UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _________ to _________
Commission File Number 0-26012
NORTHEAST INDIANA BANCORP, INC.
(Name of small business issuer in its charter)
Delaware 35-1948594
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
648 North Jefferson Street, Huntington, Indiana 46750
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (260) 356-3311
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the 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 Securities Exchange Act of 1934 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 contained herein, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |_|
Our revenues for the most recent fiscal year: $14.1 million.
The aggregate market value of the voting stock held by non-affiliates,
computed by reference to the average of the bid and asked price of such stock as
of March 5, 2004, was $24.2 million. (The exclusion from such amount of the
market value of the shares owned by any person shall not be deemed an admission
by the registrant that such person is an affiliate.)
As of March 5, 2004, there were 1,490,614 shares outstanding of the
registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part II of Form 10-KSB - Annual Report to Stockholders for the fiscal year
ended December 31, 2003. Part III of Form 10-KSB - Proxy Statement for
Annual Meeting of Stockholders.
Transitional Small Business Disclosure Format: YES |_|; NO |X|
FORWARD-LOOKING STATEMENTS
Northeast Indiana Bancorp, Inc. (Northeast Indiana) and its wholly-owned
subsidiary, First Federal Savings Bank (First Federal) and its wholly-owned
subsidiary, Northeast Indiana Financial, Inc. (Northeast Financial), may from
time to time make written or oral "forward-looking statements," including
statements contained in its filings with the Securities and Exchange Commission
(the SEC). These forward-looking statements may be included in this Annual
Report on Form 10-KSB and the exhibits attached to it, in Northeast Indiana's
reports to stockholders and in other communications, which are made in good
faith by us pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995.
These forward-looking statements include statements about our beliefs,
plans, objectives, goals, expectations, anticipations, estimates and intentions,
that are subject to significant risks and uncertainties, and are subject to
change based on various factors, some of which are beyond our control. The words
"may," "could," "should," "would," "believe," "anticipate," "estimate,"
"expect," "intend," "plan" and similar expressions are intended to identify
forward-looking statements. The following factors, among others, could cause our
financial performance to differ materially from the plans, objectives,
expectations, estimates and intentions expressed in the forward-looking
statements:
o the strength of the United States economy in general and the
strength of the local economies in which we conduct operations;
o the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the Federal Reserve
Board;
o inflation, interest rate, market and monetary fluctuations;
o the timely development of and acceptance of our new products and
services and the perceived overall value of these products and
services by users, including the features, pricing and quality
compared to competitors' products and services;
o the willingness of users to substitute our products and services for
products and services of our competitors;
o our success in gaining regulatory approval of our products and
services, when required;
o the impact of changes in financial services' laws and regulations
(including laws concerning taxes, banking, securities and
insurance);
o the impact of technological changes;
o acquisitions;
o changes in consumer spending and saving habits; and
o our success at managing the risks involved in the foregoing.
The list of important factors stated above is not exclusive. We do not
undertake to update any forward-looking statement, whether written or oral, that
may be made from time to time by or on behalf of Northeast Indiana, First
Federal or Northeast Financial.
2
PART I
Item 1. Description of Business
Northeast Indiana, a Delaware corporation, is the holding company for
First Federal and its subsidiary Northeast Financial. All references to
Northeast Indiana prior to June 27, 1995, the date of First Federal's conversion
from mutual to stock form, except where otherwise indicated, are to First
Federal. References in this Form 10-KSB to "we," "us" and "our" refer to
Northeast Indiana and/or First Federal and/or Northeast Financial as the context
requires.
At December 31, 2003, we had $227.4 million of assets and stockholders'
equity of $27.2 million (or 12.0% of total assets).
First Federal is a federally chartered stock savings association
headquartered in Huntington, Indiana. Our deposits are insured up to applicable
limits by the Federal Deposit Insurance Corporation (FDIC), which is backed by
the full faith and credit of the United States Government.
Northeast Financial, an Indiana corporation, was established as a
subsidiary of First Federal to provide brokerage services through an affiliation
with Multi-Financial Securities Corporation (broker/dealer).
Our principal business consists of attracting retail deposits from the
general public and investing those funds primarily in first mortgage loans on
owner-occupied, single-family residential real estate. We also originate
commercial real estate, construction, consumer and commercial business loans. We
have in the past purchased a limited number of loans and equipment leases. At
December 31, 2003, substantially all of the real estate mortgage loans,
including commercial and multi-family, were secured by properties located in our
market area. We also invest in obligations of states and political subdivisions,
mutual funds and other permissible investments.
We offer traditional trust services made possible by a cooperative
agreement with another financial institution located in northern Indiana. This
agreement was signed and First Federal's existing trust assets were converted to
the other financial institution during 2003 following the resignation of First
Federal's senior trust officer. Under the new agreement, First Federal will
continue to offer trust services to existing customers and solicit new business
with technical support from the other institution.
Our revenues are derived principally from interest on loans, investment
and other securities and service fee income. We do not originate loans to fund
leveraged buyouts, and have no loans to foreign corporations or governments.
While we generally solicit deposits only in our primary market area, at December
31, 2003, we had $7.7 million in brokered deposits.
Our executive offices are located at 648 North Jefferson Street,
Huntington, Indiana 46750, and our telephone number at that address is (260)
356-3311.
3
Risk Factors
Like all regulated financial institutions, we are exposed to numerous
risks that could adversely impact profits, financial condition and cash flows,
and, ultimately, franchise value. In order to mitigate these risks somewhat, we
have various policies, personnel and committees that establish limits for and
monitor various aspects of our risk profile. There can be no assurance that such
policies, personnel and committees will be effective in controlling these or
other risks.
Geographic Risks. A significant majority of our assets, deposits and fee
income are generated in our local lending area. As a result, deterioration of
local economic conditions in this area could expose us to losses associated with
higher loan default rates and lower asset collateral values, deposit withdrawals
and other factors that could adversely impact our financial condition and
results of operations.
Fluctuations in Interest Rates (Market Risk). Significant increases in
market interest rates, or the perception that an increase may occur, could
adversely impact our ability to generate new variable loans and cause the value
of our fixed-rate assets to decline. An increase in market interest rates may
also adversely impact the ability of adjustable rate borrowers to meet repayment
obligations, thereby causing nonperforming loans and loan charge-offs to
increase. Significant decreases in market interest rates could result in an
acceleration of loan repayments thereby mitigating the positive impact of
declining interest rates on fixed rate assets. Changes in market interest rates,
including changes in the relationship between short-term and long-term market
interest rates or between different rate indices, can impact interest rate
spread.
Competition Risk. We face significant competitive pressure from local and
regional banking institutions as well as thrifts, finance companies, credit
unions, brokerage and insurance companies and other financial intermediaries.
Many of our competitors are larger and have greater financial and other
resources. We compete on the basis of our reputation, localized decision-making,
interest rates, convenient locations and quality of customer service.
Credit Risk. We are exposed to credit risk on the loans and other credit
instruments we have in our portfolio. While the portfolio is closely monitored
and an on-going analysis and evaluation of this risk is performed, because of
the nature of our business, unexpected credit losses may subsequently be
identified as a result of additional analysis we perform or comments received
from regulatory examiners. In addition, collateral values may deteriorate
subsequent to the making of a loan so that a loss exposure develops.
Legislative and Regulatory Risk. Our operations are subject to extensive
regulation by federal banking authorities and are also subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on our operations. Policies adopted and positions taken by these regulatory and
administrative entities can impact our operations. In addition, these
authorities periodically examine us and may impose various requirements or
sanctions. The regulatory environment may periodically change significantly as
new laws and regulations are promulgated. As a result of new laws and
regulations, the competitive environment may also change significantly.
Dividend Limitation Risk. Northeast Indiana is a holding company and its
operations are conducted primarily through First Federal, its operating
subsidiary. Thus, Northeast Indiana's ability to pay dividends to its
shareholders and to service its debt is dependent primarily upon the ability of
First Federal to make dividend and other payments to Northeast Indiana. Certain
laws and regulatory requirements restrict the ability of First Federal to make
such payments to Northeast Indiana, and Northeast Indiana to make payments to
shareholders.
Liquidity Risk. We closely monitor our liquidity position including our
sources of funding and commitments to fund assets or deposit withdrawals. We
maintain adequate credit facilities. We believe that we have sufficient
liquidity to fund our commitments. However, changes in the stability of the
economic, social or political environments culminating in large withdrawals, or
a deterioration in the public's confidence in the banking system in general or
in us in particular, could have an adverse impact on our liquidity position.
4
Operational Risk. We rely on various information systems for operating
significant aspects of our business, including loan and deposit information, as
well as internal management systems. These systems and our operations could be
adversely affected by, among other things, damage or interruption from natural
disasters, power loss, network failure, improper operations, security breaches,
computer viruses or sabotage. Controls and procedures have been implemented to
minimize these risks, but any disruption in the operation of our various
information systems could adversely impact our operations which may affect our
results of operations and financial condition.
Reputation Risk. We strive to operate in a professional manner and have
implemented various personnel policies and procedures, including an employee
code of conduct applicable to all employees, to help ensure the maintenance of
integrity and professionalism. Nevertheless, Northeast Indiana or its employees
may fail to perform in accordance with these policies and procedures, or we may
find ourselves in a situation that is embarrassing from a public relations
perspective and, upon this information becoming public knowledge, may suffer
damage to our reputation. This damage could adversely impact customer confidence
and have an adverse impact on our financial condition and results of operations.
Disintermediation. In the banking and financial services businesses,
disintermediation is the process by which customers and potential customers
bypass banks and other traditional financial institutions thereby depleting
anticipated revenue streams. While we continue our efforts to make our products
and services an integral, valuable component of our customers' financial
transactions, the possibility of disintermediation is an inherent risk in the
banking and traditional financial services business as customers may migrate to
other financial intermediaries.
Market Area
Our office is located at 648 North Jefferson Street in Huntington,
Indiana. The City of Huntington is located in Huntington County, Indiana, and 25
miles southwest of Fort Wayne, Indiana. The City of Huntington is the County
Seat of Huntington County and has a population of approximately 17,500. Along
with an agricultural base, the major employers in Huntington County are engaged
in the light manufacturing, education and health care industries and include the
following: United Technologies, CFM Majestic, Wabash/Optek Sensor Group, Bendix
Commercial Vehicle System Co., Dana Corporation, Hayes Lemmerz, Square D, Good
Humor-Breyers Ice Cream, Our Sunday Visitor, Huntington County Community School
Corporation and Parkview-Huntington Hospital.
