-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C7tJdKx9mWj8TDWh3WQh0yMADSaORW87HUtLCK3xvMOZ2J8sKE9z/2w3HnD4n0ze B44aBN9rTVY8zJXU7EL/hA== 0000928385-03-000976.txt : 20030331 0000928385-03-000976.hdr.sgml : 20030331 20030331125118 ACCESSION NUMBER: 0000928385-03-000976 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST CAPITAL INC CENTRAL INDEX KEY: 0001070296 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 352056949 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-25023 FILM NUMBER: 03628654 BUSINESS ADDRESS: STREET 1: 220 FEDERAL DRIVE N W CITY: CORYDON STATE: IN ZIP: 47112 BUSINESS PHONE: 8127382198 MAIL ADDRESS: STREET 1: 220 FEDERAL DRIVE N W CITY: CORYDON STATE: IN ZIP: 47112 10-K 1 d10k.txt FORM 10-KSB U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number: 0-25023 FIRST CAPITAL, INC. ----------------------------------------------------------- (Name of small business issuer in its charter) Indiana 35-2056949 - ----------------------------------------- --------------------------------- (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification No.) 220 Federal Drive, N.W., Corydon, Indiana 47112 - ----------------------------------------- --------------------------------- (Address of principal executive offices) (Zip Code) Issuer's telephone number: (812) 738-2198 Securities registered under 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, par value $0.01 per share (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. X The issuer's revenues for the year ended December 31, 2002 were $20.6 million. The aggregate market value of the voting common equity held by non-affiliates as of March 3, 2003 was approximately $49.4 million. This figure is based on the average of the bid and asked price on the Nasdaq Stock Market for a share of the issuer's common stock on March 3, 2003, which was $21.13 per share. For purposes of this calculation, the issuer is assuming that the issuer's directors and executive officers are affiliates. As of March 3, 2003, there were 2,538,171 shares of the registrant's common stock outstanding. Transitional Small Business Disclosure Format: Yes [ ] No [X] DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Stockholders for the Fiscal Year Ended December 31, 2002 ("Annual Report"). (Parts I and II) 2. Portions of the Proxy Statement for the 2002 Annual Meeting of Stockholders ("Proxy Statement"). (Part III) INDEX
PAGE Part I Item 1. Description of Business........................................................................3 Item 2. Description of Property.......................................................................24 Item 3. Legal Proceedings.............................................................................24 Item 4. Submission of Matters to a Vote of Security Holders...........................................25 Part II Item 5. Market for Common Equity and Related Stockholder Matters......................................25 Item 6. Management's Discussion and Analysis..........................................................25 Item 7. Financial Statements..........................................................................25 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure .........25 Part III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act........................................................25 Item 10. Executive Compensation........................................................................26 Item 11. Security Ownership of Certain Beneficial Owners and Management................................26 Item 12. Certain Relationships and Related Transactions................................................26 Item 13. Exhibits and Reports on Form 8-K..............................................................27 Item 14. Controls and Procedures ......................................................................27
SIGNATURES CERTIFICATIONS 2 This report contains certain "forward-looking statements" concerning the future operations of First Capital, Inc. Forward-looking statements are used to describe future plans and strategies, including expectations of future financial results. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors that could affect actual results include interest rate trends, the general economic climate in the market area in which First Capital operates, as well as nationwide, First Capital's ability to control costs and expenses, competitive products and pricing, loan delinquency rates, and changes in federal and state legislation and regulation. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Except as may be required by applicable law or regulation, First Capital assumes no obligation to update any forward-looking statements. PART I ITEM 1. DESCRIPTION OF BUSINESS. GENERAL First Capital, Inc. ("Company" or "First Capital") was incorporated under Indiana law in September 1998. The Company was organized for the purpose of becoming the holding company for First Federal Bank, A Federal Savings Bank ("Bank") upon the Bank's reorganization as a wholly owned subsidiary of the Company resulting from the conversion of First Capital, Inc., M.H.C. ("MHC"), from a federal mutual holding company to a stock holding company ("Conversion and Reorganization"). The Conversion and Reorganization was completed on December 31, 1998. In the Conversion and Reorganization, the Company sold 768,767 shares of its common stock to the public at $10 per share in a public offering and issued 523,057 shares in exchange for the outstanding shares of the Bank held by the Bank's stockholders other than the MHC. On January 12, 2000, the Company completed a merger of equals with HCB Bancorp, the former holding company for Harrison County Bank. The Bank changed its name to First Harrison Bank in connection with the merger. On September 25, 2002, the Company and Hometown Bancshares, Inc., the bank holding company for Hometown National Bank in New Albany, Indiana, entered into an Agreement and Plan of Merger whereby each of the issued and outstanding common shares of Hometown will be exchanged for shares of the Company or $46.50 in cash per share. The merger is subject to regulatory and stockholder approvals. It is anticipated that the merger will be consummated in March 2003. The Company has no significant assets, other than all of the outstanding shares of the Bank and the portion of the net proceeds from the Offering retained by the Company, and no significant liabilities. Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank in accordance with applicable regulations. The Bank is regulated by the Office of Thrift Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The Bank's deposits are federally insured by the FDIC under the Savings Association Insurance Fund ("SAIF"). The Bank is a member of the Federal Home Loan Bank ("FHLB") System. MARKET AREA AND COMPETITION The Bank considers Harrison, Floyd, and Washington counties in Indiana as its primary market area. All of our offices are located in these three counties, which results in most of our loans being made in these three counties. The main office of the Bank is located in Corydon, Indiana, 35 miles west of Louisville, Kentucky. The Bank aggressively competes for business with local banks as well as large regional banks. Its most direct competition for deposit and loan business has come from the commercial banks operating in these three counties. The Bank is the leader in deposit market share in Harrison County, its primary county of operation. LENDING ACTIVITIES General. The principal lending activity of the Bank is the origination of residential mortgage loans. To a lesser extent, the Bank also originates consumer, commercial business, commercial real estate (including farm properties) and residential construction loans. 3 Loan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio by type of loan at the dates indicated.
AT DECEMBER 31, ----------------------------------------------------------------------------- 2002 2001 2000 ----------------------- ----------------------- ----------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ---------- ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Mortgage Loans: Residential (1) ........................... $ 145,467 65.79% $ 132,350 64.35% $ 109,813 59.80% Land ...................................... 4,821 2.18 4,381 2.13 3,356 1.83 Commercial real estate .................... 16,760 7.58 15,811 7.69 20,372 11.10 Residential construction (2) .............. 9,783 4.42 10,477 5.09 9,665 5.26 ---------- ---------- ---------- ---------- ---------- ---------- Total mortgage loans .................... 176,831 79.97 163,019 79.26 143,206 77.99 ---------- ---------- ---------- ---------- ---------- ---------- Consumer Loans: Home equity and second mortgage loans ............................ 18,640 8.43 12,963 6.30 11,349 6.18 Automobile loans ........................... 9,598 4.34 10,376 5.04 10,156 5.53 Loans secured by savings accounts .......... 1,249 0.56 1,309 0.64 1,554 0.85 Unsecured loans ............................ 1,193 0.54 1,721 0.84 1,609 0.88 Mobile home loans .......................... -- -- -- -- -- -- Other (3) .................................. 4,176 1.89 4,949 2.41 5,920 3.22 ---------- ---------- ---------- ---------- ---------- ---------- Total consumer loans .................... 34,856 15.76 31,318 15.23 30,588 16.66 ---------- ---------- ---------- ---------- ---------- ---------- Commercial business loans .................. 9,440 4.27 11,339 5.51 9,816 5.35 ---------- ---------- ---------- ---------- ---------- ---------- Total loans ............................. 221,127 100.00% 205,676 100.00% 183,610 100.00% ---------- ========== ---------- ========== ---------- ========== Less: Due to borrowers on loans in process ...... 3,887 2,727 2,893 Deferred loan fees net of direct costs .................................... 26 116 229 Allowance for loan losses ................. 1,218 1,103 1,184 ---------- ---------- ---------- Total loans receivable, net ............. $ 215,996 $ 201,730 $ 179,304 ========== ========== ========== AT DECEMBER 31, -------------------------------------------------- 1999 1998 ----------------------- ----------------------- AMOUNT PERCENT AMOUNT PERCENT ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Mortgage Loans: Residential (1) ........................... $ 99,797 62.49% $ 89,779 65.10% Land ...................................... 1,379 0.86 1,735 1.26 Commercial real estate .................... 15,014 9.40 4,890 3.55 Residential construction (2) .............. 8,774 5.49 11,125 8.07 ---------- ---------- ---------- ---------- Total mortgage loans .................... 124,964 78.24 107,529 77.98 ---------- ---------- ---------- ---------- Consumer Loans: Home equity and second mortgage loans ............................ 6,947 4.35 2,668 1.93 Automobile loans ........................... 7,923 4.96 6,798 4.93 Loans secured by savings accounts .......... 1,156 0.72 1,118 0.81 Unsecured loans ............................ 1,084 0.68 728 0.53 Mobile home loans .......................... -- -- -- -- Other (3) .................................. 6,284 3.93 9,454 6.86 ---------- ---------- ---------- ---------- Total consumer loans .................... 23,394 14.64 20,766 15.06 ---------- ---------- ---------- ---------- Commercial business loans .................. 11,376 7.12 9,590 6.96 ---------- ---------- ---------- ---------- Total loans ............................. 159,734 100.00% 137,885 100.00% ---------- ========== ---------- ========== Less: Due to borrowers on loans in process ...... 3,307 1,031 Deferred loan fees net of direct costs .................................... 251 235 Allowance for loan losses ................. 1,194 1,240 ---------- ---------- Total loans receivable, net ............. $ 154,982 $ 135,379 ========== ==========
- ---------- (1) Includes conventional one- to four-family and multi-family residential loans. (2) Includes construction loans for which the Bank has committed to provide permanent financing. (3) Includes loans secured by lawn and farm equipment, mobile homes, and other personal property. 4 Residential Loans. The Bank's lending activities have concentrated on the origination of residential mortgages, primarily for retention in the Bank's loan portfolio. Residential mortgages secured by multi-family properties are an immaterial portion of the residential loan portfolio. Substantially all residential mortgages are collateralized by properties within the Bank's market area. The Bank offers both fixed-rate mortgage loans and adjustable rate mortgage ("ARM") loans typically with terms of 15 to 30 years. Although the Bank originates all residential mortgage loans for investment, the Bank uses loan documents approved by the Federal National Mortgage Corporation ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"). ARM loans originated have interest rates that adjust at regular intervals of one year, with 1.5% annual and 6% lifetime caps, and at intervals of five years with 1.5% per adjustment period and 6% lifetime caps, based upon changes in the prevailing interest rates on U.S. Treasury Bills. The Bank may occasionally use below market interest rates and other marketing inducements to attract ARM loan borrowers. The majority of ARM loans provide that the amount of any increase or decrease in the interest rate is limited to 1.5% (upward or downward) per adjustment period and generally contain minimum and maximum interest rates. Borrower demand for ARMs versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and interest rates and loan fees for ARM loans. The relative amount of fixed-rate and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The Bank's lending policies generally limit the maximum loan-to-value ratio on fixed-rate and ARM loans to 80% of the lesser of the appraised value or purchase price of the underlying residential property unless private mortgage insurance to cover the excess over 80% is obtained, in which case the mortgage is limited to 90% (or 97% under a Freddie Mac program) of the lesser of appraised value or purchase price. The loan-to-value ratio, maturity and other provisions of the loans made by the Bank are generally reflected in the policy of making less than the maximum loan permissible under federal regulations, in accordance with established lending practices, market conditions and underwriting standards maintained by the Bank. The Bank requires title, fire and extended insurance coverage on all mortgage loans originated. All of the Bank's real estate loans contain due on sale clauses. The Bank obtains appraisals on all its real estate loans from outside appraisers. Construction Loans. Although the Bank originates construction loans that are repaid with the proceeds of a limited number of mortgage loan obtained by the borrower from another lender, the majority of the construction loans that the Bank originates are construction/permanent loans, which are originated with one loan closing at either a fixed or variable rate of interest and for terms up to 30 years. Construction loans originated without a commitment by the Bank to provide permanent financing are generally originated for a term of six to 12 months and at a fixed interest rate based on the prime rate. In the case of construction/permanent loans, the construction loan is also generally for a term of six to 12 months and the rate charged is the rate chosen by the borrower for the permanent loan. Accordingly, if the borrower chooses a fixed interest rate for the permanent loan, the construction loan rate is also fixed at the same rate. The Bank originates speculative construction loans to a limited number of builders operating and based in the Bank's primary market area and with whom the Bank has well-established business relationships. At December 31, 2002, speculative construction loans, for which there is not a commitment for permanent financing in place at the time the construction loan was originated, amounted to $1.2 million. The Bank generally limits the number of speculative construction loans outstanding at any one time to any one builder to two loans. All construction loans are originated with a loan-to-value ratio not to exceed 80% of the appraised estimated value of the completed property. The construction loan documents require the disbursement of the loan proceeds in increments as construction progresses. Disbursements are based on periodic on-site inspections by an independent appraiser and/or Bank personnel approved by the Board of Directors. Construction lending is inherently riskier than one- to four-family mortgage lending. Construction loans, on average, generally have higher loan balances than one- to four-family mortgage loans. In addition, the potential for cost overruns because of the inherent difficulties in estimating construction costs and, therefore, collateral values and the difficulties and costs associated with monitoring construction progress, among other things, are major contributing factors to this greater credit risk. Speculative construction loans have the added risk that there is not an identified buyer for the completed home when the loan is originated, with the risk that the builder will have to service the construction loan debt and finance the other carrying costs of the completed home for an extended time period until a buyer is identified. Furthermore, the demand for construction loans and the ability of construction loan borrowers to service their debt depends highly on the state of the general economy, including market interest rate levels, and the state of the economy 5 of the Bank's primary market area. A material downturn in economic conditions would be expected to have a material adverse effect on the credit quality of the construction loan portfolio. Commercial Real Estate Loans. Commercial real estate loans are generally secured by small retail stores, professional office space and, in certain instances, farm properties. Commercial real estate loans are generally originated with a loan-to-value ratio not to exceed 75% of the appraised value of the property. Property appraisals are performed by independent appraisers approved by the Bank's Board of Directors. The Bank attempts to originate commercial real estate loans at variable interest rates based on the U.S. Treasury Bill rate for terms not to exceed five years. However, in the current low interest rate environment, borrower demand for variable rate loans is low and the Bank is generally originating commercial real estate loans with fixed interest rates for terms ranging between ten and 15 years over which principal and interest is fully amortized. These loans are generally written as five year balloon loans to help manage interest risk. Commercial real estate lending affords the Bank an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by such properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks by limiting the maximum loan-to-value ratio to 75% and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. The Bank also obtains loan guarantees from financially capable parties based on a review of personal financial statements. Commercial Business Loans. Commercial business loans are generally secured by inventory, accounts receivable, and business equipment such as trucks and tractors. Many commercial business loans also have real estate as collateral. The Bank generally requires a personal guaranty of payment by the principals of a corporate borrower, and reviews the personal financial statements and income tax returns of the guarantors. Commercial business loans are generally originated with loan-to-value ratios not exceeding 75%. Aside from lines of credit, commercial business loans are generally originated for terms not to exceed seven years with variable interest rates based on the Bank's cost of funds. Approved credit lines totaled $6.9 million at December 31, 2002, of which $4.1 million was outstanding. Lines of credit are originated at fixed interest rates for one year renewable terms. A director of the Bank is a shareholder of a farm implement dealership that has contracted with the Bank to provide sales financing to the dealership's customers. The Bank does not grant preferential credit under this arrangement. All sales contracts are presented to the Bank on a 50% recourse basis, with the dealership responsible for the sale and disposition of any repossessed equipment. During the year ended December 31, 2002, the Bank granted approximately $1.8 million of credit to customers of the dealership and such loans had an aggregate outstanding balance of $3.3 million at December 31, 2002. At December 31, 2002, 15 loans were delinquent 30 days or more with an aggregate outstanding balance of $135,000. Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral-based lending with loan amounts based on predetermined loan-to-collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. Consumer Loans. The Bank offers a variety of secured or guaranteed consumer loans, including automobile and truck loans (both new and used), home equity loans, home improvement loans, boat loans, mobile home loans, and loans secured by savings deposits. In addition, the Bank offers unsecured consumer loans. Consumer loans are generally originated at fixed interest rates and for terms not to exceed seven years. The largest portion of the Bank's consumer loan portfolio consists of home equity and second mortgage loans followed by automobile and truck loans. Automobile 6 and truck loans are originated on both new and used vehicles. Such loans are generally originated at fixed interest rates for terms up to five years and at loan-to-value ratios up to 80% of the blue book value in the case of used vehicles and 80% of the purchase price in the case of new vehicles. Home equity and second mortgage loans are generally originated for terms not to exceed five years and at adjustable rates of interest. The loan-to-value ratio on such loans is limited to 95%, taking into account the outstanding balance on the first mortgage loan. The Bank's underwriting procedures for consumer loans includes an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loans. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, to the proposed loan amount. The Bank underwrites and originates the majority of its consumer loans internally, which management believes limits exposure to credit risks relating to loans underwritten or purchased from brokers or other outside sources. Consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by assets that depreciate rapidly, such as automobiles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by the borrower against the Bank as the holder of the loan, and a borrower may be able to assert claims and defenses which it has against the seller of the underlying collateral. LOAN MATURITY AND REPRICING The following table sets forth certain information at December 31, 2002 regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity, but does not include potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances do not include undisbursed loan proceeds, unearned income and allowance for loan losses.
