A reconciliation of income tax expense at the statutory rate to the Company's
actual income tax expense is shown below (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Computed at the statutory rate of 34% $928 $2,296 $114
Increase (decrease) resulting from:
State income taxes 48 97 5
Tax exempt interest (97) (79) (16)
Nondeductible expenses 15 13 4
Compensation expense on
stock options 14 - -
Increase in cash surrender
value of life insurance (68) (64) (15)
Other (52) 10 3
---- ------ ----
Income tax expense $788 $2,273 $ 95
==== ====== ====
The significant components of deferred tax assets and liabilities are reflected
in the following table (in thousands):
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Deferred tax assets
Allowance for loan losses $1,288 $ 971 $ 871
Basis differential in equity method investment - - 211
ESOP liability 35 57 67
Deferred loan fees 230 283 227
Net operating loss and charitable contribution
carryovers - - 119
Alternative minimum tax credit carryover - - 9
Transaction costs 35 35 38
Accrued expenses 27 - 17
Building donation 92 90 -
Unrealized losses on available-for-sale securities 37 71 -
Other 22 4 -
------ ------ ------
Total deferred tax assets 1,766 1,511 1,559
------ ------ ------
Deferred tax liabilities
Depreciation 322 386 400
Federal Home Loan Bank stock dividends 580 532 511
Unrealized gains on available-for-sale securities - - 1,944
Core deposit intangible 48 64 78
Fair market value adjustments 67 141 236
Other 1 1 15
------ ------ ------
Total deferred tax liabilities 1,018 1,124 3,184
------ ------ ------
Net deferred tax (assets) liabilities $ (748) $ (387) $1,625
====== ====== ======
Retained earnings at December 31, 2006, December 31, 2005 and December 31, 2004,
include approximately $2,135,000 for which no deferred federal income tax
liability has been recognized. This amount represents an allocation of income to
bad debt deductions for tax purposes only. Reduction of amounts so allocated for
purposes other than tax bad debt losses or adjustments arising from carryback of
net operating losses would create income for tax purposes only, which would be
subject to the then-current corporate income tax rate. The deferred income tax
liabilities on the preceding amounts that would have been recorded if they were
expected to reverse into taxable income in the foreseeable future were
approximately $726,000 at December 31, 2006, December 31, 2005 and December 31,
2004.
13. Capital Requirements and Restrictions on Retained Earnings
Banks and holding companies are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and,
additionally for banks, prompt corrective action regulations involve
quantitative measures of assets, liabilities and certain off-balance-sheet items
calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by regulators. Failure
to meet capital requirements can initiate regulatory action.
Prompt corrective action regulations provide five classifications: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and capital restoration plans are required.
At year-end 2006, the Bank was considered well capitalized under these
regulations. Actual and required capital amounts and ratios are presented below
(in thousands except ratios).
To Be Well
Capitalized Under
For Capital Adequacy Prompt Corrective
Actual Purposes Action Provisions
----------------- -------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2006
Total capital (to risk-weighted assets)
Consolidated $41,233 15.9% $20,800 8.0% $ N/A N/A%
Bank 38,200 14.7 20,767 8.0 25,958 10.0
Tier 1 capital (to risk-weighted assets)
Consolidated 37,977 14.6 10,400 4.0 N/A N/A
Bank 34,949 13.5 10,383 4.0 15,575 6.0
Tier 1 capital (to average assets)
Consolidated 37,977 11.6 13,144 4.0 N/A N/A
Bank 34,949 10.7 13,099 4.0 16,374 5.0
As of December 31, 2005
Total capital (to risk-weighted assets)
Consolidated $38,987 15.1% $20,671 8.0% $ N/A N/A%
Bank 35,082 13.6 20,643 8.0 25,804 10.0
Tier 1 capital (to risk-weighted assets)
Consolidated 33,845 13.1 10,335 4.0 N/A N/A
Bank 32,171 12.5 10,322 4.0 15,482 6.0
Tier 1 capital (to average assets)
Consolidated 33,845 10.2 13,269 4.0 N/A N/A
Bank 32,171 9.7 13,212 4.0 16,515 5.0
The Bank is subject to certain regulations on the amount of dividends it may
declare without prior regulatory approval. Under these regulations, the amount
of dividends that may be paid in any year is limited to that year's net profits,
as defined, combined with the retained net profits of the preceding two years,
less dividends declared during those periods. The Company's ability to pay
dividends is substantially determined by the Bank's ability to pay dividends to
the Company. At January 1, 2007, the Bank could pay dividends of approximately
$7,883,000 to the Company without regulatory approval.