Lending Activities
Our loan portfolio consists primarily of conventional, first mortgage
loans secured by one-to four-family residences and, to a lesser extent, consumer
loans, commercial real estate loans, commercial business loans, construction or
development loans and loans secured by multi-family real estate. At December 31,
2003, gross loans outstanding totaled $169.4 million, of which $91.6 million or
54.10% were one-to four-family residential mortgage loans. Of the one-to
four-family mortgage loans outstanding at that date, 63.57% were fixed-rate
loans, and 36.43% were adjustable-rate loans. At that same date, commercial real
estate and multi-family loans totaled $25.1 million, of which 82.42% were
fixed-rate loans and 17.58% were adjustable-rate loans. Also at that date,
construction or development loans totaled $9.5 million or 5.59% of the total
loan portfolio, 37.92% of which were adjustable-rate loans. At December 31,
2003, commercial business loans totaled $22.0 million or 12.96% of the total
loan portfolio, of which 49.96% were fixed-rate loans and 50.04% were
adjustable-rate loans.
At December 31, 2003, the balance of our consumer loans consisted of $21.2
million of loans, which represented 12.51% of the gross loan portfolio. Of the
consumer loans outstanding, 68.32% were fixed-rate loans and 31.68% were
adjustable-rate loans.
The aggregate amount of loans that First Federal is permitted to make
under applicable federal regulations to any one borrower, including related
entities, is generally equal to the greater of 15% of unimpaired capital and
surplus or $500,000. At December 31, 2003, the maximum amount, which First
Federal could have lent to any one borrower and the borrower's related entities,
was approximately $4.0 million. See "Regulation - Federal Regulation of Savings
Associations." At December 31, 2003, we had no loans or groups of loans to
related borrowers with outstanding balances in excess of this amount. Our
largest lending relationship at December 31, 2003 was $3.0 million in loans to
one borrower and was secured primarily by real estate.
5
Loan Portfolio Composition. The following table sets forth information
concerning the composition of our loan portfolio in dollar amounts and in
percentages (before deductions for loans in process, deferred fees and discounts
and allowance for loan losses) as of the dates indicated.
December 31,
----------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Real Estate Loans
One- to four-family ....... $ 91,637 54.10% $ 86,489 54.47% $ 95,777 57.03% $117,683 57.61% $119,283 55.50%
Multi-family .............. 4,709 2.78 3,709 2.34 3,625 2.16 4,377 2.14 3,779 1.76
Commercial ................ 20,424 12.06 19,482 12.27 20,199 12.03 24,519 12.00 24,471 11.39
Construction or development 9,469 5.59 6,074 3.82 6,363 3.79 7,188 3.52 12,613 5.87
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 126,239 74.53 115,754 72.90 125,964 75.01 153,767 75.27 160,146 74.52
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Other Loans:
Consumer Loans:
Deposit account ........... 153 .09 127 .08 34 .02 53 0.03 47 0.02
Automobile ................ 9,591 5.66 10,409 6.55 12,788 7.61 14,098 6.90 15,442 7.18
Home equity ............... 6,148 3.63 6,140 3.87 5,821 3.47 6,961 3.41 6,366 2.96
Home improvement .......... 628 .37 1,472 .93 2,791 1.66 1,251 0.61 805 0.37
Other ..................... 4,664 2.76 5,620 3.54 6,277 3.74 7,422 3.63 7,935 3.70
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans ... 21,184 12.51 23,768 14.97 27,711 16.50 29,785 14.58 30,595 14.23
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial business loans . 21,956 12.96 19,263 12.13 14,259 8.49 20,730 10.15 24,184 11.25
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans ............ 169,379 100.00% 158,785 100.00% 167,934 100.00% 204,282 100.00% 214,925 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed portion of
construction loans ........ 3,503 1,455 2,217 1,745 4,088
Loans in process .......... 134 318 641 156 443
Deferred fees and discounts 293 316 291 229 233
Allowance for loan losses . 1,772 2,136 1,955 2,001 1,766
-------- -------- -------- -------- --------
Total loans receivable, net $163,677 $154,560 $162,830 $200,151 $208,395
======== ======== ======== ======== ========
6
The following table shows the composition of our loan portfolio by
fixed-and adjustable-rate at the dates indicated.
December 31,
----------------------------------------------------------------------
2003 2002 2001
----------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
----------------------------------------------------------------------
(Dollars in Thousands)
Fixed-Rate Loans:
Real estate:
One- to four-family ............................... $ 58,254 34.39% $ 56,424 35.54% $ 56,043 33.37%
Multi-family ...................................... 2,926 1.73 3,594 2.26 2,732 1.63
Commercial ........................................ 17,788 10.50 17,670 11.13 18,097 10.78
Construction or development ....................... 5,878 3.47 4,163 2.62 4,714 2.81
-------- ------ -------- ------ -------- ------
Total real estate loans ........................ 84,846 50.09 81,851 51.55 81,586 48.59
-------- ------ -------- ------ -------- ------
Consumer ........................................... 14,472 8.54 16,419 10.34 19,325 11.51
Commercial business ................................ 10,969 6.48 7,523 4.74 6,999 4.17
-------- ------ -------- ------ -------- ------
Total fixed-rate loans ......................... 110,287 65.11 105,793 66.63 107,910 64.27
Adjustable-Rate Loans:
Real estate:
One- to four-family ............................... 33,383 19.71 30,065 18.94 39,734 23.66
Multi-family ...................................... 1,783 1.05 115 .07 893 0.53
Commercial ........................................ 2,636 1.56 1,812 1.14 2,102 1.25
Construction or development ....................... 3,591 2.12 1,911 1.20 1,649 0.98
-------- ------ -------- ------ -------- ------
Total real estate loans ........................ 41,393 24.44 33,903 21.35 44,378 26.42
-------- ------ -------- ------ -------- ------
Consumer ........................................... 6,712 3.96 7,349 4.63 8,386 4.99
Commercial business ................................ 10,987 6.49 11,740 7.39 7,260 4.32
-------- ------ -------- ------ -------- ------
Total adjustable-rate loans .................... 59,092 34.89 52,992 33.37 60,024 35.73
-------- ------ -------- ------ -------- ------
Total loans .................................... 169,379 100.00% 158,785 100.00% 167,934 100.00%
====== ====== ======
Less:
Undisbursed portion of construction loans ..... 3,503 1,455 2,217
Loans in process .............................. 134 318 641
Deferred fees and discounts ................... 293 316 291
Allowance for loan losses ..................... 1,772 2,136 1,955
-------- -------- --------
Total loans receivable, net ............. $163,677 $154,560 $162,830
======== ======== ========
7
The following schedule illustrates the interest rate sensitivity of our
loan portfolio at December 31, 2003. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
Real Estate
---------------------------------------------------------
Multi-family and Construction or Commercial
One- to Four-Family Commercial Development Consumer Business Total
-----------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
-----------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Due During the
Period Ending
December 31,
2004 ......... $ 5 8.51% $ 62 8.06% $9,294 6.06% $ 4,871 8.82% $ 8,011 4.81% $ 22,243 6.25%
2005 and 2006 443 6.77 1,797 8.51 175 6.25 3,315 8.48 2,443 5.73 8,173 7.54
2007 and 2008 2,728 6.85 764 5.76 -- -- 6,151 6.93 5,232 6.02 14,875 6.53
2009 to 2013 . 12,753 6.46 8,898 7.05 -- -- 6,621 6.36 3,283 6.00 31,555 6.56
2014 to 2033 . 75,708 6.02 13,612 7.34 -- -- 226 7.96 2,987 5.99 92,533 6.22
------- ------- ------ ------- ------- --------
$91,637 6.11% $25,133 7.27% $9,469 6.06% $21,184 7.44% $21,956 5.54% $169,379 6.38%
======= ======= ====== ======= ======= ========
The total amount of loans due after December 31, 2003 which have
predetermined interest rates is $97.2 million, while the total amount of loans
due after such dates which have floating or adjustable interest rates is $49.9
million.
8
All of our lending is subject to our written underwriting standards and
loan origination procedures. Decisions on loan applications are made on the
basis of detailed applications and property valuations. Properties securing real
estate loans made by us are generally appraised by Board-approved independent
appraisers. In the loan approval process, we assess the borrower's ability to
repay the loan, the adequacy of the proposed security, the employment stability
of the borrower and the credit-worthiness of the borrower.
We require evidence of marketable title and lien position or appropriate
title insurance on all loans secured by real property. We also require fire and
extended coverage casualty insurance in amounts at least equal to the lesser of
the principal amount of the loan or the value of improvements on the property,
depending on the type of loan. As required by federal regulations, we also
require flood insurance to protect the property securing its interest if such
property is located in a designated flood area.
One- to Four-Family Residential Mortgage Lending. Residential loan
originations are generated by our marketing efforts, our present customers,
walk-in customers and referrals from real estate brokers. We have focused our
lending efforts primarily on the origination of loans secured by first mortgages
on owner-occupied, single-family residences in our market area. At December 31,
2003, one- to four-family residential mortgage loans totaled $91.6 million, or
54.10%, of the gross loan portfolio.
We currently offer fixed-rate and adjustable-rate mortgage loans. For the
year ended December 31, 2003, we originated $41.5 million of fixed-rate loans
and $16.2 million of adjustable-rate real estate loans, all of which were
secured by one- to four-family residential real estate. Substantially all of our
one- to four-family residential mortgage originations are secured by properties
located in our market area.
We offer adjustable-rate mortgage loans at rates and on terms determined
in accordance with market and competitive factors. We originate adjustable-rate
mortgage loans with terms of up to 30 years. We offer one-year, three-year and
five-year adjustable-rate mortgage loans (where the terms are fixed for the
first one-year, three-years and five-years, respectively, and thereafter adjust
annually) with a stated interest rate margin over the United States Treasury.
Increases or decreases in the interest rate of our adjustable-rate loans are
generally limited to 1.0% at any adjustment date and, for example the one year
adjustable rate mortgage product has limits of 5.0% over the life of a loan. As
a consequence of using caps, the interest rates on these loans may not be as
rate sensitive as is our cost of funds. Currently, all adjustable-rate mortgage
loans originated do provide for a minimum interest rate based on margins and
caps over the life of the loans. At December 31, 2003, the total balance of one-
to four-family adjustable-rate loans was $33.4 million or 19.71% of our gross
loan portfolio.
We also offer fixed-rate mortgage loans with maturities of up to 30 years.
At December 31, 2003, the total balance of one- to four-family fixed-rate loans
was $58.2 million or 34.39% of our gross loan portfolio.
Currently we will lend up to 97% of the lesser of the sales price or
appraised value of the security property on owner occupied single family
residence loans, provided that private mortgage insurance is obtained in an
amount sufficient to reduce our exposure to not more than 80% of the appraised
value or sales price, as applicable. Residential loans do not include prepayment
penalties, are non-assumable (other than government-insured or guaranteed
loans), and do not produce negative amortization. Real estate loans originated
by us contain a "due on sale" clause allowing us to declare the unpaid principal
balance due and payable upon the sale of the security property.