AFTER AFTER AFTER AFTER ONE YEAR 3 YEARS 5 YEARS 10 YEARS WITHIN THROUGH THROUGH THROUGH THROUGH AFTER ONE YEAR 3 YEARS 5 YEARS 10 YEARS 15 YEARS 15 YEARS TOTAL --------- --------- --------- --------- --------- --------- --------- (IN THOUSANDS) Mortgage loans: Residential ...................... $ 7,600 $ 13,243 $ 14,222 $ 35,066 $ 31,443 $ 43,893 $ 145,467 Commercial real estate and land loans ...................... 3,971 3,045 4,650 5,078 3,490 1,347 21,581 Residential construction (1) ..... 7,022 100 7 22 31 2,601 9,783 Consumer loans ...................... 9,142 9,927 13,305 2,386 48 48 34,856 Commercial business ................. 4,251 3,477 1,118 481 57 56 9,440 --------- --------- --------- --------- --------- --------- --------- Total gross loans ............. $ 31,986 $ 29,792 $ 33,302 $ 43,033 $ 35,069 $ 47,945 $ 221,127 ========= ========= ========= ========= ========= ========= =========
- ---------- (1) Includes construction loans for which the Bank has committed to provide permanent financing. The contractual maturities reflect the principal payments due following the period of construction. 7 The following table sets forth the dollar amount of all loans due after December 31, 2003, which have fixed interest rates and have floating or adjustable interest rates. FLOATING OR FIXED ADJUSTABLE RATES RATES ---------- ---------- (IN THOUSANDS) Mortgage loans: Residential ......................... $ 114,792 $ 23,075 Commercial real estate and land loans 8,448 9,162 Residential construction ............ 2,761 -- Consumer loans ......................... 11,545 14,169 Commercial business .................... 3,687 1,502 ---------- ---------- Total gross loans ................ $ 141,233 $ 47,908 ========== ========== Loan Solicitation and Processing. A majority of the loans originated by the Bank are made to existing customers. Walk-ins and customer referrals are also a source of loans originations. Upon receipt of a loan application, a credit report is ordered to verify specific information relating to the loan applicant's employment, income and credit standing. A loan applicant's income is verified through the applicant's employer or from the applicant's tax returns. In the case of a real estate loan, an appraisal of the real estate intended to secure the proposed loan is undertaken, generally by an independent appraiser approved by the Bank. The mortgage loan documents used by the Bank conform to secondary market standards. The Bank requires that borrowers obtain certain types of insurance to protect its interest in the collateral securing the loan. The Bank requires either a title insurance policy insuring that the Bank has a valid first lien on the mortgaged real estate or an opinion by an attorney regarding the validity of title. Fire and casualty insurance is also required on collateral for loans. The Bank's lending practices generally limit the maximum loan to value ratio on conventional residential mortgage loans to 80% (or 90% under a Freddie Mac program) of the appraised value of the property as determined by an independent appraisal or the purchase price, whichever is less, and 75% for commercial real estate loans. Loan Commitments and Letters of Credit. The Bank issues commitments for fixed- and adjustable-rate single-family residential mortgage loans conditioned upon the occurrence of certain events. Such commitments are made in writing on specified terms and conditions and are honored for up to 60 days from the date of application, depending on the type of transaction. The Bank had outstanding loan commitments of approximately $5.8 million at December 31, 2002. As an accommodation to its commercial business loan borrowers, the Bank issues standby letters of credit or performance bonds usually in favor of municipalities for whom its borrowers are performing services. At December 31, 2002, the Bank had outstanding letters of credit of $689,000. Loan Origination and Other Fees. The Bank, in most instances, receives loan origination fees and discount "points." Loan fees and points are a percentage of the principal amount of the mortgage loan that are charged to the borrower for funding the loan. The Bank usually charges a fixed origination fee on one- to four-family residential real estate loans and long-term commercial real estate loans. On residential construction loans the bank usually charges one point. Current accounting standards require loan origination fees and certain direct costs of underwriting and closing loans to be deferred and amortized into interest income over the contractual life of the loan. Deferred fees and costs associated with loans that are sold are recognized as income at the time of sale. The Bank had $26,000 of net deferred loan fees at December 31, 2002. Delinquencies. The Bank's collection procedures provide for a series of contacts with delinquent borrowers. A late charge is assessed and a late charge notice is sent to the borrower after the 15th day of delinquency. After 20 days the collector will place a phone call to the borrower. When a payment becomes 60 days past due, the collector will issue a default letter. If a loan continues in a delinquent status for 90 days or more, the Bank generally initiates foreclosure or other litigation proceedings. 8 Nonperforming Assets. Loans are reviewed regularly and when loans become 90 days delinquent, the loan is placed in nonaccrual status and the previously accrued interest income is reversed. Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan. The following table sets forth information with respect to the Bank's nonperforming assets for the periods indicated. At the dates indicated, the Bank had no restructured loans within the meaning of SFAS No. 15.
AT DECEMBER 31, -------------------------------------------------------- 2002 2001 2000 1999 1998 -------- -------- -------- -------- -------- Loans accounted for on a nonaccrual basis: Residential real estate ............... $ 494 $ 172 $ 241 $ 197 $ 189 Commercial real estate ................ 36 566 -- -- 25 Commercial business ................... -- 49 -- -- 78 Consumer .............................. 77 -- 10 -- -- -------- -------- -------- -------- -------- Total .............................. 607 787 251 197 292 -------- -------- -------- -------- -------- Loans past due 90 days on accrual status: Residential real estate ............... 373 375 280 -- 19 Commercial real estate ................ 203 -- -- 6 -- Commercial business ................... 7 -- -- -- -- Consumer............................... 147 97 41 5 54 -------- -------- -------- -------- -------- Total .............................. 730 472 321 11 73 -------- -------- -------- -------- -------- Foreclosed real estate, net .............. 102 212 119 256 -- -------- -------- -------- -------- -------- Total nonperforming assets ............... $ 1,439 $ 1,471 $ 691 $ 464 $ 365 ======== ======== ======== ======== ======== Total loans delinquent 90 days or more to net loans ....................... 0.62% 0.62% 0.32% 0.13% 0.27% Total loans delinquent 90 days or more to total assets ......................... 0.43% 0.45% 0.23% 0.09% 0.19% Total nonperforming assets to total assets ............................ 0.47% 0.52% 0.28% 0.21% 0.19%
The Bank accrues interest on loans over 90 days past due when, in the opinion of management, the estimated value of collateral and collection efforts are deemed sufficient to ensure full recovery. The Bank recognized $82,000 in interest income on nonaccrual loans for the fiscal year ended December 31, 2002. Classified Assets. The OTS has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss. All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful can be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated "special mention" and monitored by the Bank. 9 Current accounting rules require that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or if expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. A loan is classified as impaired by management when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due in accordance with the terms of the loan agreement. If the fair value, as measured by one of these methods, is less than the recorded investment in the impaired loan, the Bank establishes a valuation allowance with a provision charged to expense. Management reviews the valuation of impaired loans on a quarterly basis to consider changes due to the passage of time or revised estimates. Assets that do not expose the Bank to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management. An insured institution is required to establish and maintain an allowance for loan losses at a level that is adequate to absorb estimated credit losses associated with the loan portfolio, including binding commitments to lend. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities. When an insured institution classifies problem assets as "loss," it is required either to establish an allowance for losses equal to 100% of the amount of the assets, or charge off the classified asset. The amount of its valuation allowance is subject to review by the OTS which can order the establishment of additional general loss allowances. The Bank regularly reviews the loan portfolio to determine whether any loans require classification in accordance with applicable regulations. At December 31, 2002, 2001 and 2000, the aggregate amounts of the Bank's classified assets at those dates and the general loss allowances for the periods then ended, were as follows: AT DECEMBER 31, --------------------------- 2002 2001 2000 ------- ------- ------- (IN THOUSANDS) Classified assets: Loss ...................... $ -- $ -- $ -- Doubtful (impaired) ....... 1,158 806 251 Substandard ............... 798 1,148 888 Special mention ........... -- 426 3,010 General loss allowances: Impaired loans ............ 420 166 -- Other ..................... 798 937 1,184 Foreclosed Real Estate. Foreclosed real estate held for sale is carried at the lower of fair value minus estimated costs to sell, or cost. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. The net income from operations of foreclosed real estate held for sale is reported in non-interest income. At December 31, 2002, the Bank had foreclosed real estate totaling $102,000. Allowance for Loan Losses. Loans are the Company's largest concentration of assets and continue to represent the most significant potential risk. In originating loans, the Bank recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral. The Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance for loan losses represents management's estimate of probable loan losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management's evaluation of the loan portfolio, including historical loan loss experience, delinquencies, known and inherent risks in the nature and volume of the loan portfolio, information about specific borrower situations, estimated collateral values, and economic conditions. The loan portfolio is reviewed quarterly by management to evaluate the adequacy of the allowance for loan losses to determine the amount of any adjustment required after considering the loan charge-offs and recoveries for the quarter. Management applies a systematic methodology that incorporates it current judgments about the credit quality of the loan portfolio. In addition, the OTS, as an integral part of their examination process, periodically review the 10 Bank's allowance for loan losses and may require the Bank to make additional provisions for estimated losses based on their judgments about information available to them at the time of their examination. The methodology used in determining the allowance for loan losses includes segmenting the loan portfolio by identifying risk characteristics common to groups of loans, determining and measuring impairment of individual loans based on the present value of expected future cash flows or the fair value of collateral, and determining and measuring impairment for groups of loans with similar characteristics by applying loss factors that consider the qualitative factors which may effect the loss rates. The Allowance for Loan Loss Analysis table that follows shows changes in the break down of the allowance for loan losses by loan category. Management continues to refine the methodology used to allocate loan losses by category. Based on the Bank's low historical charge offs, management is continuing to refine their methodology for allocating loan loss reserves by type of loan. Specific allowances related to impaired loans and other classified loans are established where management has identified significant conditions or circumstances related to a loan that management believes indicate that a loss has been incurred. The identification of these loans results from the loan review process that identifies and monitors credits with weaknesses or conditions which call into question the full collection of the contractual payments due under the terms of the loan agreement. Factors considered by management include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. For loans evaluated on a group basis, management applies loss factors to groups of loans with common risk characteristics (i.e. residential mortgage loans, home equity loans, credit card loans). The loss factors are derived from the Bank's historical loss experience or, where the Bank does not have loss experience, the peer group loss experience. Peer group loss experience is used after evaluating the attributes of the Bank's loan portfolio as compared to the peer group. Loss factors are adjusted for significant environmental factors that, in management's judgment, affect the collectibility of the loan portfolio segment. The significant environmental factors include the levels and trends in charge-offs and recoveries, trends in volume and terms of loans, levels and trends in delinquencies, the effects of changes in underwriting standards and other lending practices or procedures, the experience and depth of the lending management and staff, effects of changes in credit concentration, changes in industry and market conditions and national and local economic trends and conditions. Management evaluates these conditions on a quarterly basis and evaluates and modifies the assumptions used in establishing the loss factors. The allowance for loan losses was $1.2 million at December 31, 2002, $1.1 million at December 31, 2001 and $1.2 million at December 31, 2000. Management has deemed these amounts as adequate on those dates based on its evaluation methodology. At December 31, 2002, nonperforming loans totaled $1.3 million or 0.43% of total assets. Included in nonperforming loans are loans over 90 days past due secured by one-to-four family residential real estate in the amount of $373,000, commercial real estate loans totaling $203,000, commercial business loans totaling $7,000 and consumer loans in the amount of $147,000. These loans are accruing interest as the estimated value of the collateral and collection efforts are deemed sufficient to ensure full recovery. 11 The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated.
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Allowance at beginning of period ................. $ 1,103 $ 1,184 $ 1,194 $ 1,240 $ 1,222 Provision for loan losses ........................ 305 66 48 142 83 ---------- ---------- ---------- ---------- ---------- 1,408 1,250 1,242 1,382 1,305 ---------- ---------- ---------- ---------- ---------- Recoveries: Residential real estate ........................ -- 8 3 13 79 Commercial business ............................ 22 -- -- 2 -- Consumer ....................................... 35 67 15 21 23 ---------- ---------- ---------- ---------- ---------- Total recoveries ............................. 57 75 18 36 102 ---------- ---------- ---------- ---------- ---------- Charge-offs: Residential real estate ........................ 78 2 13 -- 10 Commercial business ............................ 2 114 3 79 -- Consumer ....................................... 167 106 60 145 157 ---------- ---------- ---------- ---------- ---------- Total charge-offs ............................ 247 222 76 224 167 ---------- ---------- ---------- ---------- ---------- Net (charge-offs) recoveries ................. (190) (147) (58) (188) (65) ---------- ---------- ---------- ---------- ---------- Balance at end of period ......................... $ 1,218 $ 1,103 $ 1,184 $ 1,194 $ 1,240 ========== ========== ========== ========== ========== Ratio of allowance to total loans outstanding at the end of the period ........................ 0.55% 0.54% 0.64% 0.75% 0.90% Ratio of net charge-offs to average loans outstanding during the period .................. 0.09% 0.08% 0.03% 0.13% 0.05%
12 Allowance for Loan Losses Analysis The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.
AT DECEMBER 31, ------------------------------------------------------------------------------ 2002 2001 2000 ------------------------ ------------------------ ------------------------ PERCENT OF PERCENT OF PERCENT OF OUTSTANDING OUTSTANDING OUTSTANDING LOANS LOANS LOANS AMOUNT IN CATEGORY AMOUNT IN CATEGORY AMOUNT IN CATEGORY ---------- ----------- ---------- ----------- ---------- ----------- Residential real estate (1) .... $ 375 70.21% $ 199 69.44% $ 614 65.06% Commercial real estate and land loans............... 18 9.76 120 9.82 226 12.93 Commercial business ............ 297 4.27 294 5.51 90 5.35 Consumer ....................... 528 15.76 490 15.23 254 16.66 Unallocated .................... -- -- -- -- -- -- ---------- ----------- ---------- ----------- ---------- ----------- Total allowance for loan losses ................. $ 1,218 100.00% $ 1,103 100.00% $ 1,184 100.00% ========== =========== ========== =========== ========== =========== AT DECEMBER 31, --------------------------------------------------- 1999 1998 ------------------------ ------------------------ PERCENT OF PERCENT OF OUTSTANDING OUTSTANDING LOANS LOANS AMOUNT IN CATEGORY AMOUNT IN CATEGORY ---------- ----------- ---------- ----------- Residential real estate (1) .... $ 504 67.98% $ 481 68.65% Commercial real estate and land loans............... 190 10.26 253 9.33 Commercial business ............ 150 7.12 96 6.96 Consumer ....................... 350 14.64 410 15.06 Unallocated .................... -- -- -- -- ---------- ----------- ---------- ----------- Total allowance for loan losses .................. $ 1,194 100.00% $ 1,240 100.00% ========== =========== ========== ===========
- ---------- (1) Includes residential construction loans. 13 INVESTMENT ACTIVITIES Federally chartered savings institutions have authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the applicable FHLB, certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds. Subject to various restrictions, such savings institutions may also invest a portion of their assets in commercial paper, corporate debt securities and mutual funds, the assets of which conform to the investments that federally chartered savings institutions are otherwise authorized to make directly. Savings institutions are also required to maintain minimum levels of liquid assets that vary from time to time. The Bank may decide to increase its liquidity above the required levels depending upon the availability of funds and comparative yields on investments in relation to return on loans. The Bank is required under federal regulations to maintain a minimum amount of liquid assets and is also permitted to make certain other securities investments. The balance of the Bank's investments in short-term securities in excess of regulatory requirements reflects management's response to the significantly increasing percentage of deposits with short maturities. It is the intention of management to hold securities with short maturities in the Bank's investment portfolio in order to enable the Bank to match more closely the interest-rate sensitivities of its assets and liabilities. The Bank periodically invests in mortgage-backed securities, including mortgage-backed securities guaranteed or insured by Ginnie Mae, Fannie Mae or Freddie Mac. Mortgage-backed securities generally increase the quality of the Bank's assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Bank. Of the Bank's total mortgage-backed securities portfolio, securities with a book value of $368,000 have adjustable rates as of December 31, 2002. At December 31, 2002, neither the Company nor the Bank had an investment in securities (other than U.S. Government and agency securities and mutual funds that invest in such securities), which exceeded 10% of the Company's stockholders' equity at that date. During 2002 and 2001, the Bank sold non-rated municipal securities classified as held to maturity with an amortized cost of $150,000 and $356,000, respectively and recognized gross gains of $900 and $16,000, respectively. These securities were sold following a recent examination by the OTS which has required divestiture of these holdings within three years. The OTS limits the holdings of non-rated municipal securities to those issued by a municipality in which the institution has an office. Through the merger with HCB Bancorp, the Bank acquired certain non-rated municipal securities issued by municipalities in which the Bank does not have an office. At December 31, 2002, the Bank did not hold any non-rated municipal securities subject to the OTS limitation. 14 The following tables sets forth the securities portfolio at the dates indicated.
AT DECEMBER 31, ------------------------------------------------------------------------------------- 2002 2001 ----------------------------------------- ----------------------------------------- PERCENT WEIGHTED PERCENT WEIGHTED FAIR AMORTIZE OF AVERAGE FAIR AMORTIZE OF AVERAGE VALUE COST PORTFOLIO YIELD(2) VALUE COST PORTFOLIO YIELD(2) -------- -------- -------- -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) Securities Held to Maturity Debt securities: U.S. agency: Due after five years through ten years................... $ -- $ -- --% --% $ -- $ -- --% --% Municipal: Due in one year or less ............ 114 113 0.17 8.87 830 827 1.47 5.93 Due after one year through five years............... 194 189 0.29 8.59 539 525 0.93 8.65 Due after five years through ten years................ 74 74 0.11 10.23 91 91 0.16 10.23 Due after ten years ................ 876 800 1.23 8.33 -- -- -- -- Mortgage-backed securities (3) ........ 295 298 0.46 4.66 390 393 0.70 5.63 -------- -------- -------- -------- -------- -------- $ 1,553 $ 1,474 2.26% $ 1,850 $ 1,836 3.26% ======== ======== ======== ======== ======== ======== Securities Available for Sale Debt securities: U.S. agency: Due in one year or less ............ $ 4,131 $ 4,004 6.17% 5.65% $ 3,570 $ 3,492 6.20% 6.56% Due after one year through five years ................ 38,105 37,074 57.18 4.73 31,450 31,157 55.30 5.08 Due after five years through ten years ................. -- -- -- -- 5,053 5,013 8.90 6.06 Due after ten years through fifteen years ............. -- -- -- -- -- -- -- -- Mortgage-backed securities ............ 10,963 10,833 16.71 3.96 6,591 6,609 11.73 5.09 Municipal: Due in one year or less ............ 145 140 0.22 7.89 427 425 0.75 5.91 Due after one year through five years ................ 1,885 1,769 2.73 6.79 1,093 1,055 1.87 7.02 Due after five years through ten years ................. 5,503 5,335 8.23 6.55 4,035 4,041 7.17 6.47 Due after ten years ................ 3,001 2,979 4.59 6.97 1,506 1,541 2.73 7.00 Equity securities: Mutual fund ........................ 1,247 1,238 1.91 N/A 1,166 1,176 2.09 N/A -------- -------- -------- -------- -------- -------- $ 64,980 $ 63,372 97.74% $ 54,891 $ 54,509 96.74% ======== ======== ======== ======== ======== ======== AT DECEMBER 31, ----------------------------------------- 2000 ----------------------------------------- PERCENT WEIGHTED FAIRE AMORTIZED OF AVERAGE VALUE COST PORTFOLIO YIELD(2) -------- -------- -------- ------- Securities Held to Maturity Debt securities: U.S. agency: Due after five years through ten years................... $ 8,388 $ 8,485 18.35% 6.44% Municipal: Due in one year or less ............ 308 307 0.66 8.89 Due after one year through five years ................ 1,505 1,473 3.19 9.06 Due after five years through ten years ................. 455 440 0.95 9.67 Due after ten years ................ 14 14 0.03 10.23 Mortgage-backed securities (3) 492 510 1.10 6.07 -------- -------- -------- $ 11,162 $ 11,229 24.28% ======== ======== ======== Securities Available for Sale Debt securities: U.S. agency: Due in one year or less ............ $ 3,774 $ 3,781 8.18% 5.75% Due after one year through five years .............. 8,737 8,667 18.74 6.58 Due after five years through ten years .............. 9,853 10,000 21.62 6.58 Due after ten years through fifteen years ........... 2,912 3,000 6.49 6.69 Mortgage-backed securities (3)......... 3,470 3,511 7.59 6.50 Municipal: Due in one year or less ............ 100 100 0.22 5.99 Due after one year through five years .............. 857 854 1.85 6.51 Due after five years through ten years ............... 2,909 2,911 6.29 6.41 Due after ten years ................ 1,077 1,089 2.35 7.19 Equity securities: Mutual fund ........................ 1,090 1,106 2.39 N/A -------- -------- -------- $ 34,779 $ 35,019 75.72% ======== ======== ========
- ---------- (1) Securities held to maturity are carried at amortized cost. (2) Yields are calculated on a fully taxable equivalent basis using a marginal federal income tax rate of 34%. (3) The expected maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty. DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS General. Deposits and loan repayments are the major source of the Bank's funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowing may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or may also be used on a longer term basis for interest rate risk management. Deposit Accounts. Deposits are attracted from within the Bank's primary market area through the offering of a broad selection of deposit instruments, including negotiable order of withdrawal ("NOW") accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. Deposit account terms vary, according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Bank considers the rates offered by its competition, profitability to the Bank, matching deposit and loan products and its customer preferences and concerns. The Bank generally reviews its deposit mix and pricing weekly. 15 The following table presents the maturity distributions of time deposits of $100,000 or more as of December 31, 2002. AMOUNT AT MATURITY PERIOD DECEMBER 31, 2002 ----------------------------- ------------------ (IN THOUSANDS) Three months or less........... $ 5,216 Over three through six months.. 2,653 Over six through 12 months..... 6,194 Over twelve months............. 11,066 ------------------ Total $ 25,129 ================== The following tables set forth the balances of deposits in the various types of accounts offered by the Bank at the dates indicated.