14. Related Party Transactions
Loans to executive officers and directors, including loans to affiliated
companies of which executive officers and directors are principal owners, and
loans to members of the immediate family of such persons are summarized as
follows (in thousands):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Balance at beginning of period $9,983 $5,397 $4,571
Changes in composition of related
parties - 4,308 -
New loans, including renewals and 2,019 4,026 832
advances
Payments, including renewals (5,077) (3,748) (6)
------ ------ ------
Balance at end of period $6,925 $9,983 $5,397
====== ====== ======
In management's opinion, such loans and other extensions of credit and deposits
were made in the ordinary course of business and were made on substantially the
same terms (including interest rates and collateral) as those prevailing at the
time for comparable transactions with other persons. Further, in management's
opinion, these loans did not involve more than normal risk of collectibility or
present other unfavorable features.
Deposits from related parties held by the Bank at December 31, 2006, December
31, 2005 and December 31, 2004, totaled $1,016,000, $839,000 and $1,578,000,
respectively.
Leases from related parties are disclosed in Note 8.
15. Employee Benefits
The Bank has a retirement savings 401(k) plan covering substantially all
employees. The Company amended the plan at the time of merger allowing employees
to contribute up to 15% of their compensation with 1st Independence Bank, which
is matched at a discretionary rate determined annually by the board of
directors. Prior to the amendment, employees could contribute up to 15% of their
compensation with the Bank matching 25% of the employee's contribution on the
first 6% of the employee's compensation. Effective January 1, 2006, the 401(k)
plan was combined with the Company's ESOP plan and now a portion of the released
ESOP shares are used as the Company's 401(k) match. Employer contributions
charged to expense for the year ended December 31, 2006, for the year ended
December 31, 2005 and the three months ended December 31, 2004, were $88,000,
$91,000 and $21,000, respectively.
As part of the conversion of the Bank from the mutual to stock form of
ownership, in 1995 the Company established an employee stock ownership plan
("ESOP") covering substantially all employees of the Bank. The ESOP acquired
174,570 shares of Company common stock at $10 per share at the time of the
conversion with funds provided by a loan from the Company. Accordingly,
$1,745,700 of common stock acquired by the ESOP was shown as a reduction of
stockholders' equity. Shares are released to participants proportionately as the
loan is repaid. Dividends on allocated shares are recorded as dividends and
charged to retained earnings. Dividends on unallocated shares are used to reduce
the Bank's obligation to repay the loan and are treated as compensation expense.
Compensation expense is recorded equal to the fair market value of the stock
when contributions are made to the ESOP.
ESOP expense for the year ended December 31, 2006, for the year ended December
31, 2005 and the three months ended December 31, 2004, was $103,000, $210,000
and $50,000, respectively.
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Allocated shares 120,563 119,925 117,268
Shares released for allocation 8,914 10,941 2,657
Unearned shares 29,110 38,024 48,965
Less shares distributed to former
employees - (10,303) -
-------- -------- --------
Total ESOP shares 158,587 158,587 168,890
======== ======== ========
Fair value of unearned shares $477,404 $703,444 $929,356
======== ======== ========
16. Stock Incentives
The Company has two stock option plans. The 1996 plan is a fixed option plan
under which the Company may grant options that vest over four years (20%
immediate and 20% on each of the next four anniversary dates) to selected
employees and directors for up to 200,000 shares of common stock. The exercise
price of each option is intended to equal the fair value of the Company's stock
on the date of grant. An option's maximum term is 10 years. At December 31,
2006, 30,000 options remain available to be granted under this plan. Under the
plan's terms, no options can be granted after January 28, 2007.
In July 2004, the Company formed a second plan for up to 300,000 shares of the
Company's common stock. The plan allows for both incentive and non-qualified
options to be granted to selected employees and directors at the discretion of
the Company's board of directors, generally with ten year maturities and with a
three year vesting schedule (25% immediate and 25% on each of the next three
anniversary dates). Commensurate with the Company's acquisition of Independence
Bancorp, 60,300 options of Independence Bancorp were transferred into the plan
at their existing terms. At December 31, 2006, 223,450 options remain available
to be granted under this plan.
In addition to the two stock option plans described above, the Company has a
restricted stock plan that was approved by the stockholders of the Company in
2006. This plan superceded a previous restricted stock plan that had been
approved by the stockholders of the Company in 1997. The current restricted
stock plan allows for awards to selected employees for up to 80,500 shares of
the Company's common stock. Awards made to employees and directors under the
plan have a five year vesting schedule (20% on each of the five anniversary
dates following the date of grant). The Company expenses the restricted stock
awards over the years during which the shares vest based on the fair market
value of the common stock at the date of the grant to the employee or director.