The loans currently originated by us are typically underwritten and
documented pursuant to the guidelines of Freddie Mac. Under our current policy,
we originate and hold all adjustable-rate mortgage loans and most 10 through 20
year fixed rate mortgages in the portfolio while selling conforming fixed rate
mortgages with terms in excess of 20 years.
Commercial and Multi-Family Real Estate Lending. We have also engaged in
commercial and multi-family real estate lending in our market area. At December
31, 2003, we had $20.4 million and $4.7 million of commercial and multi-family
real estate loans, which represented 12.06% and 2.78%, of the gross loan
portfolio.
9
The commercial and multi-family real estate loan portfolio is secured
primarily by retail properties, apartments, churches and real estate located in
Huntington and Allen Counties, Indiana. Commercial and multi-family real estate
loans generally have terms that do not exceed 15 years and a variety of rate
adjustment features and other terms. Generally, the loans are made in amounts up
to 75% of the lesser of the appraised value or sales price of the security
property. We currently offer one-year, three-year and five-year adjustable-rate
commercial and multi-family real estate loans (where the terms are fixed for the
first one-year, three-years and five-years, respectively, and thereafter adjust
annually) with a margin over a designated index. In underwriting these loans, we
analyze the financial condition of the borrower, the borrower's credit history,
and the reliability and predictability of the cash flow generated by the
property securing the loan. We generally require personal guaranties of the
borrowers. Appraisals on properties securing commercial real estate loans
originated by us are performed by independent appraisers, to the extent required
by federal regulations.
Multi-family and commercial real estate loans generally present a higher
level of risk than loans secured by one- to four-family residences. This greater
risk is due to several factors, including the concentration of principal in a
limited number of loans and borrowers, the effect of general economic conditions
on income producing properties and the increased difficulty of evaluating and
monitoring these types of loans. Furthermore, the repayment of loans secured by
multi-family and commercial real estate is typically dependent upon the
successful operation of the related real estate project. If the cash flow from
the project is reduced (for example, if leases are not obtained or renewed, or a
bankruptcy court modifies a lease term, or a major tenant is unable to fulfill
its lease obligations), the borrower's ability to repay the loan may be
impaired.
Construction or Development Lending. At December 31, 2003, we had $9.5
million of construction or development loans. We offer loans to both builders
and borrowers for the construction of one- to four-family residences, and to a
lesser extent, commercial real estate and multi-family properties. Currently,
such loans are offered with fixed or adjustable rates of interest. At December
31, 2003, we had $5.9 million and $3.6 million of fixed-rate and adjustable-rate
construction or development loans, respectively, which represented 3.47% and
2.12%, respectively, of our gross loan portfolio. Following the construction
period, these loans may become permanent loans, with terms for up to 25 years
for adjustable-rate loans and 20 years for fixed-rate loans.
Construction lending is generally considered to involve a higher level of
credit risk than one- to four-family residential lending since the risk of loss
on construction loans is dependent largely upon the accuracy of the initial
estimate of the individual property's value upon completion of the project and
the estimated cost (including interest) of the project. If the cost estimate
proves to be inaccurate, we may be required to advance funds beyond the amount
originally committed to permit completion of the project.
Consumer Lending. We offer a variety of secured consumer loans, including
automobile, home equity lines of credit, second mortgage and loans secured by
savings deposits. We also offer unsecured consumer loans. We currently originate
substantially all of our consumer loans in our primary market area. We originate
consumer loans on a direct basis and on an indirect basis through the
acquisition of installment payment contracts from dealers who extend credit to
their customers for the purchase of an automobile, both new and used.
A significant component of our consumer loan portfolio consists of
automobile loans. These loans generally have terms that do not exceed six years
and carry a variety of rate adjustment features and other terms. Generally,
loans on new vehicles are made in amounts up to 100% of dealer cost and loans on
used vehicles are made in amounts up to its published value, less certain
adjustments. At December 31, 2003, automobile loans totaled $9.6 million or
5.66% of the gross loan portfolio. Of this amount, approximately $3.7 million or
38.54% and $5.9 million or 61.46% were originated on a direct and indirect
basis, respectively.
We also originate fixed rate second mortgages and adjustable rate home
equity line of credit loans. Home equity and second mortgage loans secured by
mortgages, together with loans secured by all prior liens, are generally limited
to 90% or less of the appraised value (where we have the first mortgage) of the
property securing the loan or 80% or less of appraised value (where we do not
have the first mortgage) or 75% or less of appraised value (where the collateral
property is non-owner occupied). Generally, such loans have a maximum term of up
to 10 years. As of December 31, 2003, home equity and second mortgage loans,
most of which are secured by mortgages, amounted to $6.1 million and $600,000,
which represented 3.63% and .37% of the gross loan portfolio.
10
At December 31, 2003, the consumer loan portfolio totaled $21.2 million,
or 12.51% of our gross loan portfolio. At December 31, 2003, approximately 8.54%
of consumer loans were short- and intermediate-term, fixed-rate consumer loans
and 3.96% were adjustable rate consumer loans.
Our underwriting standards for consumer loans include an application, a
determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on the proposed
loan. Although creditworthiness of the applicant is a primary consideration, the
underwriting process also includes a comparison of the value of the security, if
any, in relation to the proposed loan amount.
Consumer loans may entail greater credit risk than do residential mortgage
loans, particularly in the case of consumer loans which are unsecured or are
secured by rapidly depreciable assets, such as automobiles. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be affected by adverse personal
circumstances. Furthermore, the application of various federal and state laws,
including bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans. At December 31, 2003, $207,000 of our consumer loans
were non-performing, representing .12% of the gross loan portfolio.
The $207,000 of non-performing consumer loans includes $72,000 that
represented the present value of individual lease contracts and their residual
value that were received from the foreclosure of a commercial borrower in the
fourth quarter of 2000. The present value of $72,000 at December 31, 2003 has
been reduced from $685,000 of present value of the collateral at December 31,
2001. The present value of the leases and contracts was $1.5 million at December
31, 2000.
Commercial Business Lending. We also originate commercial business loans
and purchase commercial leases. At December 31, 2003 approximately $22.0
million, or 12.96% of our gross loan portfolio was commercial business lending.
The largest commercial business loan at this date was a combination real estate
and equipment loan of $2.4 million to a foundry operation.
Commercial business loans typically are made on the basis of the
borrower's ability to make repayment from the cash flow of the borrower's
business. As a result, the availability of funds for the repayment of commercial
business loans may be substantially dependent on the success of the business
itself (which, in turn, is likely to be dependent upon the general economic
environment). Our commercial business loans are usually, but not always, secured
by business assets. However, the collateral securing the loans may depreciate
over time, may be difficult to appraise and may fluctuate in value based on the
success of the business.
Our commercial business lending policy includes credit file documentation
and analysis of the borrower's character, capacity to repay the loan, the
adequacy of the borrower's capital and collateral as well as an evaluation of
conditions affecting the borrower. Analysis of the borrower's past, present and
future cash flows is also an important aspect of our credit analysis.
Nonetheless, such loans carry a higher credit risk than more traditional thrift
lending.
Originations, Purchases and Sales of Loans
Loan originations are developed from continuing business with depositors
and borrowers, soliciting realtors, builders, walk-in customers and other
third-party sources.
While we originate both adjustable-rate and fixed-rate loans, our ability
to originate loans to a certain extent is dependent upon the relative customer
demand for loans in its market, which is affected by the interest rate
environment, among other factors. For the year ended December 31, 2003, we
originated $71.8 million in fixed-rate loans and $39.7 million in adjustable
rate loans.
One- to four-family loan originations increased for the year to $57.7
million in 2003 from $37.1 million in 2002, reflecting the drop in mortgage
rates resulting in an increase in refinancing during 2003.
11
We have purchased loans from time to time from other Financial
Institutions with whom we have developed a comfort level. These purchases are
typically secured by commercial real estate or leased equipment and help in
managing First Federal's loan diversity and overall asset liability management.
Management imposes similar underwriting standards to these purchases that would
apply to its own originations. During the year ended December 31, 2003, First
Federal purchased $1.7 million in loans from other financial institutions.
First Federal began selling conforming long term fixed rate mortgages to
Freddie Mac during 2000. The intent was to both improve First Federal's
sensitivity to interest rate risk and to provide another source of liquidity. We
additionally have sold participations in our own loan originations on occasion
to other financial institutions. The purpose of such sales would be to decrease
First Federal's concentration risk with any single borrower. During the year
ended December 31, 2003, First Federal originated $19.1 million in conforming
fixed rate mortgages that were sold to Freddie Mac. There were no participation
loans sold during the same time frame.
Asset Quality
The following table sets forth our loan delinquencies by type, by amount
and by percentage of type at December 31, 2003. The amounts presented in the
table below represent the total remaining principal balances of the loans,
rather than the actual payment amounts which are overdue.
Loans Delinquent For:
------------------------------------------------------------
30 to 89 Days 90 Days and Over Total Delinquent Loans
---------------------------------------------------------------------------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
---------------------------------------------------------------------------------------------
(Dollars in Thousands)
Real Estate:
One- to four-family ........... 20 $ 832 0.91% 2 $ 81 0.09% 22 $ 913 1.00%
Multi-family .................. 0 -- 0.00 0 -- 0.00 0 -- 0.00
Commercial .................... 0 -- 0.00 35 2,047 10.02 35 2,047 10.02
Construction or development ... 1 61 0.64 0 -- 0.00 1 61 0.64
Consumer ...................... 49 412 1.94 43 207 0.98 92 619 2.92
Commercial Business ........... 2 28 0.13 3 78 0.36 5 106 0.48
-- ------ ---- -- ------ ----- --- ------ ----
Total ......................... 72 $1,333 0.79% 83 $2,413 1.42% 155 $3,746 2.21%
== ====== ==== == ====== ===== === ====== ====
When a borrower fails to make a required payment on a loan, we contact the
borrower in an attempt to cure the delinquency. In the case of loans secured by
real estate, reminder notices are sent to borrowers. If payment is late,
appropriate late charges are assessed, and a notice of late charges is sent to
the borrower. If the loan is in excess of 90 days delinquent, the loan will be
referred to our legal counsel for collection. In all cases, if we believe that
collateral is at risk and added delay would place the collectibility of the
balance of the loan in further question, we may refer loans for collection even
sooner than the 90 days described above.
When a loan becomes delinquent 90 days or more, we place the loan on
non-accrual status and previously accrued interest income on the loan is charged
against current income. The loan will remain on a non-accrual status as long as
the loan is 90 days delinquent.
Delinquent consumer loans are handled in a similar manner as those
described above; however, shorter time frames for each step apply due to the
type of collateral generally associated with such types of loans. Our procedures
for repossession and sale of consumer collateral are subject to various
requirements under Indiana consumer protection laws.
