As filed with the Securities and Exchange Commission on March 31, 2006.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Endedfiscal year ended December 31, 20042005
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period fromto
Commission File No.file number: 0-26486
Auburn National Bancorporation, Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 63-0885779 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 100 N. Gay Street | ||
| Auburn, Alabama | 36830 | |
| (Address of principal executive offices) | (Zip Code) | |
100 N. Gay Street
Auburn, Alabama 36830
(334) 821-9200
(Address andRegistrant’s telephone number, of principal executive offices)including area code)
[None]
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Title of each class | Name of each exchange on which registered | |
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, Par Value, $.01 Per Share
(Title of class)$0.01 par value per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
CheckIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate by check mark whether the issuerregistrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
CheckIndicate by check mark if disclosure of delinquent filers in responsepursuant to Item 405 of Regulation S-K is not contained in this form,herein, and no disclosure will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x¨
CheckIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act Rule 12b-2)Act). Yes ¨ No x
TheAs of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant computed by reference towas $52,986,587 based on the closing sale price at whichas reported on the common stock was last sold asNational Association of June 30, 2004 was $52,479,832.Securities Dealers Automated Quotation System.
AsThe number of March 11, 2005, there were issued and outstanding 3,843,911 shares of the registrant’s $.01 par value common stock.
stock outstanding, as of March 10, 2006 was 3,784,536.
Documents Incorporated by ReferenceDOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statementProxy Statement for the 2006 Annual Meeting of Shareholders (“Proxy Statement”) to be held on May 10, 20059, 2006, are incorporated by reference intoin Part III.
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements made herein under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors” and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.
All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may”, “will”, “anticipate”, “assume”, “should”, “indicate”, “would”, “believe”, “contemplate”, “expect”, “seek”, “estimate”, “continue”, “plan”,“may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “continue,” “plan,” “point to”, “project”, “predict”, “could”, “intend”, “target”, “potential”,to,” “project,” “predict,” “could,” “intend,” “target,” “potential,” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:
All written or oral forward-looking statements that are attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.
PART I
ITEM 1. BUSINESS
Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was incorporated in Delaware in 1990, and in 1994 it succeeded its Alabama predecessor as the bank holding company controlling AuburnBank, an Alabama state member bank with its principal office in Auburn, Alabama (the “Bank”). The Company and its predecessor have controlled the Bank since 1984. As a bank holding company, the Company may diversify into a broader range of financial services and other business activities than currently are permitted to the Bank under applicable law. The holding company structure also provides greater financial and operating flexibility than is presently permitted to the Bank.
2
The Bank has operated continuously since 1907 and conducts its business in East Alabama, including Lee County and surrounding areas. In April 1995, in order to gain flexibility and reduce certain regulatory burdens, the Bank converted from a national bank to an Alabama state bank that is a member of the Federal Reserve System (the “Charter Conversion”). Upon consummation of the Charter Conversion, the Bank’s primary regulator changed from the Office of the Comptroller of the Currency to the Federal Reserve and the Alabama Superintendent of Banks (the “Alabama Superintendent”). The Bank has been a member of the Federal Home Loan Bank of Atlanta (the “FHLB”) since 1991.
General
The Company’s business is conducted primarily through the Bank. Although it has no immediate plans to conduct any other business, the Company may engage directly or indirectly in a number of activities whichthat the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
The Company’s principal executive offices are located at 100 N. Gay Street, Auburn, Alabama 36830, and its telephone number at such address is (334) 821-9200. The Company maintains an Internet website atwww.auburnbank.com. The Company is not incorporating the information on that website into this report, and the website and the information appearing on the website are not included in, and are not part of, this report.
Services
The Bank offers checking, savings, transaction deposit accounts and certificates of deposit, and is an active residential mortgage lender in its primary service area (“PSA”). The Bank also offers commercial, financial, agricultural, real estate construction and consumer loan products and other financial services. The Bank is one of the largest providers of automated teller services in East Alabama, operating ATM machines in 14 locations.The13 locations. The Bank offers VISA Checkcards, which are debit cards with the VISA logo that work like checks but can be used anywhere VISA is accepted, including ATMs. The Bank’s VISA Checkcards can be used internationally through the Cirrus® network. The Bank offers online banking and bill payment services through its Internet website,www.auburnbank.com.
Competition
The banking business in Alabama, including Lee County, is highly competitive with respect to loans, deposits, and other financial services. The area is dominated by a number of regional and national banks and bank holding companies whichthat have substantially greater resources, and numerous offices and affiliates operating over wide geographic areas. The Bank competes for deposits, loans and other business with these banks, as well as with credit unions, mortgage companies, insurance companies, and other local and nonlocal financial institutions, including institutions offering services through the mail, by telephone and over the Internet. As more and different kinds of businesses enter the market for financial services, competition from nonbank financial institutions may be expected to intensify further.
Among the advantages that larger financial institutions have over the Bank are their ability to finance extensive advertising campaigns and to allocate and diversify their assets among loans and securities of the highest yield in locations with the greatest demand. Many of the major commercial banks or their affiliates operating in the Bank’s service area offer services which are not presently offered directly by the Bank and they may also have substantially higher lending limits than the Bank.
Community banks also have experienced significant competition for deposits from mutual funds, insurance companies and other investment companies and from money center banks’ offerings of high-yield investments and deposits. Certain of these competitors are not subject to the same regulatory restrictions as the Bank.
3
Selected Economic Data
The Bank’s PSA includes the cities of Auburn and Opelika, Alabama and nearby surrounding areas in East Alabama, primarily in Lee County. Outside of the Bank’s PSA, the Bank has a residential mortgage loan office locatedoriginator in Gulf Shores,Orange Beach, Alabama, a beach community in south Alabama. Lee County’s population is approximately 120,000. Approximately 71% of the land in Lee County is devoted to agriculture, of which approximately 91% is comprised of forests. An estimated 10% is urban or developed. Timber and timber products, greenhouses and horticulture, beef cattle, and cotton are the major agricultural products. Principal manufactured products in the Company’s PSA include tires, textiles, small gasoline engines and hardware. The largest employers in the area are Auburn University, East Alabama Medical Center, Wal-Mart Distribution Center, Uniroyal-Goodrich, West Point Stevens and Briggs & Stratton.
Loans and Loan Concentrations
The Bank makes loans for commercial, financial and agricultural purposes, as well as for real estate mortgage, real estate construction and consumer purposes. While there are certain risks unique to each type of lending, management believes that there is more risk associated with commercial, real estate construction, agricultural and consumer lending than with real estate mortgage loans. To help manage these risks, the Bank has established underwriting standards used in evaluating each extension of credit on an individual basis, which are substantially similar for each type of loan. These standards include a review of the economic conditions affecting the borrower, the borrower’s financial strength and capacity to repay the debt, the underlying collateral and the borrower’s past credit performance. These standards are used to determine the creditworthiness of the borrower at the time a loan is made and are monitored periodically throughout the life of the loan.
The Bank has loans outstanding to borrowers in all industries within its PSA. Any adverse economic or other conditions affecting these industries would also likely have an adverse effect on the local workforce, other local businesses, and individuals in the community that have entered into loans with the Bank. However, management believes that due to the diversified mix of industries located within the Bank’s PSA, adverse changes in one industry may not necessarily affect other area industries to the same degree or within the same time frame. Management realizes that the Bank’s PSA is also subject to both local and national economic fluctuations.
Employees
At December 31, 2004,2005, the Bank had 135133 full-time equivalent employees, including 3130 officers.
Statistical Information
Certain statistical information (as required by Guide 3) is included in response to Item 7 of this Annual Report on Form 10-K. Certain statistical information is also included in response to Item 6, Item 7A and Item 8 of this Annual Report on Form 10-K.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under federal and state law. This discussion is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be a complete description of the status or regulations applicable to the Company’s and the Bank’s business. Supervision, regulation and examination of the Company and the Bank and their respective subsidiaries by the bank regulatory agencies are intended primarily for the protection of depositors rather than holders of Company capital stock and other securities. Any change in applicable law or regulation may have a material effect on the Company’s business.
4
Bank Holding Company Regulation
The Company, as a bank holding company, is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the BHC Act. Bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Company is required to file with the Federal Reserve periodic reports and such other information as the Federal Reserve may request. The Federal Reserve examines the Company, and may examine its subsidiaries. The State of Alabama currently does not regulate bank holding companies.
The BHC Act requires prior Federal Reserve approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all the assets of any bank, or for a merger or consolidation of a bank holding company with another bank holding company. With certain exceptions, the BHC Act prohibits a bank holding company from acquiring direct or indirect ownership or control of voting shares of any company whichthat is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or performing services for its authorized subsidiary. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities whichthat the Federal Reserve has determined by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
The Gramm-Leach-Bliley Act of 1999 (“GLB Act”) revised the statutory restrictions separating banking activities from certain other financial activities. Under the GLB Act, bank holding companies that are “well-capitalized” and “well-managed”,“well-managed,” as defined in Federal Reserve Regulation Y as promulgated by the Federal Reserve, and whose subsidiary banks have and maintain satisfactory or better ratings under the Community Reinvestment Act of 1977, as amended (the “CRA”), and meet certain other conditions can elect to become “financial holding companies.” Financial holding companies and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting, travel agency activities, broad insurance agency activities, merchant banking and other activities that the Federal Reserve determines to be financial in nature or complementary thereto. In addition, under the merchant banking authority added by the GLB Act and Federal Reserve regulations, financial holding companies are authorized to invest in companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment with the intention of limiting the terms of its investment, does not manage the company on a day-to-day basis, and the investee company does not cross-market with any of the financial holding company’s controlled depository institutions. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLB Act applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. While the Company has not elected to become a financial holding company, in order to exercise the broader activity powers provided by the GLB Act, it may elect to do so in the future. The GLB Act also includes consumer privacy provisions, and the Federal Reserve and the other federal bank regulatory agencies have adopted extensive privacy rules.
The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company. The Company and the Bank are subject to Section 23A of the Federal Reserve Act and Federal Reserve Regulation W thereunder. Section 23A defines “covered transactions”,transactions,” which include extensions of credit, and limits a bank’s covered transactions with any affiliate to 10% of such bank’s capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the bank’s affiliates. Finally, Section 23A requires that all of a bank’s extensions of credit to its affiliates be appropriately secured by acceptable collateral, generally United States government or agency securities. The Company and the Bank also are subject to Section 23B of the Federal Reserve Act, which generally requires covered and other transactions among affiliates to be on terms and under circumstances, including credit standards, that are substantially the same as or at least as favorable to the bank or its subsidiary as those prevailing at the time for similar transactions with unaffiliated companies.
5
Federal Reserve policy requires a bank holding company to act as a source of financial strength and to take measures to preserve and protect its bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. In addition, where a bank holding company has more than one bank or thrift subsidiary, each of the bank holding company’s subsidiary depository institutions are responsible for any losses to the Federal Deposit Insurance Corporation (“FDIC”) as a result of an affiliated depository institution’s failure. As a result, a bank holding company may be required to loan money to its subsidiary in the form of capital notes or other instruments which qualify as capital under regulatory rules. However, any loans from the holding company to such subsidiary banks likely will be unsecured and subordinated to such bank’s depositors and perhaps to other creditors of the bank.
Bank and Bank Subsidiary Regulation
The Bank is subject to supervision, regulation and examination by the Federal Reserve and the Alabama Superintendent, of Banks, which monitor all areas of the operations of the Bank, including reserves, loans, mortgages, issuances of securities, payment of dividends, establishment of branches, capital adequacy and compliance with laws. The Bank is a member of the FDIC and, as such, its deposits are insured by the FDIC to the maximum extent provided by law. See “FDIC Insurance Assessments.INSURANCE ASSESSMENTS.”
Alabama law permits statewide branching by banks. The powers granted to Alabama-chartered banks by state law include certain provisions designed to provide such banks with competitive equality to the powers of national banks regulated by the Office of the Comptroller of the Currency.
The Federal Reserve adopted the Federal Financial Institutions Examination Council’s (“FFIEC”) updated rating system which assigns each financial institution a confidential composite “CAMELS” rating based on an evaluation and rating of six essential components of an institution’s financial condition and operations including Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk. For most institutions, the FFIEC has indicated that market risk primarily reflects exposures to changes in interest rates. When regulators evaluate this component, consideration is expected to be given to: management’s ability to identify, measure, monitor and control market risk; the institution’s size; the nature and complexity of its activities and its risk profile, and the adequacy of its capital and earnings in relation to its level of market risk exposure. Market risk is rated based upon, but not limited to, an assessment of the sensitivity of the financial institution’s earnings or the economic value of its capital to adverse changes in interest rates, foreign exchange rates, commodity prices, or equity prices; management’s ability to identify, measure, monitor and control exposure to market risk; and the nature and complexity of interest rate risk exposure arising from nontrading positions.
The GLB Act requires banks and their affiliated companies to adopt and disclose privacy policies, including policies regarding the sharing of personal information they obtain from customers with third parties. The GLB Act also permits bank subsidiaries to engage in “financial activities” similar to those permitted to financial holding companies.
Community Reinvestment Act
The Company and the Bank are subject to the provisions of the CRA and the Federal Reserve’s regulations thereunder. Under the CRA, all banks and thrifts have a continuing and affirmative obligation, consistent with their safe and sound operation, to help meet the credit needs for their entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires a depository institution’s primary federal regulator, in connection with its examination of the institution, to assess the institution’s record of assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the institution’s record is made available to the public. Further, such assessment is required of any institution which has applied to: (i) charter a national bank; (ii) obtain deposit insurance coverage for
6
a newly-chartered institution; (iii) establish a new branch office that accepts deposits; (iv) relocate an office; or
(v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the records of each subsidiary depository institution of the applicant bank holding company, and such records may be the basis for denying the application. A less than satisfactory CRA rating will slow, if not preclude expansion of banking activities. The Bank currently has a satisfactory CRA rating.
Current CRA regulations rate institutions based on their actual performance in meeting community credit needs. CRA performance is evaluated by the Federal Reserve, the Bank’s primary federal regulator, using a lending test, an investment test, and a service test. The Federal Reserve also will consider: (i) demographic data about the community; (ii) the institution’s capacity and constraints; (iii) the institution’s product offerings and business strategy; and (iv) data on the prior performance of the institution and similarly-situated lenders. As a result of the GLB Act, CRA agreements with private parties must be disclosed and annual CRA reports must be made to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLB Act may be commenced by a bank holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a “satisfactory” CRA rating in its latest CRA examination. The federal bank regulators recently proposed revisions to their CRA regulations that would, among other things, require that evidence of discriminatory, illegal or abusive lending practices be considered in the CRA evaluation.
The Bank is also subject to, among other things, the provisions of the Equal Credit Opportunity Act (the “ECOA”) and the Fair Housing Act (the “FHA”), both of which prohibit discrimination based on race or color, religion, national origin, sex and familial status in any aspect of a consumer or commercial credit or residential real estate transaction. In April 1994, the Department of Housing and Urban Development, the Department of Justice (the “DoJ”), and the federal banking agencies issued an Interagency Policy Statement on Discrimination in Lending to provide guidance to financial institutions in determining whether discrimination exists, how the agencies will respond to lending discrimination and what steps lenders might take to prevent discriminatory lending practices. The DoJ has also increased its efforts to prosecute what it regards as violations of the ECOA and FHA.
Other Laws and Regulations
The GLB Act requires banks and their affiliated companies to adopt and disclose privacy policies regarding the sharing of personal information they obtain from their customers with third parties. The GLB Act also permits bank subsidiaries to engage in “financial activities” through subsidiaries similar to those permitted to financial holding companies. See the discussion regarding the GLB Act in “Bank Holding Company Regulation”“BANK HOLDING COMPANY REGULATION” above.
The International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001 specifies new “know your customer” requirements that obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Banking regulators will consider compliance with this Act’s money laundering provisions in acting upon acquisition and merger proposals, and sanctions for violations of this Act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1 million.
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001.2001 (“USA PATRIOT Act”). Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as to enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps –steps:
7
The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs, and sets forth minimum standards for these programs, including:
In addition, the USA PATRIOT Act authorizes the Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to have violated the privacy provisions of the GLB Act, as discussed above.
The Federal Reserve, the FDIC and the Alabama Superintendent of Banks monitor compliance with laws and regulations. Violations of laws and regulations, or other unsafe and unsound practices, may result in these agencies imposing fines or penalties, cease and desist orders, or taking other enforcement actions. Under certain circumstances, these agencies may enforce these remedies directly against officers, directors, employees and others participating in the affairs of a bank or bank holding company.
We areThe Company is also required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as new rules and regulations adopted by the SEC, the Public Company Accounting Oversight Board and Nasdaq. In particular, wethe Company will be required to include management and auditor reports on internal controls as part of ourits annual report for the year ended December 31, 20062007 pursuant to Section 404 of the Sarbanes-Oxley Act. It may be necessary to spend significant amounts of time and money on compliance with these rules. WeWhile management is working diligently to ensure compliance with this deadline, it is possible that management may not be able to complete ourits assessment of ourits internal controls in a timely manner. Our failureIf the Company fails to comply with these internal control rules, it may materially adversely affect ourits reputation, ourits ability to obtain the necessary certifications to ourits financial statements, and the values of ourits securities.
Payment of Dividends
The Company is a legal entity separate and distinct from the Bank. The prior approval of the Federal Reserve and/or the Alabama Superintendent is required if the total of all dividends declared by a state member bank (such as the Bank) in any calendar year will exceed the sum of such bank’s net profits for the year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits any state member bank from paying dividends that would be greater than such bank’s undivided profits after deducting statutory bad debt reserves in excess of such bank’s allowance for loan losses. During 2004,2005, the Bank paid cash dividends of $2,237,000$3,199,000 to the Company.
8
In addition, the Company and the Bank are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory
minimums. The appropriate federal and state regulatory authorities are authorized to determine, under certain circumstances relating to the financial condition of a state member bank or a bank holding company, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The Federal Reserve and the Alabama Superintendent have indicated that paying dividends that deplete a state member bank’s capital base to an inadequate level would be an unsound and unsafe banking practice. The Federal Reserve and the Alabama Superintendent also have indicated that depository institutions should generally pay dividends only out of current operating earnings.
Capital
The Federal Reserve has risk-based capital guidelines for bank holding companies and state member banks, respectively. These guidelines require a minimum ratio of capital to risk-weighted assets (including certain off-balance-sheetoff-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must consist of common equity, retained earnings and a limited amount of qualifying preferred stock, less goodwill and certain core deposit intangibles (“Tier 1 capital”). Voting common equity must be the predominant form of capital. The remainder may consist of non–qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible debt, term subordinated debt and intermediate term preferred stock, up to 45% of pretax unrealized holding gains on available for sale equity securities with readily determinable market values that are prudently valued, and a limited amount of general loan loss allowance (“Tier 2 capital” and, together with Tier 1 capital, “Total Capital”).