AT DECEMBER 31, ------------------------------------------------------------------------------------------- 2002 2001 ------------------------------------------- -------------------------------------------- PERCENT PERCENT OF INCREASE OF INCREASE AMOUNT TOTAL (DECREASE) AMOUNT TOTAL (DECREASE) ------------ ------------ ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS) Non-interest-bearing demand .. $ 20,052 9.27% $ 1,423 $ 18,629 9.13% $ 1,506 NOW accounts ................. 33,778 15.62 3,147 30,631 15.01 3,855 Savings accounts ............. 20,075 9.29 2,801 17,274 8.46 2,490 Money market accounts ........ 34,597 16.00 1,136 33,461 16.39 1,905 Fixed rate time deposits which mature: Within one year ............. 50,758 23.48 (9,253) 60,011 29.40 14,936 After one year, but within three years.......... 30,407 14.06 1,268 29,139 14.28 (9,994) After three years, but within five years........... 25,732 11.90 11,487 14,245 6.98 3,935 After five years ............ 701 0.32 43 658 0.32 124 Club accounts ................ 102 0.06 28 74 0.03 (3) ------------ ------------ ------------ ------------ ------------ ------------ Total .................... $ 216,202 100.00% $ 12,080 $ 204,122 100.00% $ 18,754 ============ ============ ============ ============ ============ ============ AT DECEMBER 31, 2000 --------------------------- PERCENT OF AMOUNT TOTAL ------------ ------------ (DOLLARS IN THOUSANDS) Non-interest-bearing demand .. $ 17,123 9.24% NOW accounts ................. 26,776 14.44 Savings accounts ............. 14,784 7.98 Money market accounts ........ 31,556 17.02 Fixed rate time deposits which mature: Within one year ............. 45,075 24.32 After one year, but within three years.......... 39,133 21.11 After three years, but within five years........... 10,310 5.56 After five years ............ 534 0.29 Club accounts ................ 77 0.04 ------------ ------------ Total .................... $ 185,368 100.00% ============ ============
The following table sets forth the amount and maturities of time deposits by rates at December 31, 2002.
AMOUNT DUE PERCENT --------------------------------------------------------- OF TOTAL LESS THAN 1 - 3 3 - 5 AFTER 5 TIME ONE YEAR YEARS YEARS YEARS TOTAL DEPOSITS ------------ ------------ ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS) Below 2.00% .................. $ 9,228 $ 1,540 $ - $ - $ 10,768 10.01% 2.00% -- 2.99% ............... 15,649 4,495 10 - 20,154 18.73 3.00% -- 3.99% ............... 9,955 5,335 5,186 14 20,490 19.04 4.00% -- 4.99% ............... 2,764 6,388 8,035 249 17,436 16.20 5.00% -- 5.99% ............... 4,224 4,091 11,559 268 20,142 18.72 6.00% -- 6.99% ............... 6,187 6,292 890 160 13,529 12.57 7.00% -- 7.99% ............... 2,733 2,266 52 1 5,052 4.70 8.00% -- 8.99% ............... 18 - - 9 27 0.03 ------------ ------------ ------------ ------------ ------------ ------------ Total ..................... $ 50,758 $ 30,407 $ 25,732 $ 701 $ 107,598 100.00% ============ ============ ============ ============ ============ ============
Borrowings. Deposits are the primary source of funds for the Bank's lending and investment activities and for its general business purposes. The Bank has at times relied upon advances from the FHLB of Indianapolis to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB of Indianapolis are 16 secured by certain first mortgage loans and investment and mortgage-backed securities. The Bank also uses retail repurchase agreements as a source of borrowings. The FHLB functions as a central reserve bank providing credit for savings and loan associations and certain other member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution's net worth or on the FHLB's assessment of the institution's creditworthiness. Under its current credit policies, the FHLB generally limits advances to 20% of a member's assets, and short-term borrowing of less than one year may not exceed 10% of the institution's assets. The FHLB determines specific lines of credit for each member institution. The following table sets forth certain information regarding the Bank's use of FHLB advances. AT OR FOR THE YEAR ENDED DECEMBER 31, --------------------------------------- 2002 2001 2000 ----------- ---------- ---------- (DOLLARS IN THOUSANDS) Maximum balance at any month end $ 53,320 $ 43,575 $ 30,074 Average balance ................ 46,750 34,918 19,159 Period end balance ............. 53,320 42,825 30,074 Weighted average interest rate: At end of period .............. 5.49% 5.87% 6.30% During period ................. 5.80% 6.19% 6.43% The following table sets forth certain information regarding the Bank's use of retail repurchase agreements during the periods indicated. AT OR FOR THE YEAR ENDED DECEMBER 31, --------------------------------------- 2002 2001 2000 ----------- ---------- ---------- (DOLLARS IN THOUSANDS) Maximum balance at any month end $ 457 $ 579 $ -- Average balance.................. 186 91 -- Period end balance............... 457 284 -- Weighted average interest rate: At end of period................ 0.93% 1.50% N/A During period................... 1.39% 3.12% N/A 17 SUBSIDIARY ACTIVITIES As of December 31, 2002, the Bank was the Company's only insured subsidiary, and was wholly owned by the Company. The Bank's sole subsidiary, First Harrison Financial Services, Inc., is involved with the sale of property and casualty insurance, life insurance and non-deposit investment products. PERSONNEL As of December 31, 2002, the Bank had 104 full-time employees and 18 part-time employees. A collective bargaining unit does not represent the employees and the Bank considers its relationship with its employees to be good. REGULATION AND SUPERVISION GENERAL As a savings and loan holding company, the Company is required by federal law to file reports with, and otherwise comply with, the rules and regulations of the OTS. The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Savings Association Insurance Fund managed by the FDIC. The Bank must file reports with the OTS 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 savings institutions. The OTS and/or the FDIC conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-KSB does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company. HOLDING COMPANY REGULATION The Company is a nondiversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the Company was not generally restricted as to the types of business activities in which it may engage, provided that the Bank continued to be a qualified thrift lender. See "Federal Savings Institution Regulation - QTL Test." The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, so long as the Bank continues to comply with the QTL Test the Company does not qualify for the grandfather. Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the qualified thrift lender test and is deemed to be a savings institution by the OTS, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under the Bank Holding Company Act, subject to the prior approval of the OTS, and certain activities authorized by OTS regulation. However, the OTS has issued an interpretation concluding that multiple savings and loan holding companies may also engage in activities permitted for financial holding companies. A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company, without prior written approval of the OTS and from acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS considers the financial and managerial 18 resources and future prospects of the Company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors. The OTS may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions. Although savings and loan holding companies are not subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the OTS 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution. Acquisition of the Company. Under the Federal Change in Bank Control Act ("CIBCA"), a notice must be submitted to the OTS if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company's outstanding voting stock, unless the OTS has found that the acquisition will not result in a change of control of the Company. Under the CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company. FEDERAL SAVINGS INSTITUTION REGULATION Business Activities. Federal law and regulations govern the activities of federal savings institutions. These laws and regulations delineate the nature and extent of the activities in which federal associations may engage. In particular, many types of lending authority for federal association, e.g., commercial, non-residential real property loans and consumer loans, are limited to a specified percentage of the institution's capital or assets. Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMEL financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The OTS regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank. The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OTS capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The OTS also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution's capital level is or may become inadequate in light of the particular circumstances. At December 31, 2002, the Bank met each of its capital requirements. 19 The following table presents the Bank's capital position at December 31, 2002. Capital ------------------- Actual Required Excess Actual Required Capital Capital Amount Percent Percent -------- --------- -------- -------- --------- (Dollars in thousands) Tangible................ $ 33,564 $ 4,612 $ 28,952 10.92% 1.50% Core (Leverage)......... 33,564 12,299 21,265 10.92 4.00 Risk-based.............. 34,782 14,257 20,525 19.52 8.00 Prompt Corrective Regulatory Action. The OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Insurance of Deposit Accounts. The Bank is a member of the Savings Association Insurance Fund. The FDIC maintains a risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends upon the categories to which it is assigned. Assessment rates for Savings Association Insurance Fund member institutions are determined semi-annually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest. In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the Savings Association Insurance Fund. During 2002, FICO payments for Savings Association Insurance Fund members approximated 1.75 basis points of assessable deposits. The Bank's risk-based classifications resulted in no assessments during 2002. The FDIC has authority to increase insurance assessments. A significant increase in Savings Association Insurance Fund insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future. 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 or the OTS, may terminate insurance of deposits. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. A savings institution may not make a loan or extend credit to a single 20 or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral. At December 31, 2002, the Bank's limit on loans to one borrower was $5.2 million, and the Bank's largest aggregate outstanding balance of loans to one borrower was $1.7 million. QTL Test. The Home Owners' Loan Act requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of December 31, 2002, the Bank maintained 83.3% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments." Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the OTS is required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under OTS regulations (i.e., generally, examination ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with OTS. If an application is not required, the institution must still provide prior notice to the OTS of the capital distribution if, like the Bank, it is a subsidiary of a holding company. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended December 31, 2002 totaled $70,000. Transactions with Related Parties. The Bank's authority to engage in transactions with "affiliates" (e.g., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. The recently enacted Sarbanes-Oxley Act generally prohibits loans by the Company to its executive officers and directors. However, that act contains a specific exception for loans by the Bank to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is limited. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially 21 the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. 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 insiders over other employees. Enforcement. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that a savings institution fails to meet any standard prescribed by the guidelines, the OTS may require the institution to submit an acceptable plan to achieve compliance with the standard. FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. The Bank complied with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2002 of $2.7 million. The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank's net interest income would likely also be reduced. Recent legislation has changed the structure of the Federal Home Loan Banks funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership. FEDERAL RESERVE SYSTEM The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $42.1 million; and a 10% reserve ratio is applied above $42.1 million. The first $6.0 million of otherwise reservable balances are exempted from the reserve requirements. The amounts are adjusted annually. The Bank complied with the foregoing requirements at December 31, 2002. 22 FEDERAL AND STATE TAXATION FEDERAL TAXATION General. The Company and the Bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Bank has not been audited by the Internal Revenue Service ("IRS") in the past five years. Bad Debt Reserve. For taxable years beginning after December 31, 1995, the Bank is entitled to take a bad debt deduction for federal income tax purposes which is based on its current or historic net charge-offs. For tax years beginning prior to December 31, 1995, the Bank as a qualifying thrift had been permitted to establish a reserve for bad debts and to make annual additions to such reserve, which were deductible for federal income tax purposes. Under such prior tax law, generally the Bank recognized a bad debt deduction equal to 8% of taxable income. Under the 1996 Tax Act, the Bank is required to recapture all or a portion of its additions to its bad debt reserve made subsequent to the base year (which is the Bank's last taxable year beginning before January 1, 1988). This recapture is required to be made, after a deferral period based on certain specified criteria, ratably over a six-year period commencing in the Bank's calendar 1998 tax year. The Bank, in fiscal 1997, recorded a deferred tax liability for this bad debt recapture. As a result, the recapture is not anticipated to effect the Bank's future net income or federal income tax expense for financial reporting purposes. Potential Recapture of Base Year Bad Debt Revenue. The Bank's bad debt reserve as of the base year is not subject to automatic recapture as long as the Bank continues to carry on the business of banking. If the Bank no longer qualifies as a bank, the balance of the pre-1988 reserves (the base year reserves) are restored to income over a six-year period beginning in the tax year the Bank no longer qualifies as a bank. Such base year bad debt reserve is subject to recapture to the extent that the Bank makes "non-dividend distributions" that are considered as made from the base year bad debt. To the extent that such reserves exceed the amount that would have been allowed under the experience method ("Excess Distributions"), then an amount based on the amount distributed will be included in the Bank's taxable income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. Thus, any dividends to the Company that would reduce amounts appropriated to the Bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. The Bank makes a "non-dividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state and local taxes). The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserve. Corporate Alternative Minimum Tax. The Internal Revenue Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction claimed by the Bank over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating loss carryovers of which the Bank currently has none. AMTI is increased by an amount equal to 75% of the amount by which the Bank's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). In addition, for taxable years beginning after June 30, 1986 and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modifications) over $2.0 million is imposed on corporations, including the Bank, whether or not an Alternative Minimum Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT. Dividends Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the 23 Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank own more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. INDIANA TAXATION Indiana imposes an 8.5% franchise tax based on a financial institution's adjusted gross income as defined by statute. In computing adjusted gross income, deductions for municipal interest, U.S. Government interest, the bad debt deduction computed using the reserve method and pre-1990 net operating losses are disallowed. The Bank's state income tax returns were audited for the years ended December 31, 1993, 1994 and 1995 without amendment and without additional tax liability. The Bank's state income tax returns have not been audited for any subsequent period. ITEM 2. DESCRIPTION OF PROPERTY. The following table sets forth certain information regarding the Bank's offices as of December 31, 2002.
APPROXIMATE YEAR NET BOOK OWNED/ SQUARE LOCATION OPENED VALUE (1) LEASED FOOTAGE - ----------------------------------- ------ -------------- --------- ----------- (In thousands) MAIN OFFICE: 220 Federal Drive, N.W. Corydon, Indiana 47112 ............. 1997 $ 2,131 Owned 12,000 BRANCH OFFICES: 391 Old Capitol Plaza, N.W. Corydon, Indiana 47112 ............. 1997 12 Leased/(2)/ 425 8095 State Highway 135, N.W. New Salisbury, Indiana 47161 ....... 1999 1,006 Owned 3,500 710 Main Street Palmyra, Indiana 47114 ............ 1991 1,452 Owned 6,000 6040 Main Street NE Crandall, Indiana 47114 ........... 1938 92 Owned 1,000 9849 Highway 150 Greenville, Indiana 47124 ......... 1986 231 Owned 2,484 1058 North Luther Road Georgetown, Indiana 47122 ......... 1995 110 Leased/(3)/ 1,800 State Road 150 Hardinsburg, Indiana 47125 ........ 1996 110 Owned 1,834 4303 Charlestown Road New Albany, Indiana 47150 ......... 1999 988 Owned 3,500
- ---------- (1) Represents the net value of land, buildings, furniture, fixtures and equipment owned by the Bank. (2) Lease expires on November 30, 2003. (3) Lease expires November 2005. ITEM 3. LEGAL PROCEEDINGS. At December 31, 2002, neither the Company nor the Bank was involved in any pending legal proceedings that are believed by management to be material to the Company's financial condition or results of operations. In addition, from time to time, the Bank is involved in legal proceeding occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition or results of operations. 24 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 of the fiscal year ended December 31, 2002. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information contained in the section captioned, "Corporate Information" in the Annual Report is incorporated herein by reference. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference. ITEM 7. FINANCIAL STATEMENTS. . Independent Auditors' Report* . Consolidated Balance Sheets as of December 31, 2002 and 2001* . Consolidated Statements of Stockholders Equity for the Years Ended December 31, 2002 and 2001* . Consolidated Statements of Income for the Years Ended December 31, 2002 and 2001* . Consolidated Statements of Cash Flows for the Years Ended December 31, 2002 and 2001* . Notes to Consolidated Financial Statements* - ---------- *Contained in the Annual Report to Stockholders filed as an exhibit hereto and incorporated herein by reference. All schedules have been omitted as the required information is either inapplicable or contained in the Consolidated Financial Statements or related Notes contained in the Annual Report to Stockholders. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. The information required by this Item with respect to Directors is incorporated herein by reference to the Proxy Statement under the heading "Proposal 1--Election of Directors." The information contained under the section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement is incorporated herein by reference. EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
NAME AGE(1) POSITION - ------------------------------------ ------ ------------------------------------------------------------ M. Chris Frederick ................. 35 Senior Vice President, Chief Financial Officer and Treasurer Joel E. Voyles ..................... 50 Senior Vice President - Retail and Corporate Secretary Dennis L. Thomas ................... 46 Senior Vice President - Lending Bradley B. Backherms ............... 52 Senior Vice President - Operations
- ---------- (1) As of December 31, 2002. 25 BIOGRAPHICAL INFORMATION M. Chris Frederick has been affiliated with the Bank since 1990 and has served in his present position since 1997. Joel E. Voyles has been affiliated with the Bank since December 1996 and has served in his present position since 1997. Dennis L. Thomas has been affiliated with the Bank since January 2000. He was employed by Harrison County Bank from 1981 until the merger with the Bank. Bradley B. Backherms has been affiliated with the Bank since January 2000. He was employed by Harrison County Bank from 1982 until the merger with the Bank. ITEM 10. EXECUTIVE COMPENSATION. The information required by this Item is incorporated herein by reference to the Proxy Statement under the heading "Executive Compensation" and "Proposal 1 -- Election of Directors." ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated herein by reference to the Proxy Statement under the heading "Stock Ownership." EQUITY COMPENSATION PLAN INFORMATION AS OF DECEMBER 31, 2002
PLAN CATEGORY NUMBER OF SECURITIES WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES TO BE ISSUED UPON EXERCISE PRICE OF OUTSTANDING REMAINING AVAILABLE FOR OF OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND FUTURE ISSUANCE UNDER WARRANTS AND RIGHTS RIGHTS EQUITY COMPENSATION PLANS (EXCLUDING SECURITIES REFLECTED IN COLUMN (a)) (a) (b) (c) - ----------------------------- -------------------------- ------------------------- ---------------------------- Equity compensation plans 73,923 $ 10.68 39,292 approved by security holders - ----------------------------- -------------------------- ------------------------- ---------------------------- Equity compensation plans not approved by security - - - holders - ----------------------------- -------------------------- ------------------------- ---------------------------- Total 73,923 $ 10.68 39,292 - ----------------------------- -------------------------- ------------------------- ----------------------------