As of December 31, 2006, 4,000 shares had been awarded under the current plan
with 76,500 shares remaining available to be awarded. The previous plan had
4,500 shares that had been awarded that were still outstanding.
The following summarizes activity under the plans for the years 2004, 2005 and
2006:
Restricted
Options Stock
------------------------------------------------- -------------
Range of
Exercise Weighted Average
Shares Prices Exercise Price Shares
---------- --------------- --------------- ----------
Outstanding September 30, 2004 255,300 $8.00 to $16.50 $14.52 -
Granted - - - -
Exercised (3,000) $10.00 $10.00 -
Forfeited - - - -
------- -----
Outstanding December 31, 2004 252,300 $8.00 to $16.50 $14.58 -
Granted 10,000 $18.99 $18.99 2,000
Exercised (54,500) $8.00 to $16.50 $15.61 -
Forfeited (22,500) $13.50 to $18.99 $16.11 (500)
------- -----
Outstanding December 31, 2005 185,300 $8.00 to $18.99 $14.33 1,500
Granted 9,500 $17.75 $17.75 7,000
Exercised (51,500) $8.00 to $16.50 $13.60 -
Forfeited (10,750) $10.00 to $16.50 $16.41 -
------- -----
Outstanding December 31, 2006 132,550 $8.00 to $18.99 $14.69 8,500
======= =====
(Weighted average contractual
life of 2.3 years)
Exercisable Options:
December 31, 2004 250,300 $8.00 to $16.50 $14.61
December 31, 2005 179,675 $8.00 to $18.99 $14.18
December 31, 2006 122,050 $8.00 to $18.99 $14.38
The aggregate intrinsic value of stock options outstanding at December 31, 2006
and stock options exercisable at December 31, 2006 was $227,000 and $247,000,
respectively.
The following table summarizes information about stock options outstanding at
December 31, 2006:
Options Outstanding Options Exercisable
------------------------------------------------ ---------------------------------
Weighted
Average Weighted Weighted
Range of Number Contractual Average Number Average
Exercise Prices Outstanding Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---- -------------- ----------- --------------
$8.00 21,300 3.1 years $8.00 21,300 $8.00
$10.00 13,750 6.2 years $10.00 13,750 $10.00
$16.50 to $18.99 97,500 1.5 years $16.81 87,000 $16.64
------- -------
$8.00 to $18.99 132,550 2.3 years $14.69 122,050 $14.38
======= =======
The weighted average fair value of stock options granted in 2006 and 2005 was
$4.87 and $6.65, respectively. The total intrinsic value of stock options
exercised during 2006 and 2005 was $198,000 and $214,000, respectively. The
total fair value of stock options vested during 2006 and 2005 was $23,000 and
$17,000, respectively.
17. Net Income Per Share Computations
The following is a reconciliation of the numerator and denominator of the basic
and diluted per share computations (in thousands except per share data):
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
---- ---- ----
Income (numerator) amounts used for basic and diluted per
share computations:
Income from continuing operations $1,940 $4,489 $236
====== ====== ====
Income from discontinued operations $ - $ 4 $ 7
====== ====== ====
Net income $1,940 $4,481 $240
====== ====== ====
Shares (denominator) used for basic per share computations:
Weighted average shares of common stock outstanding 1,941 1,889 1,864
===== ===== =====
Shares (denominator) used for diluted per share computations:
Weighted average shares of common stock outstanding 1,941 1,889 1,864
Plus: dilutive effect of stock options 16 40 53
----- ----- -----
Adjusted weighted average shares 1,957 1,929 1,917
===== ===== =====
Basic net income per share:
Income from continuing operations $1.00 $2.38 $0.13
Income from discontinued operations - - -
Net income 1.00 2.37 0.13
Diluted net income per share:
Income from continuing operations $0.99 $2.33 $0.12
Income from discontinued operations - - -
Net income 0.99 2.32 0.13
Options to purchase 16,500 and 7,500 common shares for the year ended December
31, 2006 and 2005, respectively, were excluded from the diluted calculations
above because the exercise price on the options were greater than the average
market price for certain periods within the year.
18. Disclosures About Fair Value of Financial Instruments
The following table presents estimated fair values of the Company's financial
instruments. The fair values of certain of these instruments were calculated by
discounting expected cash flows, which involves significant judgments by
management and uncertainties. Fair value is the estimated amount at which
financial assets or liabilities could be exchanged in a current transaction
between willing parties, other than in a forced or liquidation sale. Because no
market exists for certain of these financial instruments and because management
does not intend to sell these financial instruments, the Company does not know
whether the fair values shown below represent values at which the respective
financial instruments could be sold individually or in the aggregate (in
thousands).