In addition, the federal regulatory agencies have established minimum leverage ratio guidelines for bank holding companies and state member banks, which provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets (“leverage ratio”) equal to 3%, plus an additional cushion of 1.0% –to 2.0%, if the institution has less than the highest regulatory rating. The guidelines also provide that institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Higher capital may be required in individual cases and depending upon a bank holding company’s risk profile. All bank holding companies and banks are expected to hold capital commensurate with the level and nature of their risks including the volume and severity of their problem loans. Lastly, the Federal Reserve’s guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve has not advised the Company or the Bank of any specific minimum leverage ratio or tangible Tier 1 leverage ratio applicable to them.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal banking agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: “well capitalized”,capitalized,” “adequately capitalized”, “undercapitalized”,capitalized,” “undercapitalized,” “significantly undercapitalized”, and “critically undercapitalized”.undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.
All of the federal banking agencies have adopted regulations establishing relevant capital measures and relevant capital levels. The relevant capital measures are the Total Capital ratio, Tier 1 capital ratio and the leverage ratio. Under the regulations, a state member bank will bebe: (i) well capitalized if it has a Total Capital ratio of 10% or greater, a Tier 1 capital ratio of 6% or greater, a Tier 1 leverage ratio of 5% or greater and is not subject to any written agreement, order, capital directive or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure; (ii) adequately capitalized if it has a Total Capital ratio of 8% or greater, a Tier 1 capital ratio of 4% or greater, and a leverage ratio of 4% or greater (3% in certain circumstances); (iii) undercapitalized if it has a Total Capital ratio of less than 8%, a Tier 1 capital ratio of less than 4% (3% in certain circumstances); (iv) significantly undercapitalized if it has a Total Capital ratio of less than 6%, a Tier 1 capital ratio of less than 3% and a leverage ratio of less than 3%; or (v) critically undercapitalized if its tangible equity is equal to or less than 2% of average quarterly tangible assets.
9
On March 1, 2005, the Federal Reserve adopted changes to its capital rules that permit qualified trust preferred securities and other restricted capital elements to be included as Tier 1 capital up to 25% of core capital, net of goodwill and intangibles. The Company expects that it will continue to treat its $7.0 million of trust preferred securities as Tier 1 capital.
As of December 31, 2004,2005, the consolidated capital ratios of the Company and the Bank were as follows:
Regulatory Minimum | Company | Bank | |||||||
Tier 1 risk-based capital ratio | 4.0 | % | 16.09 | % | 15.08 | % | |||
Total risk-based capital ratio | 8.0 | % | 17.15 | % | 16.15 | % | |||
Tier 1 leverage ratio | 3.0-5.0 | % | 8.86 | % | 8.29 | % |
Regulatory Minimum | Company | Bank | |||||||
Tier 1 risk-based capital ratio | 4.0 | % | 15.88 | % | 15.22 | % | |||
Total risk-based capital ratio | 8.0 | % | 16.99 | % | 16.33 | % | |||
Tier 1 leverage ratio | 3.0-5.0 | % | 9.11 | % | 8.78 | % |
The Company and the Bank are well capitalized.
FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit a capital restoration plan for approval. For a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of 5% of the depository institution’s total assets at the time it became undercapitalized and the amount necessary to bring the institution into compliance with applicable capital standards. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. If the controlling holding company fails to fulfill its obligations under FDICIA and files (or has filed against it) a petition under the federal Bankruptcy Code, the claim would be entitled to a priority in such bankruptcy proceeding over third party creditors of the bank holding company. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator. Because the Company and the Bank exceed applicable capital requirements, the respective managements of the Company and the Bank do not believe that the provisions of FDICIA have had or will have any material impact on the Company and the Bank or their respective operations.
FDICIA
FDICIA directs that each federal banking regulatory agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth composition, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares, and such other standards as the federal regulatory agencies deem appropriate.
Enforcement Policies and Actions
The Federal Reserve and the Alabama Superintendent monitor compliance with laws and regulations. Violations of laws and regulations, or other unsafe and unsound practices, may result in these agencies imposing fines or penalties, cease and desist orders, or taking other enforcement actions. Under certain circumstances, these agencies may enforce these remedies directly against officers, directors, employees and others participating in the affairs of a bank or bank holding company.
10
Fiscal and Monetary Policy
Banking is a business which depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings. Thus, the earnings and growth of the Company and the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits. The nature and timing of any changes in such policies and their effect on the Company and the Bank cannot be predicted. In 2004,2005, the Federal Reserve raised the targeted federal funds rate and the discount rate fiveeight times for a total of 1.25%2.0%. In February and March 2005,2006, the Federal Reserve raised these rates by a total of 0.50%0.25% and indicated that further increases were likely in the future.
FDIC Insurance Assessments
The Bank is subject to FDIC deposit insurance assessments. The Bank’s deposits are insured by the FDIC’s Bank Insurance Fund (“BIF”), and it has no deposits insured by the Savings Association Insurance Fund (“SAIF”). In 1996, the FDIC began applying a risk-based premium schedule which decreased the assessment rates for BIF depository institutions. Under this schedule, the annual premiums range from zero to $.27 for every $100 of deposits. The Deposit Insurance Funds Act of 1996 authorized The Financing Corporation (“FICO”) to levy assessments on BIF-assessable deposits. Since 1999, the FICO assessment rates have been the same for BIF and SAIF-assessable deposits. The FICO assessments are set quarterly, and for 2005 ranged from 1.44 basis points in the first quarter to 1.34 basis points in the fourth quarter. In 2004, the FICO assessments ranged from 1.54 basis points in the first quarter to 1.46 basis points in the fourth quarter. In 2003, the FICO assessments ranged from 1.68 basis points in the first quarter to 1.52 basis points in the fourth quarter. The FICO assessment rate for the first quarter of 20052006 is 1.441.32 basis points.
Each financial institution is assigned to one of three capital groups – well capitalized, adequately capitalized or undercapitalized – and further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institution’s primary federal and, if applicable, state regulators, and other information relevant to the institution’s financial condition and the risk posed to the applicable insurance fund. The actual assessment rate applicable to a particular institution will, therefore, depend in part upon the risk assessment classification so assigned to the institution by the FDIC. During the three years ended December 31, 2004,2005, the Bank paid no BIF deposit insurance premiums, and paid approximately $61,000, $65,000 $182,000 and $174,000$182,000 in FICO assessments during 2005, 2004 2003 and 2002,2003, respectively.
In February 2006, Congress passed the Federal Deposit Insurance Reform Act. This Act will change a number of laws including merging the BIF and SAIF. A bank’s deposits will remain insured up to a maximum of $100,000 but will be adjusted every five years based on inflation. Retirement accounts will be insured for up to $250,000 and a bank that is less than adequately capitalized will not be able to accept employee benefit deposits. This law also changes the way FDIC insurance assessments and credits are calculated and authorizes the FDIC to revise its risk-based deposit insurance assessment scheme.
Legislative and Regulatory Changes
The State of Alabama has been considering tax reform for several years and the Alabama legislature currently is considering legislation that may increase the Company’s state taxes. In addition, the Alabama Banking Department has introduced legislation in the Alabama legislature that would, among other things, permit interstate de novo branching in Alabama by out-of-state banks, regulate bank holding companies and expand the enforcement powers of the Alabama Banking Department. Other bills being considered by the Alabama legislature may adversely affect the Bank’s ability to attract and retain state deposits.
11
Various legislative and regulatory proposals regarding changes in banking, and the regulation of banks, thrifts and other financial institutions and bank and bank holding company powers, as well as the taxation of these entities, are being considered by the executive branch of the Federal government, Congress and various state governments. The FDIC has proposed a restructuring of the federal deposit insurance system, to better measure and price deposit insurance, to merge BIF and SAIF and increase FDIC insurance coverage. OtherThere are proposals pending in Congress that would, among other things, allow banks to pay interest on checking accounts, allow the Federal Reserve to pay interest on reserves and permitde novo interstate branching.Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. It cannot be predicted whether any of these proposals will be adopted, and, if adopted, how these proposals will affect the Company and the Bank. Various federal oversight authorities are also reviewing the capital adequacy and riskiness of government sponsored enterprises such as Fannie Mae and Freddie Mac. Changes from such review could affect the cost and availability of Fannie Mae and Freddie Mac services and the mortgage markets generally. The Alabama Superintendent of Banks has adopted regulations that strengthen the requirements for independent reviews or audits of Alabama banks by independent auditors.
On January 10, 2006, the federal bank regulatory agencies released proposed guidance on “Concentrations in Commercial Real Estate Lending” (the “Proposed Guidance”). This proposal defines commercial real estate (“CRE”) loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. Loans to REITs and unsecured loans to developers that closely correlate to the inherent risks in CRE markets would also be considered CRE loans under the Proposed Guidance. Loans on owner occupied CRE are generally excluded.
The Proposed Guidance requires that appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, CRE underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and capital levels may also be required. The Proposed Guidance is triggered when CRE loan concentrations exceed either:
The Proposed Guidance may also be required to be adopted when a bank has a sharp increase in CRE loans or has significant concentrations of CRE secured by a particular property type.
The Company believes that the Proposed Guidance, if adopted in its current form, may apply to the Company’s CRE lending activities due to its concentration in construction and land development loans. The Company does not exceed the two CRE loan concentration thresholds mentioned above as of December 31, 2005. The Company has $37,991,000 in construction, land development and other land loans or 66.8% of the bank’s total capital as of December 31, 2005. The Company has $136,137,000 in loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development and other land or 239.5% of the bank’s total capital as of December 31, 2005. The Company has always had meaningful exposures to loans secured by commercial real estate due to the nature of its growing markets and the loan needs of both its retail and commercial customers. The Company believes its long term experience in CRE lending, underwriting policies, internal controls, and other policies currently in place are generally appropriate to managing its concentrations as required under the Proposed Guidance. Should the Proposed Guidance be adopted by the agencies, the Company may need to consider additional procedures to monitor the level of CRE loan concentrations.
12
ITEM 1A. RISK FACTORS
Our future success is dependent on our ability to compete effectively in highly competitive markets.
The Alabama banking market in which we do business is highly competitive and our future growth and success will depend on our ability to compete effectively in these markets. We compete for loans, deposits and other financial services in our markets with other local, regional and national commercial banks, thrifts, credit unions, mortgage lenders, and securities and insurance brokerage firms. Many of our competitors offer products and services different from us, and have substantially greater resources, name recognition and market presence than we do, which benefits them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we are able to and have broader customer and geographic bases to draw upon.
Our success depends on local economic conditions where we operate.
Our success depends on the general economic conditions of the geographic markets we serve in Alabama. The local economic conditions in our markets have a significant impact on our commercial, real estate and construction loans, the ability of borrowers to repay these loans and the value of the collateral securing these loans. Adverse changes in the economic conditions of the Southeastern United States in general or in one or more of our local markets could negatively impact our results of operations and our profitability.
Our cost of funds may increase as a result of general economic conditions, interest rates and competitive pressures.
Our cost of funds may increase as a result of general economic conditions, interest rates and competitive pressures. We have traditionally obtained funds principally through local deposits and borrowings from other institutional lenders. Generally, we believe local deposits are a cheaper and more stable source of funds than borrowings because interest rates paid for local deposits are typically lower than interest rates charged for borrowings from other institutional lenders.
Our profitability and liquidity may be affected by changes in interest rates and economic conditions.
Our profitability depends upon net interest income, which is the difference between interest earned on assets, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest earned on loans and investments. Interest rates, and consequently our results of operations, are affected by general economic conditions (domestic and foreign) and fiscal and monetary policies. Monetary and fiscal policies may materially affect the level and direction of interest rates. Beginning in June 2004, the Federal Reserve has raised the federal funds rate 14 times from 1.0% to 4.50%. Increases in interest rates generally decrease the market values of fixed-rate, interest-bearing investments and loans held and the production of mortgage and other loans, and therefore may adversely affect our liquidity and earnings.
We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, our financial condition, liquidity and results of operations would be adversely affected.
We and the Bank must meet regulatory capital requirements. If we fail to meet these capital and other regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected. Our failure to remain “well capitalized” and “well managed” for regulatory purposes could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance, our ability to raise brokered deposits, our ability to pay dividends on common stock, our ability to make acquisitions, and we would no longer meet the requirements for remaining a financial holding company.
13
We are subject to extensive regulation that could limit or restrict our activities and adversely affect our earnings.
We are regulated by several regulators, including the Federal Reserve, the Alabama Superintendent, the SEC and the FDIC. Our success is affected by state and federal regulations affecting banks, bank holding companies and the securities markets and our costs of compliance could adversely affect our earnings. Banking regulations are primarily intended to protect depositors, not shareholders. The financial services industry also is subject to frequent legislative and regulatory changes and proposed changes, the effects of which cannot be predicted.
We may need to raise additional capital in the future, but that capital may not be available when it is needed or on favorable terms.
We anticipate that our current capital resources will satisfy our capital requirements for the foreseeable future. We may, however, need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. If we cannot raise additional capital on acceptable terms when needed, our ability to further expand our operations through internal growth and acquisitions could be limited.
Technological changes affect our business, and we may have fewer resources than many competitors to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many competitors have substantially greater resources to invest in technological improvements.
Our ability to continue to pay dividends to shareholders in the future is subject to profitability, capital, liquidity and regulatory requirements and these limitations may prevent us from paying dividends in the future.
Cash available to pay dividends to the Company’s shareholders is derived primarily from dividends paid to the Company by its subsidiaries. The ability of the Company’s subsidiaries to pay dividends, as well as our ability to pay dividends to its shareholders, will continue to be subject to and limited by the results of operations of our subsidiaries and its need to maintain appropriate liquidity and capital consistent with regulatory requirements and the needs of its businesses.
Our common stock is not heavily traded.
Although our common stock is listed for trading in the Nasdaq Capital Market, the trading volume in our common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.
Severe weather, natural disasters, acts of war or terrorism or other external events could have a significant impact on our business.
Severe weather, natural disasters, acts of war or terrorism or other external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
14
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business from its main office and seven branches. The Bank also has threetwo mortgage loan offices located in Gulf Shores, Phenix City and Valley, Alabama. In addition, the Bank has a mortgage loan originator in Orange Beach, Alabama, a beach community located near Pensacola, Florida. The main office is located in downtown Auburn, Alabama, in a building owned by the bank with approximately 16,000 square feet of space. The original building was constructed in 1964, and an addition was completed in 1981. Portions of the building have been renovated within the last fiveten years in order to accommodate growth and changes in the Bank’s operational structure and to adapt to technological changes. The main office building is surrounded on two sides by paved areas that provide parking for 84 vehicles, including four handicapped spaces. The main office offers the full line of the Bank’s services and has 2two ATMs, including one walk-up ATM and one drive-through ATM. The Bank owns a drive-in facility located directly across the street from its main office. This drive-in facility was constructed in 1979 and has five drive-through lanes and a walk-up window.
The Bank’s Kroger branch was opened in August 1988 and is located in the Kroger supermarket in the Corner Village Shopping Center in Auburn, Alabama for approximately 500 square feet of space. In April 2003, the Bank entered into a new lease agreement for another five years. This branch offers the full line of the Bank’s services including an ATM, with the exception of safe deposit boxes.
The Opelika branch is located in Opelika, Alabama. This branch was built in 1991 and owned by the Bank with approximately 4,000 square feet of space. This branch offers the full line of the Bank’s services and has drive-through windows and an ATM. This branch offers parking for approximately 36 vehicles, including two handicapped spaces.
The Bank’s Phenix City branch was opened in August 1998 in the Wal-Mart shopping center in Phenix City, Alabama, about 35 miles southeast of Auburn, Alabama for approximately 600 square feet of space in the Wal-Mart. In September 2003, the Bank entered into a new lease agreement for another five years with an option to extend for an additional five years. This branch offers the full line of the Bank’s deposit and other services including an ATM, except safe deposit boxes.
The Bank’s Hurtsboro branch was opened in June 1999. This branch is located in Hurtsboro, Alabama, about 35 miles south of Auburn, Alabama. This branch was built in 1999 and is owned by the Bank with approximately 1,000 square feet of space. The Bank leasedleases the land for this branch from a third party. In June 2004, the Bank exercised its option to extend this land lease for another five years. This branch offers the full line of the Bank’s services including safe deposit boxes, drive-through window and an ATM. This branch offers parking for approximately 12 vehicles, including a handicapped ramp.
The Bank’s Auburn Wal-Mart Supercenter branch was opened in September 2000 inside the Wal-Mart shopping center on the south side of Auburn, Alabama. TheIn September 2005, the Bank has a five-year lease agreement with anexercised its option to extend the lease for another five years. The lease is for approximately 695700 square feet of space in the Wal-Mart. This branch offers the full line of the Bank’s deposit and other services, including an ATM, except safe deposit boxes.
The Bank’s Notasulga branch was opened in August 2001. This branch is located in Notasulga, Alabama, about 1215 miles south of Auburn, Alabama. This branch is owned by the Bank with approximately 1,400 square feet of space. The Bank leased the land for this branch from a third party. In May 2001, the Bank entered into this land lease for five years with an option to extend for an additional five years. This branch offers the full line of the Bank’s services including safe deposit boxes and a drive-through window. This branch offers parking for approximately 11 vehicles, including a handicapped ramp.
In November 2002, the Bank opened a mortgage loan office in Phenix City. The mortgage office is located in Phenix City, Alabama, about 35 miles south of Auburn, Alabama. In November 2004, the Bank moved this mortgage loan office to a larger location with approximately 1,200 square feet of space and entered into a lease agreement for five years. This office only offers mortgage loan services.
15
Also in July 2002, the Bank’s Opelika Wal-Mart Supercenter branch was opened inside the Wal-Mart shopping center in Opelika, Alabama. The bank has a five-year lease agreement with an option to extend for approximately 700 square feet of space in the Wal-Mart. This branch offers the full line of the Bank’s deposits and other services including an ATM, except safe deposit boxes.
In March 2004, the Bank opened a mortgage loan office in Gulf Shores. The mortgage office is located in downtown Gulf Shores, Alabama, a beach community located near Pensacola, Florida and about 250 miles southwest of Auburn, Alabama for approximately 950 square feet of space. The Bank has a two year lease agreement. This office only offers mortgage loan services.
In September 2004, the Bank opened a mortgage loan office in Valley. The mortgage office is located in Valley, Alabama, about 30 miles northeast of Auburn, Alabama for approximately 1,6501,600 square feet of space. In December 2004,January 2006, the Bank entered into aexercised its option to extend the lease agreement for one year with an option to extend.another two years. This office only offers mortgage loan services.