12
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in our loan portfolio. Loans are placed on
non-accrual status when the collection of principal and/or interest becomes
doubtful. For all years presented, we had no troubled debt restructurings (which
involve forgiving a portion of interest or principal on any loans or making
loans at a rate materially less than that of market rates). Foreclosed assets
include assets acquired in settlement of loans.
December 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------------------------------------------------------------
(Dollars in Thousands)
Non-accruing loans:
One- to four-family .................... $ 81 $ 495 $ 442 $ 608 $ 339
Multi-family ........................... -- -- -- 29 22
Commercial real estate ................. 2,047 4,500 5,085 708 247
Construction or development ............ -- 506 -- 472 683
Consumer ............................... 207 510 1,125 1,691 186
Commercial business .................... 78 207 267 198 233
------ ------ ------ ------ ------
Total ................................ 2,413 6,218 6,919 3,706 1,710
------ ------ ------ ------ ------
Foreclosed assets:
One- to four-family .................... 146 420 46 -- 49
Commercial and land .................... 16 96 173 185 --
------ ------ ------ ------ ------
Total ................................ 162 516 219 185 49
------ ------ ------ ------ ------
Repossessed assets:
Consumer and commercial ................ 3 12 83 539 14
------ ------ ------ ------ ------
Total ................................ 3 12 83 539 14
------ ------ ------ ------ ------
Total non-performing assets ............... $2,578 $6,746 $7,221 $4,430 $1,773
====== ====== ====== ====== ======
Total as a percentage of total assets ..... 1.13% 3.00% 3.03% 1.79% 0.70%
====== ====== ====== ====== ======
Total non-performing assets decreased from $6.7 million at December 31,
2002 to $2.6 million at December 31, 2003. Management was able to reduce
non-performing assets by $4.1 million or 61.2% during the year ended December
31, 2003 through increased collection efforts implemented in the latter part of
2002 and maintained during 2003. At December 31, 2003, one borrower comprised
$1.4 million or 53.8% of the $2.6 million in total non-performing assets.
Management has already established a specific reserve to cover potential losses
related to this borrower and does not anticipate any further loss at this time.
For the year ended December 31, 2003, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms was $334,000, of which $156,000 was included in interest
income.
Classified Assets. Federal regulations classify loans and other assets,
such as debt and equity securities considered by the Office of Thrift
Supervision ("OTS") to be of lesser quality, as "substandard," "doubtful" or
"loss." An asset is considered "substandard" if it is inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged, if any. "Substandard" assets include those characterized by the
"distinct possibility" that the insured institution will sustain "some loss" if
the deficiencies are not corrected. Assets classified as "doubtful" have all of
the weaknesses inherent in those classified "substandard," with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
13
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
problem assets as "loss," it is required either to establish a specific
allowance for losses equal to 100% of that portion of the asset so classified or
to charge off such amount. An institution's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the regulatory authorities, who may order the establishment
of additional general or specific loss allowances.
In connection with the filing of our periodic reports with the OTS and in
accordance with our classification of assets policy, we regularly review the
problem assets in our portfolio to determine whether any assets require
classification in accordance with applicable regulations. At December 31, 2003,
we had classified $2.2 million of our assets, net of specific reserves, as
substandard, representing 8.1% of the stockholders' equity or 1.0% of total
assets. These figures represent significant improvements over December 31, 2002
substandard classified assets, net of specific reserves, of $5.4 million,
representing 20.3% of stockholders' equity or 2.4% of total assets.
Other Loans of Concern. Other than the (i) non-performing loans,
repossessed assets and foreclosed real estate held for sale set forth in the
tables above, (ii) impaired loans incorporated by reference from the Annual
Report to Shareholders, and (iii) the classified assets, there were no
classified loans with respect to which known information about the possible
credit problems of the borrowers or the cash flows of the security properties,
have caused management to have doubts as to the ability of the borrowers to
comply with present loan repayment terms and which may result in the future
inclusion of such items in the non-performing asset categories.
Allowance for Loan Losses. The allowance for loan losses is established
based on our evaluation of the risk inherent in our loan portfolio and changes
in the nature and volume of our loan activity, including those loans which are
being specifically monitored. Such evaluation, which includes a review of loans
for which full collectibility may not be reasonably assured, considers among
other matters, the loan classifications discussed above, the estimated fair
value of the underlying collateral, economic conditions, historical loan loss
experience, the amount of loans outstanding and other factors that warrant
recognition in providing for an adequate loan loss allowance.
There were no provision for loan losses in 2003 compared to $732,000 in
2002. This sharp decrease in provisions was possible due to the Company's
dramatic improvement in non-performing loans as evidenced in Note 3 to the
Consolidated Financial Statements. The decreased provision for loan losses less
net charge-offs for the year resulted in a $364,000 decrease in the allowance
for loan losses. The allowance for loan losses of $1.8 million at December 31,
2003 was a 17.0% decrease compared to December 31, 2002. Management will
continue to maintain the allowance for loan losses at a level deemed adequate by
management based on its quarterly analysis and will include additional
consideration of non-performing loans.
Although we believe that we use the best information available to
determine the allowance, unforeseen market conditions could result in
adjustments and net earnings could be significantly affected if circumstances
differ substantially from the assumptions used in making the final
determination. Future additions to the allowance will be the result of periodic
loan, property and collateral reviews and thus cannot be predicted in advance.
At December 31, 2003, we had a total allowance for loan losses of $1.8 million
or 73.4% of non-performing loans. See Note 3 of the Notes to Consolidated
Financial Statements in our Annual Report to Shareholders for the year ended
December 31, 2003, attached hereto as Exhibit 13 (Annual Report to
Shareholders).
14
The distribution of the allowance for loan losses at the dates indicated
is summarized as follows:
December 31,
----------------------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------------------------------------------------------------------------------------
Percent Percent Percent
of Loans of Loans of Loans
Amount Loan in Each Amount Loan in Each in Each
of Loan Amounts Category of Loan Amounts Category Amount of Loan Category
Loss by to Total Loss by to Total Loan Loss Amounts by to Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
----------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
One- to four-family .. $ 107 $ 91,637 54.10% $ 112 $ 86,489 54.47% $ 108 $ 95,777 57.03%
Multi-family ......... 7 4,709 2.78 7 3,709 2.34 6 3,625 2.16
Commercial real estate 578 20,424 12.06 986 19,482 12.27 825 20,199 12.03
Construction or
development .......... 15 9,469 5.59 8 6,074 3.82 8 6,363 3.79
Consumer ............. 499 21,184 12.51 380 23,768 14.97 535 27,711 16.50
Commercial business .. 566 21,956 12.96 643 19,263 12.13 473 14,259 8.49
Unallocated .......... -- -- -- -- -- -- -- -- --
-------- -------- ------ -------- -------- ------ -------- -------- ------
Total ..... $ 1,772 $169,379 100.00% $ 2,136 $158,785 100.00% $ 1,955 $167,934 100.00%
======== ======== ====== ======== ======== ====== ======== ======== ======
December 31,
-----------------------------------------------------------------------
2000 1999
-----------------------------------------------------------------------
Percent Percent
of Loans of Loans
in Each in Each
Amount of Loan Category Amount of Loan Category
Loan Loss Amounts by to Total Loan Loss Amounts by to Total
Allowance Category Loans Allowance Category Loans
-----------------------------------------------------------------------
(Dollars in Thousands)
One- to four-family .. $ 172 $117,683 57.61% $ 278 $119,283 55.50%
Multi-family ......... 9 4,377 2.14 35 3,779 1.76
Commercial real estate 595 24,519 12.00 272 24,471 11.39
Construction or
development .......... 182 7,188 3.52 284 12,613 5.87
Consumer ............. 608 29,785 14.58 273 30,594 14.23
Commercial business .. 435 20,730 10.15 413 24,184 11.25
Unallocated .......... -- -- -- 212 -- --
-------- -------- ------ -------- -------- ------
Total ..... $ 2,001 $204,282 100.00% $ 1,767 $214,925 100.00%
======== ======== ====== ======== ======== ======
15
The following table sets forth an analysis of the allowance for loan
losses.
Year Ended December 31,
--------------------------------------------------------
2003 2002 2001 2000 1999
--------------------------------------------------------
(Dollars in Thousands)
Balance at beginning of period ..................... $2,136 $1,955 $2,001 $1,767 $1,454
Charge-offs:
One- to four-family ............................. 26 -- 58 1 1
Commercial real estate .......................... 236 109 -- -- --
Commercial ...................................... 160 -- 392 1,150 26
Consumer ........................................ 226 727 385 259 159
------ ------ ------ ------ ------
648 836 835 1,410 186
------ ------ ------ ------ ------
Recoveries:
One- to four-family ............................. -- -- 3 -- --
Commercial real estate .......................... -- -- -- -- --
Commercial ...................................... 96 82 153 4 --
Consumer ........................................ 188 203 58 50 50
------ ------ ------ ------ ------
284 285 214 54 50
------ ------ ------ ------ ------
Net charge-offs .................................... 364 551 621 1,356 136
Additions charged to operations .................... -- 732 575 1,590 449
------ ------ ------ ------ ------
Balance at end of period ........................... $1,772 $2,136 $1,955 $2,001 $1,767
====== ====== ====== ====== ======
Ratio of net charge offs during the
period to average loans outstanding
during the period .................................. 0.23% 0.34% 0.34% 0.65% 0.07%
====== ====== ====== ====== ======
Ratio of net charge-offs during the period
to average non-performing loans .................... 10.31% 8.63% 8.81% 51.77% 9.80%
====== ====== ====== ====== ======
Investment Activities
Liquidity may increase or decrease depending upon the availability of
funds and comparative yields on investments in relation to the return on loans.
Our liquidity level is now higher than our peers, historically we have generally
maintained liquid assets at levels above the minimum requirements that had been
imposed by OTS regulations and at levels believed adequate to meet the
requirements of normal operations, including repayments of maturing debt and
potential deposit outflows. At December 31, 2003, our liquidity ratio (liquid
assets as a percentage of net withdrawable savings deposits and current
borrowings) was 15.6%.
Federally chartered savings institutions have the authority to invest in
various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, obligations of states and
municipalities, certain certificates of deposit of insured banks and savings
institutions, certain bankers' acceptances, repurchase agreements and federal
funds. Subject to various restrictions, federally chartered savings institutions
may also invest their assets in commercial paper, investment grade corporate
debt securities and mutual funds whose assets conform to the investments that a
federally chartered savings institution is otherwise authorized to make
directly.
16
Generally, our investment policy is to invest funds among various
categories of investments and maturities based upon our liquidity needs,
asset/liability management policies, investment quality, marketability and
performance objectives.