The Company does not maintain any equity compensation plans that have not been approved by security holders. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated herein by reference to the Proxy Statement under the heading "Proposal 1 -- Election of Directors" and "Transactions with Management." 26 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS 3.1 Articles of Incorporation of First Capital, Inc. (1) 3.2 Second Amended and Restated Bylaws of First Capital, Inc.(6) 10.1 Employment Agreement with James G. Pendleton (3) 10.2 Employment Agreement with Samuel E. Uhl (2) 10.3 Employment Agreement with M. Chris Frederick (2) 10.4 Employment Agreement with Joel E. Voyles (2) 10.5 Employee Severance Compensation Plan (3) 10.6 First Federal Bank, A Federal Savings Bank 1994 Stock Option Plan (as assumed by First Capital, Inc. effective December 31, 1998) (4) 10.7 First Capital, Inc. 1999 Stock-Based Incentive Plan (5) 10.8 1998 Officers' and Key Employees' Stock Option Plan for HCB Bancorp (5) 10.9 Employment Agreement with William W. Harrod (2) 13.0 Annual Report to Stockholders 21.0 Subsidiaries of the Registrant (incorporated by reference to Part I, "Business--Subsidiary Activities" of this Form 10-KSB). 23.0 Consent of Monroe Shine and Co., Inc. 99.1 Chief Executive Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Chief Financial Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - ---------- (1) Incorporated by reference from the Exhibits filed with the Registration Statement on Form SB-2, and any amendments thereto, Registration No. 333-63515. (2) Incorporated by reference to the Annual Report on Form 10-KSB for the year ended December 31, 1999. (3) Incorporated by reference to the Quarterly Report on Form 10-QSB for the quarter ended December 31, 1998. (4) Incorporated by reference from the Exhibits filed with the Registration Statement on Form S-8, and any amendments thereto, Registration Statement No. 333-76543. (5) Incorporated by reference from the Exhibits filed with the Registration Statement on Form S-8, and any amendments thereto, Registration Statement No. 333-95987. (6) Incorporated by reference to the Annual Report on Form 10-KSB for the year ended December 31, 2001. (b) REPORTS ON FORM 8-K No Forms 8-K were filed during the quarter ended December 31, 2002. ITEM 14. CONTROLS AND PROCEDURES. (a) Evaluation of disclosure controls and procedures. The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed within 90 days of the filing date of this report, the Chief Executive Officer and the Chief Financial Officer of the Company concluded that the Company's disclosure controls and procedures were adequate. (b) Changes in internal controls. The Company made no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation of those controls by the Chief Executive Officer and the Chief Financial Officer. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST CAPITAL, INC. /s/ William W. Harrod -------------------------- William W. Harrod President, Chief Executive Officer and Director In accordance with the requirements of the Securities Act of 1933, this Registration Statement was signed by the following persons in the capacities and on the dates stated. Name Title Date - ---------------------------- ----------------------------- -------------- /s/ William W. Harrod President, Chief Executive March 28, 2003 - ---------------------------- Officer and Director William W. Harrod (principal executive officer) /s/ J. Gordon Pendleton Chairman March 28, 2003 - ---------------------------- J. Gordon Pendleton /s/ Michael C. Frederick Chief Financial Officer and March 28, 2003 - ---------------------------- Treasurer Michael C. Frederick (principal accounting and financial officer) /s/ Samuel E. Uhl Director March 28, 2003 - ---------------------------- Samuel E. Uhl /s/ Mark D. Shireman Director March 28, 2003 - ---------------------------- Mark D. Shireman /s/ Dennis L. Huber Director March 28, 2003 - ---------------------------- Dennis L. Huber /s/ Kenneth R. Saulman Director March 28, 2003 - ---------------------------- Kenneth R. Saulman /s/ John W. Buschemeyer Director March 28, 2003 - ---------------------------- John W. Buschemeyer /s/ Gerald L. Uhl Director March 28, 2003 - ---------------------------- Gerald L. Uhl /s/ James S. Burden Director March 28, 2003 - ---------------------------- James S. Burden /s/ James E. Nett Director March 28, 2003 - ---------------------------- James E. Nett /s/ Michael L. Shireman Director March 28, 2003 - ---------------------------- Michael L. Shireman /s/ Kathy Ernstberger Director March 28, 2003 - ---------------------------- Kathy Ernstberger CERTIFICATIONS I, William W. Harrod, President and Chief Executive Officer, of First Capital, Inc., certify that: (1) I have reviewed this annual report on Form 10-KSB of First Capital, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of the internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 28, 2003 /s/ William W. Harrod ------------------------------------- William W. Harrod President and Chief Executive Officer (principal executive officer) CERTIFICATIONS I, Michael C. Frederick, Senior Vice President, Chief Financial Officer and Treasurer of First Capital, Inc., certify that: (1) I have reviewed this annual report on Form 10-KSB of First Capital, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of the internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 28, 2003 /s/ Michael C. Frederick -------------------------------------------- Michael C. Frederick Senior Vice President, Chief Financial Officer and Treasurer (principal financial and accounting officer) EX-13 3 dex13.txt EXHIBIT 13 EXHIBIT 13 FIRST CAPITAL, INC. TABLE OF CONTENTS Page Letter to Stockholders............................................ 2 Selected Financial and Other Data................................. 3-4 Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 5-15 Independent Auditor's Report...................................... 16 Consolidated Financial Statements................................. 17-20 Notes to Consolidated Financial Statements........................ 21-42 Board of Directors................................................ 43 Corporate Information............................................. 44-45 BUSINESS OF THE COMPANY First Capital, Inc. (the Company) is the thrift holding company of First Harrison Bank (the Bank). The Bank's deposit accounts are insured up to applicable legal limits by the Federal Deposit Insurance Corporation through the Savings Association Insurance Fund. The Bank is a member of the Federal Home Loan Bank System. The Bank conducts its operations through its nine locations in Southern Indiana. The Bank's main office is located at 220 Federal Drive, N.W., Corydon, Indiana. The telephone number is (812) 738-2198. The Bank is a community-oriented financial institution offering traditional financial services primarily to residents of Harrison County, Indiana, and contiguous counties. The Bank's primary business is attracting deposits from the general public and using those funds to originate one-to-four family residential mortgage loans. The Bank also originates multi-family and commercial real estate loans primarily secured by properties located in Southern Indiana. To a lesser extent, the Bank originates commercial and consumer loans. The Bank's wholly-owned subsidiary, First Harrison Financial Services, Inc., sells property and casualty insurance and non-deposit investment products. -1- [GRAPHIC APPEARS HERE] Dear Shareholders: Management and the Board of Directors of First Capital, Inc. would like to thank our shareholders, customers, and staff for helping reach our goals in 2002. We are very proud of our stock appreciation from $14.40 per share on January 2nd to $20.33 per share on December 30th. This increase ranks us as one of the best performing stocks in the state of Indiana. We had a busy year while meeting the demands of our long-term strategic plan. Our announcement of the new office in Jeffersonville will further help us position the Company as one of the strongest financial service providers in southern Indiana. We anticipate this office opening in May and look forward to the additional growth opportunities this new office will provide. In September we announced our intent to merge with Hometown Bancshares, Inc., the parent company for Hometown National Bank in New Albany, Indiana. Everything is on target to close this transaction and merge the bank into First Harrison Bank by the end of the first quarter. We are excited about the opportunities this offers us to further expand our market share in Floyd County, Indiana. Our plan is to become a major competitor in markets we serve and merging the customers and the excellent staff of Hometown National Bank will offer us this opportunity in Floyd County and New Albany. During the year we completed our technology upgrade, which will pay long-term benefits to customers and staff. We improved our teller systems to make them more efficient and allow them to better serve our customers. Our loan department has gone through many internal changes to better serve customers and to help the staff become more efficient in their daily jobs. As always we cannot thank our staff enough for their personal commitment to the communities we serve. The bank is able to give financially, but that cannot measure up to the amount of time our staff has given to programs like Relay for Life, United Way, Big Brothers-Big Sisters, American Heart Association, Harrison County 4H, reading programs at the county jail, and our continued business partnership with New Middletown School. Our belief is all these things lead to improved value for our shareholders. You can count on our continued hard work in these and many other areas. We are proud of our past and look forward to a bright future. Thank you for your continued support. Sincerely, /s/ William Harrod /s/ J. Gordon Pendleton - ------------------ ----------------------- William Harrod J. Gordon Pendleton President CEO Chairman of the Board -2- SELECTED FINANCIAL AND OTHER DATA The financial data presented below is qualified in its entirety by the more detailed financial data appearing elsewhere in this report, including the Company's audited financial statements. The following tables set forth certain information concerning the financial position and results of operations of the Company at the dates indicated.
FINANCIAL CONDITION DATA: AT DECEMBER 31, ------------------------------------------------------------------------ 2002 2001 2000 1999 1998 ------------ ------------ ------------ ------------ ------------ (In thousands) Total assets $ 308,553 $ 282,823 $ 248,582 $ 222,797 $ 191,350 Cash and interest-bearing deposits (1) 12,653 12,382 11,468 9,522 16,459 Securities available for sale 64,980 54,891 34,779 30,097 22,302 Securities held to maturity 1,474 1,836 11,229 12,325 6,140 Loans receivable, net 215,996 201,730 179,304 154,982 135,379 Deposits 216,202 204,122 185,368 175,342 155,495 Advances from Federal Home Loan Bank 53,320 42,825 30,074 16,750 5,250 Stockholders' equity, substantially restricted 36,330 33,481 31,107 28,877 28,930
OPERATING DATA: FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------ 2002 2001 2000 1999 1998 ------------ ------------ ------------ ------------ ------------ (In thousands) Interest income $ 18,912 $ 18,960 $ 17,363 $ 15,101 $ 13,506 Interest expense 8,802 9,842 9,267 7,566 6,848 ------------ ------------ ------------ ------------ ------------ Net interest income 10,110 9,118 8,096 7,535 6,658 Provision for loan losses 305 66 48 142 83 ------------ ------------ ------------ ------------ ------------ Net interest income after provision for loan losses 9,805 9,052 8,048 7,393 6,575 ------------ ------------ ------------ ------------ ------------ Noninterest income 1,737 1,706 1,219 1,031 898 Noninterest expense (2) 6,531 5,945 5,629 5,574 4,390 ------------ ------------ ------------ ------------ ------------ Income before income taxes 5,011 4,813 3,638 2,850 3,083 Income tax expense 1,763 1,714 1,180 1,080 1,077 ------------ ------------ ------------ ------------ ------------ Net Income $ 3,248 $ 3,099 $ 2,458 $ 1,770 $ 2,006 ============ ============ ============ ============ ============ PER SHARE DATA: Net income - basic $ 1.31 $ 1.26 $ 1.00 $ 0.72 $ 0.79 Net income - diluted 1.30 1.25 1.00 0.71 0.79 Dividends 0.52 0.48 0.41 0.35 N/A Dividends of pooled affiliate (3) N/A N/A N/A 0.39 0.39 Dividends to minority stockholders prior to conversion N/A N/A N/A N/A 0.27
(1) Includes interest-bearing deposits in other depository institutions. (2) Includes merger related expenses of $439,000 in 1999. (3) Includes dividends paid by HCB Bancorp which merged with and into First Capital, Inc. on January 12, 2000. -3- SELECTED FINANCIAL AND OTHER DATA - CONTINUED
SELECTED FINANCIAL RATIOS: AT AND FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ------------ ------------ ------------ ------------ ------------ PERFORMANCE RATIOS: Return on assets (1) 1.10% 1.17% 1.05% 0.84% 1.00% Return on average equity (2) 9.32% 9.49% 8.27% 6.05% 7.81% Dividend payout ratio (3) 39.90% 38.52% 41.40% 51.38% 42.78% Average equity to average assets 11.77% 12.31% 12.64% 13.95% 12.81% Interest rate spread (4) 3.16% 3.01% 2.99% 3.16% 3.18% Net interest margin (5) 3.70% 3.73% 3.75% 3.86% 3.96% Non-interest expense to average assets 2.20% 2.24% 2.39% 2.66% 2.48% Average interest earning assets to average interest bearing liabilities 117.39% 118.41% 118.30% 118.01% 119.11% REGULATORY CAPITAL RATIOS: Tier I - adjusted total assets 10.92% 11.25% 11.92% 12.13% 13.51% Tier I - risk based 18.83% 19.67% 19.97% 19.64% 22.90% Total risk-based 19.52% 20.36% 20.63% 19.64% 23.91% ASSET QUALITY RATIOS: Nonperforming loans as a percent of loans receivable, net (6) 0.62% 0.62% 0.32% 0.13% 0.27% Nonperforming assets as a percent of total assets (7) 0.47% 0.52% 0.28% 0.21% 0.19% Allowance for loan losses as a percent of gross loans receivable 0.55% 0.54% 0.64% 0.75% 0.90%
- ---------- (1) Net income divided by average assets. (2) Net income divided by average equity. (3) Dividends declared per share divided by net income per share. The dividend payout ratio for 1998 was computed considering only the dividends to the minority shareholders of First Federal Bank and their proportionate share of net income prior to conversion from mutual to stock form. Prior to the conversion on December 31, 1998, First Capital, Inc., M.H.C., a federally- chartered mutual holding company, was the majority owner of First Federal Bank and, with the approval of the OTS, elected to waive the receipt of dividends. (4) Difference between weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities. (5) Net interest income as a percentage of average interest-earning assets. (6) Nonperforming loans consist of loans accounted for on a nonaccrual basis and accruing loans 90 days or more past due. (7) Nonperforming assets consist of nonperforming loans and real estate acquired in settlement of loans, but exclude restructured loans. -4- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Bank's results of operations depend primarily on net interest income, which is the difference between the income earned on its interest-earning assets, such as loans and investments, and the cost of its interest-bearing liabilities, consisting primarily of deposits and borrowings from the Federal Home Loan Bank of Indianapolis. The Bank's net income is also affected by, among other things, fee income, provisions for loan losses, operating expenses and income tax provisions. The Bank's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the intended actions of the regulatory authorities. Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company and the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes to consolidated financial statements included elsewhere in this report. OPERATING STRATEGY The Company is the parent company to an independent community-oriented financial institution that delivers quality customer service and offers a wide range of deposit, loan and investment products to its customers. The Company has no other material income other than that generated by the Bank and the Bank's wholly-owned subsidiary, First Harrison Financial Services, Inc., which sells property and casualty insurance and non-deposit investment products. The Bank's primary business strategy is attracting deposits from the general public and using those funds to originate one-to-four family residential mortgage loans. The Bank's lending activity also includes multi-family residential loans, commercial real estate and business loans and consumer loans. The Bank invests excess liquidity primarily in interest-bearing deposits with the Federal Home Loan Bank of Indianapolis and other financial institutions, U.S. government and agency securities, local municipal obligations and, to a lesser extent, mortgage-backed securities. In recent years, the Company's operating strategy has also included enhancing profitability by increasing sources of non-interest income and improving operating efficiency while managing its capital and limiting its credit risk and interest rate risk exposures. To accomplish these objectives, the Company has focused on the following: .. Control credit risk by focusing on the origination of one-to-four family residential mortgage loans and consumer loans, consisting primarily of home equity loans and lines of credit while increasing the market share of commercial real estate and small business loans. .. Provide quality customer service by expanding and upgrading the branch offices, introducing Internet banking and broadening its commercial deposit and loan products. .. Capitalize on the efficiencies, personnel and opportunities following the merger with HCB Bancorp in January 2000. .. Increase fee income from non-deposit investment products and providing property and casualty insurance. .. Continue to invest in technology to increase productivity and efficiency. .. Engage in a capital management strategy to repurchase Company stock and pay dividends to enhance shareholder value. -5- PENDING MERGER On September 25, 2002, the Company and Hometown Bancshares, Inc. (Hometown), a bank holding company for Hometown National Bank in New Albany, Indiana, entered into an agreement and plan of merger whereby each of the issued and outstanding common shares of Hometown will be exchanged for shares of the Company's common stock or $46.50 in cash per share. The number of shares of the Company's common stock to be exchanged for each share of Hometown's common stock will be based on the average closing price of the Company's common stock over a twenty day trading period shortly before the closing of the merger. Elections to receive stock, cash or a combination of stock and cash by the Hometown shareholders will be limited by a requirement that 50% of the total number of outstanding shares of Hometown's common stock be exchanged for Company common stock. The merger is subject to regulatory and shareholder approvals. The merger is expected to be completed in March 2003. FORWARD LOOKING STATEMENTS This report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on the Company's current expectations regarding its business strategies and their intended results and its future performance. Forward-looking statements are preceded by terms such as "expects," "believes," "anticipates," "intends" and similar expressions. Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause or contribute to the Company's actual results, performance and achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, general economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; legislative and regulatory changes; and other factors disclosed periodically in the Company's filings with the Securities and Exchange Commission. Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by the Company or on its behalf by its authorized officers. Except as may be required by applicable law and regulation, the Company assumes no obligation to update any forward-looking statements. -6- CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that require management to make assumptions about matters that are highly uncertain at the time an accounting estimate is made; and different estimates that the Company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the Company's financial condition, changes in financial condition, or results of operations. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under generally accepted accounting principles. Significant accounting policies, including the impact of recent accounting pronouncements, are discussed in Note 1 of the Notes to Consolidated Financial Statements. Those policies considered to be critical accounting policies are described below. Allowances for Loan Losses. Management's evaluation of the adequacy of the allowance for loan losses is the most critical of accounting estimates for a financial institution. The methodology for determining the allowance for loan losses and the related provision for loan losses is described below in "Allowance for Loan Losses". This accounting estimate is highly subjective and requires a significant amount of judgment because a multitude of factors can influence the ultimate collection of a loan. The methodology for determining the allowance for loan losses attempts to identify the amount of probable losses in the loan portfolio. However, there can be no assurance that the methodology will successfully identify all probable losses as the factors and conditions that influence the estimate are subject to significant change and management's judgments. As a result, additional provisions for loan losses may be required that would adversely impact earnings in future periods. Valuation Methodologies. In the ordinary course of business, management applies various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when active markets do not exist for the items being valued. Generally, in evaluating various assets for potential impairment, management compares the fair value to the carrying value. Quoted market prices are referred to when estimating fair values for certain assets, such as investment securities. However, for those items for which market-based prices do not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include capitalized servicing assets, estimated present value of impaired loans, deferred compensation plans, value ascribed to stock-based compensation and certain other financial investments. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company's results of operations. Specific discussion of assumptions and estimates utilized by management are discussed in detail in the accompanying notes 1, 5, 13, 14 and 19 of Notes to Consolidated Financial Statements. Income Taxes. The accounting for income taxes requires the asset and liability approach for financial accounting and reporting for deferred income taxes. See Notes 1 and 11 in the accompanying Notes to Consolidated Financial Statements. As part of the process of preparing the consolidated financial statements, management estimates the income taxes in each of the taxing jurisdictions in which the Company operates. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for financial accounting and tax purposes, such as depreciation, loan fees and costs, loan losses, compensation plans and unrealized securities gains and losses. These differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheet. Management must assess the likelihood that deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely establish a valuation allowance. Significant management judgment is required in determining the provision for income taxes, the deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. To the extent a valuation allowance is recorded or increased, an expense is recognized within the tax provisions in the statement of income. -7- COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND 2001 Total assets increased 9.1% from $282.8 million at December 31, 2001 to $308.6 million at December 31, 2002, primarily as a result of increases in investment securities and loans receivable, net, that were funded by growth in deposits and advances from the Federal Home Loan Bank of Indianapolis. Loans receivable, net, were $201.7 million at December 31, 2001 compared to $216.0 million at December 31, 2002, a 7.1% increase. The loan growth is attributable primarily to an 8.5% increase in residential mortgage and construction loans and a 43.8% growth in home equity and second mortgage loans. Residential mortgage and construction loans were $142.8 million at December 31, 2001, compared to $155.0 million at December 31, 2002 and home equity and second mortgage loans increased from $13.0 million at December 31, 2001 to $18.6 million at December 31, 2002. Also, commercial real estate loans increased from $15.8 million at December 31, 2001 to $17.0 million at December 31, 2002. Commercial business loans decreased $1.9 million from $11.3 million at December 31, 2001 to $9.4 million at December 31, 2002, and other consumer loans decreased during the year from $18.4 million to $16.2 million. During 2002, the Bank focused on originating one-to-four family first mortgage loans and home equity loans to provide for loan growth while maintaining portfolio credit quality. Securities available for sale, at fair value, consisting primarily of U. S. agency mortgage-backed obligations, U. S. agency notes and bonds, and municipal obligations, increased $10.1 million or 18.4%, from $54.9 million at December 31, 2001 to $65.0 million at December 31, 2002 primarily as a result of purchases of $26.6 million net of maturities and repayments of $16.8 million. The investment in securities held to maturity, consisting of federal agency mortgage-backed certificates and municipal obligations, decreased from $1.8 million at December 31, 2001 to $1.5 million at December 31, 2002 primarily as a result of maturities and repayments of $1.3 million offset by purchases of $1.1 million. Also, the Bank sold certain non-rated municipal securities with an amortized cost of $150,000 due to regulatory restrictions (see Note 4 - Notes to Consolidated Financial Statements). Cash and interest-bearing deposits with banks increased from $12.4 million at December 31, 2001 to $12.7 million at December 31, 2002 as a result of excess liquidity funded by growth in deposits. Total deposits increased from $204.1 million at December 31, 2001 to $216.2 million at December 31, 2002, a 5.9% increase. The increase in deposits resulted from growth in all categories of deposit accounts. Interest-bearing demand deposits increased $3.1 million in 2002, while noninterest-bearing demand deposits increased $1.4 million in 2002. Savings and money market accounts increased $4.0 million from $50.8 million at December 31, 2001 to $54.8 million at December 31, 2002. Time deposits increased $3.5 million from $104.1 million at December 31, 2001 to $107.6 million at December 31, 2002. Management attributes the growth in deposits to the Bank's marketing efforts and the weakened stock market as customers look to safer investments with a guaranteed rate of return. Federal Home Loan Bank borrowings increased $10.5 million from $42.8 million at December 31, 2001 to $53.3 million at December 31, 2002. The new advances were drawn primarily to fund loan growth while taking advantage of historically low interest rates at favorable terms. Total stockholders' equity increased from $33.5 million at December 31, 2001 to $36.3 million at December 31, 2002 primarily as a result of retained net income of $2.0 million and a net unrealized gain on securities available for sale of $740,000. During 2002, the Company repurchased 1,834 shares of its common stock at an average price of $15.91 per share. At year end the Company had 336,020 shares remaining under its Board-authorized repurchase program of 345,000 shares. -8- ALLOWANCE FOR LOAN LOSSES Loans are the Bank's largest concentration of assets and continue to represent the most significant potential risk. In originating loans, the Bank recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral. The Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance for loan losses represents management's estimate of probable loan losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management's evaluation of the loan portfolio, including historical loan loss experience, delinquencies, known and inherent risks in the nature and volume of the loan portfolio, information about specific borrower situations, estimated collateral values, and economic conditions. The loan portfolio is reviewed quarterly by management to evaluate the adequacy of the allowance for loan losses to determine the amount of any adjustment required after considering the loan charge-offs and recoveries for the quarter. Management applies a systematic methodology that incorporates its current judgments about the credit quality of the loan portfolio. In addition, the Office of Thrift Supervision (OTS), as an integral part of their examination process, periodically review the Bank's allowance for loan losses and may require the Bank to make additional provisions for estimated losses based on their judgments about information available to them at the time of their examination. The methodology used in determining the allowance for loan losses includes segmenting the loan portfolio by identifying risk characteristics common to groups of loans, determining and measuring impairment of individual loans based on the present value of expected future cash flows or the fair value of collateral, and determining and measuring impairment for groups of loans with similar characteristics by applying loss factors that consider the qualitative factors which may effect the loss rates. Specific allowances related to impaired loans and other classified loans are established where management has identified significant conditions or circumstances related to a loan that management believes indicate that a loss has been incurred. The identification of these loans results from the loan review process that identifies and monitors credits with weaknesses or conditions which call into question the full collection of the contractual payments due under the terms of the loan agreement. Factors considered by management include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. For loans evaluated on a group basis, management applies loss factors to groups of loans with common risk characteristics (i.e. residential mortgage loans, home equity loans, credit card loans). The loss factors are derived from the Bank's historical loss experience or, where the Bank does not have loss experience, the peer group loss experience. Peer group loss experience is used after evaluating the attributes of the Bank's loan portfolio as compared to the peer group. Loss factors are adjusted for significant environmental factors that, in management's judgment, affect the collectibility of the loan portfolio segment. The significant environmental factors include the levels and trends in charge-offs and recoveries, trends in volume and terms of loans, levels and trends in delinquencies, the effects of changes in underwriting standards and other lending practices or procedures, the experience and depth of the lending management and staff, effects of changes in credit concentration, changes in industry and market conditions and national and local economic trends and conditions. Management evaluates these conditions on a quarterly basis and evaluates and modifies the assumptions used in establishing the loss factors. The allowance for loan losses was $1.2 million at December 31, 2002 and $1.1 million at December 31, 2001. Management has deemed these amounts as adequate on those dates based on its evaluation methodology. At December 31, 2002, nonperforming loans totaled $1.3 million or 0.43% of total assets. Included in nonperforming loans are loans over 90 days past due secured by one-to-four family residential real estate in the amount of $373,000, loans secured by commercial real estate of $203,000, commercial business loans of $7,000 and consumer loans in the amount of $147,000. These loans are accruing interest as the estimated value of the collateral and collection efforts are deemed sufficient to ensure full recovery. -9- COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001 Net Income. Net income was $3.2 million ($1.30 per share diluted) for the year ended December 31, 2002 compared to $3.1 million ($1.25 per share diluted) for the year ended December 31, 2001. The increase was attributable primarily to an increase in net interest income of $993,000 offset by an increase in the provision for loan losses of $239,000 and noninterest expenses of $617,000. Net Interest Income. Net interest income increased $993,000 or 10.9% from $9.1 million in 2001 to $10.1 million in 2002 primarily due to an increase in average interest-earning assets during 2002 and an increase in the interest rate spread offset by an increase in average interest-bearing liabilities. Total interest income remained relatively unchanged for 2002 compared to 2001. This results from higher average balances for interest-earning assets offset by lower average yields due to the impact of lower market interest rates. Interest on loans receivable increased $28,000 and interest on investment securities increased $114,000 as a result of higher average balances in 2002 offset by lower average yields. Interest income on interest-bearing deposits with banks decreased $203,000 due to a decrease in the average yield and lower average balance. During 2002, management sought to reduce the average balance in short-term investments by focusing on loan originations and investments in debt securities. The average balance of total interest-earning assets increased from $251.2 million in 2001 to $280.0 million in 2002. During 2001, the Federal Reserve Bank lowered the discount rate by 4.50% from 5.75% in January to 1.25% at December 31, 2001. In November 2002, the discount rate was again lowered to 0.75%. While a majority of the loan and securities portfolios are fixed rate in nature, the Bank does hold variable rate investments and loans that have repriced during the year leading to a lower overall effective yield. Also, loan refinancings triggered by lower market interest rates have reduced the loan portfolio average yield. The average yield on total interest-earning assets decreased from 7.65% for 2001 to 6.85% for 2002 due to the decline in market interest rates. Total interest expense decreased $1.0 million, or 10.6%, to $8.8 million for 2002 compared to $9.8 million for 2001 primarily due to a decrease in the average cost of funds offset by increases in average deposits and borrowings from the Federal Home Loan Bank. The average balances of interest-bearing deposits and advances from the Federal Home Loan Bank were $191.5 million and $46.8 million, respectively, for 2002 compared to $177.1 million and $34.9 million for 2001. The average cost of funds decreased from 4.64% in 2001 to 3.69% in 2002 due to lower market interest rates. For further information see "Average Balance Sheets" below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2002 and 2001 are shown in the schedule captioned "Rate/Volume Analysis" included herein. Provision for Loan Losses. The provision for loan losses was $305,000 for 2002 compared to $66,000 for 2001. During 2002, the net loan portfolio growth was $14.3 million. Residential and commercial real estate loans and consumer loans increased $12.8 million, $1.2 million, and $3.5 million, respectively, during this period while commercial business loans decreased $1.9 million. The consistent application of management's allowance methodology resulted in an increase in the level of the allowance for loan losses due to net charge-offs during 2002 of $190,000 compared to $147,000 for 2001 and the general weakening of economic conditions. The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year. See "Allowance for Loan Losses". Provisions for loan losses are charges to earnings to maintain the total allowance for loan losses at a level considered reasonable by management to provide for probable known and inherent loan losses based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans, and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank's control. While the Bank maintains the allowance for loan losses at a level, which it considers adequate to provide for, estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts. -10- Noninterest income. Noninterest income increased $61,000 or 3.6%, for 2002 compared to 2001. During 2001, the Bank recognized gains of $124,000 on the sale of mortgage loans. The Bank sold no loans during 2002 in an effort to better leverage capital. Service charges on deposit accounts increased $152,000 from $1.2 million for 2001 to $1.4 million for 2002. Overdraft service charges on the new "Carefree Checking" account offered by the Bank is the primary reason for this increase. Noninterest expense. Noninterest expense increased $617,000 or 10.4% to $6.5 million for 2002 compared to $5.9 million in 2001. The increase results primarily from increases in compensation and benefits, data processing expenses, and other operating expenses. Compensation and benefits expense increased $357,000 due to normal salary increases, an increase in staff, an increase in the cost of providing employee health insurance, and a reduction in the amount of compensation and benefit costs deferred in connection with loan originations. Data processing expenses increased $53,000 primarily due to increased automated teller machine processing fees and depreciation charges on new equipment purchased during 2001 and 2002. Other operating expenses increased $203,000 primarily due to increases in office supplies, correspondent bank charges and telephone expenses. Office supplies and telephone expenses have increased due to the Bank's growth and new systems implemented during 2002. Income tax expense. Income tax expense for the year ended December 31, 2002 was $1.8 million, compared to $1.7 million for the same period in 2001. The effective tax rate for 2002 was 35.2% compared to 35.6 % for 2001. See Note 11 in the accompanying Notes to Consolidated Financial Statements. -11- AVERAGE BALANCE SHEETS The following table sets forth certain information for the periods indicated regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earnings assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average historical cost balances of assets or liabilities, respectively, for the periods presented and do not give effect to changes in fair value that are included as a separate component of stockholders' equity. Average balances are derived from daily balances.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------ 2002 2001 -------------------------------------- ------------------------------------ AVERAGE AVERAGE (Dollars in Thousands) AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST ---------- ---------- ---------- ---------- ---------- ---------- Interest-earning assets: Loans receivable (1) $ 208,308 $ 15,526 7.45% $ 189,916 $ 15,512 8.17% Investment securities: Taxable (2) 55,775 2,804 5.03% 45,321 2,730 6.02% Tax-exempt (3) 9,488 648 6.83% 7,609 568 7.46% ---------- ---------- ---------- ---------- Total investment securities 65,263 3,452 5.29% 52,930 3,298 6.23% ---------- ---------- ---------- ---------- Federal funds sold -- -- -- -- -- -- Interest-bearing deposits with banks 6,351 190 2.99% 8,310 393 4.73% ---------- ---------- ---------- ---------- Total interest-earning assets 279,922 19,168 6.85% 251,156 19,203 7.65% ---------- ---------- ---------- ---------- Noninterest-earning assets 16,318 14,101 ---------- ---------- Total assets $ 296,240 $ 265,257 ========== ========== Interest-bearing liabilities: Savings and interest-bearing demand deposits $ 84,196 $ 1,185 1.41% $ 76,445 $ 1,966 2.57% Time deposits 107,325 4,904 4.57% 100,681 5,714 5.68% ---------- ---------- ---------- ---------- Total deposits 191,521 6,089 3.18% 177,126 7,680 4.34% ---------- ---------- ---------- ---------- Retail repurchase agreements 186 3 1.61% 92 3 3.26% FHLB advances 46,753 2,710 5.80% 34,885 2,159 6.19% ---------- ---------- ---------- ---------- Total interest-bearing liabilities 238,460 8,802 3.69% 212,103 9,842 4.64% ---------- ---------- ---------- ---------- Noninterest-bearing liabilities: Noninterest-bearing deposits 19,533 18,205 Other liabilities 3,384 2,295 ---------- ---------- Total liabilities 261,377 232,603 Stockholders' equity 34,863 32,654 ---------- ---------- Total liabilities and stockholders' equity $ 296,240 $ 265,257 ========== ========== Net interest income $ 10,366 $ 9,361 ========== ========== Interest rate spread 3.16% 3.01% ========== ========== Net interest margin 3.70% 3.73% ========== ========== Ratio of average interest-earning assets to average interest-bearing liabilities 117.39% 118.41% ========== ==========
YEAR ENDED DECEMBER 31, ------------------------------------- 2000 ------------------------------------- AVERAGE YIELD/ (Dollars in Thousands) BALANCE INTEREST COST ---------- ---------- --------- Interest-earning assets: Loans receivable (1) $ 167,981 $ 14,030 8.35% Investment securities: Taxable (2) 40,580 2,608 6.43% Tax-exempt (3) 7,325 570 7.78% ---------- ---------- Total investment securities 47,905 3,178 6.63% ---------- ---------- Federal funds sold 533 33 6.19% Interest-bearing deposits with banks 5,794 352 6.08% ---------- ---------- Total interest-earning assets 222,213 17,593 7.92% ---------- ---------- Noninterest-earning assets 12,964 ---------- Total assets $ 235,177 ========== Interest-bearing liabilities: Savings and interest-bearing demand deposits $ 75,231 $ 2,735 3.64% Time deposits 93,450 5,300 5.67% ---------- ---------- Total deposits 168,681 8,035 4.76% ---------- ---------- Retail repurchase agreements -- -- -- FHLB advances 19,159 1,232 6.43% ---------- ---------- Total interest-bearing liabilities 187,840 9,267 4.93% ---------- ---------- Noninterest-bearing liabilities: Noninterest-bearing deposits 15,243 Other liabilities 2,376 ---------- Total liabilities 205,459 Stockholders' equity 29,718 ---------- Total liabilities and stockholders' equity $ 235,177 ========== Net interest income $ 8,326 ========== Interest rate spread 2.99% ========== Net interest margin 3.75% ========== Ratio of average interest-earning assets to average interest-bearing liabilities 118.30% ==========
- ---------- (1) Average loans receivable includes nonperforming loans. (2) Includes taxable debt and equity securities and Federal Home Loan Bank Stock. (3) Tax-exempt income has been adjusted to a tax equivalent basis using the federal marginal tax rate of 34%. -12- RATE/VOLUME ANALYSIS The following table sets forth the effects of changing rates and volumes on net interest income and interest expense. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) effects attributable to changes in rate and volume (change in rate multiplied by changes in volume). Tax exempt income has been adjusted to a tax-equivalent basis using the federal marginal tax rate of 34%.
2002 COMPARED TO 2001 INCREASE (DECREASE) DUE TO ------------------------------------------------------------ RATE/ RATE VOLUME VOLUME NET (In Thousands) Interest-earning assets: Loans receivable $ (1,358) $ 1,507 $ (135) $ 14 Investment securities: Taxable (450) 628 (104) 74 Tax-exempt (48) 140 (12) 80 ------------ ------------ ------------ ------------ Total investment securities (498) 768 (116) 154 ------------ ------------ ------------ ------------ Federal funds sold -- -- -- -- Interest-bearing deposits with banks (144) (93) 34 (203) ------------ ------------ ------------ ------------ Total net change in income on interest-earning assets (2,000) 2,182 (217) (35) ------------ ------------ ------------ ------------ Interest-bearing liabilities: Interest-bearing deposits (2,052) 628 (167) (1,591) Retail repurchase agreements (2) 4 (2) -- FHLB advances (137) 734 (46) 551 ------------ ------------ ------------ ------------ Total net change in expense on interest-bearing liabilities (2,191) 1,366 (215) (1,040) ------------ ------------ ------------ ------------ Net change in net interest income $ 191 $ 816 $ (2) $ 1,005 ============ ============ ============ ============ 2001 COMPARED TO 2000 INCREASE (DECREASE) DUE TO ------------------------------------------------------------ RATE/ RATE VOLUME VOLUME NET (In Thousands) Interest-earning assets: Loans receivable $ (305) $ 1,829 $ (42) $ 1,482 Investment securities: Taxable (165) 306 (19) 122 Tax-exempt (23) 22 (1) (2) ------------ ------------ ------------ ------------ Total investment securities (188) 328 (20) 120 ------------ ------------ ------------ ------------ Federal funds sold (33) (33) 33 (33) Interest-bearing deposits with banks (78) 153 (34) 41 ------------ ------------ ------------ ------------ Total net change in income on interest-earning assets (604) 2,277 (63) 1,610 ------------ ------------ ------------ ------------ Interest-bearing liabilities: Interest-bearing deposits (713) 397 (39) (355) Retail repurchase agreements -- -- 3 3 FHLB advances (46) 1,011 (38) 927 ------------ ------------ ------------ ------------ Total net change in expense on interest-bearing liabilities (759) 1,408 (74) 575 ------------ ------------ ------------ ------------ Net change in net interest income $ 155 $ 869 $ 11 $ 1,035 ============ ============ ============ ============
-13- LIQUIDITY AND CAPITAL RESOURCES The Bank's primary sources of funds are deposits and proceeds from loan repayments and prepayments, and from the sale and maturity of securities. The Bank may also borrow from the Federal Home Loan Bank of Indianapolis. While loan repayments and maturities and sales of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, general economic conditions and competition. At December 31, 2002, the Bank had cash and interest-bearing deposits with banks of $12.7 million and securities available for sale with a fair value of $65.0 million. If the Bank requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the Federal Home Loan Bank of Indianapolis and collateral eligible for repurchase agreements. The Bank's primary investing activity is the origination of one-to-four family mortgage loans and, to a lesser extent, consumer, multi-family, commercial real estate, commercial business and residential construction loans. The Bank also invests in U.S. government and agency securities and mortgage-backed securities issued by U.S. government agencies. The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities. At December 31, 2002, the Bank had total commitments to extend credit of $26.5 million. See Note 15 in the accompanying Notes to Consolidated Financial Statements. At December 31, 2002, the Bank had certificates of deposit scheduled to mature within one year of $50.8 million. Historically, the Bank has been able to retain a significant amount of its deposits as they mature. The Bank is required to maintain specific amounts of capital pursuant to OTS regulations. As of December 31, 2002, the Bank was in compliance with all regulatory capital requirements which were effective as of such date with tangible, core and risk-based capital ratios of 10.9%, 10.9% and 19.5%, respectively. See Note 18 in the accompanying Notes to Consolidated Financial Statements. EFFECT OF INFLATION AND CHANGING PRICES The financial statements and related financial data presented in this report have been prepared in accordance with generally accepted accounting principles, which generally require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, virtually all the assets and liabilities of the financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the financial institutions performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. MARKET RISK ANALYSIS Qualitative Aspects of Market Risk. The Bank's principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Bank has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. In order to reduce the exposure to interest rate fluctuations, the Bank has developed strategies to manage its liquidity, shorten its effective maturities of certain interest-earning assets and decrease the interest rate sensitivity of its asset base. Management has sought to decrease the average maturity of its assets by emphasizing the origination of short-term commercial and consumer loans, all of which are retained by the Bank for its portfolio. The Bank relies on retail deposits as its primary source of funds. Management believes retail deposits, compared to brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds. -14- Quantitative Aspects of Market Risk. The Bank does not maintain a trading account for any class of financial instrument nor does the Bank engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Bank is not subject to foreign currency exchange rate risk or commodity price risk. The Bank uses interest rate sensitivity analysis to measure its interest rate risk by computing changes in NPV (net portfolio value) of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or decrease in market interest rates with no effect given to any steps that management might take to counter the effect of that interest rate movement. Using data compiled by the OTS, the Bank receives a report that measures interest rate risk by modeling the change in NPV (net portfolio value) over a variety of interest rate scenarios. This procedure for measuring interest rate risk was developed by the OTS to replace the "gap" analysis (the difference between interest-earning assets and interest-bearing liabilities that mature or reprice within a specific time period). The following table is provided by the OTS and sets forth the change in the Bank's NPV at December 31, 2002, based on OTS assumptions, that would occur in the event of an immediate change in interest rates, with no effect given to any steps that management might take to counteract that change. Due to the level of market interest rates at December 31, 2002, the table provides information for only a sustained 100 basis point decrease in market interest rates.