The Bank’s Winn DixieA new in-store branch is planned to open in 2006 at the Kroger supermarket to be located in the Tiger Crossing Shopping Center, which openedTown shopping center in April 1997, was closed in April 2002 when the lease expired. This branch was consolidated with the Auburn Wal-Mart Supercenter branch.
Opelika, Alabama.
In addition, the Bank leases from the Company approximately 8,3008,500 square feet of space in the AuburnBank Center (the “Center”), which is located next to the main office. This building, which has approximately 18,000 square feet of space, is also leased to outside third parties. Leases between the Bank and the Company are based on the same terms and conditions as leases to outside third parties leasing space in the same building. The Bank’s data processing activities, as well as other operations, are located in this leased space. The parking lot provides parking for approximately 120 vehicles, including handicapped parking.
Directly behind the Center is an older home that is also owned by the Company. This building is rented as housing to university students. The rear portion of this property is used as a parking area for approximately 20 vehicles of Bank employees.
The Bank also owns a two-story building located directly behind the main office. The first floor of this buildingoffice which is leased to unaffiliated third parties. The Bank uses the second floor for storage.
currently unoccupied.
The Company owns a commercial office building (the “Hudson Building”) located across the street from the main office in downtown Auburn. The Hudson Building has two floors and a basement which contain approximately 14,39514,500 square feet of leasable space. Approximately 60% of this building is rented by unaffiliated third-party
tenants. The Bank occupies approximately 3,1003,000 square feet, which includes a portion of the basement level used for storage and office space used to house certain bank functions. The Bank pays rent to the Company based on current market rates for such space.
In 1994, the Bank acquired a parcel of commercial real estate located in Auburn on U.S. Highway 29. This property, which was acquired in satisfaction of debt previously contracted, was formerly used by a floor covering business and contained approximately 6,0456,050 square feet of office, showroom, and warehouse space. The Bank subsequently removed an underground storage tank (“UST”) containing petroleum products from the site. In 1995, the property was sold to a third party and the purchaser was indemnified of any environmental liability associated with the UST. Also in 1995, the Alabama Department of Environmental Management (“ADEM”) requested that the Bank submit a Secondary Investigation Plan (“Secondary Investigation”) as a result of underground soil and water contamination of petroleum-based hydrocarbon products. The Secondary Investigation was completed and submitted to ADEM by Roy F. Weston, Inc. (“Weston”), an independent consultant hired by the Bank. The Secondary Investigation indicated low concentrations of soil contamination on site and elevated concentrations of gasoline constituents both on-site and off-site. The Secondary Investigation indicated a low risk to human receptors, and Weston recommended to ADEM initiation of a quarterly ground water monitoring program for one year, at which time the program would be reassessed. In response to ADEM’s Letter of Requirement dated January 18, 1996, Weston prepared and submitted, on behalf of the Bank, a Monitoring Only Corrective Action Plan on February 20,
16
1996. In 1999, Weston installed a passive waste removal system to remove petroleum-based hydrocarbon products from the groundwater test well. Quarterly groundwater monitoring will continue in 20052006 as required by ADEM. Samples from the eight existing monitoring wells will be collected and analyzed by Weston. The monitoring data will be submitted by Weston to ADEM as required. It is estimated that the cost for monitoring and providing reporting data to ADEM for 20052006 will be approximately $9,000$50,000 (unless the site is released by ADEM during the year). The extent and cost of any further testing and remediation, if any, cannot be predicted at this time.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of its business, the Company and the Bank from time to time are involved in legal proceedings. The Company and Bank management believe there are no pending or threatened legal proceedings whichthat upon resolution are expected to have a material adverse effect upon the Company’s or the Bank’s financial condition or results of operations.
We have not incurred any penalties for failing to include on our tax returns any information required to be disclosed under Section 6011 of the Internal Revenue code of 1988, as amended (the “Code”) with respect to a “reportable transaction” under the Code and that is required to be reported under Code Section 6707A(e).
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2004.2005.
17
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s Common Stock is listed on the Nasdaq SmallCapCapital Market, under the symbol “AUBN”. As of March 11, 2005,10, 2006, there were approximately 3,843,9113,784,536 shares of the Company’s Common Stock issued and outstanding, which were held by approximately 450435 shareholders of record. The following table sets forth, for the indicated periods, the high and low closing sale prices for the Company’s Common Stock as reported on the Nasdaq SmallCapCapital Market, and the cash dividends paid to shareholders during the indicated periods.
Closing Price Per Share (1) | Cash Dividends Declared | Closing Price Per Share (1) | Cash Dividends Declared | |||||||||||||||
| High | Low | |||||||||||||||||
2005 | ||||||||||||||||||
First Quarter | $ | 23.50 | $ | 20.00 | $ | 0.145 | ||||||||||||
Second Quarter | 22.91 | 21.00 | 0.145 | |||||||||||||||
Third Quarter | 24.50 | 21.50 | 0.145 | |||||||||||||||
Fourth Quarter | 24.06 | 21.08 | 0.145 | |||||||||||||||
| High | Low | Cash Dividends Declared | ||||||||||||||||
| 2004 | ||||||||||||||||||
First Quarter | $ | 21.50 | $ | 18.60 | $ | 0.125 | $ | 21.50 | $ | 18.60 | $ | 0.125 | ||||||
Second Quarter | 22.00 | 19.50 | 0.125 | 22.00 | 19.50 | 0.125 | ||||||||||||
Third Quarter | 21.90 | 19.28 | 0.125 | 21.90 | 19.28 | 0.125 | ||||||||||||
Fourth Quarter | 21.90 | 19.50 | 0.125 | 21.90 | 19.50 | 0.125 | ||||||||||||
| 2003 | ||||||||||||||||||
First Quarter | $ | 14.30 | $ | 12.91 | $ | 0.12 | ||||||||||||
Second Quarter | 16.00 | 12.90 | 0.12 | |||||||||||||||
Third Quarter | 18.95 | 15.06 | 0.12 | |||||||||||||||
Fourth Quarter | 21.50 | 17.72 | 0.12 | |||||||||||||||
| (1) | The price information represents actual transactions. |
The Company has paid cash dividends on its capital stock since 1985. Prior to this time, the Bank paid cash dividends since its organization in 1907, except during the Depression years of 1932 and 1933. Holders of Common Stock are entitled to receive such dividends as may be declared by the Company’s Board of Directors. The amount and frequency of cash dividends will be determined in the judgment of the Company���sCompany’s Board of Directors based upon a number of factors, including the Company’s earnings, financial condition, capital requirements and other relevant factors. Company management currently intends to continue its present dividend policies.
The amount of dividends payable by the Bank is limited by law and regulation. The need to maintain adequate capital in the Bank also limits dividends that may be paid to the Company. Although Federal Reserve policy could restrict future dividends on Common Stock, such policy places no current restrictions on such dividends. See “SUPERVISION ANDAND REGULATION — DIVIDENDS” and “MANAGEMENT’S DISCUSSIONAND ANALYSISOF FINANCIAL CONDITIONAND RESULTSOF OPERATIONS — CAPITAL RESOURCES.”
In November 2003, the Company’s Board of Directors authorized the Company18
ISSUER PURCHASES OF EQUITY SECURITIES1
Period | Total Number of Shares (or Units) Purchased | Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased or Programs | Total Number of Shares (or Units) Purchased | Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs | ||||||||||||
| (Dollars in thousands except share data) | (Dollars in thousands except share data) | |||||||||||||||||||
October 1 – October 31 | 1,500 | $ | 20.06 | 1,500 | $ | 1,032 | 10,000 | $ | 23.18 | N/A | $ | 0 | ||||||||
November 1 – November 30 | 1,200 | $ | 21.42 | 1,200 | $ | 0 | 16,000 | $ | 22.39 | N/A | $ | 0 | ||||||||
December 1 – December 31 | 1,930 | 21.04 | N/A | $ | 0 | 2,039 | $ | 21.50 | N/A | $ | 0 | |||||||||
Total | 4,630 | 2,700 | 28,039 | $ | 22.61 | |||||||||||||||
| 1 | A total of |
ITEM 6. SELECTED FINANCIAL DATA
| For the Year Ended December 31, | For the Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||
| 2004 | 2003 | 2002 | 2001 | 2000 | 2005 | 2004 | 2003 | 2002 | 2001 | |||||||||||||||||||||||||||||||
| (Dollars in thousands, except per share data) | (Dollars in thousands, except per share data) | |||||||||||||||||||||||||||||||||||||||
Earnings | ||||||||||||||||||||||||||||||||||||||||
Net Interest Income | $ | 14,669 | $ | 13,518 | $ | 14,570 | $ | 13,845 | $ | 12,584 | $ | 14,702 | $ | 14,669 | $ | 13,518 | $ | 14,570 | $ | 13,845 | ||||||||||||||||||||
Provision for Loan Losses | 600 | 675 | 1,680 | 3,555 | 2,622 | 485 | 600 | 675 | 1,680 | 3,555 | ||||||||||||||||||||||||||||||
Net Earnings | 6,510 | 5,419 | 5,055 | 4,578 | 3,014 | 6,470 | 6,510 | 5,419 | 5,055 | 4,578 | ||||||||||||||||||||||||||||||
Per Share: | ||||||||||||||||||||||||||||||||||||||||
Net Earnings – basic and diluted | 1.68 | 1.39 | 1.30 | 1.17 | 0.77 | 1.69 | 1.68 | 1.39 | 1.30 | 1.17 | ||||||||||||||||||||||||||||||
Cash Dividends | 0.50 | 0.48 | 0.44 | 0.40 | 0.40 | 0.58 | 0.50 | 0.48 | 0.44 | 0.40 | ||||||||||||||||||||||||||||||
Book Value | 11.57 | 10.38 | 10.16 | 9.20 | 8.10 | 11.58 | 11.57 | 10.38 | 10.16 | 9.20 | ||||||||||||||||||||||||||||||
Shares Issued | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | 3,957,135 | ||||||||||||||||||||||||||||||
Weighted Average Shares Outstanding | 3,870,198 | 3,894,969 | 3,894,649 | 3,908,084 | 3,924,573 | 3,830,002 | 3,870,198 | 3,894,969 | 3,894,649 | 3,908,084 | ||||||||||||||||||||||||||||||
Financial Condition | ||||||||||||||||||||||||||||||||||||||||
Total Assets | $ | 591,161 | $ | 590,115 | $ | 505,027 | $ | 473,010 | $ | 404,689 | $ | 608,154 | $ | 591,161 | $ | 590,115 | $ | 505,027 | $ | 473,010 | ||||||||||||||||||||
Loans | 258,943 | 257,092 | 260,360 | 271,834 | 262,529 | 282,059 | 251,129 | 244,652 | 254,344 | 262,303 | ||||||||||||||||||||||||||||||
Investment Securities | 282,199 | 285,319 | 190,918 | 151,474 | 111,730 | 274,961 | 282,199 | 285,319 | 190,918 | 151,474 | ||||||||||||||||||||||||||||||
Total Deposits | 429,339 | 434,042 | 395,191 | 369,668 | 315,641 | 454,995 | 429,339 | 434,042 | 395,191 | 369,668 | ||||||||||||||||||||||||||||||
Long Term Debt | 105,441 | 105,589 | 53,436 | 53,581 | 48,721 | |||||||||||||||||||||||||||||||||||
Long-Term Debt | 105,422 | 105,441 | 105,589 | 53,436 | 53,581 | |||||||||||||||||||||||||||||||||||
Shareholders’ Equity | 44,504 | 40,408 | 39,582 | 35,834 | 31,805 | 43,954 | 44,504 | 40,408 | 39,582 | 35,834 | ||||||||||||||||||||||||||||||
Selected Ratios | ||||||||||||||||||||||||||||||||||||||||
Return on Average Total Assets | 1.10 | % | 1.05 | % | 1.04 | % | 1.07 | % | 0.77 | % | 1.08 | % | 1.10 | % | 1.05 | % | 1.04 | % | 1.07 | % | ||||||||||||||||||||
Return on Average Total Equity | 15.69 | % | 13.47 | % | 13.66 | % | 13.40 | % | 10.30 | % | 14.26 | % | 15.69 | % | 13.47 | % | 13.66 | % | 13.40 | % | ||||||||||||||||||||
Average Stockholders’ Equity to Average Assets | 7.03 | % | 7.78 | % | 7.65 | % | 7.97 | % | 7.47 | % | 7.56 | % | 7.03 | % | 7.78 | % | 7.65 | % | 7.97 | % | ||||||||||||||||||||
Allowance for Loan Losses As a % Of Loans | 1.33 | % | 1.68 | % | 1.96 | % | 1.96 | % | 1.38 | % | ||||||||||||||||||||||||||||||
Loans To Total Deposits | 60.31 | % | 59.23 | % | 65.88 | % | 73.53 | % | 83.17 | % | ||||||||||||||||||||||||||||||
Allowance for Loan Losses as a % of Loans | 1.36 | % | 1.38 | % | 1.76 | % | 2.01 | % | 2.04 | % | ||||||||||||||||||||||||||||||
Loans to Total Deposits | 61.99 | % | 58.49 | % | 56.37 | % | 64.36 | % | 70.96 | % | ||||||||||||||||||||||||||||||
19
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is designed to provide a better understanding of various factors related to the Company’s results of operations and financial condition. Such discussion and analysis should be read in conjunction with “BUSINESS” and “FINANCIAL STATEMENTSAND SUPPLEMENTARY DATA.”
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the three years ended December 31, 2005, 2004 2003 and 2002.2003. This discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere herein.
Overview
The Company was incorporated in Delaware in 1990, and in 1994 it succeeded its Alabama predecessor as the bank holding company controlling the Bank. The Company’s business is conducted primarily through the Bank.
Like most financial institutions, the Company’s profitability depends largely upon the Bank’s net interest income, which is the difference between the interest received on earning assets, such as loans and investment securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. The Company’s results of operations are also affected by the Bank’s provision for loan losses; non-interest expenses, such as salaries, employee benefits, and occupancy expenses; and non-interest income, such as mortgage loan fees and service charges on deposit accounts.
Economic conditions, competition and federal monetary and fiscal policies also affect financial institutions. For example, 20042005 was characterized by steady lowsteadily increasing interest rates intended to stabilize the economy and stimulate industrial economic growth. The Bank closed over $113$153 million in residential mortgage activity during 2004.2005. Approximately 5.2%6.0% of the Bank’s 20042005 gross revenue was a product of its traditional residential mortgage origination business. Management anticipates a decline in mortgage production volumes and revenues during 20052006 due to anticipated higher interest rates but also anticipates offsetting this decline somewhat due to the opening of two new mortgage loan offices in 2004.rates. Lending activities are also influenced by regional and local economic factors, such as housing supply and demand, competition among lenders, customer preferences and levels of personal income and savings in the Company’s PSA.
Our balanced growth continued during 2004,2005, with increases in assets, loans, shareholders’ equity,deposits and earnings per share and returns on average assets and equity.share. The following chart shows our growth in these areas from December 31, 20022003 to December 31, 2004:2005:
| December 31, 2004 | % Change | December 31, 2003 | % Change | December 31, 2002 | December 31, 2005 | % Change | December 31, 2004 | % Change | December 31, 2003 | |||||||||||||||||||||||||||
| (Dollars in thousands, except per share data) | (Dollars in thousands, except per share data) | |||||||||||||||||||||||||||||||||||
Net Earnings | $ | 6,510 | 20.1 | % | $ | 5,419 | 7.2 | % | $ | 5,055 | $ | 6,470 | -0.6 | % | $ | 6,510 | 20.1 | % | $ | 5,419 | ||||||||||||||||
Net Earnings Per Share - basic and diluted | 1.68 | 20.9 | % | 1.39 | 6.9 | % | 1.30 | 1.69 | 0.6 | % | 1.68 | 20.9 | % | 1.39 | ||||||||||||||||||||||
Total Assets | 591,161 | 0.2 | % | 590,115 | 16.8 | % | 505,027 | 608,154 | 2.9 | % | 591,161 | 0.2 | % | 590,115 | ||||||||||||||||||||||
Investment Securities | 282,199 | -1.1 | % | 285,319 | 49.4 | % | 190,918 | 274,961 | -2.6 | % | 282,199 | -1.1 | % | 285,319 | ||||||||||||||||||||||
Loans | 258,943 | 0.7 | % | 257,092 | -1.3 | % | 260,360 | 282,059 | 12.3 | % | 251,129 | 2.6 | % | 244,652 | ||||||||||||||||||||||
Deposits | 429,339 | -1.1 | % | 434,042 | 9.8 | % | 395,191 | 454,995 | 6.0 | % | 429,339 | -1.1 | % | 434,042 | ||||||||||||||||||||||
Shareholders’ Equity | 44,504 | 10.1 | % | 40,408 | 2.1 | % | 39,582 | 43,954 | -1.2 | % | 44,504 | 10.1 | % | 40,408 | ||||||||||||||||||||||
Return on Average Total Assets | 1.10 | % | 4.8 | % | 1.05 | % | 1.0 | % | 1.04 | % | 1.08 | % | -1.8 | % | 1.10 | % | 4.8 | % | 1.05 | % | ||||||||||||||||
Return on Average Total Equity | 15.69 | % | 16.5 | % | 13.47 | % | -1.4 | % | 13.66 | % | 14.26 | % | -9.1 | % | 15.69 | % | 16.5 | % | 13.47 | % | ||||||||||||||||
20
Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to United States generally accepted accounting principles and to general practices within the banking industry. The allowance for loan losses is an accounting policy applied by the Company whichthat is deemed critical. Critical accounting policies are defined as policies whichthat are important to the portrayal of the Company’s financial condition and results of operations, and that require management’s most difficult, subjective or complex judgements. The Company’s financial results could differ significantly if different judgements or estimates are applied in the application of this policy. See “ALLOWANCEFOR LOAN LOSSESAND RISK ELEMENTS.”
Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain a level management considers adequate to absorb anticipated loan losses. When management believes the collection of the principal of a loan is unlikely, a loan is charged off against the allowance for loan losses. Subsequent recoveries of principal are added back to the allowance for loan losses. Management’s evaluation of the adequacy of the allowance for loan losses is based on a formal analysis which assesses the risks within the loan portfolio. In assessing the adequacy of the allowance, management reviews the size, quality and risk of loans in the portfolio. Management also considers such factors as the Bank’s loan loss experience, the amount of past due and nonperforming loans, specific known risk, the status and amount of nonperforming assets, underlying collateral values securing loans, current and anticipated economic conditions and other factors whichthat affect the allowance for loan losses. In 2004,2005, the credit administration area reviewed approximately 20%44% of the total loan portfolio. In addition, the Bank has engaged an outside loan review consultant, on a semi-annual basis, to perform an independent review of the quality of the loan portfolio. In 2004,2005, the outside loan review consultant reviewed approximately 44%34% of the total loan portfolio. The current economic conditions have slowed loan growth in 2004 and 2003. The Company is closely monitoring certain portions of its loan portfolio that management believes to be of higher risk under the current economic situation.