December 31, 2006 December 31, 2005
----------------- -----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- --------- ---------
Financial assets
Cash and cash equivalents $ 23,579 $ 23,579 $ 21,563 $ 21,563
Interest-bearing deposits 100 100 100 100
Available-for-sale securities 16,421 16,421 16,140 16,140
Held-to-maturity securities 1,900 1,930 1,975 1,974
Loans held for sale 1,227 1,227 1,278 1,297
Loans, net of allowance for
loan losses 270,478 271,995 266,978 266,091
FHLB stock 2,313 2,313 2,688 2,688
Interest receivable 1,927 1,927 1,665 1,665
Financial liabilities
Deposits $254,077 $253,764 $264,323 $263,115
Short-term borrowings 36,526 36,526 18,747 18,747
Long-term debt 10,279 10,264 13,279 13,268
Interest payable 817 817 666 666
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Cash and Cash Equivalents, Interest-bearing Deposits, FHLB Stock and Interest
Receivable The carrying amount approximates fair value.
Securities
Fair values equal quoted market prices, if available. If quoted market prices
are not available, fair value is estimated based on quoted market prices of
similar securities.
Loans
The fair value of loans, including loans held for sale, is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities. Loans with similar characteristics were aggregated for
purposes of the calculations. The carrying amount of accrued interest
approximates its fair value.
Deposits
Deposits include demand deposits, savings accounts, NOW accounts and certain
money market deposits. The carrying amount approximates fair value. The fair
value of fixed-maturity time deposits is estimated using a discounted cash flow
calculation that applies the rates currently offered for deposits of similar
remaining maturities.
Short-term Borrowings, FHLB Advances and Interest Payable The carrying amount
approximates fair value.
Long-term Debt
Rates currently available to the Company for debt with similar terms and
remaining maturities are used to estimate the fair value of existing debt.
Commitments to Originate Loans, Letters of Credit and Lines of Credit
The fair value of commitments to originate loans is estimated using 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 also considers the
difference between current levels of interest rates and the committed rates. The
fair value of forward sale commitments is estimated based on current market
prices for loans of similar terms and credit quality. The fair values of letters
of credit and lines of credit are based on fees currently charged for similar
agreements or on the estimated cost to terminate or otherwise settle the
obligations with the counterparties at the reporting date. The fair value of
commitments to originate loans, letters of credit and lines of credit are not
material.
19. Significant Estimates and Concentrations and Contingencies
Accounting principles generally accepted in the United States of America require
disclosure of certain significant estimates and current vulnerabilities due to
certain concentrations. Estimates related to the allowance for loan losses are
reflected in the footnote regarding loans. Current vulnerabilities due to
certain concentrations of credit risk are discussed in the note on commitments
and credit risk.
The Company is currently a defendant in a lawsuit that asserts that the Company
made certain material misrepresentations in connection with certain statements
made in connection with its offer to purchase up to 300,000 shares of stock in a
tender offer in May 2003. The plaintiffs are seeking to recover damages in
connection with the shares they sold in the tender offer and attorneys fees.
This matter is currently scheduled for trial in July 2007. Based upon the advice
of counsel, management records an estimate of the amount of ultimate expected
loss for litigation, if any. Management has not recorded a loss provision for
this litigation as, after discussion with legal counsel, management believes the
ultimate results of this litigation will not have a material adverse effect on
the Company's financial position, results of operations or cash flows. Events
could occur that could cause the estimate of ultimate loss to differ materially
in the near term.
20. Commitments and Credit Risks
Commitments to Originate Loans
Commitments to originate loans are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since a portion of the commitments may expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. Each customer's creditworthiness is evaluated on a
case-by-case basis. The amount of collateral obtained, if deemed necessary, is
based on management's credit evaluation of the counterparty. Collateral held
varies, but may include accounts receivable, inventory, property, plant and
equipment, commercial real estate and residential real estate.
At December 31, 2006 and 2005, the Bank had outstanding commitments to originate
loans aggregating approximately $21,385,000 and $3,283,000, respectively. Also
at December 31, 2006 and 2005, the Bank had commitments to originate
approximately $5,773,000 and $2,669,000, respectively, of fixed rate loans for
sale into the secondary market. The commitments extended over varying periods of
time with the majority being disbursed within a one-year period.
Letters of Credit
Letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party. These guarantees are primarily
issued to support public and private borrowing arrangements, including
commercial paper, bond financing and similar transactions. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loans to customers.
The Bank had total outstanding letters of credit amounting to approximately
$2,405,000 and $2,474,000, at December 31, 2006 and 2005, respectively.