At December 31, 2002 ---------------------------------------------------------------------------------- Net Portfolio Value Net Portfolio Value as a ------------------------------------------- ---------------------------------- Change Dollar Dollar Percent Percent of Present Value of Assets - ------------------ ------------ ------------ ------------ ---------------------------------- In Rates Amount Change Change NPV Ratio Change - ------------------ ------------ ------------ ------------ ------------ ------------------ (Dollars in thousands) 300bp $ 32,637 $ (7,632) (19)% 10.66% (178)bp 200bp 36,565 (3,704) (9) 11.68 (76)bp 100bp 39,685 (584) (1) 12.42 (2)bp --bp 40,269 -- -- 12.44 --bp (100)bp 38,533 (1,736) (4) 11.82 (62)bp
The above table indicates that in the event of a sudden and sustained increase or decrease in prevailing market interest rates, the Bank's NPV would be expected to decrease. The expected decrease in the Bank's NPV is primarily attributable to the relatively high percentage of fixed-rate loans in the Bank's loan portfolio. At December 31, 2002, approximately 75% of the loan portfolio consisted of fixed-rate loans. Certain assumptions utilized by the OTS in assessing the interest rate risk of savings associations within its region were utilized in preparing the preceding table. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in calculating the table. -15- [LETTERHEAD OF MONROE SHINE] INDEPENDENT AUDITOR'S REPORT The Board of Directors First Capital, Inc. Corydon, Indiana We have audited the accompanying consolidated balance sheets of First Capital, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 31, 2002 and 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Capital, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the years ended December 31, 2002 and 2001 in conformity with accounting principles generally accepted in the United States of America. /s/ Monroe Shine New Albany, Indiana January 17, 2003 -16- FIRST CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
2002 2001 -------------- -------------- ASSETS Cash and due from banks $ 6,609,568 $ 7,183,882 Interest-bearing deposits with banks 6,043,699 5,198,423 Securities available for sale, at fair value 64,980,033 54,891,268 Securities held to maturity (fair value $1,553,248; $1,850,258 in 2001) 1,474,236 1,835,651 Loans receivable, net of allowance for loan losses of $1,218,246 in 2002 and $1,102,653 in 2001 215,996,193 201,730,217 Federal Home Loan Bank stock, at cost 2,716,000 2,178,800 Foreclosed real estate held for sale 102,300 212,293 Premises and equipment 7,000,741 5,940,291 Accrued interest receivable 1,794,313 1,841,245 Cash value of life insurance 1,266,917 1,214,260 Other assets 568,647 597,015 -------------- -------------- Total Assets $ 308,552,647 $ 282,823,345 ============== ============== LIABILITIES Deposits: Noninterest-bearing $ 20,051,772 $ 18,629,242 Interest-bearing 196,150,460 185,492,942 -------------- -------------- Total deposits 216,202,232 204,122,184 Retail repurchase agreements 456,732 284,221 Advances from Federal Home Loan Bank 53,319,551 42,824,645 Accrued interest payable 1,127,553 1,252,736 Other liabilities 1,116,805 858,894 -------------- -------------- Total Liabilities 272,222,873 249,342,680 -------------- -------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock of $.01 par value per share Authorized 1,000,000 shares; none issued -- -- Common stock of $.01 par value per share Authorized 5,000,000 shares; issued 2,551,763 shares (2,545,961 shares in 2001) 25,518 25,460 Additional paid-in capital 12,954,838 12,878,050 Retained earnings-substantially restricted 23,079,438 21,127,319 Accumulated other comprehensive income 970,977 231,153 Unearned stock compensation (143,582) (212,083) Unearned ESOP shares (440,760) (481,760) Less treasury stock, at cost - 8,980 shares (7,146 shares in 2001) (116,655) (87,474) -------------- -------------- Total Stockholders' Equity 36,329,774 33,480,665 -------------- -------------- Total Liabilities and Stockholders' Equity $ 308,552,647 $ 282,823,345 ============== ==============
See notes to consolidated financial statements. -17- FIRST CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001 -------------- -------------- INTEREST INCOME Loans, including fees $ 15,489,849 $ 15,462,139 Securities: Taxable 2,660,755 2,600,194 Tax-exempt 427,903 374,889 Federal Home Loan Bank dividends 143,276 130,078 Interest-bearing deposits in banks 190,111 392,708 -------------- -------------- Total interest income 18,911,894 18,960,008 -------------- -------------- INTEREST EXPENSE Deposits 6,089,360 7,679,827 Retail repurchase agreements 2,589 2,831 Advances from Federal Home Loan Bank 2,709,548 2,159,527 -------------- -------------- Total interest expense 8,801,497 9,842,185 -------------- -------------- Net interest income 10,110,397 9,117,823 Provision for loan losses 305,000 66,000 -------------- -------------- Net interest income after provision for loan losses 9,805,397 9,051,823 -------------- -------------- NONINTEREST INCOME Service charges on deposit accounts 1,382,286 1,230,002 Commission income 260,655 244,644 Gain on sale of securities 18,229 15,555 Net gain on sale of mortgage loans -- 123,591 Other income 75,351 91,895 -------------- -------------- Total noninterest income 1,736,521 1,705,687 -------------- -------------- NONINTEREST EXPENSE Compensation and benefits 3,554,330 3,197,793 Occupancy and equipment 745,997 741,007 Data processing 508,369 455,566 Other expenses 1,722,224 1,549,479 -------------- -------------- Total noninterest expense 6,530,920 5,943,845 -------------- -------------- Income before income taxes 5,010,998 4,813,665 Income tax expense 1,762,639 1,714,422 -------------- -------------- Net Income $ 3,248,359 $ 3,099,243 ============== ============== Net income per common share, basic $ 1.31 $ 1.26 ============== ============== Net income per common share, diluted $ 1.30 $ 1.25 ============== ==============
See notes to Consolidated financial statements. -18- FIRST CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002 AND 2001
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED COMPREHENSIVE STOCK CAPITAL EARNINGS INCOME (LOSS) Balances at January 1, 2001 $ 25,373 $ 12,811,494 $ 19,221,842 $ (145,398) COMPREHENSIVE INCOME Net income - - 3,099,243 - Other comprehensive income: Change in unrealized gain on securities available for sale, net of deferred income tax expense of $246,981 - - - 376,551 Less: Reclassification adjustment - - - - Total comprehensive income Cash dividends ($0.48 per share) - - (1,193,766) - Options exercised 87 50,283 - - Shares released by ESOP trust - 16,273 - - Stock compensation expense - - - - Purchase of 7,146 treasury shares - - - - ------------------------------------------------------------------ Balances at December 31, 2001 25,460 12,878,050 21,127,319 231,153 COMPREHENSIVE INCOME Net income - - 3,248,359 - Other comprehensive income: Change in unrealized gain on securities available for sale, net of deferred income tax expense of $492,135 - - - 750,317 Less: Reclassification adjustment net of deferred income tax benefit of $6,883 - - - (10,493) Total comprehensive income Cash dividends ($0.52 per share) - - (1,296,240) - Restricted stock grants - 1,523 - - Forfeiture of restricted stock - - - - Options exercised 58 47,913 - - Shares released by ESOP trust - 27,352 - - Stock compensation expense - - - - Purchase of 1,834 treasury shares - - - - --------------------------------------------------------------------- Balances at December 31, 2002 $ 25,518 $ 12,954,838 $ 23,079,438 $ 970,977 ===================================================================== UNEARNED UNEARNED STOCK ESOP TREASURY COMPENSATION SHARES STOCK TOTAL Balances at January 1, 2001 $ (282,854) $ (522,760) $ - $ 31,107,697 COMPREHENSIVE INCOME Net income - - - 3,099,243 Other comprehensive income: Change in unrealized gain on securities available for sale, net of deferred income tax expense of $246,981 - - - 376,551 Less: Reclassification adjustment - - - - ------------ Total comprehensive income 3,475,794 ------------ Cash dividends ($0.48 per share) - - - (1,193,766) Options exercised - - - 50,370 Shares released by ESOP trust - 41,000 - 57,273 Stock compensation expense 70,771 - - 70,771 Purchase of 7,146 treasury shares - - (87,474) (87,474) ------------------------------------------------------------ Balances at December 31, 2001 (212,083) (481,760) (87,474) 33,480,665 COMPREHENSIVE INCOME Net income - - - 3,248,359 Other comprehensive income: Change in unrealized gain on securities available for sale, net of deferred income tax expense of $492,135 - - - 750,317 Less: Reclassification adjustment net of deferred income tax benefit of $6,883 - - - (10,493) ------------ Total comprehensive income 3,988,183 ------------ Cash dividends ($0.52 per share) - - - (1,296,240) Restricted stock grants (7,894) - 6,371 - Forfeiture of restricted stock 6,371 - (6,371) - Options exercised - - - 47,971 Shares released by ESOP trust - 41,000 68,352 Stock compensation expense 70,024 - - 70,024 Purchase of 1,834 treasury shares - - (29,181) (29,181) ------------------------------------------------------------ Balances at December 31, 2002 $ (143,582) $ (440,760) $ (116,655) $ 36,329,774 ============================================================
See notes to consolidated financial statements. -19- FIRST CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 3,248,359 $ 3,099,243 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of premium and accretion of discount on securities, net 218,461 30,847 Depreciation expense 480,393 463,264 Deferred income taxes (24,088) 18,971 ESOP and stock compensation expense 138,376 128,044 Increase in cash value of life insurance (52,657) (53,275) Provision for loan losses 305,000 66,000 Net gain on sale of securities (18,229) (15,555) Proceeds from the sale of mortgage loans - 5,488,218 Mortgage loans originated for sale - (5,364,627) Net gain on sale of mortgage loans - (123,591) Net gain on sale of foreclosed real estate (14,506) - Net change in other assets/liabilities (253,135) 165,754 -------------- -------------- Net Cash Provided By Operating Activities 4,027,974 3,903,293 -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in interest-bearing deposits with banks (845,276) 259,990 Purchase of securities available for sale (26,590,589) (42,716,013) Purchase of securities held to maturity (1,100,000) (500,000) Proceeds from maturities of securities available for sale 15,177,000 21,938,000 Proceeds from maturities of securities held to maturity 1,218,800 9,270,100 Proceeds from sale of securities available for sale 693,402 - Proceeds from sale of securities held to maturity 150,750 356,432 Principal collected on mortgage-backed securities 1,748,130 1,540,387 Net increase in loans receivable (14,771,683) (22,618,022) Purchase of Federal Home Loan Bank stock (537,200) (675,000) Proceeds from sale of foreclosed real estate 325,206 32,422 Purchase of premises and equipment (1,540,843) (175,809) -------------- -------------- Net Cash Used By Investing Activities (26,072,303) (33,287,513) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 12,080,048 18,754,032 Advances from Federal Home Loan Bank 15,000,000 16,000,000 Repayment of advances from Federal Home Loan Bank (4,505,094) (3,249,562) Net increase in retail repurchase agreements 172,511 284,221 Exercise of stock options 47,971 50,370 Purchase of treasury stock (29,181) (87,474) Dividends paid (1,296,240) (1,193,766) -------------- -------------- Net Cash Provided By Financing Activities 21,470,015 30,557,821 -------------- -------------- Net Increase (Decrease) in Cash and Due From Banks (574,314) 1,173,601 Cash and due from banks at beginning of year 7,183,882 6,010,281 -------------- -------------- Cash and Due From Banks at End of Year $ 6,609,568 $ 7,183,882 ============== ==============
See notes to consolidated financial statements. -20- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 AND 2001 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS First Capital, Inc. (the Company) is the thrift holding company of First Harrison Bank (the Bank), a wholly-owned subsidiary. The Bank is a federally-chartered savings bank which provides a variety of banking services to individuals and business customers through nine locations in Southern Indiana. The Bank's primary source of revenue is single-family residential loans. The Bank's wholly-owned subsidiary, First Harrison Financial Services, Inc., sells property and casualty insurance and non-deposit investment products. BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year presentation. STATEMENTS OF CASH FLOWS For purposes of the statements of cash flows, the Bank has defined cash and cash equivalents as those amounts included in the balance sheet caption "Cash and due from banks." USE OF ESTIMATES 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. 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 and the valuation of foreclosed real estate. In connection with the determination of estimated losses on loan and foreclosed real estate, management obtains appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, further reductions in the carrying amounts of loans and foreclosed assets may be necessary based on changes in local economic conditions. In addition, as an integral part of their examination process, regulatory agencies periodically review the estimated losses on loans and foreclosed real estate. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible the estimated losses on loans and foreclosed real estate may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated. SECURITIES AVAILABLE FOR SALE Securities available for sale consist of debt and equity securities and are stated at fair value. Amortization of premium and accretion of discount are recognized in interest income using the interest method over the remaining period to maturity, adjusted for anticipated prepayments. Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by issuers of the securities. Unrealized gains and losses, net of tax, on securities available for sale are reported as a separate component of stockholders' equity until realized. Realized gains and losses on the sale of securities available for sale are determined using the specific identification method. -21- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (1 - continued) SECURITIES HELD TO MATURITY Debt securities for which the Bank has the positive intent and ability to hold to maturity are carried at cost, adjusted for amortization of premium and accretion of discount using the interest method over the remaining period to maturity, adjusted for anticipated prepayments. Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by issuers of the securities. LOANS Loans receivable are stated at unpaid principal balances, less net deferred loan fees and the allowance for loan losses. The Bank's real estate loan portfolio consists primarily of long-term loans, collateralized by first mortgages on single-family residences and multi-family residential properties located in the southern Indiana area and commercial real estate loans. In addition to real estate loans, the Bank makes commercial loans and consumer loans. Loan origination fees and certain direct costs of underwriting and closing loans are deferred and the net fee or cost is recognized as an adjustment to interest income over the contractual life of the loans using the interest method. The accrual of interest is discontinued on a loan when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. The Bank does not accrue interest on loans past due 90 days or more except when the estimated value of collateral and collection efforts are deemed sufficient to ensure full recovery. When a loan is placed on non accrual status, previously accrued but unpaid interest is charged against interest income. Interest payments on nonaccrual loans, including specific impaired loans, are accounted for as interest income using the cash receipts method or cost recovery method until qualifying for return to accrual. Generally, the cash receipts method is used when the likelihood of further loss on the loan is remote. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Bank's practice is to charge off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower's failure to meet repayment terms, the borrower's deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loans classification as a loss by regulatory examiners, or for other reasons. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans, and economic conditions. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term. -22- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (1 - continued) A loan is considered impaired when, based on current information and events, it is probable that the Bank 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 by either the present value of expected future cash flows at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. FORECLOSED REAL ESTATE HELD FOR SALE Foreclosed real estate is carried at the lower of fair value minus estimated costs to sell or cost. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. The net expense from operations of foreclosed real estate held for sale is reported in non-interest expense. PREMISES AND EQUIPMENT The Bank uses the straight line and accelerated methods of computing depreciation at rates adequate to amortize the cost of the applicable assets over their useful lives. Items capitalized as part of premises and equipment are valued at cost. Maintenance and repairs are expensed as incurred. The cost and related accumulated depreciation of assets sold, or otherwise disposed of, are removed from the related accounts and any gain or loss is included in earnings. MORTGAGE SERVICING RIGHTS AND LOAN SERVICING Mortgage servicing rights are recognized as separate assets when servicing rights are acquired through purchase or loan originations when there is a definitive plan to sell the underlying loan. Capitalized mortgage servicing rights are periodically evaluated for impairment based on the fair value of those rights. Capitalized mortgage servicing rights are amortized in proportion to, and over the period of, estimated future net servicing income of the underlying mortgage loans. Loan servicing fees are recognized in income as monthly principal and interest payments are collected on mortgages. Costs of loan servicing are charged to expense as incurred. INCOME TAXES Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of available for sale securities, allowance for loan losses, accumulated depreciation and accrued income and expenses for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. -23- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (1 - continued) STOCK-BASED COMPENSATION Under the provisions of SFAS 123, Accounting for Stock-Based Compensation, the Company elects to measure and recognize compensation cost related to stock-based compensation plans using the intrinsic value method and discloses the pro forma effect of applying the fair value method contained in SFAS 123. Accordingly, no compensation cost is charged against earnings for stock options granted under the Company's stock-based compensation plans. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, FASB issued SFAS 143, Accounting for Asset Retirement Obligations. This statement applies to all entities and the legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal operation of a long-lived asset, except for certain obligations of lessees. This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The implementation of this standard is not expected to have a material impact on the Company's financial condition and results of operations. In August 2001, FASB issued SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement supersedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and establishes a single financial accounting model for long-lived assets to be disposed of by sale. The statement retains the requirements of SFAS 121 to recognize an impairment loss if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and measure an impairment loss as the difference between the carrying amount and the fair value of the asset. This statement is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The implementation of this standard had no material impact on the Company's financial condition or results of operations. In May 2002, FASB issued SFAS 145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections as of April 2002. This Statement rescinds SFAS 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, SFAS 64, Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds SFAS 44, Accounting for Intangible Assets of Motor Carriers, and amends SFAS 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. This statement is effective for transactions occurring after May 15, 2002. The implementation of this standard had no material impact on the Company's financial condition or results of operations. In June 2002, FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses the accounting and reporting for costs associated with exit or disposal activities and nullifies previous guidance. The principal difference between this statement and prior guidance is that a liability for a cost associated with an exit or disposal activity can only be recognized when actually incurred versus the date when management commits to the plan. This statement establishes that fair value is the objective for initial measurement of the liability. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. The implementation of this standard is not expected to have a material impact on the Company's financial condition or results of operations. -24- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (1 - continued) In October 2002, the FASB issued SFAS 147, Acquisitions of Certain Financial Institutions, an amendment of FASB Statements 72 and 144 and FASB Interpretation 9, which addresses the financial accounting and reporting for the acquisitions of all or part of a financial institution. SFAS 147 removes acquisitions of financial institutions, except for transactions between two or more mutual enterprises, from the scope of both SFAS 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets. SFAS 147 also amends SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to include in its scope long-term customer-relationship and credit cardholder intangible assets, and requires companies to cease amortization of unidentifiable assets associated with certain branch acquisitions. The provisions of this statement were effective beginning October 1, 2002. The implementation of this standard had no material impact on the Company's financial condition or results of operation. In November 2002, the FASB issued FASB Interpretation (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this interpretation are applied prospectively to guarantees issued or modified after December 31, 2002. The adoption of these recognition provisions will result in recording liabilities associated with certain guarantees provided by the Company. These currently include standby letters of credit. The disclosure requirements of this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The implementation of the recognition provisions of this interpretation are not expected to have a material impact on the Company's financial condition or results of operation. (2) PENDING MERGER On September 25, 2002, the Company and Hometown Bancshares, Inc. (Hometown), a bank holding company for Hometown National Bank in New Albany, Indiana, entered into an agreement and plan of merger whereby each of the issued and outstanding common shares of Hometown will be exchanged for shares of the Company's common stock or $46.50 in cash per share. The number of shares of the Company's common stock to be exchanged for each share of Hometown's common stock will be based on the average closing price of the Company's common stock over a twenty day trading period shortly before the closing of the merger. Elections to receive stock, cash or a combination of stock and cash by the Hometown shareholders will be limited by a requirement that 50% of the total number of outstanding shares of Hometown's common stock be exchanged for Company common stock. The merger is subject to regulatory and shareholder approvals. The merger is expected to be completed in March 2003. (3) RESTRICTION ON CASH AND DUE FROM BANKS The Bank is required to maintain reserve balances on hand and with the Federal Reserve Bank which are noninterest bearing and unavailable for investment. The average amount of those reserve balances for the year ended December 31, 2002 and 2001 were approximately $1,649,000 and $1,104,000 respectively. -25- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (4) INVESTMENT SECURITIES Debt and equity securities have been classified in the balance sheets according to management's intent. Investment securities at December 31, 2002 and 2001 are summarized as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE DECEMBER 31, 2002: Securities available for sale: Mortgage-backed securities: FNMA certificates $ 1,759,759 $ 25,638 $ - $ 1,785,397 GNMA certificates 874,617 7,608 - 882,225 FHLMC certificates 200,241 2,539 - 202,780 FNMA REMICS 2,008,096 32,698 - 2,040,794 FHLMC REMICS 5,989,820 62,590 163 6,052,247 --------------------------------------------------------- 10,832,533 131,073 163 10,963,443 --------------------------------------------------------- Other debt securities: Federal agency 41,078,195 1,160,051 2,242 42,236,004 Municipal 10,223,239 320,196 9,529 10,533,906 --------------------------------------------------------- 62,133,967 1,611,320 11,934 63,733,353 --------------------------------------------------------- Mutual funds 1,238,223 36,059 27,602 1,246,680 --------------------------------------------------------- Total securities available for sale $ 63,372,190 $ 1,647,379 $ 39,536 $ 64,980,033 ========================================================= Securities held to maturity: Mortgage-backed securities: FNMA certificates $ 183,534 $ 2,901 $ 8,932 $ 177,503 GNMA certificates 114,194 3,655 260 117,589 --------------------------------------------------------- 297,728 6,556 9,192 295,092 --------------------------------------------------------- Other debt securities: Municipal 1,176,508 81,648 - 1,258,156 --------------------------------------------------------- Total securities held to maturity $ 1,474,236 $ 88,204 $ 9,192 $ 1,553,248 ========================================================= DECEMBER 31, 2001: Securities available for sale: Mortgage-backed securities: FNMA certificates $ 457,668 $ - $ 10,716 $ 446,952 GNMA certificates 1,785,617 6,480 - 1,792,097 FHLMC certificates 310,174 4,523 - 314,697 FNMA REMICS 2,022,167 4,639 19,487 2,007,319 FHLMC REMICS 2,033,426 16,353 19,394 2,030,385 --------------------------------------------------------- 6,609,052 31,995 49,597 6,591,450 --------------------------------------------------------- Other debt securities: Federal agency 39,662,021 528,972 117,898 40,073,095 Municipal 7,061,710 71,290 72,106 7,060,894 --------------------------------------------------------- 46,723,731 600,262 190,004 47,133,989 --------------------------------------------------------- Mutual funds 1,175,717 10,218 20,106 1,165,829 --------------------------------------------------------- Total securities available for sale $ 54,508,500 $ 642,475 $ 259,707 $ 54,891,268 =========================================================
-26- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (4 - continued)
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE DECEMBER 31, 2001: Securities held to maturity: Mortgage-backed securities: FNMA certificates $ 240,634 $ 1,554 $ 4,644 $ 237,544 GNMA certificates 152,014 1,610 736 152,888 --------------------------------------------------------- 392,648 3,164 5,380 390,432 --------------------------------------------------------- Other debt securities: Municipal 1,443,003 16,823 - 1,459,826 --------------------------------------------------------- Total securities held to maturity $ 1,835,651 $ 19,987 $ 5,380 $ 1,850,258 =========================================================
During 2002 and 2001, the Bank sold non-rated municipal securities classified as held to maturity with an amortized cost of $149,897 and $356,432, respectively, and realized gross gains of $853 and $15,555, respectively. These securities were sold as a result of an Office of Thrift Supervision (OTS) examination in 2000 which required divestiture of these holdings within three years. The OTS limits the holdings of non-rated municipal securities to those issued by a municipality in which the institution has an office. Through the merger with HCB Bancorp in January 2000, the Bank acquired certain non-rated municipal securities issued by municipalities in which the Bank does not have an office. At March 31, 2001, the Bank transferred from the held to maturity category to the available for sale category certain non-rated municipal securities with an amortized cost of $182,376. During 2002, the Bank sold available for sale securities for total proceeds of $693,402, resulting in gross realized gains of $17,376. The amortized cost and fair value of debt securities as of December 31, 2002, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty.