Management believes the allowance for loan losses is adequate at December 31, 2004.2005. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on economic changes and other changes that can effect the various borrowers. Certain economic and interest rate factors could have a material impact on the determination of the allowance for loan losses. The Bank’s allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, the Federal Reserve and the Alabama Superintendent may require a bank to make additional provisions to its allowance for loan losses where, in the opinion of the regulators, credit evaluations and allowance for loan loss methodology differ materially from those of management. See “SUPERVISIONAND REGULATION.”
Management, considering current information and events regarding a borrowers’borrower’s ability to repay its obligations, considers a loan to be impaired when the ultimate collectibility of all amounts due, according to the contractual terms of the loan agreement, is in doubt. When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. If the loan is collateral-dependent, the fair value of the collateral is used to determine the amount of the impairment. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Cash receipts on accruing impaired loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans whichthat are not accruing interest are applied first to principal and then to interest income.
Commercial real estate mortgage loans were $136,037,000$148.1 million which represented 52.5% of the total loans at December 31, 2004.2005. The largest 10 commercial real estate mortgage relationships approximated $48.6$54.3 million or 18.8%19.2% of the total loans outstanding at December 31, 2004.2005. There are no significant concentrations of industries or loan types within the commercial real estate loan portfolio. The Bank’s commercial real estate loans are secured by real estate located principally in Lee County, Alabama. Accordingly, the ultimate collectibility of a substantial
portion of the Bank’s loan portfolio is susceptible to changes in market conditions in this area. A rapidly rising interest rate environment could have a material impact on certain borrowers’ ability to pay. The Company currently
21
anticipates that interest rates will slightly increase in 2005.2006. In the event of a deeper recession or a significant increase in interest rates, the Bank’s credit costs and losses could increase significantly. See “QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.”
Financial Condition
Total assets at December 31, 2005 and 2004 were $608,154,000 and 2003 were $591,161,000, and $590,115,000, respectively, reflecting growth of $1,046,000 (0.2%)$16,993,000 or 2.9%. The Company’s growth during 2004This increase in total assets resulted primarily from the slight growthan increase of $24,517,000 in loans, and securities sold under agreements to repurchase. These increasesincluding loans held for sale. The primary sources of funding for these loans were offset byan increase in total deposits of $25,656,000 and a decrease in deposits and investment securities.
securities available for sale of $7,063,000 during 2005.
Investment Securities
Investment securities held to maturity were $809,000$633,000 and $1,238,000$809,000 at December 31, 20042005 and 2003,2004, respectively. This decrease of $429,000 (34.7%)$176,000 or 21.8% in 20042005 resulted primarily from scheduled paydowns, maturities and calls of principal amounts. The investment securities available for sale portfolio was $281,390,000$274,327,000 and $284,081,000$281,390,000 at December 31, 20042005 and 2003,2004, respectively. This decrease of $2,691,000 (0.9%)$7,063,000 or 2.5% reflects purchases of $20,583,000$19,981,000 in U.S. agency securities, $59,987,000$32,658,000 in mortgage-backed securities, $12,487,000$4,067,000 in collateralized mortgage obligations (“CMOs”), $1,000,000$3,962,000 in corporate securities and $21,430,000$11,720,000 in state and political subdivision securities. This increase is offset by $40,210,000$38,880,000 of scheduled paydowns, maturities and calls of principal amounts. In addition, $18,709,000$10,976,000 of U.S. agency securities, $7,721,000 of CMOs, $7,404,000$4,395,000 of state and political subdivisions, $42,891,000and $17,975,000 of mortgage-backed securities and $809,000 of equity securities were sold in 2004. In November 2003, the Company formed a wholly-owned subsidiary, Auburn National Bancorporation Capital Trust I. This unconsolidated subsidiary issued approximately $7 million in preferred trust securities in 2003. The Company obtained these proceeds through a note payable to trust. Approximately $5 million of proceeds were given to the Bank in the form in dividend. This additional capital allowed the Bank to borrow additional funds from the FHLB. These funds were used to buy approximately $70 million in investment securities available for sale as part of a leverage transaction in 2003.
2005.
The composition of the Company’s total investment securities portfolio reflects the Company’s investment strategy to provide acceptable levels of interest income from portfolio yields while maintaining an appropriate level of liquidity to assist with controlling the Company’s interest rate position. In 2003 and 2004, the Company invested $45 million in tax-exempt securities to fully realize the benefits of the preferential treatment afforded tax-exempt securities under the tax laws. The majority of the purchases of taxable securities have been in investment grade mortgage-backed securities (“MBS”) and CMOs because of their liquidity, credit quality and yield characteristics. The yields, values, and durations of such MBS and CMOs generally vary with interest rates, prepayment levels, and general economic conditions, and as a result, the values of such instruments may be more volatile and unpredictable than other instruments with similar maturities. Such MBS and CMOs also may have longer stated maturities than other securities, which may result in further price volatility. The weighted average yields for state and political subdivisions have been computed on a tax-equivalent basis.
The following table indicates the amortized cost of the portfolio of investment securities held to maturity at the end of the last three years:
Amortized Cost December 31, | Amortized Cost December 31, | |||||||||||||
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||
| (In thousands) | (In thousands) | |||||||||||||
Investment Securities Held to Maturity: | ||||||||||||||
U.S. government agencies | $ | — | — | 5,000 | ||||||||||
State and political subdivisions | 362 | 370 | 564 | $ | 355 | 362 | 370 | |||||||
Mortgage-backed securities | 447 | 868 | 1,491 | 278 | 447 | 868 | ||||||||
Collateralized mortgage obligations | — | — | 873 | |||||||||||
Total investment securities held to maturity | $ | 809 | 1,238 | 7,928 | $ | 633 | 809 | 1,238 | ||||||
22
The following table indicates the fair value of the portfolio of investment securities available for sale at the end of the last three years:
Fair Value December 31, | |||||||
| 2004 | 2003 | 2002 | |||||
| (In thousands) | |||||||
Investment Securities Available for Sale: | |||||||
U.S. government agencies | $ | 57,800 | 62,667 | 39,567 | |||
State and political subdivisions | 42,389 | 28,076 | 3,686 | ||||
Mortgage-backed securities | 157,375 | 171,219 | 73,296 | ||||
Collateralized mortgage obligations | 17,513 | 16,084 | 63,124 | ||||
Corporate securities | 6,313 | 5,277 | 2,500 | ||||
Equity securities | — | 758 | 817 | ||||
Total investment securities available for sale | $ | 281,390 | 284,081 | 182,990 | |||
| Fair Value December 31, | |||||||
| 2005 | 2004 | 2003 | |||||
| (In thousands) | |||||||
Investment Securities Available for Sale: | |||||||
U.S. government agencies | $ | 61,435 | 57,800 | 62,667 | |||
State and political subdivisions | 49,038 | 42,389 | 28,076 | ||||
Mortgage-backed securities | 137,085 | 157,375 | 171,219 | ||||
Collateralized mortgage obligations | 16,549 | 17,513 | 16,084 | ||||
Corporate securities | 10,220 | 6,313 | 5,277 | ||||
Equity securities | — | — | 758 | ||||
Total investment securities available for sale | $ | 274,327 | 281,390 | 284,081 | |||
At December 31, 2004,2005, the Bank owned CMOs with a total amortized cost of $17,632,000.$17,036,000. All of the CMOs are rated AAA and Aaa. The CMOs are all backed by federal agency guaranteed mortgages.
The MBS portfolio’s total amortized cost of $158,779,000$142,405,000 at December 31, 2004,2005, is a mixture of fixed rate mortgages, adjustable rate mortgages (“ARMs”) and securities with balloon payments. At the time of purchase, the Bank considers various prepayment speeds and makes the purchase based on the ability to accept the yield and average life based on both increasing and decreasing prepayment speeds.
The following tables present the maturities and weighted average yields of investment securities at December 31, 2004:2005:
Maturities of Held-to-Maturity Amortized Cost | |||||||
| After one Through five years | After five through ten years | After ten years | |||||
| (In thousands) | |||||||
State and political subdivisions | $ | — | — | 362 | |||
Mortgage-backed securities | 268 | 1 | 178 | ||||
Total investment securities held to maturity | $ | 268 | 1 | 540 | |||
Weighted Average Yields of Held-to-Maturity Investment Securities | |||||||||
After one through five years | After five through ten years | After ten years | |||||||
State and political subdivisions | — | — | 8.13 | % | |||||
Mortgage-backed securities | 7.22 | % | 4.40 | % | 4.39 | % | |||
Maturities of Available for Sale Investment Securities Amortized Cost | |||||||
After one through five years | After five through ten Years | After ten years | |||||
| (In thousands) | |||||||
U.S. government agencies | $ | 26,938 | 19,779 | 11,308 | |||
State and political subdivisions | 435 | 1,299 | 39,837 | ||||
Mortgage-backed securities | 4,559 | 73,779 | 79,994 | ||||
Collateralized mortgage obligations | — | — | 17,632 | ||||
Corporate securities | — | 2,500 | 3,716 | ||||
Total investment securities available for sale | $ | 31,932 | 97,357 | 152,487 | |||
Weighted Average Yields of Available for Sale Investment Securities | |||||||||
After one through five years | After five through ten years | After ten years | |||||||
U.S. government agencies | 3.33 | % | 3.33 | % | 3.80 | % | |||
State and political subdivisions | 3.56 | % | 4.48 | % | 5.99 | % | |||
Mortgage-backed securities | 3.00 | % | 3.50 | % | 4.49 | % | |||
Collateralized mortgage obligations | — | — | 4.14 | % | |||||
Corporate securities | — | 6.75 | % | 4.93 | % | ||||
Maturities of Held-to-Maturity Amortized Cost | ||||||||||
| After one through five years | After five through ten years | After ten years | ||||||||
| (In thousands) | ||||||||||
State and political subdivisions | $ | — | — | 355 | ||||||
Mortgage-backed securities | 149 | 39 | 90 | |||||||
Total investment securities held to maturity | $ | 149 | 39 | 445 | ||||||
Weighted Average Yields of Investment Securities | ||||||||||
| After one through five years | After five through ten years | After ten years | ||||||||
State and political subdivisions | — | — | 3.69 | % | ||||||
Mortgage-backed securities | 7.19 | % | 5.93 | % | 5.09 | % | ||||
As of December 31, 2003, the Company had one investment which had been in an unrealized loss position greater than one year in which the Company decided not23
Financial Statements
Maturities of Available for Sale Amortized Cost | ||||||||||
| After one through five years | After five through ten years | After ten years | ||||||||
| (In thousands) | ||||||||||
U.S. government agencies | $ | 37,941 | 22,802 | 1,990 | ||||||
State and political subdivisions | 435 | 1,902 | 46,552 | |||||||
Mortgage-backed securities | 17,464 | 54,179 | 70,484 | |||||||
Collateralized mortgage obligations | — | — | 17,036 | |||||||
Corporate securities | — | 3,510 | 6,661 | |||||||
Total investment securities available for sale | $ | 55,840 | 82,393 | 142,723 | ||||||
Weighted Average Yields of Available for Sale Investment Securities | ||||||||||
After one years | After five years | After ten years | ||||||||
U.S. government agencies | 3.70 | % | 3.83 | % | 4.06 | % | ||||
State and political subdivisions (1) | 3.56 | % | 5.05 | % | 5.97 | % | ||||
Mortgage-backed securities | 3.63 | % | 3.60 | % | 4.60 | % | ||||
Collateralized mortgage obligations | — | — | 4.65 | % | ||||||
Corporate securities | — | 6.53 | % | 6.58 | % | |||||
| (1) | Yields on tax-exempt securities have been computed on a tax-equivalent basis. |
Loans Held for Sale
Total loans were $258,943,000 at December 31, 2004, an increase of $1,851,000 (0.7%), over total loans of $257,092,000 at December 31, 2003. The primary increase during 2004 occurred in the commercial real estate mortgage loans. In addition, the above was offset by decreases in commercial, financial and agricultural loans and residential held for sale loans. The commercial real estate mortgage loan component of the loan portfolio increased $13,640,000 (11.1%) to $136,037,000 at December 31, 2004, from the 2003 balance of $122,397,000 and represented 52.5% of the total loan portfolio at December 31, 2004, as compared to 47.6% at December 31, 2003.
This above increase is offset by decreases in the commercial, financial and agricultural loans and residential held for sale loans. The commercial, financial and agricultural loans decreased $5,241,000 (9.5%) to $49,758,000 at December 31, 2004 compared to $54,999,000 at December 31, 2003. Commercial, financial and agricultural loans represented 19.2% and 21.4% of the total loans at December 31, 2004 and 2003, respectively. The real estate held for sale decreased $4,626,000 (37.2%)$6,414,000 or 82.1% to $1,400,000 at December 31, 2005 compared to $7,814,000 at December 31, 2004 compared to $12,440,000 at December 31, 2003.2004. The decrease in 20042005 was due primarily to increased demand in 2003 of new and refinanced residential loans due to record low interest rates. Residential held for salereclassification of a number of loans represented 3.0% and 4.8% ofthat the total loans at December 31, 2004 and 2003, respectively.
Bank decided to no longer sell in the secondary market.
In addition to originating mortgage loans for its own portfolio, the Company also originates residential mortgage loans whichthat are sold in the secondary market. In addition to selling real estate mortgage loans to the Federal National Mortgage Association (“FNMA”) with the Bank retaining the servicing rights, the Bank has arranged with one mortgage servicing company to originate and sell, without recourse, residential first mortgage real estate loans, with servicing rights released. During 2004,2005, the Bank sold mortgage loans totaling approximately $44,136,000$23,535,000 to FNMA, with the Bank retaining the servicing rights, and sold mortgage loans totaling approximately $22,173,000$58,003,000 to the mortgage servicing company with servicing rights released. At December 31, 2004,2005, the Bank was servicing loans totaling approximately $154,021,000.$152,790,000. The Bank collects monthly servicing fees of 0.25% to 0.375% annually of the outstanding balances of loans serviced for FNMA. See “– EFFECTSOF INFLATIONAND CHANGING PRICES.”
24
Loans
Total loans were $282,059,000 at December 31, 2005, an increase of $30,930,000 or 12.3%, over total loans of $251,129,000 at December 31, 2004. The primary increases during 2005 occurred in the residential and commercial real estate mortgage loans. The residential real estate mortgage loan component of the loan portfolio increased $17,212,000 or 40.5% to $59,757,000 at December 31, 2005, from the 2004 balance of $42,545,000 and represented 21.2% of the total loan portfolio at December 31, 2005, as compared to 16.9% at December 31, 2004. The commercial real estate mortgage loan component of the loan portfolio increased $12,081,000 or 8.9% to $148,118,000 at December 31, 2005, from the 2004 balance of $136,037,000 and represented 52.5% of the total loan portfolio at December 31, 2005, as compared to 54.2% at December 31, 2004.
The following table presents the composition of the loan portfolio by major categories at the end of the last five years:
| 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||
| (In thousands) | ||||||||||||||||
Commercial, financial and agricultural | $ | 49,758 | 54,999 | 56,490 | 63,158 | 71,636 | ||||||||||
Leases – commercial | 5,397 | 6,630 | 7,128 | 8,113 | — | |||||||||||
Real estate – construction: | ||||||||||||||||
Commercial | 945 | 2,099 | 1,392 | 3,562 | 9,883 | |||||||||||
Residential | 5,426 | 4,866 | 4,768 | 7,932 | 4,973 | |||||||||||
Real estate – mortgage: | ||||||||||||||||
Commercial | 136,037 | 122,397 | 124,490 | 112,075 | 89,465 | |||||||||||
Residential | 42,545 | 41,988 | 46,105 | 51,806 | 60,128 | |||||||||||
Real estate – held for sale | 7,814 | 12,440 | 6,016 | 9,531 | 7,534 | |||||||||||
Consumer installment | 11,021 | 11,673 | 13,971 | 15,657 | 18,910 | |||||||||||
Total loans | $ | 258,943 | 257,092 | 260,360 | 271,834 | 262,529 | ||||||||||
Less: Allowance for loan losses | (3,456 | ) | (4,312 | ) | (5,104 | ) | (5,340 | ) | (3,634 | ) | ||||||
Loans, net | $ | 255,487 | 252,780 | 255,256 | 266,494 | 258,895 | ||||||||||
Commercial, financial and agricultural Leases – commercial Real estate – construction: Commercial Residential Real estate – mortgage: Commercial Residential Consumer installment Total loans Less: Allowance for loan losses Loans, net 2005 2004 2003 2002 2001 (In thousands) $ 51,491 49,758 54,999 56,490 63,158 1,488 5,397 6,630 7,128 8,113 2,039 945 2,099 1,392 3,562 8,832 5,426 4,866 4,768 7,932 148,118 136,037 122,397 124,490 112,075 59,757 42,545 41,988 46,105 51,806 10,334 11,021 11,673 13,971 15,657 $ 282,059 251,129 244,652 254,344 262,303 (3,843 ) (3,456 ) (4,312 ) (5,104 ) (5,340 ) $ 278,216 247,673 240,340 249,240 256,963
The following table presents maturities by major loan classifications and the sensitivity of loans to changes in interest rates within each maturity category at December 31, 2004:2005:
| Maturities of Loan Portfolio | Maturities of Loan Portfolio | |||||||||||||||||
Within one year | After one through five years | After five years | Total | Within one year | After one through five years | After five years | Total | |||||||||||
| (In thousands) | (In thousands) | |||||||||||||||||
Commercial, financial and agricultural | $ | 20,987 | 27,861 | 910 | 49,758 | $ | 29,596 | 21,274 | 621 | 51,491 | ||||||||
Leases – commercial | 3,123 | 1,580 | 694 | 5,397 | 504 | 984 | — | 1,488 | ||||||||||
Real estate – construction | 6,320 | 51 | — | 6,371 | 6,530 | 4,341 | — | 10,871 | ||||||||||
Real estate – mortgage | 24,229 | 102,177 | 52,176 | 178,582 | 33,156 | 109,429 | 65,290 | 207,875 | ||||||||||
Real estate – held for sale | — | 103 | 7,711 | 7,814 | ||||||||||||||
Consumer installment | 3,194 | 7,506 | 321 | 11,021 | 4,590 | 5,430 | 314 | 10,334 | ||||||||||
Total loans | $ | 57,853 | 139,278 | 61,812 | 258,943 | $ | 74,376 | 141,458 | 66,225 | 282,059 | ||||||||
Variable-rate loans | $ | 30,837 | 67,428 | 42,774 | 141,039 | $ | 48,854 | 69,132 | 50,781 | 168,767 | ||||||||
Fixed-rate loans | 27,016 | 71,850 | 19,038 | 117,904 | 25,522 | 72,326 | 15,444 | 113,292 | ||||||||||
Total loans | $ | 57,853 | 139,278 | 61,812 | 258,943 | $ | 74,376 | 141,458 | 66,225 | 282,059 | ||||||||
25
Allowance for Loan Losses and Risk Elements
Interest on loans is normally accrued from the date an advance is made. The performance of loans is evaluated primarily on the basis of a review of each customer relationship over a period of time and the judgment of lending officers as to the ability of borrowers to meet the repayment terms of loans. If there is reasonable doubt as to the repayment of a loan in accordance with the agreed terms, the loan may be placed on a nonaccrual basis pending the sale of any collateral or a determination as to whether sources of repayment exist. This action may be taken even though the financial condition of the borrower or the collateral may be sufficient ultimately to reduce or satisfy the obligation. Generally, when a loan is placed on a nonaccrual basis, all payments are applied to reduce principal to the extent necessary to eliminate doubt as to the repayment of the loan. Thereafter, any interest income on a nonaccrual loan is recognized only on a cash basis.