Securities and Other Interest-Earning Assets. At December 31, 2003, our
interest-earning cash and cash equivalents totaled $6.8 million, or 3.0% of
total assets, and our securities, consisting of obligations of states and
political subdivisions, money market mutual funds, and other securities totaled
$43.8 million, or 19.3% of total assets. Included in other securities, as of
such date, we had a $5.3 million investment in Federal Home Loan Bank (FHLB)
stock, satisfying our requirement for membership in the FHLB of Indianapolis.
At December 31, 2003, we had $150,000 in securities held to maturity
consisting of obligations of states and political subdivisions and other debt
securities, and we had securities available for sale with a fair value of $43.7
million. See Note 2 of the Notes to the Consolidated Financial Statements in the
Annual Report to Shareholders.
The following table sets forth the composition of our securities portfolio
at the dates indicated.
2003 2002 2001
--------------------------------------------------------------------
Carrying % of Carrying % of Carrying % of
--------------------------------------------------------------------
(Dollars in Thousands)
Debt securities:
Obligations of states and political ..................... $ 3,167 7.22% $ 396 .92% $ 462 1.16%
Mortgage-backed securities .............................. 17,628 40.21 16,408 38.10 25,301 63.78
U.S. Government agencies ................................ 9,767 22.28 6,137 14.25 4,045 10.20
Corporate bonds ......................................... 115 .26 115 .27 115 0.29
Mutual funds ............................................ 4,180 9.54 11,106 25.79 899 2.27
------- ------ ------- ------ ------- ------
Total debt securities ................................. 34,857 79.51 34,162 79.33 30,822 77.70
Equity securities:
Equity securities ....................................... 8,980 20.49 8,901 20.67 8,849 22.30
------- ------ ------- ------ ------- ------
Total securities ...................................... $43,837 100.00% $43,063 100.00% $39,671 100.00%
======= ====== ======= ====== ======= ======
The following table sets forth the carrying value of debt securities by
maturity and weighted average yield for each range of maturities at December 31,
2003.
Maturity
----------------------------------------------------------------------------------
Within One Year 1 to 5 years 5 to 10 years Over 10 years
--------------- ------------ ------------- -------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
U.S. Government agencies ................... $ 4,237 4.23% $ 4,043 3.44% $ 1,487 4.00% -- --
Mortgage-backed securities ................. -- -- 1,184 3.95 5,224 4.42 $11,220 4.81%
Obligations of states and political(1) ..... 35 4.55 288 4.26 2,844 3.51 -- --
Corporate bonds ............................ -- -- 115 8.55 -- -- -- --
------- ---- ------- ---- ------- ---- ------- ----
Total ................................... $ 4,272 4.23% $ 5,630 3.70% $ 9,555 4.09% $11,220 4.81%
======= ==== ======= ==== ======= ==== ======= ====
----------
(1) Yields are not presented on a tax equivalent basis.
Northeast Indiana also has $4.2 million in mutual funds, backed by debt
securities, that contain no contractual maturity date. The weighted average
rates are based on coupon rates for securities purchased at par value and on
effective rates considering amortization or accretion if the securities were
purchased at a premium or discount.
17
Sources of Funds
Our primary sources of funds are deposits, payment of principal and
interest on loans, interest earned on securities, interest earned on
interest-earning deposits with other banks, FHLB advances, the sale of fixed
rate mortgages to the secondary market and other funds provided from operations.
FHLB advances are used to support lending activities and to assist in our
asset/liability management strategy. Typically, we do not use other forms of
borrowings. At December 31, 2003, we had total FHLB advances of $63.0 million
with the capacity to borrow as of December 31, 2003 an additional $6.2 million,
based on collateral currently pledged to FHLB. See Note 8 of the Notes to
Consolidated Financial Statements in the Annual Report to Shareholders.
Deposits. We offer a variety of deposit accounts having a wide range of
interest rates and terms. Deposits consist of passbook savings, NOW, checking,
money market deposit and time deposit accounts. The time deposit accounts
currently range in terms from 182 days to five years.
We rely primarily on advertising, competitive pricing policies and
customer service to attract and retain these deposits. We generally solicit
deposits from our market area and occasionally accept brokered funds and out of
area jumbos as a source of deposits. During 2003, there was a concerted effort
made to change First Federal's deposit funding mix in favor of lower-cost
transaction and savings accounts and less dependence on brokered and out of area
jumbo time deposits. Even though total deposits declined $347,000 to $122.0
million at December 31, 2003, the core objective of shifting the deposit funding
mix was successful. Passbook, MMDA, and NOW/Demand accounts increased $2.9
million or 6.1% to $49.2 million at December 31, 2003, while time deposits
decreased $3.2 million or 4.2% to $72.8 million at December 31, 2003. The flow
of deposits is influenced significantly by general economic conditions, changes
in money market and prevailing interest rates and competition.
We have become more susceptible to short-term fluctuations in deposit
flows as customers have become more interest rate conscious. We endeavor to
manage the pricing of our deposits in keeping with our profitability objectives
giving consideration to our asset/liability management. Our ability to attract
and maintain savings accounts and time deposit accounts and the rates paid on
these deposits, has been and will continue to be significantly affected by
market conditions.
18
The following table sets forth our deposit flows during the periods
indicated.
Year Ended December 31,
------------------------------------------------
2003 2002 2001
------------------------------------------------
(Dollars in Thousands)
Opening balance ................................ $ 122,357 $ 137,030 $ 146,806
Deposits ....................................... 609,904 659,547 649,701
Withdrawals .................................... 613,263 678,535 666,529
Interest credited .............................. 3,012 4,315 7,052
--------- --------- ---------
Ending Balance ................................. $ 122,010 $ 122,357 $ 137,030
========= ========= =========
Net change ..................................... $ (347) $ (14,673) $ (9,776)
========= ========= =========
Percent change ................................. (.28%) (10.71%) (6.66%)
========= ========= =========
The following table sets forth the dollar amount of deposits in the
various types of deposit programs we offered for the periods indicated.
December 31,
----------------------------------------------------------------------
2003 2002 2001
----------------------------------------------------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
----------------------------------------------------------------------
(Dollars in Thousands)
Transactions and savings deposits:
Passbook Accounts (.50%)(1) ................... $ 10,917 8.95% $ 10,397 8.50% $ 9,261 6.76%
Demand and NOW Accounts (.31%)(1) ............. 18,951 15.53 17,871 14.60 16,962 12.38
Money Market Accounts (1.09%)(1) .............. 19,335 15.85 18,085 14.78 18,968 13.84
-------- ------ -------- ------ -------- ------
Total non-time deposits ....................... 49,203 40.33 46,353 37.88 45,191 32.98
-------- ------ -------- ------ -------- ------
Time deposits:
Less than 1.00% ............................... 283 0.23 -- -- -- --
1.00 - 1.99% .................................. 11,851 9.71 2,815 2.30 -- --
2.00 - 3.99% .................................. 51,591 42.28 46,529 38.03 22,424 16.36
4.00 - 5.99% .................................. 5,997 4.92 19,062 15.58 41,233 30.09
6.00 - 7.99% .................................. 3,085 2.53 7,598 6.21 28,182 20.57
-------- ------ -------- ------ -------- ------
Total time deposits ........................... 72,807 59.67 76,004 62.12 91,839 67.02
-------- ------ -------- ------ -------- ------
Total deposits ................................ $122,010 100.00% $122,357 100.00% $137,030 100.00%
======== ====== ======== ====== ======== ======
----------
(1) End of year 2003 average interest rates.
19
The following table shows rate and maturity information for our time
deposit accounts as of December 31, 2003.
Less
than 1.00- 2.00- 4.00- 6.00- Percent
1.00% 1.99% 3.99% 5.99% 7.99% Total of Total
------------------------------------------------------------------------------------
(Dollars in Thousands)
Time deposit accounts
maturing in quarter ending:
March 31, 2004 ..................... -- $ 2,581 $ 4,969 $ 3,726 $ 699 $11,975 16.45%
June 30, 2004 ...................... $ 283 4,363 9,740 423 491 15,300 21.01
September 30, 2004 ................. -- 2,330 3,995 1,167 -- 7,492 10.29
December 31, 2004 .................. -- 2,231 2,005 24 499 4,759 6.54
March 31, 2005 ..................... -- 20 12,069 245 100 12,434 17.08
June 30, 2005 ...................... -- 15 4,851 57 -- 4,923 6.76
September 30, 2005 ................. -- 240 1,874 47 536 2,697 3.70
December 31, 2005 .................. -- 71 2,460 104 760 3,395 4.66
March 31, 2006 ..................... -- -- 1,527 30 -- 1,557 2.14
June 30, 2006 ...................... -- -- 3,471 -- -- 3,471 4.77
September 30, 2006 ................. -- -- 117 -- -- 117 0.16
December 31, 2006 .................. -- -- 482 -- -- 482 0.66
Thereafter ......................... -- -- 4,031 174 -- 4,205 5.78
------------------------------------------------------------------------------------
Total ......................... $ 283 $11,851 $51,591 $ 5,997 $ 3,085 $72,807 100.00%
====================================================================================
Percent of total .............. 0.39% 16.27% 70.86% 8.24% 4.24% 100.00%
==== ===== ===== ==== ==== ======
The following table indicates the amount of our time deposit accounts by
time remaining until maturity as of December 31, 2003.
Maturity
----------------------------------------------------------------
Over Over
3 Months or 3 to 6 6 to 12 Over 12
Less Months Months Months Total
----------------------------------------------------------------
(Dollars in Thousands)
BALANCES
Time deposits less than $100,000 .............. $ 8,176 $10,025 $ 8,886 $19,302 $46,389
Time deposits of $100,000 or more ............. 2,643 5,117 3,365 13,259 24,384
Public funds (1) .............................. 1,156 158 -- 720 2,034
--------------------------------------------------------------
Total time deposits ........................... $11,975 $15,300 $12,251 $33,281 $72,807
==============================================================
Maturity
----------------------------------------------------------------
Over Over
3 Months or 3 to 6 6 to 12 Over 12
Less Months Months Months Total
----------------------------------------------------------------
NUMBER OF ACCOUNTS
Time deposits less than $100,000 .............. 498 637 556 1,087 2,778
Time deposits of $100,000 or more ............. 23 36 29 120 208
Public funds (1) .............................. 2 1 -- 2 5
------- ------- ------- ------- -------
Total time deposits ........................... 523 674 585 1,209 2,991
======= ======= ======= ======= =======
----------
(1) Deposits from governmental and other public entities, all over $100,000.
20
Borrowings. Although deposits are our primary source of funds, our policy
has been to utilize borrowings when they are a less costly source of funds or
can be invested at a positive rate of return. We may obtain advances from the
FHLB of Indianapolis upon the security of our capital stock in the FHLB of
Indianapolis and certain of our mortgage loans and mortgage-backed securities.