SECURITIES AVAILABLE FOR SALE SECURITIES HELD TO MATURITY ------------------------------- ------------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE Due in one year or less $ 4,144,130 $ 4,275,271 $ 114,000 $ 114,150 Due after one year through five years 38,843,276 39,990,125 188,508 194,335 Due after five years through ten years 5,334,978 5,502,672 74,000 74,000 Due after ten years 2,979,050 3,001,842 800,000 875,671 ----------------------------------------------------------------- 51,301,434 52,769,910 1,176,508 1,258,156 Mortgage-backed securities 10,832,533 10,963,443 297,728 295,092 ----------------------------------------------------------------- $ 62,133,967 $ 63,733,353 $ 1,474,236 $ 1,553,248 =================================================================
Investment securities with a carrying amount of $499,475 were pledged to secure public deposits at December 31, 2002. -27- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (5) LOANS Loans receivable at December 31, 2002 and 2001 consisted of the following:
2002 2001 -------------- -------------- Real estate mortgage loans: Residential $ 145,467,644 $ 132,348,492 Land 4,820,715 4,381,011 Residential construction 9,782,878 10,476,939 Commercial real estate 16,760,389 15,810,867 Commercial business loans 9,440,238 11,339,361 Consumer loans: Home equity and second mortgage loans 18,639,762 12,962,816 Automobile loans 9,597,787 10,376,402 Loans secured by savings accounts 1,249,277 1,309,396 Unsecured loans 1,192,579 1,721,400 Other consumer loans 4,176,322 4,949,299 ------------------------------- Gross loans receivable 221,127,591 205,675,983 ------------------------------- Less: Deferred loan origination fees, net 25,864 116,189 Undisbursed portion of loans in process 3,887,288 2,726,924 Allowance for loan losses 1,218,246 1,102,653 ------------------------------- 5,131,398 3,945,766 ------------------------------- Loans receivable, net $ 215,996,193 $ 201,730,217 ===============================
Mortgage loans serviced for the benefit of others amounted to $5,182,427 and $10,061,396 at December 31, 2002 and 2001, respectively. The balance of capitalized mortgage servicing rights, carried at estimated fair value, included in other assets at December 31, 2002 and 2001, was $66,119 and $124,231, respectively. The estimated fair value of mortgage servicing rights was determined using discount rates ranging from 7.5 to 10 percent and prepayment speeds ranging from .06 percent to 33.48 percent, depending upon the stratification of the specific rights. The Bank had no capitalized mortgage servicing rights during 2002. The Bank capitalized mortgage servicing rights of $77,206 for the year ended December 31, 2001. The Bank recognized amortization of $58,112 and $68,836, for the years ended December 31, 2002 and 2001, respectively. An analysis of the allowance for loan losses is as follows:
2002 2001 -------------- -------------- Beginning balances $ 1,102,653 $ 1,183,638 Provision 305,000 66,000 Recoveries 57,552 74,940 Loans charged-off (246,959) (221,925) ------------------------------- Ending balances $ 1,218,246 $ 1,102,653 ===============================
At December 31, 2002 and 2001, the total recorded investment in loans on nonaccrual amounted to approximately $607,000 and $787,000, respectively. The total recorded investment in loans past due ninety days or more and still accruing interest amounted to approximately $730,000 and $471,000 at December 31, 2002 and 2001, respectively. The total recorded investment in loans specifically classified as impaired amounted to $1,158,000 and $806,000 at December 31, 2002 and 2001, respectively. The average recorded investment in impaired loans amounted to approximately $1,085,000 and $356,000 for the years ended December 31, 2002 and 2001, respectively. The Bank had a specific allowance for loan losses related to impaired loans of $420,072 and $165,729 at December 31, 2002 and 2001, respectively. Interest income on impaired loans of $82,225 and $18,374 was recognized for cash payments received in 2002 and 2001, respectively. -28- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (5 - continued) The Bank has entered into loan transactions with certain directors, officers and their affiliates (related parties). In the opinion of management, such indebtedness was incurred in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with other persons. The following table represents the aggregate activity for related party loans during the year ended December 31, 2002: Beginning balance $ 1,916,740 New loans 388,073 Payments (198,568) ------------ Ending balance $ 2,106,245 ============ The Bank has purchased commercial paper from a corporation where a director is considered a related party. In the opinion of management, these transactions were made in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated parties. During the year ended December 31, 2002, the Bank granted- approximately $1,827,000, to customers of the corporation and such loans had an aggregate outstanding balance of approximately $3,295,000 and $1,957,000 at December 31, 2002 and 2001, respectively. (6) PREMISES AND EQUIPMENT Premises and equipment as of December 31 consisted of the following:
2002 2001 -------------- -------------- Land and land improvements $ 1,671,929 $ 1,146,490 Leasehold improvements 157,777 153,077 Office buildings 5,224,823 4,870,478 Furniture, fixtures and equipment 2,813,271 2,308,390 -------------------------------- 9,867,800 8,478,435 Less accumulated depreciation 2,867,059 2,538,144 -------------------------------- Totals $ 7,000,741 $ 5,940,291 ================================
(7) DEPOSITS The aggregate amount of time deposit accounts with balances of $100,000 or more was approximately $25,129,000 and $24,592,000 at December 31, 2002 and 2001, respectively. Deposit account balances in excess of $100,000 are not federally insured. At December 31, 2002, scheduled maturities of time deposits were as follows: Year ending December 31: 2003 $ 50,757,566 2004 15,227,738 2005 15,180,207 2006 13,574,380 2007 and thereafter 12,857,933 ------------- Total $ 107,597,822 ============= The Bank held deposits of approximately $7,027,000, and $6,670,000 for related parties at December 31, 2002 and 2001, respectively. -29- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (8) RETAIL REPURCHASE AGREEMENTS Retail repurchase agreements represent overnight borrowings from deposit customers and the debt securities sold under the repurchase agreements were under the control of the Bank at December 31, 2002 and 2001. Information concerning borrowings under repurchase agreements at December 31, 2002 and 2001 and for the years then ended is summarized as follows:
2002 2001 ------------ ----------- Weighted average interest rate during the year 1.39% 3.12% Average daily balance $ 185,929 $ 90,752 Maximum month-end balance during the year $ 456,732 $ 578,534 Amortized cost of debt securities underlying the agreements $ 1,009,365 $ 1,019,710 Fair value of debt securities underlying the agreements $ 1,040,721 $ 1,056,644
(9) ADVANCES FROM FEDERAL HOME LOAN BANK At December 31, 2002 and 2001, advances from the Federal Home Loan Bank were as follows:
2002 2001 ------------------------ ----------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE RATE AMOUNT RATE AMOUNT Fixed rate advances 5.49% $ 53,319,551 5.87% $ 42,824,645 ======================== =======================
At December 31, 2002, advances from the Federal Home Loan Bank totaling $20,000,000 were putable advances whereby the Federal Home Loan Bank will automatically convert the fixed rate advance to a variable rate should the market interest rate exceed a pre-determined strike rate. The following is a schedule of maturities for advances outstanding as of December 31, 2002: Due in: 2003 $ 3,678,004 2004 3,142,497 2005 8,501,821 2006 4,061,097 2007 5,742,274 Thereafter 28,193,858 ------------- Total $ 53,319,551 ============= The advances are secured under a blanket collateral agreement. At December 31, 2002, the carrying value of residential mortgage loans and investment securities pledged as security for the advances was $127,882,941 and $1,014,493, respectively. (10) LEASE COMMITMENTS On April 1, 1997, the Bank entered into a noncancellable sub-lease agreement for a branch office for an initial lease term of eight years. The sub-lessor has a fixed term lease with the owner with an initial term expiring November 30, 2003. The Bank also has a noncancellable lease agreement for a branch office dated December 1, 1995 that expires in the year 2005. -30- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (10 - continued) The following is a schedule by years of future minimum rental payments required under these operating leases: Year ending December 31: 2003 $ 30,833 2004 19,200 2005 17,600 -------- Total minimum payments required $ 67,633 ======== Total minimum rental expense for all operating leases for each of the periods ended December 31, 2002 and 2001 amounted to $31,890. (11) INCOME TAXES The components of income tax expense were as follows:
2002 2001 -------------- -------------- Current $ 1,786,727 $ 1,695,451 Deferred (24,088) 18,971 -------------------------------- Totals $ 1,762,639 $ 1,714,422 ================================
Significant components of the deferred tax assets and liabilities as of December 31, 2002 and 2001 were as follows:
2002 2001 -------------- -------------- Deferred tax assets (liabilities): Depreciation $ (262,907) $ (197,962) Deferred loan fees and costs (68,474) (49,080) Deferred compensation plans 163,496 153,176 Stock compensation plan 27,136 27,400 Allowance for loan losses 472,104 426,765 Post-1987 bad debt deduction (28,633) (57,266) Unrealized gain on securities available for sale (636,867) (151,614) Other (18,244) (42,641) -------------------------------- Net deferred tax asset (liability) $ (352,389) $ 108,778 ================================
The reconciliation of income tax expense with the amount which would have been provided at the federal statutory rate of 34 percent follows:
2002 2001 -------------- -------------- Provision at federal statutory tax rate $ 1,703,739 $ 1,636,646 State income tax-net of federal tax benefit 229,184 227,740 Tax-exempt interest income (146,627) (135,758) Increase in cash value of life insurance (17,903) (18,114) Other (5,754) 3,908 -------------------------------- Totals $ 1,762,639 $ 1,714,422 ================================ Effective tax rate 35.2% 35.6% ================================
-31- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (11 - continued) Prior to July 1, 1996, the Bank was permitted by the Internal Revenue Code to deduct from taxable income an annual addition to a statutory bad debt reserve subject to certain limitations. Retained earnings at December 31, 2002 includes approximately $1,040,000 of cumulative deductions for which no deferred federal income tax liability has been recorded. Reduction of these reserves for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes subject to the then current corporate income tax rate. The unrecorded deferred liability on these amounts was approximately $354,000 at December 31, 2002. Federal legislation enacted in 1996 repealed the use of the qualified thrift reserve method of accounting for bad debts for tax years beginning after December 31, 1995. As a result, the Bank discontinued the calculation of the annual addition to the statutory bad debt reserve using the percentage-of-taxable-income method and adopted the experience reserve method for banks. Under this method, the Bank computes its federal tax bad debt deduction based on actual loss experience over a period of years. The legislation required the Bank to recapture into taxable income over a six-year period its post-1987 additions to the qualified thrift statutory bad debt reserve, thereby generating additional tax liability. At December 31, 2002, the remaining unamortized balance of the post-1987 reserves totaled $84,214 for which a deferred tax liability of $28,633 has been recorded. The legislation also provided that the Bank will not be required to recapture its pre-1988 statutory bad debt reserves if it ceases to meet the qualifying thrift definitional tests as provided under prior law and if the Bank continues to qualify as a "bank" under existing provisions of the Internal Revenue Code. (12) EMPLOYEE BENEFIT PLANS DEFINED CONTRIBUTION PLAN: The Bank has a qualified contributory defined contribution plan available to all eligible employees. The plan allows participating employees to make tax-deferred contributions under Internal Revenue Code Section 401(k). The Bank contributed $128,359 and $109,773 to the plan for the years ended December 31, 2002 and 2001, respectively. EMPLOYEE STOCK OWNERSHIP PLAN: On December 31, 1998, the Company established a leveraged employee stock ownership plan (ESOP) covering substantially all employees. The ESOP trust acquired 61,501 shares of Company common stock financed by a term loan with the Company. The employer loan and the related interest income are not recognized in the consolidated financial statements as the debt is serviced from Company contributions. Dividends payable on allocated shares are charged to retained earnings and are satisfied by the allocation of cash dividends to participant accounts. Dividends payable on unallocated shares are not considered dividends for financial reporting purposes. Shares held by the ESOP trust are allocated to participant accounts based on the ratio of the current year principal and interest payments to the total of the current year and future years principal and interest to be paid on the employer loan. Compensation expense is recognized based on the average fair value of shares released for allocation to participant accounts during the year with a corresponding credit to stockholders' equity. Compensation expense recognized for the years ended December 31, 2002 and 2001 amounted to $68,327 and $50,251, respectively. -32- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (12 - continued) Company common stock held by the ESOP trust at December 31 was as follows:
2002 2001 -------------- -------------- Allocated shares $ 17,425 $ 13,325 Shares committed to be released - - Unearned shares 44,076 48,176 ------------------------------- Total ESOP shares 61,501 61,501 =============================== Fair value of unearned shares $ 896,065 $ 693,734 ===============================
(13) DEFERRED COMPENSATION PLANS The Bank has a deferred compensation plan whereby certain officers will be provided specific amounts of income for a period of fifteen years following normal retirement. The benefits under the agreements become fully vested after four years of service beginning with the effective date of the agreements. The Bank accrues the present value of the benefits so the amounts required will be provided at the normal retirement dates and thereafter. Assuming normal retirement, the benefits under the plan will be paid in varying amounts between 1999 and 2022. The Bank is the owner and beneficiary of insurance policies on the lives of these officers which may provide funds for a portion of the required payments. The agreements also provide for payment of benefits in the event of disability, early retirement, termination of employment or death. Deferred compensation expense for this plan was $30,839 and $28,051 for the years ended December 31, 2002 and 2001, respectively. The Bank also has a directors' deferred compensation plan whereby a director defers into a retirement account a portion of his monthly director fees for a specified period to provide a specified amount of income for a period of fifteen years following normal retirement. The Bank also accrues the interest cost on the deferred obligation so the amounts required will be provided at the normal retirement dates and thereafter. Assuming normal retirement, the benefits under the plan will be paid in varying amounts between 1995 and 2037. The agreements also provide for payment of benefits in the event of disability, early retirement, termination of service or death. Deferred compensation expense for this plan was $7,914 and $12,208 for the years ended December 31, 2002 and 2001, respectively. (14) STOCK-BASED COMPENSATION PLANS The Company applies APB No. 25 and related interpretations in accounting for its stock-based compensation plans. In accordance with SFAS No. 123, the Company elected to continue to apply the provisions of APB No. 25. However, pro forma disclosures as if the Company adopted the compensation cost recognition provisions of SFAS No. 123, are presented along with a summary of the plans and awards. RESTRICTED STOCK COMPENSATION PLAN The Company has a restricted stock compensation plan as an encouragement for directors, officers and key employees to remain in the employment or service of the Bank. The shares granted under the plan were in the form of restricted stock vesting over a five-year period beginning one year after -33- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (14 - continued) the date of grant of the award. Since the stock issued is held in escrow by the Company before some or all of the services are performed, unearned compensation is recorded as a reduction of stockholders' equity. Compensation expense is recognized pro rata over the period during which the shares are earned. The terms of the restricted stock compensation plan include a provision whereby all unearned shares become fully vested upon a change in control. Compensation expense of $70,024 and $70,771 was recognized for the years ended December 31, 2002 and 2001, respectively. STOCK OPTION PLAN The Company's stock option plan provides for issuance of up to 138,876 shares of the Company's authorized but unissued common stock to all employees, including any officer or employee-director. Under the plan, the Company may grant both non-qualified and qualified (i.e. incentive) stock options. In the case of incentive stock options, the aggregate fair value of the stock (determined at the time the incentive stock option is granted) for which any optionee may be granted incentive options which are first exercisable during any calendar year shall not exceed $100,000. Option prices may not be less than the fair market value of the underlying stock at the date of the grant. Options granted generally vest ratably over five years and are exercisable in whole or in part for a period up to ten years from the date of the grant. The following is a summary of the Company's stock options as of December 31, 2002 and 2001, and the changes for the years then ended:
2002 2001 --------------------------- --------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE EXERCISE EXERCISE NUMBER PRICE NUMBER PRICE Outstanding at beginning of year 84,736 $ 10.46 93,629 $ 7.88 Granted 750 14.25 -- -- Exercised 5,802 7.98 8,638 5.83 Forfeited 5,761 10.69 256 7.81 ------------ ------------ Outstanding at end of year 73,923 $ 10.67 84,736 $ 10.46 ============ ============ Exercisable at end of year 37,555 $ 10.40 25,533 $ 9.52 ============ ============
For options outstanding at December 31, 2002, the following information is provided by range of exercise price:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------ --------------------------- WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE REMAINING AVERAGE RANGE OF EXERCISE CONTRACTUAL EXERCISE EXERCISE PRICES NUMBER PRICE LIFE NUMBER PRICE $6.24 - $7.41 4,364 $ 6.95 4.1 years 4,364 $ 6.95 $9.42 - $11.00 68,809 10.88 6.9 years 33,191 10.86 $14.25 750 14.25 9.1 years - - ------------ ------------ $6.24 - $14.25 73,923 $ 10.68 6.8 years 37,555 $ 10.40 ============ ============
-34- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (14 - continued) The Company accounts for the stock option plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the stock option plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation.