The Company’s policy generally is to place a loan on nonaccrual status when it is contractually past due 90
days or more as to payment of principal or interest. A loan may be placed on nonaccrual status at an earlier date when concerns exist as to the ultimate collection of principal or interest. At the time a loan is placed on nonaccrual status, interest previously accrued but not collected is reversed and charged against current earnings. Loans that are contractually past due 90 days or more whichthat are well secured and are in the process of collection generally are not placed on nonaccrual status.
Lending officers are responsible for the ongoing review and administration of loans assigned to them. As such, they make the initial identification of loans which present some difficulty in collection or where circumstances indicate that the possibility of loss exists. The responsibilities of the lending officers include the collection effort on a delinquent loan. To strengthen internal controls in the collection of delinquencies, senior management and the Directors’ Loan Committee are informed of the status of delinquent and “watch” or problem loans on a monthly basis. Senior management reviews the allowance for loan losses and makes recommendations to the Directors’ Loan Committee as to loan charge-offs on a monthly basis.
The allowance for loan losses represents management’s assessment of the risk associated with extending credit and its evaluation of the quality of the loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain a level considered adequate to absorb anticipated loan losses. In assessing the adequacy of the allowance, management reviews the size, quality and risk of loans in the portfolio. Management also considers such factors as the Bank’s loan loss experience,
the amount of past due and nonperforming loans, specific known risks, the status and amount of nonperforming assets, underlying collateral values securing loans, current and anticipated economic conditions and other factors which affect the allowance for loan losses. An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by the Bank’s Credit Administration area and presented to the Directors’ Loan Committee on a monthly basis. In addition, the Bank has engaged outside loan review consultants, on a semi-annual basis, to perform an independent review of the quality of the loan portfolio.
The Bank’s allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, the Federal Reserve and the Alabama Superintendent may require a bank to make additional provisions to its allowance for loan losses where, in the opinion of the regulators, credit evaluations and allowance for loan loss methodology differ materially from those of management. See “SUPERVISIONAND REGULATION.”
While it is the Bank’s policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses whichthat cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.
26
The following table summarizes the levels of the allowance for loan losses at the end of the last five years and activity in the allowance during such years:
Allowance for Loan Loss Activity for Year ended December 31, | ||||||||||||||||
| 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||
| (Dollars in thousands) | ||||||||||||||||
Balance at beginning of period | $ | 4,313 | 5,104 | 5,340 | 3,634 | 3,775 | ||||||||||
Provision for loan losses | 600 | 675 | 1,680 | 3,555 | 2,622 | |||||||||||
Charge-offs: | ||||||||||||||||
Commercial, financial, and agricultural | 215 | 416 | 1,210 | 1,268 | 943 | |||||||||||
Real estate | 1,507 | 1,036 | 851 | 512 | 1,113 | |||||||||||
Consumer | 44 | 125 | 212 | 190 | 1,059 | |||||||||||
Total charge-offs | 1,766 | 1,577 | 2,273 | 1,970 | 3,115 | |||||||||||
Recoveries: | ||||||||||||||||
Commercial, financial and agricultural | 219 | 52 | 181 | 40 | 250 | |||||||||||
Real estate | 11 | 8 | 67 | 11 | 11 | |||||||||||
Consumer | 79 | 51 | 109 | 70 | 91 | |||||||||||
Total recoveries | 309 | 111 | 357 | 121 | 352 | |||||||||||
Net charge-offs | 1,457 | 1,466 | 1,916 | 1,849 | 2,763 | |||||||||||
Balance at end of period | $ | 3,456 | 4,313 | 5,104 | 5,340 | 3,634 | ||||||||||
Ratio of allowance for loan losses to loans outstanding | 1.33 | % | 1.68 | % | 1.96 | % | 1.96 | % | 1.38 | % | ||||||
Ratio of allowance for loan losses to nonaccrual loans, renegotiated loans, and other nonperforming assets | 423.53 | % | 253.11 | % | 163.90 | % | 47.52 | % | 41.93 | % | ||||||
Ratio of net charge-offs to average loans outstanding | 0.55 | % | 0.57 | % | 0.71 | % | 0.70 | % | 1.06 | % | ||||||
| Allowance for Loan Loss Activity for Year ended December 31, | ||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||
| (Dollars in thousands) | ||||||||||||||||
Balance at beginning of period | $ | 3,456 | 4,313 | 5,104 | 5,340 | 3,634 | ||||||||||
Provision for loan losses | 485 | 600 | 675 | 1,680 | 3,555 | |||||||||||
Charge-offs: | ||||||||||||||||
Commercial, financial and agricultural | 39 | 215 | 416 | 1,210 | 1,268 | |||||||||||
Real estate | 124 | 1,507 | 1,036 | 851 | 512 | |||||||||||
Consumer | 193 | 44 | 125 | 212 | 190 | |||||||||||
Total charge-offs | 356 | 1,766 | 1,577 | 2,273 | 1,970 | |||||||||||
Recoveries: | ||||||||||||||||
Commercial, financial and agricultural | 89 | 219 | 52 | 181 | 40 | |||||||||||
Real estate | 100 | 11 | 8 | 67 | 11 | |||||||||||
Consumer | 69 | 79 | 51 | 109 | 70 | |||||||||||
Total recoveries | 258 | 309 | 111 | 357 | 121 | |||||||||||
Net charge-offs | 98 | 1,457 | 1,466 | 1,916 | 1,849 | |||||||||||
Balance at end of period | $ | 3,843 | 3,456 | 4,313 | 5,104 | 5,340 | ||||||||||
Ratio of allowance for loan losses to loans outstanding | 1.36 | % | 1.38 | % | 1.76 | % | 2.01 | % | 2.04 | % | ||||||
Ratio of allowance for loan losses to nonaccrual loans, renegotiated loans, and other nonperforming assets | 3558.33 | % | 423.53 | % | 253.11 | % | 163.90 | % | 47.52 | % | ||||||
Ratio of net charge-offs to average loans outstanding | 0.13 | % | 0.58 | % | 0.59 | % | 0.73 | % | 0.71 | % | ||||||
The allowance for loan losses was $3,456,000 (1.33%$3,843,000 or 1.36% of total outstanding loans)loans at December 31, 2004,2005, compared to $4,313,000 (1.68%$3,456,000, or 1.38% of total outstanding loans)loans at December 31, 2003.2004. This decreaseincrease in the allowance isfor loan losses as of December 31, 2005 compared to December 31, 2004 was primarily due to loan growth. Although the provision for loan losses decreased in 2005, the allowance for loan losses as a percentage of total loans remained fairly consistent due to the decrease in charge-offs combined with loan growth in 2005. In 2004, there was one large charge-off in 2004for which the Company had allocated a specific allowance for, reduced loan growth, and improved performance in the loan portfolio as of December 31, 2004 compared to the same period in 2003.
The Bank has been engaged in enhanced reviews of its loan approval and credit grading processes. The Bank has sought to better price its loans consistent with its costs of funds and its assessment of potential credit risk. This has had the effect of slowing the Bank’s loan growth.
allowance. During 2004,2005, the Company had loan charge-offs totaling $1,766,000$356,000 and recoveries of $309,000,$258,000, as compared to $1,577,000$1,766,000 in charge-offs and recoveries of $111,000$309,000 in the prior year. Charge-offs increaseddecreased significantly in 2004 mainly2005 due to improved loan performance. Charge-offs for 2004 primarily consisted of the one large loan.
loan that was charged off.
Management believes that the $3,456,000$3,843,000 allowance for loan losses at December 31, 2004 (1.33%2005 (1.36% of total outstanding loans), is adequate to absorb known risks in the portfolio at such date. However, no assurance can be given that adverse economic circumstances generally, including current economic events, or other events, including additional loan review or examination findings or changes in borrowers’ financial conditions, will not result in increased losses in the Bank’s loan portfolio or in additional provisions to the allowance for loan losses. The Bank has been engaged in enhanced reviews of its loan approval and credit grading processes. The Bank has sought to better price its loans consistent with its costs of funds and its assessment of potential credit risk. The Bank does not currently allocate its allowance for loan losses among its various classifications of loans. The increase in the ratio of the allowance for loan losses to nonperforming assets between year-endyear end 2005 and year end 2004 was primarily due to the reduction in nonaccrual loans. The increase in the ratio of the allowance for loan losses to nonperforming assets between year end 2004 and year-endyear end 2003 was due to the reduction in nonaccrual loans and a decrease in the allowance for loan losses offset by an increase in other nonperforming assets. The increase in the ratio of the allowance for loan losses to nonperforming assets between year-end 2003 and year-end 2002 was primarily due to the reduction in nonaccrual loans and other real estate owned.
27
While management recognizes that there is more risk traditionally associated with commercial and consumer lending as compared to real estate mortgage lending, the Bank currently has a tiered approach to determine the adequacy of its allowance for loan losses. This methodology focuses on the determination of the specific and general loss allowances for certain loans classified as problem credits and uses a five-year historical loss factor to determine the loss allocation for the remainder of the loan portfolio as opposed to allocations based on major loan categories. Level I includes specific allowances that have been reserved for impaired loans where management has identified specific losses. Level II allowances are set aside to cover general losses associated with problem loans which possess more than a normal degree of credit risk, but where no specific losses have been identified. These loans have been criticized or classified by the Bank’s regulators, external loan review personnel engaged by the Bank, or internally by management. The five-year historical loss factors, subject to certain minimum percentages considering regulatory guidelines, are applied to the Level II problem loans in determining the allocation. Level III is the allowance for the balance of the loan portfolio. The loans in this tier consist of all loans that are not classified as Level I or Level II problem credits, and less risk-free loans. Risk-free loans are defined as loans fully secured by cash or cash equivalents and readily marketable collateral. Local economic conditions are considered in determining the adequacy of the Company’s allowance for loan losses. The allocation for Level III is determined by applying the historical loss factor, derived from prior years’ actual experience, to the adjusted outstanding balance for this classification. At December 31, 2004,2005, the allowance for loan losses was allocated to approximately $196 thousand for impaired loans (Level 1), approximately $1.8$2.3 million for criticized and classified loans (Level II) and approximately $1.5 million for the general reserve (Level III). Since there were no impaired loans at December 31, 2005, none of the allowance for loan losses is allocated for impaired loans (Level I).
At December 31, 2005, the Company had no impaired loans. At December 31, 2004, the Company had approximately $677,000 of impaired loans, which included 3three loans to 3three borrowers with a total valuation allowance of approximately $177,000. At December 31, 2003, the Company had approximately $471,000 of impaired loans, which included 4 loans to 2 borrowers with a total valuation allowance of approximately $309,000.
Nonperforming Assets
Nonperforming assets consist of loans on nonaccrual status, loans that have been renegotiated at terms more favorable to the borrower than those for similar credits, real estate and other assets acquired in partial or full satisfaction of loan obligations and accruing loans that are past due 90 days or more.
Nonperforming assets were $108,000, $816,000 $1,704,000, and $3,114,000$1,704,000 at December 31, 2005, 2004 2003, and 2002,2003, respectively. These levels represent a decrease of $708,000 or 86.8% for the year ended December 31, 2005, and a decrease of $888,000 (52.1%) for the year ended December 31, 2004, and a decrease of $1,410,000 (45.3%) for the year ended December 31, 2003.2004. The decrease in 2004 was mainly due to a decrease in nonaccrual loans. The decrease in 20032005 was mainly due to a decrease in nonaccrual loans and other real estate owned. The decrease in 2004 was mainly due to a decrease in nonaccrual loans.
28
An analysis of the components of nonperforming assets at the end of the last five years is presented in the following table:
Nonperforming Assets December 31, | ||||||||||||||||
| 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||
| (Dollars in thousands) | ||||||||||||||||
Nonaccrual loans | $ | 711 | 1,704 | 2,532 | 10,211 | 7,793 | ||||||||||
Renegotiated loans | — | — | — | — | — | |||||||||||
Other nonperforming assets (primarily other real estate) | 105 | — | 582 | 1,026 | 874 | |||||||||||
Accruing loans 90 days or more past due | — | — | — | 1,469 | 28 | |||||||||||
Total nonperforming assets | $ | 816 | 1,704 | 3,114 | 12,706 | 8,695 | ||||||||||
Nonaccrual loans and renegotiated loans as a percentage of total loans | 0.27 | % | 0.66 | % | 0.97 | % | 3.76 | % | 2.97 | % | ||||||
Nonaccrual loans, renegotiated loans and other nonperforming assets as a percentage of total loans | 0.32 | % | 0.66 | % | 1.20 | % | 4.13 | % | 3.30 | % | ||||||
Total nonperforming assets as a percentage of total loans | 0.32 | % | 0.66 | % | 1.20 | % | 4.67 | % | 3.31 | % | ||||||
| Nonperforming Assets December 31, | ||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||
| (Dollars in thousands) | ||||||||||||||||
Nonaccrual loans | $ | 108 | 711 | 1,704 | 2,532 | 10,211 | ||||||||||
Renegotiated loans | — | — | — | — | — | |||||||||||
Other nonperforming assets (primarily other real estate) | — | 105 | — | 582 | 1,026 | |||||||||||
Accruing loans 90 days or more past due | — | — | — | — | 1,469 | |||||||||||
Total nonperforming assets | $ | 108 | 816 | 1,704 | 3,114 | 12,706 | ||||||||||
Nonaccrual loans and renegotiated loans as a percentage of total loans | 0.04 | % | 0.28 | % | 0.70 | % | 1.00 | % | 3.89 | % | ||||||
Nonaccrual loans, renegotiated loans and other nonperforming assets as a percentage of total loans | 0.04 | % | 0.32 | % | 0.70 | % | 1.22 | % | 4.28 | % | ||||||
Total nonperforming assets as a percentage of total loans | 0.04 | % | 0.32 | % | 0.70 | % | 1.22 | % | 4.84 | % | ||||||
If nonaccrual loans had performed in accordance with their original contractual terms, interest income would have increased approximately $36,000, $92,000 $180,000, and $462,000$180,000 for the years ended December 31, 2005, 2004 2003 and 2002,2003, respectively. The Company did not recognize any interest income on nonaccrual loans for the years ended December 31, 2005, 2004 2003 and 2002.
2003.
Other Potential Problem Loans
Potential problem loans consist of those loans where management has serious doubts as to the borrower’s ability to comply with the present loan repayment terms. At December 31, 2004,2005, the Company had identified 6965 loans totaling approximately $3,260,000,$5,365,000, or 1.3%1.9% of total loans, which were considered potential problem loans. At December 31, 2003,2004, the Company had identified 7869 loans totaling approximately $8,876,000,$3,260,000, or 3.5%1.3% of total loans, which were considered potential problem loans. Such loans have been considered in the determination of the Level II allowance previously discussed.
Deposits
Total deposits decreased $4,703,000 (1.1%)increased $25,656,000 or 6.0% to $454,995,000 at December 31, 2005, as compared to $429,339,000 at December 31, 2004, as compared to $434,042,0002004. Noninterest-bearing deposits were $70,784,000 and $65,364,000 while total interest-bearing deposits were $384,211,000 and $363,975,000 at December 31, 2003. Noninterest-bearing deposits were $65,364,0002005 and $60,507,000 while total
interest-bearing deposits were $363,975,000 and $373,535,000 at December 31, 2004, and 2003, respectively. This trend is the result of management’s decision to maintain a competitive position in its deposit rate structure coupled with the Bank’s marketing efforts to attract local deposits and fund its loan growth. At December 31, 2005, as a percentage of total deposits, noninterest-bearing accounts comprised approximately 15.6%, while MMDAs, NOWs and regular savings made up approximately 44.6%, certificates of deposit under $100,000 comprised approximately 18.7%, and certificates of deposit and other time deposits of $100,000 or more comprised 21.1%. At December 31, 2004, as a percentage of total deposits, noninterest-bearing accounts comprised approximately 15.2%, while MMDAs, NOWs and regular savings made up approximately 42.3%, certificates of deposit under $100,000 comprised approximately 20.3%, and certificates of deposit and other time deposits of $100,000 or more comprised 22.2%. At December 31, 2003, as a percentage of total deposits, noninterest-bearing accounts comprised approximately 13.9%, while MMDAs, NOWs and regular savings made up approximately 42.5%, certificates of deposit under $100,000 comprised approximately 19.7%, and certificates of deposit and other time deposits of $100,000 or more comprised 23.9%.