Such advances may be made pursuant to several different credit programs, each of
which has its own interest rate and range of maturities. At December 31, 2003,
we had $63.0 million in FHLB advances outstanding. For additional information
regarding the term to maturity and the interest rates on FHLB advances, see Note
8 of the Notes to Consolidated Financial Statements in the Annual Report to
Shareholders and "- Borrowed Funds."
The following table sets forth the maximum month-end balance and average
balance of FHLB advances for the periods indicated.
December 31,
---------------------------------
2003 2002 2001
---------------------------------
(Dollars in Thousands)
Maximum Balance:
FHLB advances ............. $67,000 $67,000 $67,400
Average Balance:
FHLB advances ............. $64,819 $65,926 $62,539
Service Corporation Activities
At December 31, 2003, First Federal had one subsidiary, Northeast
Financial, which is now functioning as our brokerage subsidiary and we have one
registered representative to provide this service to the customers. The
description of the provision that follows is a summary of the complex statutory
and regulatory framework that governs Northeast Indiana and its subsidiaries; it
does not purport to be, and is not a complete description.
Regulation
First Federal is a federally chartered savings bank, the deposits of which
are federally insured and backed by the full faith and credit of the United
States Government. Accordingly, we are subject to broad federal regulation and
oversight extending to all of our operations. First Federal is a member of the
FHLB of Indianapolis and is subject to certain limited regulation by the Board
of Governors of the Federal Reserve System ("Federal Reserve Board"). As the
savings and loan holding company of First Federal, Northeast Indiana also is
subject to federal regulation and oversight. However, since Northeast Indiana
existed as a unitary savings and loan holding company prior to May 4, 1999,
there is virtually no restriction on its activities.
Federal Regulation of Savings Associations. The OTS has extensive
authority over the operations of savings associations. As part of this
authority, we are required to file periodic reports with, and pay assessments
to, the OTS and are subject to periodic examinations by the OTS and the FDIC.
When these examinations are conducted by the OTS and the FDIC, the examiners may
require First Federal to provide for higher general or specific loan loss
reserves.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, such as First Federal and Northeast
Indiana. This enforcement authority includes, among other things, the ability to
assess civil money penalties, to issue cease-and-desist or removal orders, and
to initiate injunctive actions.
Our general permissible lending limit for loans-to-one-borrower is equal
to the greater of $500,000 or 15% of unimpaired capital and surplus (except for
loans fully secured by certain readily marketable collateral, in which case this
limit is increased to 25% of unimpaired capital and surplus). At December 31,
2003, our lending limit
21
under this restriction was approximately $4.0 million. At December 31, 2003, we
had no lending relationship to a single borrower in excess of our
loans-to-one-borrower limit.
Insurance of Accounts and Regulation by the FDIC. As insurer, the FDIC
imposes deposit insurance premiums and is authorized to conduct examinations of,
and to require reporting by, FDIC-insured institutions. It also may prohibit any
FDIC-insured institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious risk to the FHLB System or the Savings
Association Insurance Fund (SAIF). The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action, and may terminate deposit insurance if it
determines that the institution has engaged in unsafe or unsound practices, or
is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well-capitalized (i.e., a core capital ratio of at least 5%, a ratio of core
capital to risk-weighted assets of at least 6% and a risk-based capital ratio of
at least 10%) and considered healthy, pay the lowest premium, while institutions
that are less than adequately capitalized (i.e., core risk-based capital ratios
of less than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. Risk classification of
all insured institutions is made by the FDIC semi-annually. At December 31,
2003, First Federal was classified as a well-capitalized institution.
The current premium schedule for Bank Insurance Fund (BIF) and SAIF
insured institutions ranged from 0 to 27 basis points. However, SAIF insured
institutions and BIF insured institutions are required to pay a Financing
Corporation Assessment in order to fund the interest on bonds issued to resolve
thrift failures in the 1980s. For the quarter ended December 31, 2003, this
amount was equal to an annualized rate of 1.5 basis points for each $100 in
domestic deposits for SAIF members and BIF insured institutions. These
assessments, which may be revised based upon the level of BIF and SAIF deposits,
will continue until the bonds mature in 2017 through 2019.
Regulatory Capital Requirements. Federally insured savings associations,
such as First Federal, are required to maintain a minimum level of regulatory
capital. The OTS has established capital standards, including a tangible capital
requirement, a leverage ratio (or core capital) requirement and a risk-based
capital requirement applicable to such savings associations.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income and excluding certain
intangible assets. At December 31, 2003, First Federal had tangible capital of
$25.2 million, or 11.1% of adjusted total assets, which is approximately $21.7
million above the minimum requirement of 1.5% of adjusted total assets in effect
on that date. At December 31, 2003, First Federal had intangible assets
consisting of loan servicing rights of $307,000.
The capital standards also require core capital equal to 4% of adjusted
total assets, depending on an institution's supervisory rating. Core capital
generally consists of tangible capital plus certain intangible assets, including
a limited amount of purchased credit card relationships. At December 31, 2003,
First Federal had core capital equal to $25.2 million, or 11.1% of adjusted
total assets, which is $16.1 million above the minimum leverage ratio
requirement of 4% in effect on that date.
The OTS risk-based capital requirement requires savings associations to
have total capital of at least 8% of risk-weighted assets. Total capital
consists of core capital, as defined above, and supplementary capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. At
December 31, 2003, First Federal had $1.2 million of general loan loss reserves,
which was less than 1.25% of risk-weighted assets.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For example,
the OTS has assigned a risk weight of 50% for prudently underwritten permanent
one- to four-family first
22
lien mortgage loans not more than 90 days delinquent and having a loan to value
ratio of not more than 80% at origination, unless insured to such ratio by an
insurer approved by Fannie Mae or Freddie Mac.
On December 31, 2003, First Federal had total risk-based capital of $26.4
million, including approximately $25.2 million in core capital and $1.2 million
in qualifying supplementary capital and risk-weighted assets of $148.3 million,
or total capital of 17.8% of risk-weighted assets. This amount was $14.5 million
above the 8% requirement in effect on that date.
The OTS is authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis. The OTS and the
FDIC are authorized and, under certain circumstances required, to take certain
actions against savings associations that fail to meet their capital
requirements. The OTS is generally required to take action to restrict the
activities of an "undercapitalized association" (generally defined to be one
with less than either a 4% core capital ratio, a 4% core risked-based capital
ratio or an 8% risk-based capital ratio). Any such association must submit a
capital restoration plan and until such plan is approved by the OTS may not
increase its assets, acquire another institution, establish a branch or engage
in any new activities, and generally may not make capital distributions. The OTS
is authorized to impose the additional restrictions that are applicable to
significantly undercapitalized associations.
The imposition by the OTS or the FDIC of any of these measures on
Northeast Indiana or First Federal may have a substantial adverse effect on our
operations and profitability and the value of Northeast Indiana's common stock.
Northeast Indiana shareholders do not have preemptive rights and, therefore, if
Northeast Indiana is directed by the OTS or the FDIC to issue additional shares
of common stock, such issuance may result in the dilution of the percentage of
ownership of Northeast Indiana.
Limitations on Dividends and Other Capital Distributions. The OTS imposes
various restrictions on savings associations with respect to their ability to
make distributions of capital, which include dividends, stock redemptions or
repurchases, cash-out mergers and other transactions charged to the capital
account. The OTS also prohibits a savings association from declaring or paying
any dividends or from repurchasing any of its stock if, as a result of such
action, the regulatory capital of the association would be reduced below the
amount required to be maintained for the liquidation account established in
connection with the association's mutual to stock conversion.
First Federal may make a capital distribution without the approval of the
OTS provided we notify the OTS 30 days before we declare the capital
distribution and we meet the following requirements: (i) we have a regulatory
rating in one of the two top examination categories, (ii) we are not of
supervisory concern, and will remain adequately- or well-capitalized, as defined
in the OTS prompt corrective action regulations, following the proposed
distribution, and (iii) the distribution does not exceed our net income for the
calendar year-to-date plus retained net income for the previous two calendar
years (less any dividends previously paid). If we do not meet the above stated
requirements, we must obtain the prior approval of the OTS before declaring any
proposed distributions.
Qualified Thrift Lender Test. All savings institutions are required to
meet a qualified thrift lender test to avoid certain restrictions on their
operations. This test requires a savings institution to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every 12 months on a rolling basis. As an
alternative, the savings institutions may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as
amended (the "Internal Revenue Code"). Under either test, these assets primarily
consist of residential housing related loans and investments. At December 31,
2003, First Federal met the test and has always met the test since its
effectiveness. First Federal's qualified thrift lender percentage was 79.5% at
December 31, 2003.
Any savings institution that fails to meet the qualified thrift lender
test must convert to a national bank charter, unless it requalifies as a
qualified thrift lender and remains a qualified thrift lender. If an institution
does not requalify and converts to a national bank charter, it must remain
SAIF-insured until the FDIC permits it to transfer to the BIF. If an institution
has not yet requalified or converted to a national bank, its new investments and
activities are limited to those permissible for both a savings association and a
national bank, and it is limited to national bank branching rights in its home
state. In addition, the institution is immediately ineligible to receive any new
FHLB borrowings and is subject to national bank limits for payment of dividends.
If the institution has not requalified or converted to a national bank within
three years after the failure, it must sell all investments and stop all
activities not
23
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
institution that fails the qualified thrift lender test is controlled by a
holding company, then within one year after the failure, the holding company
must register as a bank holding company and become subject to all restrictions
on bank holding companies. See "- Holding Company Regulation."
Community Reinvestment Act. Under the Community Reinvestment Act (CRA),
every FDIC insured institution has a continuing and affirmative obligation,
consistent with safe and sound banking practices, to help meet the credit needs
of its entire community, including low- and moderate-income neighborhoods. The
CRA requires the OTS, in connection with its examination of First Federal, to
assess the institution's record of meeting the credit needs of our community and
to take this record into account in our evaluation of certain applications, such
as a merger or the establishment of a branch, by First Federal. An
unsatisfactory rating may be used as the basis for the denial of an application
by the OTS. First Federal was examined for CRA compliance in March 1997 and
received a rating of "satisfactory."
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was
enacted in response to the terrorist attacks in New York, Pennsylvania and
Washington, D.C. which occurred on September 11, 2001. The Patriot Act is
intended to strengthen U.S. law enforcement's and the intelligence communities'
abilities to work cohesively to combat terrorism on a variety of fronts. The
potential impact of the Patriot Act on financial institutions of all kinds is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and imposes various regulations,
including standards for verifying client identification at account opening, and
rules to promote cooperation among financial institutions, regulators and law
enforcement entities in identifying parties that may be involved in terrorism or
money laundering.
Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into
law the Sarbanes-Oxley Act of 2002, or the SOA. The SOA is the most far-reaching
U.S. securities legislation enacted in many years, and includes many substantive
and disclosure-based requirements. The stated goals of the SOA are to increase
corporate responsibility, to provide for enhanced penalties for accounting and
auditing improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to the
securities laws. The SOA generally applies to all companies, both U.S. and
non-U.S., that file or are required to file periodic reports with the Securities
and Exchange Commission under the Securities Exchange Act of 1934 (the "Exchange
Act"). Given the extensive and continuing SEC role in implementing rules
relating to many of the SOA's new requirements, the effects of these
requirements remain to be determined, although it is likely that the Company's
costs will increase somewhat, at least in the short term, as a result of SOA
implementation.
Other Laws and Regulations. The lending and deposit-taking activities of
First Federal are subject to a variety of federal and state consumer protection
laws, including the Equal Credit Opportunity Act (which prohibits discrimination
in all aspects of credit-granting), the Truth-in-Lending Act (which principally
mandates certain disclosures in connection with loans made for personal, family
or household purposes and imposes substantive restrictions with respect to home
equity lines of credit), the Truth-in-Savings Act (which principally mandates
certain disclosures in connection with deposit-taking activities), the Fair
Credit Reporting Act (which, among other things, requires a lender to disclose
the name and address of the credit bureau from whom a lender obtains a report
that resulted in a denial of credit), the Real Estate Settlement Procedures Act
(which, among other things, requires residential mortgage lenders to provide
loan applicants with closing cost information shortly after the time of
application and prohibits referral fees in connection with loan originations and
other real estate settlement services), the Electronic Funds Transfer Act
(which, among other things, requires certain disclosures in connection with
electronic funds transactions) and the Expedited Funds Availability Act (which,
among other things, requires that deposited funds be made available for
withdrawal in accordance with a prescribed schedule and that the schedule be
disclosed to customers). As a federal savings bank, First Federal is exempt from
most state laws, other than contract and commercial law; real property law; tort
law and criminal law.
Transactions with Affiliates. Under federal law, all transactions between
and among First Federal and its affiliates, which include its holding company,
are subject to Sections 23A and 23B of the Federal Reserve Act and Regulation W
promulgated thereunder as interpreted by the OTS. Generally, these requirements
limit these transactions to a percentage of the bank's capital and require all
of them to be on terms at least as favorable to the bank as transactions with
non-affiliates. In addition, a bank may not lend to any affiliate engaged in
non-banking activities not permissible for a bank holding company or acquire
shares of any affiliate that is not a subsidiary. The
24
OTS is authorized to impose additional restrictions on transactions with
affiliates if necessary to ensure safety and soundness standards. The OTS
regulations also set forth various reporting requirements relating to
transactions with affiliates.
Extensions of credit by First Federal to its executive officers,
directors and principal shareholders are subject to Section 22(h) of the Federal
Reserve Act, which among other things, generally prohibits loans to any such
individual where the aggregate amount exceeds an amount equal to 15% of an
institution's unimpaired capital and surplus plus an additional 10% of
unimpaired capital and surplus in the case of loans that are fully secured by
readily marketable collateral.
Section 22(h) permits loans to directors, executive officers and
principal stockholders made pursuant to a benefit or compensation program that
is widely available to employees of First Federal provided that no preference is
given to any officer, director or principal stockholder, or related interest
thereto, over any other employee. In addition, the aggregate amount of
extensions of credit by a savings institution to all insiders cannot exceed the
institution's unimpaired capital and surplus. Furthermore, Section 22(g) places
additional restrictions on loans to executive officers.
Holding Company Regulation. Northeast Indiana is a unitary savings and
loan holding company subject to regulatory oversight by the OTS. As such, we are
required to register and file reports with the OTS and are subject to regulation
and examination by the OTS. In addition, the OTS has enforcement authority over
Northeast Indiana and its non-savings association subsidiaries which also
permits the OTS to restrict or prohibit activities that are determined to be a
serious risk to the subsidiary savings association.
As a unitary savings and loan holding company, that has been in existence
since before May 4, 1999, Northeast Indiana generally is not subject to activity
restrictions. If Northeast Indiana acquires control of another savings
association as a separate subsidiary, it would become a multiple savings and
loan holding company, and the activities of Northeast Indiana and any of its
subsidiaries (other than First Federal or any other SAIF-insured savings
association) would become subject to certain restrictions. Additionally, if we
fail the qualified thrift lender test, within one year Northeast Indiana must
register as and will become subject to, the restrictions applicable to bank
holding companies.
Federal Securities Law. The stock of Northeast Indiana is registered with
the SEC under the Securities Exchange Act of 1934, as amended (the Exchange
Act). Northeast Indiana is subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the Exchange Act.
Northeast Indiana stock held by persons who are affiliates, (generally
officers, directors and 10% stockholders) of Northeast Indiana may not be resold
without registration unless sold in accordance with certain resale restrictions.
If Northeast Indiana satisfies the requirements of such resale restrictions and
meets specified current public information requirements, each affiliate of
Northeast Indiana is able to sell in the public market, without registration, a
limited number of shares in any three-month period.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts). At December 31, 2003, First Federal was in compliance with
these reserve requirements.
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System. First Federal is a member of the FHLB of
Indianapolis, which is one of 12 regional FHLBs that administer the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It makes loans to
members (i.e., advances) in accordance with policies and procedures, established
by the board of directors of the FHLB, which are subject to the oversight of the
Federal Housing Finance Board. All advances from the FHLB are required to be
fully secured by
25
sufficient collateral as determined by the FHLB. In addition, all long-term
advances must be used for residential home financing.
As a member, First Federal is required to purchase and maintain a minimum
amount of stock in the FHLB of Indianapolis. At December 31, 2003, First Federal
had $5.3 million in FHLB stock, which was in compliance with this requirement.
For the fiscal year ended December 31, 2003, dividends paid by the FHLB of
Indianapolis to First Federal totaled $256,000, which constitutes a $42,000
decrease compared to the amount of dividends received in fiscal 2002. In
addition, each of the four quarterly dividends from the FHLB in 2003 were paid
in the form of additional FHLB stock. This election was made by the FHLB and not
contested by First Federal. Over the past five fiscal years these dividends have
averaged 7.0% and were 5.1% for fiscal 2003.
Taxation
Federal Taxation. We file consolidated federal income tax returns on a
fiscal year basis using the accrual method of accounting. Savings institutions
that met certain definitional tests relating to the composition of assets and
other conditions prescribed by the Internal Revenue Code, had been permitted to
establish reserves for bad debts and to make annual additions which could,
within specified formula limits, be taken as a deduction in computing taxable
income for federal income tax purposes. The amount of the bad debt reserve
deduction is now computed under the experience method.
In addition to the regular income tax, corporations, including savings
institutions, generally are subject to a minimum tax. An alternative minimum tax
is imposed at a minimum tax rate of 20% on alternative minimum taxable income,
which is the sum of a corporation's regular taxable income (with certain
adjustments) and tax preference items, less any available exemption. The
alternative minimum tax is imposed to the extent it exceeds the corporation's
regular income tax and net operating losses can offset no more than 90% of
alternative minimum taxable income.
To the extent earnings appropriated to a savings institution's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the institution's supplemental reserves
for losses on loans, such excess may not, without adverse tax consequences, be
utilized for the payment of cash dividends or other distributions to a
shareholder (including distributions on redemption, dissolution or liquidation)
or for any other purpose (except to absorb bad debt losses). As of December 31,
2003, First Federal's excess for tax purposes totaled approximately $1.3
million.
We have not been audited by the IRS recently with respect to federal
income tax returns. In our opinion, any examination of still open returns would
not result in a deficiency which could have a material adverse effect on our
financial condition.
Indiana Taxation. The State of Indiana imposes an 8.5% franchise tax on
the net income of financial (including thrift) institutions, exempting them from
the current gross income, supplemental net income and intangible taxes. Net
income for franchise tax purposes will constitute federal taxable income before
net operating loss deductions and special deductions, adjusted for certain
items, including Indiana income taxes, tax exempt interest and bad debts. Other
applicable Indiana taxes include sales, use and property taxes.
Delaware Taxation. As a company incorporated under Delaware state law,
Northeast Indiana is exempted from Delaware corporate income tax but is required
to file an annual report with, and pay an annual fee to, the State of Delaware.
We are also subject to an annual franchise tax imposed by the State of Delaware.
Competition
We face strong competition, both in originating real estate loans and in
attracting deposits. Competition in originating real estate loans comes
primarily from commercial banks, mortgage companies, credit unions and savings
institutions located in our market area. Commercial banks, savings institutions
and credit unions provide vigorous competition in consumer lending. We compete
for real estate and other loans principally on the basis of
26
the quality of services we provide to borrowers, the interest rates and loan
fees we charge, and the types of loans we originate. See "- Lending Activities."
We attract most of our deposits through our retail banking offices,
primarily from the communities in which those retail banking offices are
located. Therefore, competition for those deposits is principally from retail
brokerage offices, commercial banks, savings institutions and credit unions
located in these communities. We compete for these deposits by offering a
variety of account alternatives at competitive rates and by providing convenient
business hours, branch locations and interbranch deposit and withdrawal
privileges.
We primarily serve Huntington County, Indiana. There are six commercial
banks, no savings institutions other than First Federal, and six credit unions
which compete for deposits and loans in Huntington County. We estimate that our
share of the savings market in Huntington County based on FDIC insured
institutions is approximately 27% and our share of the residential mortgage
market is approximately 20%.
Employees
At December 31, 2003, we had a total of 46 full-time, 8 part-time and no
seasonal employees. Our employees are not represented by any collective
bargaining group. Management considers its employee relations to be good.
27
Item 2. Description of Property
We conduct our business through three offices, all of which are located in
Huntington, Indiana and are owned by First Federal. The following table sets
forth information relating to each of our offices as of December 31, 2003. The
total net book value of our premises and equipment (including land, buildings
and leasehold improvements and furniture, fixtures and equipment) at December
31, 2003 was approximately $2.1 million. See Note 5 of the Notes to the
Consolidated Financial Statements in the Annual Report to Shareholders.
Total
Owned Approximate
Year or Square Net Book Value at
Location Acquired Leased Footage December 31, 2003
------------------------------ -------- ------ ----------- -----------------
Main Office:
648 North Jefferson Street
Huntington, Indiana 46750 1974 Owned 1,700 $ 458,331.36
Branch Offices:
1240 South Jefferson Street
Huntington, Indiana 46750 1981 Owned 1,700 $ 221,050.31
100 Frontage Road
Huntington, Indiana 46750 1995 Owned 5,000 $1,382,399.33
We believe that our current and planned facilities are adequate to meet
our present and foreseeable needs. We also maintain an on-line database with an
independent service bureau servicing financial institutions.