Lines of Credit
Lines of credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Lines of credit
generally have fixed expiration dates. Since a portion of the line may expire
without being drawn upon, the total unused lines do not necessarily represent
future cash requirements. Each customer's creditworthiness is evaluated on a
case-by-case basis. The amount of collateral obtained, if deemed necessary, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment, commercial real estate and residential real estate. Management uses
the same credit policies in granting lines of credit as it does for
on-balance-sheet instruments.
At December 31, 2006 and 2005, the Bank had granted unused lines of credit to
borrowers aggregating approximately $43,983,000 and $57,117,000, respectively.
Cash and Cash Equivalents
At December 31, 2006 and 2005, the Company had approximately $8,517,000 and
$5,871,000, respectively, of deposits with correspondent banks in excess of
federally insured amounts.
Bank Owned Life Insurance
As of December 31, 2006, the Company's investment in life insurance of
$3,435,000 was with one insurance company.
21. Selected Quarterly Financial Data (unaudited) All amounts are in thousands
except per share data.
Quarter
-------------------------------------------
1st 2nd 3rd 4th
------ ------ ------ ------
2006
----
Interest and dividend income $5,221 $5,637 $5,797 $5,783
Interest expense 2,610 2,886 3,107 3,212
Net interest income 2,611 2,751 2,690 2,571
Provision for loan losses 81 31 543 192
Net interest income after provision for loan losses 2,530 2,720 2,147 2,379
Noninterest income 440 479 513 359
Noninterest expense 2,255 2,288 2,200 2,096
Net income 494 627 349 470
Net income per share:
Basic 0.26 0.32 0.18 0.24
Diluted 0.25 0.32 0.18 0.24
2005
----
Interest and dividend income $4,085 $4,398 $4,766 $5,197
Interest expense 1,720 1,902 2,108 2,464
Net interest income 2,365 2,496 2,658 2,733
Provision for loan losses 202 - 60 92
Net interest income after provision for loan losses 2,163 2,496 2,598 2,641
Noninterest income 5,489 642 291 535
Noninterest expense 2,859 2,436 2,248 2,550
Net income 3,109 483 462 427
Net income per share:
Basic 1.66 0.26 0.24 0.22
Diluted 1.62 0.25 0.24 0.22
The net income for the first quarter of 2005 includes a securities gain of $3.3
million or $1.77 per basic share and $1.72 per diluted share securities.
22. 1st Independence Financial Group, Inc. (parent company only)
Condensed Balance Sheets
(in thousands)
December 31, December 31,
2006 2005
------------- -------------
Assets
Cash and cash equivalents $ 1,366 $ 1,420
Investment in subsidiaries 46,162 43,373
Available-for-sale securities 986 974
Note receivable 388 541
Debt issuance costs, net of accumulated amortization 122 127
Other assets 715 1,138
------- -------
Total assets $49,739 $47,573
======= =======
Liabilities and Stockholders' Equity
Subordinated debentures $ 9,279 $ 9,279
Other liabilities 157 33
Stockholders' equity 40,303 38,261
------- -------
Total liabilities and stockholders' equity $49,739 $47,573
======= =======
Condensed Statements of Income
(in thousands)
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
------------- ------------ ------------
Income
Cash dividends from subsidiaries $ - $ - $ -
Other income 103 85 20
------ ------ ----
Total income 103 85 20
------ ------ ----
Expenses
Interest expense 675 600 137
Amortization of core deposit intangibles and debt issuance costs 5 5 1
Other expenses 520 732 343
------ ------ ----
Total expenses 1,200 1,337 481
------ ------ ----
Income (loss) from continuing operations before income
taxes, equity in undistributed net income of subsidiary, and
equity in undistributed net income of subsidiary held for disposal (1,097) (1,252) (461)
Income tax expense (benefit) from continuing operations (420) (467) (162)
------ ------ ----
Income (loss) from continuing operations before equity in
undistributed net income of subsidiary, and equity in
undistributed net income of subsidiary held for disposal (677) (785) (299)
Equity in undistributed net income of subsidiary from
continuing operations 2,617 5,266 535
Equity in undistributed net income of subsidiary held for disposal - - 4
------ ------ ----
Net income $1,940 $4,481 $240
====== ====== ====
Condensed Statements of Cash Flows
(in thousands)
Three months
Year ended Year ended ended
December 31, December 31, December 31,
2006 2005 2004
------------ ------------ -----------
Cash flows from operating activities:
Net income $ 1,940 $ 4,481 $ 240
Adjustments to reconcile net income to net cash (used in)
operations:
Amortization of core deposit intangibles and debt
issuance costs 5 5 1
Amortization of unearned compensation on restricted stock 19 5 -
Compensation expense on stock options 40 - -
Deferred income taxes - - (3)
Goodwill impairment - - 12
Undistributed net income of subsidiary (2,617) (5,266) (535)
Undistributed net income of unconsolidated statutory trusts - 2 -
Income from discontinued operations - - (4)
Changes in:
Decrease (increase) in other assets 418 (304) (16)
Increase (decrease) in other liabilities 124 24 (168)
----------- ---------- -----------
Net cash (used in) operating activities (71) (1,053) (473)
----------- ---------- -----------
Cash flows from investing activities:
Repayment of note receivable 154 132 249
Proceeds from sale of subsidiary - 2,300 -
Additional capital contributed to subsidiary (11) (20) -
----------- ---------- -----------
Net cash provided by investing activities 143 2,412 249
----------- ---------- -----------
Cash flows from financing activities:
Proceeds from exercise of stock options 494 470 30
Cash dividends paid (620) (754) -
----------- ---------- -----------
Net cash (used in) provided by financing activities (126) (284) 30
----------- ---------- -----------
Net (decrease) increase in cash and cash equivalents (54) 1,075 (194)
Cash and cash equivalents at beginning of period 1,420 345 539
----------- ---------- -----------
Cash and cash equivalents at end of period $ 1,366 $ 1,420 $ 345
=========== ========== ===========
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Based on their evaluation as of the end of the period covered by this
Annual Report on Form 10-K, the Company's principal executive officer and
principal financial officer have concluded that the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the "Exchange Act")) are effective to ensure
that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms.
(b) Changes in Internal Control over Financial Reporting
There was no change in the Company's internal control over financial
reporting identified by the principal executive officer or principal financial
officer that occurred in the three month period ended December 31, 2006 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
Item 9B. Other Information.
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governace.
Other than the information set forth below regarding the Company's
"Code of Ethics," information concerning this item is omitted from this report
pursuant to General Instruction G. (3) of Form 10-K and instead is incorporated
by reference to the Company's definitive Proxy Statement for the Annual Meeting
of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, which the Company intends to file with the Commission not
later than 120 days after December 31, 2006.
Code of Ethics
The Company adopted a Code of Conduct for its Principal Executive
Officer and Senior Financial Officers (the "Code of Conduct") in June 2003. The
Code of Conduct is available free of charge by writing to the Secretary of the
Company at 8620 Biggin Hill Lane, Louisville, Kentucky, 40220-4117.
Item 11. Executive Compensation.
Information concerning this item is omitted from this report pursuant
to General Instruction G. (3) of Form 10-K and instead is incorporated by
reference to the Company's definitive Proxy Statement for the Annual Meeting of
Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934,
as amended, which the Company intends to file with the Commission not later than
120 days after December 31, 2006.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
Information concerning this item is omitted from this report pursuant
to General Instruction G. (3) of Form 10-K and instead is incorporated by
reference to the Company's definitive Proxy Statement for the Annual Meeting of
Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934,
as amended, which the Company intends to file with the Commission not later than
120 days after December 31, 2006.
Item 13. Certain Relationships and Related Transactions, and Director
Independence.
Information concerning this item is omitted from this report pursuant
to General Instruction G. (3) of Form 10-K and instead is incorporated by
reference to the Company's definitive Proxy Statement for the Annual Meeting of
Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934,
as amended, which the Company intends to file with the Commission not later than
120 days after December 31, 2006.
Item 14. Principal Accounting Fees and Services.
Information concerning this item is omitted from this report pursuant
to General Instruction G. (3) of Form 10-K and instead is incorporated by
reference to the Company's definitive Proxy Statement for the Annual Meeting of
Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934,
as amended, which the Company intends to file with the Commission not later than
120 days after December 31, 2006.
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a) The following exhibits are filed as part of this report.
Exhibit
number Description
------- ----------------------------------------------------------
2.1 Stock Purchase Agreement (incorporated by reference to
Exhibit 2.1 to the Company's Form 8-K filed on
October 22, 2004).
2.2 Contract of Sale (incorporated by reference to Exhibit 2.2
to the Company's Form 8-K filed on October 22, 2004).
3.1 Certificate of Incorporation (incorporated by reference
from the Exhibits to the Company's Form S-1 Registration
Statement, initially filed on June 14, 1995,
Registration No. 33-93458).
3.2 Amended Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to the Company's Form 10-KSB filed
on December 29, 2004).
3.3 Bylaws (incorporated by reference from the Exhibits to the
Company's Form S-1, Registration Statement, initially filed
on June 14, 1995, Registration No. 33-93458).
10.1* 1996 Stock Option Plan (incorporated by reference to
Exhibit 10.1 to the Company's Form 10-K filed on
December 29, 1997).