YEARS ENDED DECEMBER 31, 2002 2001 -------------- -------------- Net income, as reported $ 3,248,359 $ 3,099,243 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (12,327) (13,502) -------------------------------- Pro forma net income $ 3,236,032 $ 3,085,742 ================================ Earnings per share: Basic - as reported $ 1.31 $ 1.26 ================================ Basic - pro forma $ 1.31 $ 1.25 ================================ Diluted - as reported $ 1.30 $ 1.25 ================================ Diluted - pro forma $ 1.29 $ 1.24 ================================
For purposes of providing the pro forma disclosures required under SFAS No. 123, the fair market value of stock options granted was estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model was originally developed for use in estimating the fair value of traded options which have different characteristics from the Company's employee stock options and require the use of highly subjective assumptions which can materially affect the fair value estimate. As a result, management believes that the Black-Scholes model may not necessarily provide a reliable measure of the fair value of employee stock options. The following assumptions were used for grants for the year ended December 31, 2002: Expected dividend yields 3.14% Risk-free interest rates 4.27% Expected volatility 10.65% Expected life of options 7 years Weighted average fair value at grant date $ 1.71 -35- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (15) COMMITMENTS AND CONTINGENCIES In the normal course of business, there are outstanding various commitments and contingent liabilities, such as commitments to extend credit and legal claims, which are not reflected in the financial statements. Commitments under outstanding standby letters of credit totaled $689,460 at December 31, 2002. The following is a summary of the commitments to extend credit at December 31, 2002 and 2001:
2002 2001 -------------- -------------- Loan commitments: Fixed rate $ 5,499,450 $ 7,599,459 Adjustable rate 297,350 617,550 Undisbursed commercial and personal lines of credit 6,462,186 8,857,316 Undisbursed portion of construction loans in process 3,887,288 2,726,924 Undisbursed portion of home equity lines of credit 10,370,924 8,416,594 ------------------------------- Total commitments to extend credit $ 26,517,198 $ 28,217,843 ===============================
(16) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments (see Note 15). The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit 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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount and type of collateral obtained, if deemed necessary by the Bank upon extension of credit, varies and is based on management's credit evaluation of the counterparty. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank's policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit. The Bank has not been required to perform on any financial guarantees and has not incurred any losses on its commitments during the years ended December 31, 2002 and 2001. -36- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (17) DIVIDEND RESTRICTION As an Indiana corporation, the Company is subject to Indiana law with respect to the payment of dividends. Under Indiana law, the Company may pay dividends so long as it is able to pay its debts as they become due in the usual course of business and its assets exceed the sum of its total liabilities, plus the amount that would be needed, if the Company were to be dissolved at the time of the dividend, to satisfy any rights that are preferential to the rights of the persons receiving the dividend. The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company. The payment of dividends by the Bank is subject to regulation by the Office of Thrift Supervision (OTS). The Bank may not declare or pay a cash dividend or repurchase any of its capital stock if the effect thereof would cause the regulatory capital of the Bank to be reduced below regulatory capital requirements imposed by the OTS or below the amount of the liquidation account established upon completion of a conversion from mutual to stock form on December 31, 1998. (18) REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involved quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to quantitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2002, the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institutions' categories. The actual capital amounts and ratios are also presented in the table. No amounts were deducted from capital for interest-rate risk in either year.
MINIMUM TO BE WELL MINIMUM CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS: (Dollars in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AS OF DECEMBER 31, 2002: Total capital (to risk weighted assets) $ 34,782 19.52% $ 14,257 8.00% $ 17,821 10.00% Tier I capital (to risk weighted assets) $ 33,564 18.83% $ 7,128 4.00% $ 10,692 6.00% Tier I capital (to adjusted total assets) $ 33,564 10.92% $ 12,299 4.00% $ 15,373 5.00% Tangible capital (to adjusted total assets) $ 33,564 10.92% $ 4,612 1.50% N/A
-37- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (18 - continued)
MINIMUM TO BE WELL MINIMUM CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS: (Dollars in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AS OF DECEMBER 31, 2001: Total capital (to risk weighted assets) $ 32,921 20.36% $ 12,938 8.00% $ 16,172 10.00% Tier I capital (to risk weighted assets) $ 31,818 19.67% $ 6,469 4.00% $ 9,703 6.00% Tier I capital (to adjusted total assets) $ 31,818 11.25% $ 11,311 4.00% $ 14,138 5.00% Tangible capital (to adjusted total assets) $ 31,818 11.25% $ 4,241 1.50% N/A
(19) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following table summarizes the carrying value and estimated fair value of financial instruments at December 31:
2002 2001 ----------------------- ----------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE (In thousands) Financial assets: Cash and due from banks $ 6,610 $ 6,610 $ 7,184 $ 7,184 Interest bearing deposits in banks 6,044 6,044 5,198 5,198 Securities available for sale 64,980 64,980 54,891 54,891 Securities held to maturity 1,474 1,553 1,836 1,850 Loans receivable 217,214 216,596 202,833 201,663 Less: allowance for loan losses 1,218 1,218 1,103 1,103 ------------------------------------------------- Loans receivable, net 215,996 215,378 201,730 200,560 ------------------------------------------------- Federal Home Loan Bank stock 2,716 2,716 2,179 2,179 Financial liabilities: Deposits 216,202 221,795 204,122 206,690 Retail repurchase agreements 457 457 284 285 Advances from Federal Home Loan Bank 53,320 58,762 42,825 45,017 Off-balance-sheet financial instruments: Asset related to commitments to extend credit - 70 - 90
-38- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (19 - continued) The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: CASH AND SHORT-TERM INVESTMENTS For short-term investments, including cash and due from banks, interest bearing deposits with banks, and federal funds sold, the carrying amount is a reasonable estimate of fair value. DEBT AND EQUITY SECURITIES For debt securities, including mortgage-backed securities, the fair values are based on quoted market prices. For restricted equity securities held for investment, the carrying amount is a reasonable estimate of fair value. LOANS RECEIVABLE The fair value of loans 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. DEPOSITS The fair value of demand deposits, savings accounts, money market deposit accounts and other transaction accounts is the amount payable on demand at the balance sheet date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. BORROWED FUNDS The fair value of advances from Federal Home Loan Bank is estimated by discounting the future cash flows using the current rates at which similar loans with the same remaining maturities could be obtained. COMMITMENTS TO EXTEND CREDIT The majority of commitments to extend credit would result in loans with a market rate of interest if funded. The fair value of these commitments are the fees that would be charged to customers to enter into similar agreements. For fixed rate loan commitments, the fair value also considers the difference between current levels of interest rates and the committed rates. (20) PARENT COMPANY CONDENSED FINANCIAL INFORMATION Condensed financial information for First Capital, Inc. (parent company only) follows:
BALANCE SHEETS (In thousands) AS OF DECEMBER 31, ------------------------------- 2002 2001 -------------- -------------- Assets: Cash and interest bearing deposits $ 1,318 $ 1,037 Other assets 339 155 Investment in subsidiaries 34,704 32,289 ------------------------------- $ 36,361 $ 33,481 =============================== Liabilities and Stockholders' Equity: Other liabilities $ 31 $ - Stockholders' equity 36,330 33,481 ------------------------------- $ 36,361 $ 33,481 ===============================
-39- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (20 - continued) STATEMENTS OF INCOME (In thousands)
YEARS ENDED DECEMBER 31, 2002 2001 -------------- -------------- Interest income $ 18 $ 28 Dividend income 1,706 1,030 Other operating expenses (265) (253) -------------------------------- Income before income taxes and equity in undistributed net income of subsidiaries 1,459 805 Income tax credit 114 79 -------------------------------- Income before equity in undistributed net income of subsidiaries 1,573 884 Equity in undistributed net income of subsidiaries 1,675 2,215 -------------------------------- Net income $ 3,248 $ 3,099 ================================
STATEMENTS OF CASH FLOWS (In thousands)
YEARS ENDED DECEMBER 31, 2002 2001 -------------- -------------- Operating Activities: Net income $ 3,248 $ 3,099 Adjustments to reconcile net income to cash provided by operating activities: Equity in undistributed net income of subsidiaries (1,675) (2,215) ESOP and stock compensation expense 136 128 Net change in other assets/liabilities (153) (28) -------------------------------- Net cash provided by operating activities 1,556 984 -------------------------------- Financing Activities: Exercise of stock options 50 50 Purchase of treasury stock (29) (87) Cash dividends paid (1,296) (1,194) -------------------------------- Net cash provided by financing activities (1,275) (1,231) -------------------------------- Net increase (decrease) in cash 281 (247) Cash at beginning of year 1,037 1,284 -------------------------------- Cash at end of year $ 1,318 $ 1,037 ================================
-40- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (21) SUPPLEMENTAL DISCLOSURE FOR EARNINGS PER SHARE
YEARS ENDED DECEMBER 31, 2002 2001 -------------- -------------- Basic: Earnings: Net income $ 3,248,359 $ 3,099,243 =============================== Shares: Weighted average common shares outstanding 2,475,938 2,463,343 =============================== Net income per common share, basic $ 1.31 $ 1.26 =============================== Diluted: Earnings: Net income $ 3,248,359 $ 3,099,243 =============================== Shares: Weighted average common shares outstanding 2,475,938 2,463,433 Add: Dilutive effect of outstanding options 25,327 15,717 Dilutive effect of restricted stock 4,729 3,009 ------------------------------- Weighted average common shares outstanding, as adjusted 2,505,994 2,482,069 =============================== Net income per common share, diluted $ 1.30 $ 1.25 ===============================
Unearned ESOP shares are not considered as outstanding for purposes of computing weighted average common shares outstanding. (22) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
YEARS ENDED DECEMBER 31, 2002 2001 -------------- -------------- CASH PAYMENTS FOR: Interest $ 8,926,680 $ 9,895,455 Income taxes 1,965,453 1,581,824 NONCASH INVESTING ACTIVITIES: Transfers from loans to real estate acquired through foreclosure $ 318,631 $ 126,398 Proceeds from sales of foreclosed real estate financed through loans 87,400 34,222
(23) ADVERTISING COSTS Advertising costs are expensed when incurred. Advertising expense was $104,644 and $124,435 for the years ended December 31, 2002 and 2001, respectively. -41- FIRST CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED DECEMBER 31, 2002 AND 2001 (24) SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER 2002 (In Thousands, Except Per Share Data) Interest income $ 4,677 $ 4,720 $ 4,768 $ 4,747 Interest expense 2,225 2,227 2,234 2,116 ------------ ------------ ------------ ------------ Net interest income 2,452 2,493 2,534 2,631 Provision for loan losses 45 45 65 150 ------------ ------------ ------------ ------------ Net interest income after provision for loan losses 2,407 2,448 2,469 2,481 Noninterest income 399 420 447 471 Noninterest expenses 1,601 1,666 1,631 1,633 ------------ ------------ ------------ ------------ Income before income taxes 1,205 1,202 1,285 1,319 Income tax expense 412 428 456 467 ------------ ------------ ------------ ------------ Net income $ 793 $ 774 $ 829 $ 852 ============ ============ ============ ============ Net income per common share, basic $ 0.32 $ 0.31 $ 0.33 $ 0.35 ============ ============ ============ ============ Net income per common share, diluted $ 0.32 $ 0.31 $ 0.33 $ 0.34 ============ ============ ============ ============ 2001 Interest income $ 4,678 $ 4,701 $ 4,811 $ 4,770 Interest expense 2,530 2,462 2,516 2,334 ------------ ------------ ------------ ------------ Net interest income 2,148 2,239 2,295 2,436 Provision for loan losses 36 -- -- 30 ------------ ------------ ------------ ------------ Net interest income after provision of loan losses 2,112 2,239 2,295 2,406 Noninterest income 455 435 381 404 Noninterest expenses 1,453 1,462 1,478 1,521 ------------ ------------ ------------ ------------ Income before income taxes 1,114 1,212 1,198 1,289 Income tax expense 397 435 423 459 ------------ ------------ ------------ ------------ Net income $ 717 $ 777 $ 775 $ 830 ============ ============ ============ ============ Net income per common share, basic $ 0.29 $ 0.32 $ 0.31 $ 0.34 ============ ============ ============ ============ Net income per common share, diluted $ 0.29 $ 0.31 $ 0.31 $ 0.34 ============ ============ ============ ============
-42- BOARD OF DIRECTORS/OFFICERS DIRECTORS AND DIRECTORS EMERITUS James G. Pendleton Chairman of the Board and retired Chief Executive Officer of First Harrison Bank Dennis L. Huber President and Publisher of O'Bannon Publishing Company, Inc. Kenneth R. Saulman Supervisor for Clark County REMC Gerald L. Uhl Business Manager for Jacobi Sales, Inc. James E. Nett Accountant for Koetter Woodworking, Inc. Earl H. Book, Director Emeritus President of Carriage Ford, Inc. Mark D. Shireman President of James L. Shireman, Inc. Michael L. Shireman President of Uhl Truck Sales, Inc. John W. Buschemeyer President and Majority Owner of Hurst Lumber Company James S. Burden Owner of Tracy's Mobile Home Park Marvin E. Kiesler, Director Emeritus Retired Senior Vice President of Harrison County Bank EXECUTIVE OFFICERS William W. Harrod President and Chief Executive Officer of First Capital, Inc. and Chief Operating Officer of First Harrison Bank Samuel E. Uhl President and Chief Executive Officer of First Harrison Bank and Chief Operating Officer of First Capital, Inc. Dennis L. Thomas Senior Vice President, Consumer Lending Processing and Servicing M. Chris Frederick Senior Vice President, Chief Financial Officer and Treasurer Joel E. Voyles Senior Vice President, Retail Banking Operations and Corporate Secretary -43- - -------------------------------------------------------------------------------- CORPORATE INFORMATION - -------------------------------------------------------------------------------- GENERAL COUNSEL INDEPENDENT AUDITORS Thompson & Byrd Monroe Shine & Co., Inc. 303 N. Capitol Avenue 222 East Market Street Corydon, Indiana 47112 New Albany, Indiana 47150 SPECIAL COUNSEL TRANSFER AGENT Muldoon Murphy & Faucette LLP Registrar and Transfer Company 5101 Wisconsin Ave., N.W. 10 Commerce Drive Washington, D.C. 20016 Crawford, New Jersey 07016 1-800-368-5948 COMMON SHARES AND DIVIDEND INFORMATION The common shares of the Company are traded on the Nasdaq SmallCap Market under the symbol "FCAP." As of December 31, 2002, the Company has 1,288 stockholders of record and 2,551,763 common shares outstanding. This does not reflect the number of persons whose shares are in nominee or "street" name accounts through brokers. The following table lists quarterly market price and dividend information per common share for the years ended December 31, 2002 and 2001 as reported by Nasdaq. The market prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
HIGH LOW MARKET PRICE BID BID DIVIDENDS END OF PERIOD 2002: First Quarter $ 15.10 $ 14.05 $ 0.13 $ 15.00 Second Quarter 16.70 15.10 0.13 16.50 Third Quarter 19.00 15.20 0.13 19.00 Fourth Quarter 20.25 17.00 0.13 20.33 2001: First Quarter $ 12.13 $ 10.00 $ 0.11 $ 11.88 Second Quarter 11.50 10.50 0.12 10.80 Third Quarter 14.00 10.90 0.12 13.37 Fourth Quarter 14.15 12.01 0.13 14.40
Dividend payments by the Company depend primarily on dividends received by the Company from the Bank. See Note 17 to Consolidated Financial Statements for information regarding the dividend restrictions applicable to the Bank. ANNUAL MEETING The Annual Meeting of Stockholders will be held at 2:00 p.m., Wednesday, April 23, 2003, at the office of the Bank, 220 Federal Drive, N.W., Corydon, Indiana 47112. -44- GENERAL INQUIRIES AND REPORTS The Company is required to file an Annual Report on Form 10-KSB for its fiscal year ended December 31, 2002 with the Securities and Exchange Commission. Copies of this Annual Report and the Company's annual reports on Form 10-KSB (without exhibits) and quarterly reports on Form 10-QSB (without exhibits) may be obtained without charge by writing: William W. Harrod President and CEO First Capital, Inc. 220 Federal Drive, N.W. Corydon, Indiana 47112 (812) 738-2198 The Company's Annual Reports and Quarterly Reports are also available through the Securities and Exchange Commission's internet website (www.sec.gov). -45- EX-23 4 dex23.txt EXHIBIT 23 Exhibit 23 {Letterhead of Monroe Shine and Co., Inc.} INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in First Capital, Inc.'s Registration Statement No. 333-76543 on Form S-8 and in First Capital, Inc.'s Registration Statement No. 333-95987 on Form S-8 of our report dated January 17, 2003 contained in the annual report for the year ended December 31, 2002 appearing in this Form 10-KSB. /s/ MONROE SHINE AND CO., INC. New Albany, Indiana March 28, 2003 EX-99.1 5 dex991.txt EXHIBIT 99.1 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADDED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of First Capital, Inc. (the "Company") on Form 10-KSB for the fiscal year ended December 31, 2002 as filed with the Securities and Exchange Commission (the "Report"), I, William W. Harrod, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report. /s/ William W. Harrod ---------------------------------------- William W. Harrod President and Chief Executive Officer Date: March 28, 2003 A signed original of this written statement required by Section 906 has been provided to First Capital, Inc. and will be retained by First Capital, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-99.2 6 dex992.txt EXHIBIT 99.2 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADDED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of First Capital, Inc. (the "Company") on Form 10-KSB for the fiscal year ended December 31, 2002 as filed with the Securities and Exchange Commission (the "Report"), I, Michael C. Frederick, Senior Vice President, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report. /s/ Michael C. Frederick ---------------------------------------- Michael C. Frederick Senior Vice President, Chief Financial Officer and Treasurer Date: March 28, 2003 A signed original of this written statement required by Section 906 has been provided to First Capital, Inc. and will be retained by First Capital, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----