Item 3. Legal Proceedings
We are involved, from time to time, as plaintiff or defendant in various
legal actions arising in the normal course of their businesses. While the
ultimate outcome of these proceedings cannot be predicted with certainty, it is
the opinion of management, after consultation with counsel representing us in
the proceedings, that the resolution of these proceedings should not have a
material effect on our results of operations on a consolidated basis.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
2003.
28
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Page 52 of the Annual Report is herein incorporated by reference.
Item 6. Management's Discussion and Analysis
Pages 4 through 18 of the Annual Report are herein incorporated by
reference.
Item 7. Financial Statements
The following information appearing in the Annual Report is incorporated
herein by reference.
Pages in
Annual
Annual Report Section Report
--------------------- ------
Report of Independent Auditors 19
Consolidated Balance Sheets as of December 31, 2003 and 2002 20
Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001 21
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31,
2003, 2002 and 2001 22-23
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 24
Notes to Consolidated Financial Statements 25-51
With the exception of the aforementioned information in Part II of the
Form 10-KSB, the Annual Report is not deemed filed as part of this annual report
on Form 10-KSB.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months prior
to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
Item 8A. Controls and Procedures
Any control system, no matter how well designed and operated, can provide
only reasonable (not absolute) assurance that its objectives will be met.
Furthermore, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, have been detected.
Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934
(Exchange Act)) as of the end of the period covered by this report. Based on
such evaluation, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that, as of the end of such period, the Company's
disclosure controls and procedures are effective in recording, processing,
summarizing and reporting, on a timely basis, information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act.
29
Internal Control Over Financial Reporting
There have not been any changes in the Company's internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the fiscal year to which this report relates that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
30
PART III
Item 9. Directors and Executive Officers of the Registrant
Directors
Information concerning our Directors and Compliance with Section 16(a) of
the Exchange Act is incorporated herein by reference from the definitive proxy
statement for the annual meeting of stockholders to be held in 2004, a copy of
which will be filed not later than 120 days after the close of the fiscal year.
Executive Officers of Northeast Indiana and First Federal
The following table sets forth certain information regarding our executive
officers who are not also directors.
Position held with
Name Age(1) First Federal and Northeast Indiana
--------------------------------------------------------------------------------
Randy J. Sizemore 33 Senior Vice President, Treasurer and Chief
Financial Officer
Dee Ann Hammel 51 Senior Vice President, Secretary and Chief
Operating Officer
Thomas P. Frantz 49 Senior Vice President and Chief Lending
Officer
----------
(1) At December 31, 2003.
The business experience of the executive officers who are not also
directors is set forth below.
Randy J. Sizemore is Senior Vice President, Treasurer and Chief Financial
Officer, positions he has held since April 2002. Prior to joining First Federal,
Mr. Sizemore held positions in a similar capacity with another bank holding
company and its subsidiary since 1999, and prior to that he performed similar
job functions for another bank holding company. Mr. Sizemore has a total of 10
years experience working with financial institutions.
Dee Ann Hammel is Senior Vice President, Secretary and Chief Operations
Officer, positions she has held since March 1995. Ms. Hammel first joined First
Federal in 1975 as a teller. Ms. Hammel is responsible for directing and
controlling First Federal's daily activities.
Thomas P. Frantz is Senior Vice President and Chief Lending Officer,
positions he has held since October 2001. Prior to joining First Federal, Mr.
Frantz held positions in a lending capacity for another bank since 1995. Mr.
Frantz has a total of 29 years experience working with financial institutions.
Audit Committee Financial Expert
Information concerning the determination by the board of directors of
whether or not there is one or more audit committee financial expert(s) serving
on Northeast Indiana's audit committee is incorporated herein by reference from
the definitive proxy statement for the annual meeting of stockholders to be held
in 2004, a copy of which will be filed not later than 120 days after the close
of the fiscal year.
Code of Ethics
We have adopted a code of ethics that applies to the principal executive
officer and all professionals serving in a finance, accounting, treasury or tax
role at Northeast Indiana and its subsidiaries. We have filed a copy of this
Code of Ethics as Exhibit 14 to this Form 10-KSB.
31
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the definitive proxy statement for the annual meeting of
stockholders to be held in 2004, a copy of which will be filed not later than
120 days after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the definitive proxy
statement for the annual meeting of stockholders to be held in 2004, a copy of
which will be filed not later than 120 days after the close of the fiscal year.
The following table provides information as of December 31, 2003 related
to our equity compensation plans in effect at that time.
====================================================================================================================
Equity Compensation Plan Information
--------------------------------------------------------------------------------------------------------------------
Number of Securities to be Weighted-average Exercise Number of securities
Issued Upon Exercise of Price of Outstanding Remaining Available for
Outstanding Options, Options, Warrants and Future Issuance Under
Plan Category Warrants and Rights Rights Equity Compensation Plans
--------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
--------------------------------------------------------------------------------------------------------------------
Equity Compensation
Plans Approved by
Security Holders 138,495(1) $11.46 158,300(2)
--------------------------------------------------------------------------------------------------------------------
Equity Compensation
Plans Not Approved by
Security Holders -- -- --
--------------------------------------------------------------------------------------------------------------------
Total 138,495(1) $11.46 158,300(2)
====================================================================================================================
(1) Restated to reflect the 10% stock dividends paid in both November 1998
and November 1999. Includes outstanding options to purchase shares of the
Company's Common Stock under our 1995 Stock Option and Incentive Plan and our
2002 Omnibus Incentive Plan.
(2) Includes shares available for future issuance under our 2002 Omnibus
Incentive Plan and our Recognition and Retention Plan; excludes securities
reflected in column (a). In addition to stock options, the 2002 Omnibus
Incentive Plan and the Recognition and Retention Plan provide for the issuance
of stock appreciation rights, restricted stock, or performance awards. 1,150
shares remain available under our 1995 Stock Option and Incentive Plan, 140,024
shares remain available under our 2002 Omnibus Incentive Plan, and 17,126 remain
available under our Recognition and Retention Plan for the issuance of stock
options, stock appreciation rights, restricted stock or performance awards.
Option Grants and Exercises
Information concerning option grants and aggregated option exercises and
values is incorporated herein by reference from the definitive proxy statement
for the annual meeting of stockholders to be held in 2004 a copy of which will
be filed not later than 120 days after the close of the fiscal year.
32
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions is
incorporated herein by reference from the definitive proxy statement for the
annual meeting of stockholders to be held in 2004 a copy of which will be filed
not later than 120 days after the close of the fiscal year.
Item 13. Exhibits, List and Reports on Form 8-K
(a) Exhibits
Reference to
Regulation Prior Filing or
S-B Exhibit Exhibit Number
Number Document Attached Hereto
------------------------------------------------------------------------------------------------------------------
2 Plan of acquisition, reorganization, arrangement, liquidation or succession None
3(i) Certificate of Incorporation, including amendments thereto *
3(ii) By-Laws *
4 Instruments defining the rights of security holders, including debentures *
9 Voting trust agreement None
10 Executive Compensation Plans and Arrangements
(a) Employment Contract between Stephen E. Zahn and First Federal *
(b) Employment Contract between Randy J. Sizemore and First Federal ***
(c) Employment Contract between Dee Ann Hammel and First Federal *
(d) 1995 Stock Option and Incentive Plan *
(e) Recognition and Retention Plan *
(f) Shareholder Benefit Plan **
(g) 2002 Omnibus Incentive Plan ***
11 Statement re: computation of per share earnings ****
13 Annual report to shareholders 13
14 Code of Ethics 14
16 Letter on change in certifying accountants None
18 Letter on change in accounting principles None
20 Other documents or statements to security holders None
21 Subsidiaries of registrant 21
22 Published report regarding matters submitted to vote None
23 Consents of experts 23
24 Power of attorney Not required
31.1 Certification of Principal Executive Officer Pursuant to 31.1
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Pursuant to 31.2
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley 32
Act of 2002
----------
* Filed as an exhibit to our Form S-1 Registration Statement (File No.
33-90558). All of such previously filed documents are hereby incorporated
herein by reference in accordance with Item 601 of Regulation S-B.
** Filed as an exhibit to our Form 10-KSB filed on April 2, 2001. Such
previously filed document is hereby incorporated herein by reference in
accordance with Item 601 of Regulation S-B.
*** Filed as an exhibit to our Form 10-KSB filed on March 27, 2003. Such
previously filed document is hereby incorporated herein by reference in
accordance with Item 601 of Regulation S-B.
**** See Note 1 of the Notes to Consolidated Financial Statements in the Annual
Report to shareholders attached hereto as Exhibit 13.
33
(b) Reports on Form 8-K
During the quarter ended December 31, 2003, we filed the following Current
Reports on Form 8-K:
(i) Form 8-K filed on October 15, 2003, announcing third quarter
earnings;
(ii) Form 8-K filed on October 30, 2003, announcing increased quarterly
cash dividend.
Item 14. Principal Accountant Fees and Services
Information concerning principal accountant fees and services is
incorporated herein by reference from the definitive proxy statement for the
annual meeting of stockholders to be held in 2004 a copy of which will be filed
not later than 120 days after the close of the fiscal year.
34
SIGNATURES
In accordance with Section 13 of 15(d) of the Exchange Act, the Issuer
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NORTHEAST INDIANA BANCORP, INC.
Date: March 26, 2004 By: /s/ Stephen E. Zahn
--------------------------------
Stephen E. Zahn
(Duly Authorized Representative)
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Issuer and in the capacities and on the
dates indicated.
By: /s/ Stephen E. Zahn By: /s/ Randy J. Sizemore
--------------------------------------------- ---------------------------------------------
Stephen E. Zahn, Chairman of the Board, Randy J. Sizemore, Senior Vice President,
President and Chief Executive Officer Treasurer and Chief Financial Officer
(Principal Executive and Operating Officer) (Principal Financial and Accounting Officer)
Date: March 26, 2004 Date: March 26, 2004
By: /s/ Michael S. Zahn By: /s/ Randall C. Rider
--------------------------------------------- ---------------------------------------------
Michael S. Zahn, Director and Vice President Randall C. Rider, Director
Date: March 26, 2004 Date: March 26, 2004
By: /s/ Dan L. Stephan By: /s/ J. David Carnes
--------------------------------------------- ---------------------------------------------
Dan L. Stephan, Director J. David Carnes, MD, Director
Date: March 26, 2004 Date: March 26, 2004
By: /s/ William A. Zimmer
---------------------------------------------
William A. Zimmer, Director
Date: March 26, 2004
35
INDEX TO EXHIBITS
Exhibit No. Document
----------- --------
--------------------------------------------------------------------------------
13 Annual Report to Shareholders
14 Code of Ethics
21 Subsidiaries of the Registrant
23 Consent of Crowe Chizek and Company LLC
31.1 Certification of the Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification of the Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Exhibit 13