10.2* Restricted Stock Plan and Trust Agreement (incorporated by
reference to Exhibit 10.2 to the Company's Form 10-K filed
on December 29, 1997).
10.3* Form of Employment Agreement for N. William White
(incorporated by reference to Exhibit 10.6 to the Company's
Form S-4 Registration Statement, initially filed on
February 27, 2004, Registration No. 333-113163).
10.4* Form of Employment Agreement for R. Michael Wilbourn
(incorporated by reference to Exhibit 10.7 to the Company's
Form S-4 Registration Statement, initially filed on
February 27, 2004, Registration No. 333-113163).
10.5* Form of Employment Agreement for Kathy L. Beach
(incorporated by reference to Exhibit 10.7 to the
Company's Form 10-KSB filed on December 29, 2004).
10.6* 2004 Omnibus Stock Option Plan (incorporated by reference
to Appendix G to the proxy statement/prospectus contained
in the Company's Form S-4 Registration Statement, initially
filed on February 27, 2004, Registration No. 333-113163).
10.7* 1st Independence Restricted Stock Plan (incorporated by
reference to Exhibit 99.1 to the Company's Form S-8
Registration Statement, initially filed on August 18, 2006,
Registration No. 333-136725).
10.8* Form of Stock Option Award under the 1996 Stock Option Plan
(incorporated by reference to Exhibit 99.3 to the Company's
Form S-8 Registration Statement, initially filed on
August 13, 2004, Registration No. 333-118198).
10.9* Form of Restricted Stock Agreement under the Restricted
Stock Plan and Trust Agreement (incorporated by reference
to Exhibit 99.5 to the Company's Form S-8 Registration
Statement, initially filed on August 13, 2004,
Registration No. 333-118198).
10.10* Form of Stock Award Agreement under the 2004 Omnibus Stock
Option Plan (incorporated by reference to Exhibit 99.2 to
the Company's Post Effective Amendment No. 1 Under Cover of
Form S-8 to Form S-4 Registration Statement, initially
filed on August 13, 2004, Registration No. 333-113163).
10.11* Form of Restricted Stock Award Agreement under the 1st
Independence Restricted Stock Plan (incorporated by
reference to Exhibit 99.2 to the Company's Form S-8
Registration Statement, initially filed on August 18, 2006,
Registration No. 333-136725).
10.12* Severance Agreement and Release, dated March 31, 2005, by
and among the Company, 1st Independence Bank and Arthur L.
Freeman (incorporated by reference to Exhibit 10.13 to the
Company's Form 8-K filed on April 1, 2005).
10.13* Form of Change of Control Agreement for Gregory A. DeMuth
(incorporated by reference to Exhibit 10.1 to the Company's
Form 8-K filed on March 31, 2006).
14.1 Code of Ethics for Principal Executive Officer and Senior
Financial Officers (incorporated by reference to Exhibit
14.0 to the Company's Form 10-KSB filed on
December 23, 2003).
21.1 Subsidiaries of the Registrant.
23.1 Consent of BKD, LLP.
31.1 Rule 13a-14 (a) / 15d-14 (a) Certification of Principal
Executive Officer ("Section 302 Certifications").
31.2 Rule 13a-14 (a) / 15d-14 (a) Certification of Principal
Financial Officer ("Section 302 Certifications").
32.1 Section 1350 Certifications ("Section 906 Certifications").
* Management contract or compensatory plan or arrangement.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
1st INDEPENDENCE FINANCIAL GROUP, INC.
Date: March 15, 2007 By /s/ N. William White
---------------------------------------
N. William White, President and
Chief Executive Officer
In accordance with the Exchange Act, 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/ Matthew C. Chalfant
------------------------------
Matthew C. Chalfant Chairman of the Board and March 15, 2007
Director
/s/ N. William White
------------------------------
N. William White President, Chief Executive March 15, 2007
Officer and Director
(Principal Executive Officer)
/s/ Jack L. Coleman, Jr.
------------------------------
Jack L Coleman, Jr. Director March 15, 2007
/s/ Thomas Les Letton
------------------------------
Thomas Les Letton Director March 15, 2007
/s/ Stephen R. Manecke
------------------------------
Stephen R. Manecke Director March 15, 2007
/s/ Charles L. Moore II
------------------------------
Charles L. Moore II Director March 15, 2007
/s/ Ronald L. Receveur
------------------------------
Ronald L. Receveur Director March 15, 2007
/s/ W. Dudley Shryock
------------------------------
W. Dudley Shryock Director March 15, 2007
/s/ H. Lowell Wainwright, Jr.