29
The composition of total deposits for the last three years is presented in the following table:
| December 31, | ||||||||||||||||
| 2004 | 2003 | 2002 | ||||||||||||||
| Amount | % Change from prior year end | Amount | % Change from prior year end | Amount | % Change from prior year end | |||||||||||
| (Dollars in thousands) | ||||||||||||||||
Demand deposits | $ | 65,364 | 8.03 | % | 60,507 | 13.91 | % | 53,119 | 10.09 | % | ||||||
Interest bearing deposits: | ||||||||||||||||
NOWs | 64,938 | -25.66 | % | 87,353 | 26.69 | % | 68,950 | 15.48 | % | |||||||
MMDAs | 96,983 | 22.95 | % | 78,881 | 9.27 | % | 72,189 | 1.68 | % | |||||||
Savings | 19,656 | 9.04 | % | 18,026 | 20.71 | % | 14,933 | 8.98 | % | |||||||
Certificates of deposit under $100,000 | 87,185 | 2.09 | % | 85,401 | -4.95 | % | 89,848 | 1.97 | % | |||||||
Certificates of deposit and other time deposits of $100,000 and over | 95,213 | -8.34 | % | 103,874 | 8.03 | % | 96,152 | 8.16 | % | |||||||
Total interest bearing deposits | 363,975 | -2.56 | % | 373,535 | 9.20 | % | 342,072 | 6.43 | % | |||||||
Total deposits | $ | 429,339 | -1.08 | % | 434,042 | 9.83 | % | 395,191 | 6.90 | % | ||||||
| December 31, | ||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||
| Amount | % Change from prior year end | Amount | % Change from prior year end | Amount | % Change from prior year end | |||||||||||
| (Dollars in thousands) | ||||||||||||||||
Demand deposits | $ | 70,784 | 8.29 | % | 65,364 | 8.03 | % | 60,507 | 13.91 | % | ||||||
Interest bearing deposits: | ||||||||||||||||
NOWs | 68,203 | 5.03 | % | 64,938 | -25.66 | % | 87,353 | 26.69 | % | |||||||
MMDAs | 115,415 | 19.01 | % | 96,983 | 22.95 | % | 78,881 | 9.27 | % | |||||||
Savings | 19,573 | -0.42 | % | 19,656 | 9.04 | % | 18,026 | 20.71 | % | |||||||
Certificates of deposit under $100,000 | 84,967 | -2.54 | % | 87,185 | 2.09 | % | 85,401 | -4.95 | % | |||||||
Certificates of deposit and other time deposits of $100,000 and over | 96,053 | 0.88 | % | 95,213 | -8.34 | % | 103,874 | 8.03 | % | |||||||
Total interest bearing deposits | 384,211 | 5.56 | % | 363,975 | -2.56 | % | 373,535 | 9.20 | % | |||||||
Total deposits | $ | 454,995 | 5.98 | % | 429,339 | -1.08 | % | 434,042 | 9.83 | % | ||||||
The average balances outstanding and the average rates paid for certain categories of deposits at the end of the last three years are disclosed in the “Consolidated Average Balances, Interest Income/Expense and Yields/Rates” table immediately following:
30
AUBURN NATIONAL BANCORPORATION, INC. & SUBSIDIARY
Consolidated Average Balances, Interest Income/Expense and Yields/Rates
Taxable Equivalent Basis
| Twelve Months Ended December 31, | Twelve Months Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | ||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ASSETS | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Loans, net of unearned income (1) | $ | 262,800 | 15,807 | 6.01 | % | 256,431 | 16,299 | 6.36 | % | 268,878 | 18,460 | 6.87 | % | $ | 275,972 | 18,390 | 6.66 | % | 262,800 | 15,807 | 6.01 | % | 256,431 | 16,299 | 6.36 | % | |||||||||||||||||||||||||||||
Investment securities: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Taxable | 252,482 | 9,821 | 3.89 | % | 214,109 | 8,225 | 3.84 | % | 164,159 | 8,872 | 5.40 | % | 234,577 | 9,475 | 4.04 | % | 252,482 | 9,821 | 3.89 | % | 214,109 | 8,225 | 3.84 | % | |||||||||||||||||||||||||||||||
Tax-exempt (2) | 33,307 | 2,148 | 6.45 | % | 7,093 | 476 | 6.71 | % | 3,685 | 261 | 7.08 | % | 44,892 | 2,814 | 6.27 | % | 33,307 | 2,148 | 6.45 | % | 7,093 | 476 | 6.71 | % | |||||||||||||||||||||||||||||||
Total investment securities | 285,789 | 11,969 | 4.19 | % | 221,202 | 8,701 | 3.93 | % | 167,844 | 9,133 | 5.44 | % | 279,469 | 12,289 | 4.40 | % | 285,789 | 11,969 | 4.19 | % | 221,202 | 8,701 | 3.93 | % | |||||||||||||||||||||||||||||||
Federal funds sold | 8,819 | 118 | 1.34 | % | 8,130 | 92 | 1.13 | % | 13,243 | 214 | 1.62 | % | 8,254 | 261 | 3.16 | % | 8,819 | 118 | 1.34 | % | 8,130 | 92 | 1.13 | % | |||||||||||||||||||||||||||||||
Interest-earning deposits with other banks | 955 | 13 | 1.36 | % | 797 | 10 | 1.25 | % | 1,510 | 34 | 2.25 | % | 1,276 | 38 | 2.98 | % | 955 | 13 | 1.36 | % | 797 | 10 | 1.25 | % | |||||||||||||||||||||||||||||||
Total interest-earning assets | 558,363 | 27,907 | 5.00 | % | 486,560 | 25,102 | 5.16 | % | 451,475 | 27,841 | 6.17 | % | 564,971 | 30,978 | 5.48 | % | 558,363 | 27,907 | 5.00 | % | 486,560 | 25,102 | 5.16 | % | |||||||||||||||||||||||||||||||
Allowance for loan losses | (4,378 | ) | (4,918 | ) | (5,368 | ) | (3,722 | ) | (4,378 | ) | (4,918 | ) | |||||||||||||||||||||||||||||||||||||||||||
Cash and due from banks | 11,078 | 12,838 | 14,719 | 11,985 | 11,078 | 12,838 | |||||||||||||||||||||||||||||||||||||||||||||||||
Premises and equipment | 2,764 | 3,077 | 3,256 | 2,559 | 2,764 | 3,077 | |||||||||||||||||||||||||||||||||||||||||||||||||
Rental property, net | 1,376 | 1,475 | 1,564 | 1,297 | 1,376 | 1,475 | |||||||||||||||||||||||||||||||||||||||||||||||||
Other assets | 21,106 | 17,796 | 18,183 | 22,857 | 21,106 | 17,796 | |||||||||||||||||||||||||||||||||||||||||||||||||
Total assets | $ | 590,309 | 516,828 | 483,829 | $ | 599,947 | 590,309 | 516,828 | |||||||||||||||||||||||||||||||||||||||||||||||
| LIABILITIES & STOCKHOLDERS’ EQUITY | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Deposits: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
NOWs | $ | 76,313 | 864 | 1.13 | % | 75,307 | 959 | 1.27 | % | 64,074 | 1,114 | 1.74 | % | $ | 66,472 | 1,201 | 1.81 | % | 76,313 | 864 | 1.13 | % | 75,307 | 959 | 1.27 | % | |||||||||||||||||||||||||||||
Savings and money market | 118,218 | 1,723 | 1.46 | % | 91,738 | 1,456 | 1.59 | % | 90,305 | 1,884 | 2.09 | % | 121,961 | 2,962 | 2.43 | % | 118,218 | 1,723 | 1.46 | % | 91,738 | 1,456 | 1.59 | % | |||||||||||||||||||||||||||||||
Certificates of deposits less than $100,000 | 87,581 | 2,937 | 3.35 | % | 87,621 | 3,057 | 3.49 | % | 88,673 | 3,782 | 4.27 | % | 86,670 | 3,296 | 3.80 | % | 87,581 | 2,937 | 3.35 | % | 87,621 | 3,057 | 3.49 | % | |||||||||||||||||||||||||||||||
Certificates of deposits and other time deposits of $100,000 or more | 94,032 | 2,601 | 2.77 | % | 97,615 | 3,076 | 3.15 | % | 93,176 | 3,393 | 3.64 | % | 100,213 | 3,061 | 3.05 | % | 94,032 | 2,601 | 2.77 | % | 97,615 | 3,076 | 3.15 | % | |||||||||||||||||||||||||||||||
Total interest-bearing deposits | 376,144 | 8,125 | 2.16 | % | 352,281 | 8,548 | 2.43 | % | 336,228 | 10,173 | 3.03 | % | 375,316 | 10,520 | 2.80 | % | 376,144 | 8,125 | 2.16 | % | 352,281 | 8,548 | 2.43 | % | |||||||||||||||||||||||||||||||
Federal funds purchased and securities sold under agreements to repurchase | 2,632 | 32 | 1.22 | % | 4,279 | 48 | 1.12 | % | 3,295 | 53 | 1.61 | % | 2,675 | 91 | 3.40 | % | 2,632 | 32 | 1.22 | % | 4,279 | 48 | 1.12 | % | |||||||||||||||||||||||||||||||
Other borrowed funds | 103,345 | 4,351 | 4.21 | % | 59,201 | 2,826 | 4.77 | % | 53,513 | 2,955 | 5.52 | % | 105,431 | 4,710 | 4.47 | % | 103,345 | 4,351 | 4.21 | % | 59,201 | 2,826 | 4.77 | % | |||||||||||||||||||||||||||||||
Total interest-bearing liabilities | 482,121 | 12,508 | 2.59 | % | 415,761 | 11,422 | 2.75 | % | 393,036 | 13,181 | 3.35 | % | 483,422 | 15,321 | 3.17 | % | 482,121 | 12,508 | 2.59 | % | 415,761 | 11,422 | 2.75 | % | |||||||||||||||||||||||||||||||
Noninterest-bearing deposits | 62,900 | 55,005 | 48,426 | 68,408 | 62,900 | 55,005 | |||||||||||||||||||||||||||||||||||||||||||||||||
Accrued expenses and other liabilities | 3,803 | 5,843 | 5,352 | 2,758 | 3,803 | 5,843 | |||||||||||||||||||||||||||||||||||||||||||||||||
Stockholders’ equity | 41,485 | 40,219 | 37,015 | 45,359 | 41,485 | 40,219 | |||||||||||||||||||||||||||||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 590,309 | 516,828 | 483,829 | $ | 599,947 | 590,309 | 516,828 | |||||||||||||||||||||||||||||||||||||||||||||||
Net interest income | $ | 15,399 | $ | 13,680 | 14,660 | $ | 15,657 | $ | 15,399 | $ | 13,680 | ||||||||||||||||||||||||||||||||||||||||||||
Net yield on total interest-earning assets | 2.76 | % | 2.81 | % | 3.25 | % | 2.77 | % | 2.76 | % | 2.81 | % | |||||||||||||||||||||||||||||||||||||||||||
| (1) | Loans on nonaccrual status have been included in the computation of average balances. |
| (2) | Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%. |
31
The following table presents the maturities of certificates of deposit and other time deposits of $100,000 or more:
Maturities of Time Deposits over $100,000 December 31, 2004 | ||||
| (Dollars in thousands) | ||||
Three months or less | $ | 19,185 | ||
After three within six months | 37,351 | |||
After six within twelve months | 20,879 | |||
After twelve months | 17,798 | |||
Total | $ | 95,213 | ||
Weighted Average rate on time deposits of $100,000 or more at period end | 3.25 | % | ||
| Maturities of Time Deposits over $100,000 December 31, 2005 | ||||
| (Dollars in thousands) | ||||
Three months or less | $ | 8,328 | ||
After three within six months | 12,976 | |||
After six within twelve months | 23,315 | |||
After twelve months | 51,434 | |||
Total | $ | 96,053 | ||
Weighted Average rate on time deposits of $100,000 or more at period end | 3.83 | % | ||
Schedule of Short-term Borrowings(1)
The following table shows the maximum amount of short-term borrowings and the average and year-end amount of borrowings, as well as interest rates.
Year ended December 31 | Maximum Outstanding at any Month-end | Average Balance | Interest Rate During Year | Ending Balance | Weighted Average Interest Rate at Year-end | Maximum Outstanding at any Month-end | Average Balance | Interest Rate During Year | Ending Balance | Weighted Average Interest Rate at Year-end | ||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||
| (Dollars in thousands) | (Dollars in thousands) | |||||||||||||||||||||||||||||
| 2005 | $ | 4,078 | $ | 2,502 | 3.18 | % | $ | 1,731 | 3.91 | % | ||||||||||||||||||||
2004 | $7,613 | $ | 2,525 | 1.20 | % | $ | 7,613 | 2.23 | % | 7,613 | 2,525 | 1.20 | % | 7,613 | 2.23 | % | ||||||||||||||
2003 | 8,493 | 3,192 | 1.02 | % | 6,654 | 0.89 | % | 8,493 | 3,192 | 1.02 | % | 6,654 | 0.89 | % | ||||||||||||||||
2002 | 11,989 | 3,265 | 1.60 | % | 11,989 | 1.19 | % | |||||||||||||||||||||||
| (1) | Consists of securities sold under agreements to repurchase. |
Other Borrowed Funds and Contractual Obligations
Other borrowed funds consist of Federal Home Loan Bank advances and notes payable.advances. The following table outlines the Company’s other borrowed funds and contractual obligations as of December 31, 2004:2005:
| Payments Due by Period | ||||||||||||
| Total | Less than one year | One to five years | After five years | |||||||||
| (In thousands) | ||||||||||||
| Long-term debt: | ||||||||||||
FHLB advances | $ | 98,224 | $ | 18 | $ | 40,074 | $ | 58,132 | ||||
The Company has operating leases for certain bank premises and equipment primarily including computer equipment and copiers. In 2004, the Company paid $183,000 and $288,000 in premises and equipment leases, respectively.
| Payments Due by Period | |||||||||||||||
| Total | Less than one year | Over one | One to five years | After five years | |||||||||||
| (In thousands) | |||||||||||||||
Securities sold under agreements to repurchase | $ | 1,731 | $ | 1,731 | $ | — | $ | — | $ | — | |||||
FHLB advances | 98,205 | 18 | 10,037 | 25,036 | 63,114 | ||||||||||
Operating lease obligations | 874 | 327 | 441 | 106 | — | ||||||||||
Note payable to trust | 7,217 | — | — | — | 7,217 | ||||||||||
Total | $ | 108,027 | $ | 2,076 | $ | 10,478 | $ | 25,142 | $ | 70,331 | |||||
Note Payable to Trust
In November 2003, theThe Company formedhas a wholly owned Delaware statutory trust, Auburn National Bancorporation Capital Trust I. This unconsolidated subsidiary issued approximately $7$7.0 million in preferred trust securities. The Company obtained these proceeds through a note payable to trust (junior subordinated debentures). Approximately $5 million of proceeds were given to the Bank in the form of a dividend. This additional capital allowed the Bank to borrow additional funds from the FHLB. These funds along with some brokered CDs were used to buy additional investment securities available for sale as part of a leverage transaction. The remaining $2 million were used for the stock repurchase program. As of December 31, 2005 and 2004, and 2003, $7,217,000$7,000,000 of the note payable to trust was classified as Tier 1 Capital for regulatory purposes. For regulatory purposes, the trust preferred securities represent a minority investment in a consolidated subsidiary, which is currently included in Tier 1 Capital so long as it does not exceed 25% of total Tier 1 capital. Under Financial Accounting Standards Board (FASB) Interpretation No.46No. 46 (FIN 46) and Revised Amendment to FIN 46 (FIN 46R),
however, the trust subsidiary must be deconsolidated for accounting purposes. As a result of this accounting pronouncement, the Federal Reserve Board on March 1,
32
2005 announced changes to its capital adequacy rules, including the capital treatment of trust preferred securities. The Federal Reserve’s new rules, which will taketook effect in early April 2005, will permit the Company to continue to treat its outstanding trust preferred securities as Tier 1 Capital for the first 25 years of the 30 year term of the related junior subordinated notes. During the last five years preceding maturity, the amount included as capital will decline 20% per year. We believe that theThe Federal Reserve’s final rule with respect to the capital treatment of trust preferred securities willdid not adversely affect ourthe Company and the Bank’s regulatory capital and that the Company and the Bank’s capital ratios will remainremained at an adequate level to allow the Company and the Bank to continue to be “well capitalized” under applicable banking regulations.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such instruments involve elements of credit risk in excess of the amounts recognized in the consolidated financial statements.
The Company’s exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheeton-balance sheet instruments.
The financial instruments whose contract amounts represent credit risk as of December 31, 20042005 are as follows:
Commitments to extend credit | $ | 50,337,000 | |
Standby letters of credit | 4,149,000 |
Commitments to extend credit | $ | 50,252,000 | |
Standby letters of credit | 5,788,000 |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. All guarantees expire within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary.
Capital Resources and Stockholders’ Equity
The Company’s consolidated stockholders’ equity was $44,504,000$43,954,000 and $40,408,000$44,504,000 at December 31, 2005 and 2004, and 2003, respectively, an increasea decrease of $4,096,000 (10.1%)$550,000 or 1.2%. The decrease in stockholders’ equity for 2005 is mainly due to a decrease in the fair value of investment securities available for sale as well as cash dividends paid in 2005. This is offset by net earnings for 2005. The increase in stockholders’ equity for 2004 is mainly due to an increase in net earnings and the fair value of investment securities available for sale. This is offset by cash dividends for 2004. The increase in stockholders’ equity for 2003 is mainly due to an increase in net earnings offset by cash dividends for 2003 and the decrease in the fair value of investment securities available for sale. The Company has funded its capital growth primarily through retained earnings since its 1995 common stock offering. In November 2003, theThe Company issuedhas $7.0 million of trust preferred securities that count as Tier 1 Capital for regulatory purposes. See “ S“SUPERVISIONAND REGULATION.”
During 2004,2005, cash dividends of $1,934,000$2,220,000 or $0.50$0.58 per share, were declared on the Common Stock as compared to $1,870,000$1,934,000 or $0.48$0.50 per share, in 2003.2004. The Company plans to continue a dividend payout policy that provides cash returns to its investors and allows the Company to maintain adequate capital to support future growth and capital adequacy; however, the Company is dependent on dividends from the Bank as discussed subsequently. Management believes that a strong capital position is important to the continued profitability of the Company and provides a foundation for future growth as well as promoting depositor and investor confidence in the institution. See “SUPERVISIONAND REGULATION.”
33
Certain financial ratios for the Company for the last three years are presented in the following table:
| Equity and Asset Ratios December 31, | |||||||||
| 2004 | 2003 | 2002 | |||||||
Return on average assets | 1.10 | % | 1.05 | % | 1.04 | % | |||
Return on average equity | 15.69 | % | 13.47 | % | 13.66 | % | |||
Dividend payout ratio | 29.76 | % | 34.53 | % | 33.85 | % | |||
Average equity to average asset ratio | 7.03 | % | 7.78 | % | 7.65 | % | |||
Equity and Asset Ratios December 31, | |||||||||
| 2005 | 2004 | 2003 | |||||||
Return on average assets | 1.08 | % | 1.10 | % | 1.05 | % | |||
Return on average equity | 14.26 | % | 15.69 | % | 13.47 | % | |||
Dividend payout ratio | 34.32 | % | 29.76 | % | 34.53 | % | |||
Average equity to average asset ratio | 7.56 | % | 7.03 | % | 7.78 | % | |||
The Bank is subject to the regulatory capital requirements administered by the Federal Reserve and the Company must maintain capital required by the Alabama Superintendent. Failure to meet minimum capital requirements can initiate certain mandatory actions, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Management believes, as of December 31, 2004,2005, that the Bank meets all capital adequacy requirements to which it is subject. See “SUPERVISIONAND REGULATION.”