------------------------------
H. Lowell Wainwright, Jr. Director March 15, 2007
/s/ R. Michael Wilbourn
------------------------------
R. Michael Wilbourn Executive Vice President March 15, 2007
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ John F. Barron
------------------------------
John F. Barron Senior Vice President March 15, 2007
and Controller
Exhibit Index
-------------
Exhibit
number Description
------- -----------------------------------------------------------
2.1 Stock Purchase Agreement (incorporated by reference to
Exhibit 2.1 to the Company's Form 8-K filed on
October 22, 2004).
2.2 Contract of Sale (incorporated by reference to Exhibit 2.2
to the Company's Form 8-K filed on October 22, 2004).
3.1 Certificate of Incorporation (incorporated by reference
from the Exhibits to the Company's Form S-1 Registration
Statement, initially filed on June 14, 1995,
Registration No. 33-93458).
3.2 Amended Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to the Company's Form 10-KSB filed
on December 29, 2004).
3.3 Bylaws (incorporated by reference from the Exhibits to the
Company's Form S-1, Registration Statement, initially filed
on June 14, 1995, Registration No. 33-93458).
10.1* 1996 Stock Option Plan (incorporated by reference to
Exhibit 10.1 to the Company's Form 10-K filed on
December 29, 1997).
10.2* Restricted Stock Plan and Trust Agreement (incorporated by
reference to Exhibit 10.2 to the Company's Form 10-K filed
on December 29, 1997).
10.3* Form of Employment Agreement for N. William White
(incorporated by reference to Exhibit 10.6 to the Company's
Form S-4 Registration Statement, initially filed on
February 27, 2004, Registration No. 333-113163).
10.4* Form of Employment Agreement for R. Michael Wilbourn
(incorporated by reference to Exhibit 10.7 to the Company's
Form S-4 Registration Statement, initially filed on
February 27, 2004, Registration No. 333-113163).
10.5* Form of Employment Agreement for Kathy L. Beach
(incorporated by reference to Exhibit 10.7 to the
Company's Form 10-KSB filed on December 29, 2004).
10.6* 2004 Omnibus Stock Option Plan (incorporated by reference
to Appendix G to the proxy statement/prospectus contained
in the Company's Form S-4 Registration Statement, initially
filed on February 27, 2004, Registration No. 333-113163).
10.7* 1st Independence Restricted Stock Plan (incorporated by
reference to Exhibit 99.1 to the Company's Form S-8
Registration Statement, initially filed on August 18, 2006,
Registration No. 333-136725).
10.8* Form of Stock Option Award under the 1996 Stock Option Plan
(incorporated by reference to Exhibit 99.3 to the Company's
Form S-8 Registration Statement, initially filed on
August 13, 2004, Registration No. 333-118198).
10.9* Form of Restricted Stock Agreement under the Restricted
Stock Plan and Trust Agreement (incorporated by reference
to Exhibit 99.5 to the Company's Form S-8 Registration
Statement, initially filed on August 13, 2004,
Registration No. 333-118198).
10.10* Form of Stock Award Agreement under the 2004 Omnibus Stock
Option Plan (incorporated by reference to Exhibit 99.2 to
the Company's Post Effective Amendment No. 1 Under Cover of
Form S-8 to Form S-4 Registration Statement, initially
filed on August 13, 2004, Registration No. 333-113163).
10.11* Form of Restricted Stock Award Agreement under the 1st
Independence Restricted Stock Plan (incorporated by
reference to Exhibit 99.2 to the Company's Form S-8
Registration Statement, initially filed on August 18, 2006,
Registration No. 333-136725).
10.12* Severance Agreement and Release, dated March 31, 2005, by
and among the Company, 1st Independence Bank and Arthur L.
Freeman (incorporated by reference to Exhibit 10.13 to the
Company's Form 8-K filed on April 1, 2005).
10.13* Form of Change of Control Agreement for Gregory A. DeMuth
(incorporated by reference to Exhibit 10.1 to the Company's
Form 8-K filed on March 31, 2006).
14.1 Code of Ethics for Principal Executive Officer and Senior
Financial Officers (incorporated by reference to Exhibit
14.0 to the Company's Form 10-KSB filed on
December 23, 2003).
21.1 Subsidiaries of the Registrant.
23.1 Consent of BKD, LLP.
31.1 Rule 13a-14 (a) / 15d-14 (a) Certification of Principal
Executive Officer ("Section 302 Certifications").
31.2 Rule 13a-14 (a) / 15d-14 (a) Certification of Principal
Financial Officer ("Section 302 Certifications").
32.1 Section 1350 Certifications ("Section 906 Certifications").
* Management contract or compensatory plan or arrangement.