The following table sets forth the Bank’s actual capital levels and the related required capital levels at December 31, 2004:2005:
| Actual Capital Amount | Actual Ratio | Required Capital Amount | Required Ratio | |||||||||
| (Dollars in thousands) | ||||||||||||
Tier 1 risk-based capital | $ | 48,443 | 15.08 | % | $ | 12,850 | ³ 4 | % | ||||
Leverage ratio | 48,443 | 8.29 | % | 23,576 | 3 - 5 | % | ||||||
Total risk-based capital | 51,899 | 16.15 | % | 25,700 | ³ 8 | % | ||||||
| Actual Capital Amount | Actual Ratio | Required Capital Amount | Required Ratio | |||||||||
| (Dollars in thousands) | ||||||||||||
Tier 1 risk-based capital | $ | 53,003 | 15.22 | % | $ | 13,925 | > 4 | % | ||||
Leverage ratio | 53,003 | 8.78 | % | 24,251 | 3 -5 | % | ||||||
Total risk-based capital | 56,846 | 16.33 | % | 27,851 | > 8 | % | ||||||
Liquidity
Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand and maturing liabilities. Without proper management, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.
At the Bank, asset liquidity is provided primarily through cash, the repayment and maturity of investment securities, and the sale and repayment of loans.
Sources of liability liquidity include customer deposits, federal funds purchased and investment securities sold under agreements to repurchase. Although deposit growth historically has been a primary source of liquidity, such balances may be influenced by changes in the banking industry, interest rates available on other investments, general economic conditions, competition and other factors. The Bank has participated in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and are taken out with varying maturities. This line is collateralized by a blanket lien against the Bank’s one to fourone-to-four family residential mortgage loans and investment securities. At December 31, 2004,2005, the Bank had $98,224,000$98,205,000 in advances from FHLB.
Overall, net cash used in financing activities decreased $90,521,000 (108.1%) to $6,775,000 during 2004 from the previous year’s net cash provided by of $83,746,000. Net cash provided by operating activities increased $4,507,000 (57.0%)of $7,877,000 for the twelve months ended December 31, 2005 consisted primarily of net earnings of $6,470,000. In addition, the Company had $87,110,000 in proceeds from the sale of loans that were originated for resale. This was offset by $86,400,000 in loans were originated for resale. Net cash used in investing
34
activities of $26,725,000 principally resulted from investment securities purchases of $72,388,000 and an increase in loans of $25,609,000. This is offset by proceeds from maturities, calls and paydowns of investment securities available for sale and held to maturity of $39,055,000 and proceeds from sales of investment securities available for sale of $33,346,000. The $16,358,000 in net cash provided by financing activities resulted primarily from an increase of $7,906,000 for$20,236,000 in interest-bearing deposits and an increase of $5,421,000 in non-interest bearing deposits. In addition, securities sold under agreements to repurchase decreased by $5,882,000 and the year ended December 31, 2003. Cash used in investing activities during 2004 approximated $5,545,000.
Company paid cash dividends of $2,220,000.
The Company depends mainly on dividends, management fees and lease payments from the Bank for its liquidity. The Company only receives cash dividends from the Bank if the cash flow from other sources is not sufficient to maintain a positive cash flow, also giving consideration to regulatory restrictions. Accordingly, the Bank paid the Company $3,199,000, $2,237,000, $1,870,000, and $1,712,000$1,870,000 in cash dividends for 2005, 2004, 2003, and 20022003 respectively. The Company provides services to the Bank for which it is paid a management fee comparable to the fee an unaffiliated vendor would receive. In addition, the Bank leases premises and equipment from the Company for its operations. Leases between the Bank and the Company are based on the same terms and conditions as leases to unaffiliated parties leasing space in the same building. The Bank paid the Company $27,000$17,000 and $44,000$27,000 in management fees for the years ended December 31, 20042005 and 2003,2004, respectively. The Bank also paid $188,000$180,000 and $188,000 in lease payments for the years ended December 31, 20042005 and 2003,2004, respectively. These funds were used to pay operating expenses and fund dividends to the Company’s shareholders. In addition, the Bank makes transfers to the Company, under its Tax Sharing Agreement, for payment of consolidated tax obligations. The Tax Sharing Agreement calls for the allocation of the consolidated tax liability or benefit between the Company and each subsidiary based on their individual tax positions as if each entity filed a separate tax return.
The Bank has increased its loan to deposit ratio to 60.31%61.99% at December 31, 20042005 from 59.23%58.49% at December 31, 2003.2004. The Bank has been monitoring its liquidity, and has sought to better price its loans consistent with its costs of funds and the Bank’s assessment of potential credit risk.
Interest Rate Sensitivity Management
An integral part of the funds management of the Company and the Bank is to maintain a reasonably balanced position between interest rate sensitive assets and liabilities. The Bank’s Asset/Liability Management Committee (“ALCO”ALCO Committee”) is charged with the responsibility of managing, to the degree prudently possible, its exposure to “interest rate risk,” while attempting to provide earnings enhancement opportunities. The dollar difference between rate sensitive assets and liabilities for a given period of time is referred to as the rate sensitive gap (“GAP”). A GAP ratio is calculated by dividing rate sensitive assets by rate sensitive liabilities. Due to the nature of the Bank’s balance sheet structure and the market approach to pricing of liabilities, management and the Board of Directors recognize that achieving a perfectly matched GAP position in any given time frame would be extremely rare. ALCO Committee has determined that an acceptable level of interest rate risk would be for net interest income to fluctuate no more than 10.0% given a change in selected interest rates of up or down 200 basis points over any 12-month period. Using an increase of 200 basis points and a decrease of 200 basis points, at December 31, 2004,2005, the Bank’s net interest income would increase approximately 0.62%2.36% in a risingfalling rate environment and would decrease approximately 7.83%0.95% in a fallingrising rate environment. Interest rate scenario models are prepared using software created and licensed by The Bankers Bank.
For purposes of measuring interest rate sensitivity, Company management provides growth assumptions to incorporate over the 12-month period. Although demand and savings accounts are subject to immediate withdrawal, all passbook savings and regular NOW accounts are reflected in the model as repricing based on The Bankers Bank model standards. For repricing GAP, these accounts are repricing immediately.
Certificates of deposit are spread according to their contractual maturity. Investment securities and loans reflect either the contractual maturity, call date, repricing date or in the case of mortgage-related products, a market prepayment assumption.
December 31, 2004 One to Three Four to Twelve One to Five Over Five Years and Non-rate Earning Assets: Loans Taxable investment securities Tax-exempt investment securities Federal funds sold Interest earning deposits with other banks Total earning assets Interest bearing liabilities: NOW Savings and money market Certificates of deposit less than $100,000 Certificates of deposit and other time deposits of $100,000 or more Federal funds purchased and securities sold under agreements to repurchase FHLB and other borrowings Total interest bearing liabilities Interest sensitivity gap Cumulative interest sensitivity gap Interest Sensitivity Analysis Immediate
Months
Months
Years
Sensitive Total (In thousands) $ — 121,311 28,289 96,033 13,310 258,943 — 21,448 29,849 128,727 59,786 239,810 — 171 61 7,557 34,600 42,389 17,394 — — — — 17,394 705 — — — — 705 18,099 142,930 58,199 232,317 107,696 559,241 — 49,401 15,537 — — 64,938 — 80,191 36,448 — — 116,639 — 20,792 27,283 39,110 — 87,185 — 19,516 37,728 33,029 4,940 95,213 7,613 — — — — 7,613 — — — 40,000 58,224 98,224 7,613 169,900 116,996 112,139 63,164 469,812 10,486 (26,970 ) (58,797 ) 120,178 44,532 89,429 $ 10,486 (16,484 ) (75,281 ) 44,897 89,429
35
Interest Sensitivity Analysis December 31, 2005 | ||||||||||||||||
| Immediate | One to Three Months | Four to Twelve Months | One to Five Years | Over Five Years and Non-rate Sensitive | Total | |||||||||||
| (In thousands) | ||||||||||||||||
Earning Assets: | ||||||||||||||||
Loans (1) | $ | — | 148,768 | 31,471 | 95,630 | 7,590 | 283,459 | |||||||||
Taxable investment securities | — | 18,323 | 24,118 | 115,200 | 68,281 | 225,922 | ||||||||||
Tax-exempt investment securities | — | — | 480 | 8,898 | 39,660 | 49,038 | ||||||||||
Federal funds sold | 10,237 | — | — | — | — | 10,237 | ||||||||||
Interest-earning deposits with other banks | 2,141 | — | — | — | — | 2,141 | ||||||||||
Total interest-earning assets | 12,378 | 167,091 | 56,069 | 219,728 | 115,531 | 570,797 | ||||||||||
Interest-bearing liabilities: | ||||||||||||||||
NOW | — | 35,219 | 5,220 | 27,764 | — | 68,203 | ||||||||||
Savings and money market | — | 116,396 | 2,943 | 15,649 | — | 134,988 | ||||||||||
Certificates of deposits less than $100,000 | 6,881 | 10,590 | 30,739 | 36,757 | — | 84,967 | ||||||||||
Certificates of deposits and other time deposits of $100,000 or more | 8,378 | 6,470 | 33,467 | 47,738 | — | 96,053 | ||||||||||
Federal funds purchased and securities sold under agreements to repurchase | 1,731 | — | — | — | — | 1,731 | ||||||||||
Other borrowed funds | — | — | 10,000 | 25,000 | 63,205 | 98,205 | ||||||||||
Total interest-bearing liabilities | 16,990 | 168,675 | 82,369 | 152,908 | 63,205 | 484,147 | ||||||||||
Interest sensitivity gap | (4,612 | ) | (1,584 | ) | (26,300 | ) | 66,820 | 52,326 | 86,650 | |||||||
Cumulative interest sensitivity gap | $ | (4,612 | ) | (6,196 | ) | (32,496 | ) | 34,324 | 86,650 | |||||||
| (1) | includes loans held for sale |
The interest sensitive assets at December 31, 2004,2005, that reprice or mature within 12 months were $219,228,000$235,538,000 while the interest sensitive liabilities that reprice or mature within the same time frame were $294,509,000.$268,034,000. At December 31, 2004,2005, the 12 month cumulative GAP position was a negative $75,281,000$32,496,000 resulting in a GAP ratio of interest sensitive assets to interest sensitive liabilities of 0.74%0.88%. This negative GAP indicates that the Company has more interest-bearing liabilities than interest-earning assets that reprice within the GAP period. The Bank’s ALCO Committee realizes that GAP is limited in scope since it does not capture all the options of repricing opportunities in the balance sheet. Therefore, the ALCO Committee places its emphasis on Income at Risk and Economic Value of Equity measurements.
The Bank enters into interest rate protection contracts to help manage its interest rate exposure. These contracts include interest rate swaps, caps and floors. Interest rate swap transactions involve the exchange of fixed and floating rate interest payment obligations based on the underlying notional principal amounts. Interest rate caps and floors are purchased by the Bank for a non-refundable fixed amount. The Bank receives interest based on the underlying notional principal amount if the specified index rises above the cap rate or falls below the floor strike rate. Notional principal amounts are used to express the volume of these transactions, but because they are never exchanged, the amounts subject to credit risk are much smaller. Risks associated with interest rate contracts include interest rate risk and creditworthiness of the counterparty. These risks are considered in the Bank’s overall asset liability management program. The Bank utilizes periodic financial statements issued by the counterparty to analyze the creditworthiness of the counterparty prior to entering into a contract and to monitor changes in the financial condition of the counterparty throughout the term of the contract. Current contracts are issued by a securities broker-dealer and were entered into with the purpose of managing the Bank’s interest rate exposure. Although none of the interest rate protection agreements are traded on any organized exchange, an active secondary market is available to the Company for such contracts.
36
The Bank’s Asset Liability Management Policy states that establishing limits on interest rate swaps, caps and floors can be somewhat confusing or misleading since the notional amount by which these instruments are expressed is never exchanged between counterparties and therefore is not “at risk.” Furthermore, since they represent tools used by ALCO Committee to manage imbalances in the Bank’s balance sheet in a prudent and cost effective manner, the appropriate volume of swaps for the Bank is not static; it changes with elements such as the economic environment, the capital position and the ability to efficiently replicate hedging actions in the cash markets. The Bank endeavors to limit outstanding notional value of cash contracts executed for purposes of managing net interest income to 25% of total assets as reported in the most recent quarterly call report. Notional value of cash contracts executed with one counterparty are limited to 10% of total assets as reported in the Bank’s most recent quarterly call report.
As of December 31, 2005 and 2004, the Company had a cash flow hedge with a notional amount of $10 million for the purpose of converting the interest payments on floating rate money market accounts to a fixed rate. The Company will startstarted exchanging payments in March 2005 for this interest rate swap based on the three month Treasury bill investment rate. As of December 31, 2004, theThe Company recorded a liability for this swap of $8,000 and $216,000 for this swap.the years ended December 31, 2005 and 2004, respectively. This interest rate swap will mature in July 2007. There was not any material hedge ineffectiveness from this cash flow hedge recognized in the income statement.
Effects of Inflation and Changing Prices
Inflation generally increases the costs of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on the performance of a financial institution than the effects of general levels of inflation. In addition, inflation affects financial institutions’ cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings and stockholders’ equity. Mortgage originations and refinancings tend to slow as interest rates increase, and such increases likely will reduce the Company’s volume of such activities and the income from the sale of residential mortgage loans in the secondary market.
Pending Accounting Pronouncements
In March 2004, the SEC issued Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments.” Current accounting guidance requires the commitment to originate mortgage loans to be held for sale be recognized on the balance sheet at fair value from inception through expiration or funding. SAB 105 requires that the fair-value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. SAB 105 was effective for commitments to originate mortgage loans to be held for sale entered into after March 31, 2004. Its adoption did not have a material impact on the Company’s consolidated balance sheets or statement of earnings.
In March 2004,On November 13, 2003, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force reached a consensus on EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 provides This guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. Generally, an impairment is considered other-than-temporary unless: (i) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for an anticipated recovery of fair value up to (or beyond) the cost of the investment; and (ii) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. If impairment is determinedwas to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment’s cost and its fair value. Certain disclosure requirements of EITF 03-1 were adoptedapplied in 2003 and the Company began presenting the new disclosure requirements in its consolidated financial statements for the year ended December 31, 2003. The recognition and measurement provisions were initially effective for other-than-temporary impairment evaluations performed in reporting periods beginning after June 15, 2004. However,Disclosures were effective in September 2004,annual financial statements for fiscal years ended after December 31, 2003, for investments accounted for under SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities,and SFAS No. 124,Accounting for Certain Investments Held by Not-for-Profit Organizations.In 2005, the effective date of these provisions was delayed until the finalization of aFASB issued FASB Staff Position (FSP)(“FSB”) No 115-1,The Meaning of Other-Than-Temporary Impairment and Its Application to provide additional implementation guidance. ItsCertain Investments,which nullifies certain provisions of EITF Issue No. 03-1, while retaining the disclosure requirements that have been previously adopted by the Company. The adoption isof FSB No. 115-1 did not expectedhave a material impact on the Company’s financial statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004),Share-Based Payment(“SFAS No. 123R”), which revised SFAS No. 123,Accounting for Stock-Based Compensation. This statement supercedes APB Opinion No. 25,Accounting for Stock Issued to Employees(“APB 25”). The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of income.
On April 14, 2005, the SEC amended Rule 4-01(a) of Regulation S-X that amended the compliance date for SFAS No. 123R. The SEC’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period that begins after June 15, 2005.
On March 25, 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 provides guidance regarding the valuation of share-based payment arrangements, the classification of compensation expense, financial measures which do not follow accounting principles generally accepted in the United States (“GAAP”), first-time adoption of SFAS
37
No. 123R in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R and disclosures in Management’s Discussion and Analysis subsequent to adoption to SFAS No. 123R. The Company adopted SFAS 123R on January 1, 2006 and its adoption did not have a material impact on the consolidated balance sheets or statementstatements of earnings for the Company.
Statement of Position 03-03, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (SOP(SOP 03-03) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities loans)loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. SOP 03-03 does not apply to loans originated by the entity. SOP 03-03 is effective for loans acquired in fiscal years beginning after December 15, 2004. Early adoption iswas encouraged. Specific transition guidance applies to certain loans that currently are within the scope of Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans”. Its adoptionThe Company does not believe the determination of the impact on its financial statements will be meaningful until the Company completes a business combination with a financial institution and/or acquires a future loan portfolio.
In May 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3.SFAS No. 154 replaced APB Opinion No. 20,Accounting Changes,and SFAS No. 3Reporting Accounting Changes in Interim Financial Statements and changes in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle by requiring retrospective application to prior period financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expectedexpect the impact of SFAS No. 154 to have a material impact on the consolidated balance sheets or statement of earnings for the Company.
In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which revised SFAS No. 123, “Accounting for Stock-Based Compensation”. This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of income. The revised statement is effective as of the first interim period beginning after June 15, 2005. Its adoption is not expected to have a material impact on the consolidated balance sheets or statement of earnings for the Company.
Results of Operations
Net Earnings
Net earnings increased $1,091,000 (20.1%)decreased $40,000 or 0.6% to $6,510,000$6,470,000 during 20042005 from $5,419,000$6,510,000 for the year ended December 31, 2003.2004. Basic income per share was $1.69 and $1.68 for 2005 and $1.39 for 2004, and 2003, respectively, an increase of 20.9%0.6%. Comparatively, net earnings during 20032004 increased $364,000 (7.2%)$1,091,000 or 20.1% to $5,419,000$6,510,000 from the 20022003 total of $5,055,000,$5,419,000, while basic income per share increased $0.09$0.29 per share to $1.68 for 20032004 from a 20022003 per share total of $1.30.$1.39.
Net earnings decreased slightly in 2005. This decrease in net earnings for 2005 is attributable to a decrease in noninterest income. This is offset by an increase in net interest income and a decrease in noninterest expense and provision for loan losses. The increase in net earnings for 2004 is attributable to an increase in net interest income, noninterest income and a decrease in provision for loan losses offset by an increase in noninterest expense. The increase inIn addition, the results of the twelve months ended December 31, 2004 reflect a gain of $566 thousand, net earnings for 2003 is attributable to an increase in noninterestof applicable income andtax effects, upon the sale of a decrease in provision for loan losses offset by a decrease in net interest income and an increase in noninterest expense.
private equity investment.
Net Interest Income
Net interest income is the difference between the interest the Company earns on its loans, investment securities and other earning assets and the interest cost of its deposits, borrowed funds and other interest-bearing liabilities. This is the primary component of the Company’s earnings. Net interest income was $14,702,000 for the year ended December 31, 2005. This increase of $33,000 or 0.2% over 2004 is due to increases in average interest earning assets and the net yield on total interest earning assets of 1 basis point to 2.77%.
Net interest income was $14,669,000 for the year ended December 31, 2004. This increase of $1,151,000 (8.5%)or 8.5% over 2003 is due to an increase in average interest earning assets offset by a decrease in the net yield on total interest earning assets of 5 basis points to 2.76%.
Net interest income was $13,518,000 for the year ended December 31, 2003. This decrease of $1,052,000 (7.2%) over 2002 is due38
The Company uses interest rate protection contracts, primarily interest rate swaps, caps and floors, to protect the yields on earning assets and the rates paid on interest-bearing liabilities. Such contracts act as hedges against unfavorable rate changes. The income and expense associated with interest rate swaps, caps and floors are ultimately reflected as adjustments to the net interest income or expense of the underlying assets or liabilities. The effect of such interest rate protection contracts resulted in a net increasedecrease in net interest income of $73,000 for 2005 and increases in net interest income of $65,000 $220,000 and $188,000$220,000 for 2004 and 2003, respectively. At December 31, 2005 and 2002, respectively.2004, the Company had one interest rate swap that was accounted for as a cash flow hedge. It is the intention of the Company to continue to utilize interest rate protection contracts to manage exposure to certain future changes in interest rate environments. However, there can be no assurance that such transactions will positively affect earnings. See “— INTEREST RATE SENSITIVITY MANAGEMENT” the “CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSEAND YIELDS/RATES” table appearing elsewhere herein and the “RATE/VOLUME VARIANCE ANALYSIS” tables immediately following.
Rate/Volume Variance Analysis
Taxable-Equivalent Basis (1)(2) Years Ended December 31, 2004 Compared to 2003 | Change Due to | |||||||||||||||||||||||||
| Net Change | Rate | Volume | Rate/ Volume | |||||||||||||||||||||||
| Change Due to | ||||||||||||||||||||||||||
Taxable-Equivalent Basis (1)(2) Years Ended December 31, 2005 Compared to 2004 | Net Change | Rate | Volume | Rate/ Volume | ||||||||||||||||||||||
| (In thousands) | (In thousands) | |||||||||||||||||||||||||
Earning Assets: | ||||||||||||||||||||||||||
Loans | $ | (492 | ) | (875 | ) | 405 | (22 | ) | $ | 2,583 | 1,706 | 792 | 85 | |||||||||||||
Investment securities: | ||||||||||||||||||||||||||
Taxable | 1,596 | 103 | 1,474 | 19 | (346 | ) | 377 | (696 | ) | (27 | ) | |||||||||||||||
Tax-exempt | 1,672 | (16 | ) | 1,749 | (61 | ) | 666 | (60 | ) | 747 | (21 | ) | ||||||||||||||
Total investment securities | 3,268 | 87 | 3,223 | (42 | ) | 320 | 317 | 51 | (48 | ) | ||||||||||||||||
Federal funds sold | 26 | 17 | 8 | 1 | 143 | 161 | (8 | ) | (10 | ) | ||||||||||||||||
Interest earning deposits with other banks | 3 | 1 | 2 | — | 25 | 16 | 4 | 5 | ||||||||||||||||||
Total earning assets | $ | 2,805 | (770 | ) | 3,638 | (63 | ) | $ | 3,071 | 2,200 | 839 | 32 | ||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||||
NOWs | $ | (95 | ) | (107 | ) | 13 | (1 | ) | $ | 337 | 515 | (111 | ) | (67 | ) | |||||||||||
Savings and money market | 267 | (119 | ) | 420 | (34 | ) | 1,239 | 1,148 | 55 | 36 | ||||||||||||||||
Certificates of deposit less than $100,000 | (120 | ) | (119 | ) | (1 | ) | — | 359 | 394 | (31 | ) | (4 | ) | |||||||||||||
Certificates of deposit and other time deposits of $100,000 or more | (475 | ) | (376 | ) | (113 | ) | 14 | 460 | 271 | 171 | 18 | |||||||||||||||
Total interest bearing deposits | (423 | ) | (721 | ) | 319 | (21 | ) | 2,395 | 2,328 | 84 | (17 | ) | ||||||||||||||
Federal funds purchased and securities sold under agreements to repurchase | (16 | ) | 4 | (18 | ) | (2 | ) | 60 | 58 | 1 | 1 | |||||||||||||||
Other borrowed funds | 1,525 | (334 | ) | 2,108 | (249 | ) | 358 | 265 | 88 | 5 | ||||||||||||||||
Total interest bearing liabilities | $ | 1,086 | (1,051 | ) | 2,409 | (272 | ) | $ | 2,813 | 2,651 | 173 | (11 | ) | |||||||||||||
| (1) | For analytical purposes, income for tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 34% effective federal income tax rate). |
| (2) | The change in interest due to rate is calculated by multiplying the previous volume by the rate change and the change in interest due to volume is calculated by multiplying the change in volume by the previous rate. Changes attributable to both changes in rate and volume are calculated by multiplying the change in volume by the change in |
39
Rate/Volume Variance Analysis
Taxable-Equivalent Basis (1)(2) Years Ended December 31, 2003 Compared to 2002 | Change Due to | |||||||||||||||||||||||||
| Net Change | Rate | Volume | Rate/ Volume | |||||||||||||||||||||||
| Change Due to | ||||||||||||||||||||||||||
Taxable-Equivalent Basis (1)(2) Years Ended December 31, 2004 Compared to 2003 | Net Change | Rate | Volume | Rate/ Volume | ||||||||||||||||||||||
| (In thousands) | (In thousands) | |||||||||||||||||||||||||
Earning Assets: | ||||||||||||||||||||||||||
Loans | $ | (2,161 | ) | (1,369 | ) | (855 | ) | 63 | $ | (492 | ) | (875 | ) | 405 | (22 | ) | ||||||||||
Investment securities: | ||||||||||||||||||||||||||
Taxable | (647 | ) | (2,566 | ) | 2,700 | (781 | ) | 1,596 | 103 | 1,474 | 19 | |||||||||||||||
Tax-exempt | 215 | (14 | ) | 242 | (13 | ) | 1,672 | (16 | ) | 1,749 | (61 | ) | ||||||||||||||
Total investment securities | (432 | ) | (2,580 | ) | 2,942 | (794 | ) | 3,268 | 87 | 3,223 | (42 | ) | ||||||||||||||
Federal funds sold | (122 | ) | (64 | ) | (83 | ) | 25 | 26 | 17 | 8 | 1 | |||||||||||||||
Interest earning deposits with other banks | (24 | ) | (15 | ) | (16 | ) | 7 | 3 | 1 | 2 | — | |||||||||||||||
Total earning assets | $ | (2,739 | ) | (4,028 | ) | 1,988 | (699 | ) | $ | 2,805 | (770 | ) | 3,638 | (63 | ) | |||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||||
NOWs | $ | (155 | ) | (298 | ) | 195 | (52 | ) | $ | (95 | ) | (107 | ) | 13 | (1 | ) | ||||||||||
Savings and money market | (428 | ) | (451 | ) | 30 | (7 | ) | 267 | (119 | ) | 420 | (34 | ) | |||||||||||||
Certificates of deposit less than $100,000 | (725 | ) | (688 | ) | (45 | ) | 8 | (120 | ) | (119 | ) | (1 | ) | — | ||||||||||||
Certificates of deposit and other time deposits of $100,000 or more | (317 | ) | (457 | ) | 162 | (22 | ) | (475 | ) | (376 | ) | (113 | ) | 14 | ||||||||||||
Total interest bearing deposits | (1,625 | ) | (1,894 | ) | 342 | (73 | ) | (423 | ) | (721 | ) | 319 | (21 | ) | ||||||||||||
Federal funds purchased and securities sold under agreements to repurchase | (5 | ) | (16 | ) | 16 | (5 | ) | (16 | ) | 4 | (18 | ) | (2 | ) | ||||||||||||
Other borrowed funds | (129 | ) | (400 | ) | 314 | (43 | ) | 1,525 | (334 | ) | 2,108 | (249 | ) | |||||||||||||
Total interest bearing liabilities | $ | (1,759 | ) | (2,310 | ) | 672 | (121 | ) | $ | 1,086 | (1,051 | ) | 2,409 | (272 | ) | |||||||||||
| (1) | For analytical purposes, income for tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 34% effective federal income tax rate). |
| (2) | The change in interest due to rate is calculated by multiplying the previous volume by the rate change and the change in interest due to volume is calculated by multiplying the change in volume by the previous rate. Changes attributable to both changes in rate and volume are calculated by multiplying the change in volume by the change in |
Interest Income
Interest income is a function of the volume of interest-earning assets and their related yields. Interest income was $30,022,000, $27,177,000 $24,940,000, and $27,752,000$24,940,000 for the years ended December 31, 2005, 2004, 2003, and 2002,2003, respectively. The increase in interest income during 20042005 resulted primarily from an increase in the average volume outstanding of investment securitiesloans and an increase in the yields on investment securities.for all components of interest earning assets. Average interest-earning assets increased $71,803,000 (14.8%)$6,608,000 or 1.2% during 2004,2005, compared to an increase of $35,085,000 (7.8%)$71,803,000 or 14.8% during 2003,2004, while the fully taxable equivalent yields on average earning assets decreasedincreased 48 basis points in 2005 after decreasing 16 basis points in 2004 after decreasing 101 basis points in 2003.2004. The combination of these factors resulted in an increase in interest income of $2,845,000 or 10.5% for 2005 and an increase of $2,237,000 (9.0%) for 2004 and a decrease of $2,812,000 (10.1%)or 9.0% during 2003.2004. See “—CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSEAND YIELDS/RATES” and THETHE “RATE/VOLUME VARIANCE ANALYSIS” tables.
Loans are the main component of the Bank’s earning assets. Interest and fees on loans were $18,390,000, $15,807,000 $16,299,000, and $18,460,000$16,299,000 for the years ended December 31, 2005, 2004 2003, and 2002,2003, respectively. These levels reflected an increase of
40
$2,583,000 or 16.3% during 2005, and a decrease of $492,000 (3.0%)or 3.0% during 2004,2004. The increase in 2005 is due to an increase in the fully taxable equivalent yield on loans and a decrease of $2,161,000 (11.7%) during 2003.an increase in the average volume outstanding on loans. The decrease in 2004 is due to a decrease in the fully taxable equivalent yield on loans offset by an increase in the average volume outstanding on loans. The
decrease in 2003 is due to a decrease in the fully taxable equivalent yield on loans and a decrease in the average volume outstanding on loans. The level of average balances has increased to $275,972,000 in 2005 from $262,800,000 in 2004 fromand $256,431,000 in 2003 and $268,878,000 for 2002.2003. The fully taxable equivalent yield on loans increased 65 basis points to 6.66% in 2005, and decreased 35 basis points to 6.01% in 2004 and decreased 51 basis points to 6.36% in 2003 from the 20022003 average yield of 6.87%6.36%.
Interest income on investment securities increased $93,000 or 0.8% to $11,333,000 in 2005, following an increase of $2,701,000 (31.6%)or 31.6% to $11,240,000 in 2004 following a decrease of $505,000 (5.6%) tofrom $8,539,000 in 2003 from $9,044,0002003. The 2005 increase was due to an increase in 2002.the yield of 21 basis points offset by a $6,320,000 decrease in average volume outstanding compared to 2004 levels. The 2004 increase was due to a $64,587,000 increase in average volume outstanding and an increase in yield of 26 basis points compared to 2003 levels. The 2003 decrease was due to a decrease in yield of 151 basis points offset by a $53,358,000 increase in average volume outstanding compared to 2002 levels. The fully taxable equivalent yields on investment securities were 4.40% in 2005, 4.19% in 2004 and 3.93% in 2003, and 5.44% in 2002.2003. See “FINANCIAL CONDITION—INVESTMENT SECURITIES.”
Interest Expense
Total interest expense was $15,321,000, $12,508,000 $11,422,000 and $13,181,000$11,422,000 for the years ended December 31, 2005, 2004 2003, and 20022003 respectively, representing an increase of $2,813,000 or 22.5% during 2005 and an increase of $1,086,000 (9.5%)or 9.5% during 2004 and a decrease of $1,759,000 (13.3%) during 2003.2004. Total average balances outstanding of interest-bearing liabilities have continued an upward trend over the last three years to $483,422,000 in 2005 from $482,121,000 in 2004 fromand $415,761,000 in 2003 and $393,036,000 in 2002.2003. The rates paid on these liabilities decreasedincreased 58 basis points in 2005 to 3.17% after decreasing 16 basis points in 2004 to 2.59% after decreasing 60 basis points toduring 2004 from 2.75% during 2003 from 3.35% in 2002.
2003.
Interest on deposits, the primary component of total interest expense, decreased $423,000increased $2,395,000 to $10,520,000 or 29.5% during 2005 from $8,125,000 (4.9%) duringin 2004, from $8,548,000 in 2003, which in turn representsrepresented a $1,625,000 (16.0%)$423,000 or 4.9% decrease from the 20022003 level of $10,173,000.$8,548,000. The average balance outstanding of interest-bearing deposits has increased steadilydecreased slightly to the 20042005 level of $376,144,000$375,316,000 as compared to $376,144,000 in 2004 and $352,281,000 in 2003 and $336,228,000 in 2002.2003. The average rates paid on interest-bearing deposits were 2.16%2.80%, 2.43%,2.16% and 3.03%2.43% for 2005, 2004 and 2003, and 2002, respectively.
Interest expense on borrowed funds was $4,710,000 in 2005, $4,352,000 in 2004 and $2,826,000 in 2003, and $2,955,000 in 2002.2003. These levels represent an increase of $358,000 or 8.2% during 2005, and an increase of $1,526,000 (54.0%)or 54.0% during 2004, and a decrease of $129,000 (4.4%) during 2003.2004. The 2005 increase is due to an increase in interest rates on FHLB advances. The 2004 increase is due to additional FHLB advances as part of athe leverage transaction. The 2003 decrease is due totransaction when the refinancing of $10 millionCompany’s subsidiary issued trust preferred securities in FHLB advances to a lower interest rate in AprilNovember 2003.
Provision for Loan Losses
During 2004,2005, the Company made a total provision for loan losses of $600,000$485,000 based on management’s reviews and assessments of the risks in the loan portfolio, the amount of the loan portfolio and historical loan loss trends, and an evaluation of certain significant problem loans. During 20032004 and 2002,2003, the Company made total provisions for loan losses of $675,000$600,000 and $1,680,000,$675,000, respectively. The decrease in 20042005 and 20032004 are due to reduced loan growth and improved performance in the loan portfolio. Despite loan growth in 2005, the provision for loan losses also decreased due to the decrease in charge-offs compared to 2004. See “FINANCIAL CONDITION — ALLOWANCEFOR LOAN LOSSESAND RISK ELEMENTS.”
Noninterest Income
Noninterest income increased $142,000 (2.1%)decreased $644,000 or 9.3% to $6,915,000$6,271,000 for the year ended December 31, 2004,2005, from the 20032004 total of $6,773,000,$6,915,000, which in turn represented an increase of $1,381,000 (25.6%)$142,000 or 2.1% from the total of $5,392,000$6,773,000 for 2002.
2003.
Service charges on deposit accounts increased $7,000 or 0.5% during 2005 to $1,497,000 and decreased $7,000 (0.5%) duringor 0.5% in 2004 to $1,490,000 and increased $99,000 (7.1%)from $1,497,000 in 2003 to $1,497,000 from $1,398,000 in 2002.2003. Service charge income remained fairly stable in 2005, 2004 compared toand 2003. The increase in 2003 is due to an overall increase in service charges offset slightly by a decrease in the number of insufficient funds and overdraft charges.
Net gains from investment securities decreased $262,000 (26.3%)$722,000 or 98.5% to $733,000$11,000 for the year ended December 31, 2004,2005, from the 20032004 total of $995,000. The$733,000. This decrease is primarily due to the gainsa gain of $566 thousand in the second quarter2004, net of 2003 on the sale of specific available for sale securities. In 2004, the investment securities gains are primarily due toapplicable income tax effects, upon the sale of a privately held investment in the fourth quarter of 2004.private equity investment.
41
Other noninterest income increased $411,000 (9.6%)$70,000 or 1.5% to $4,762,000 in 2005 from $4,692,000 in 2004 from $4,281,000 in 2003.2004. Comparatively, the 20032004 total represented an increase of $780,000 (22.3%)$411,000 or 9.6% from $3,501,000$4,281,000 in 2002.2003. The increase in 2005 was primarily due to a $321,000 increase in the gain on sale of mortgage loans. This is somewhat offset by a $293,000 decrease in MasterCard/VISA discounts and fees. This decrease is due to the Company moving its MasterCard/VISA merchant processing to a third party in mid 2005. The increase in 2004 was primarily due to an increase of $271,000$280,000 in MasterCard/VISA discounts and fees due to an increase in transaction volume and fees, $73,000 in servicing fees and $132,000 in dividends from stock in other companies. These increases were offset by a decrease of $336,000 on the gains on the sale of mortgage loans. The increase in 2003 was primarily due to an increase of $421,000 in MasterCard/VISA discounts and fees due to an increase in transaction volume and fees and $319,000 in gains on the sale of mortgage loans. See “-I“ITEM 1 – BUSINESS SERVICES.”
Noninterest Expense
Total noninterest expense was $11,809,000 for 2005, $12,125,000 for 2004, and $11,914,000 for 2003 and $11,143,000reflecting a decrease of $316,000 or 2.6% for 2002 reflecting2005, and an increase of $211,000 (1.8%)or 1.8% for 2004, and an increase of $771,000 (6.9%) for 2003.
2004.
Salaries and benefits increased $66,000 or 1.2% to $5,453,000 for the year ended December 31, 2005, and increased $636,000 (13.4%)or 13.4% to $5,387,000 for the year ended December 31, 2004, and increased $109,000 (2.3%) to $4,751,000 for the year ended December 31, 2003, from the 20022003 total of $4,642,000.$4,751,000. At December 31, 2004, the Company had 135 full-time equivalent employees, an increase of 2 over the level at December 31, 2003. At December 31, 2003,2005, the Company had 133 full-time equivalent employees, an increase of 10 over the level at December 31, 2002. The increasesa number which has remained fairly stable compared to 135 and 133 for 2004 and 2003, wererespectively. The increase in salary and benefit expenses for 2005 and 2004 was primarily due to new hires, merit raises and the cost of benefits associated with such increases.
Net occupancy expense was $1,079,000, $1,234,000 and $1,251,000 for 2005, 2004 and $1,229,000 for 2004, 2003, and 2002, respectively, representing a decrease of $155,000 or 12.6% in 2005 and a decrease of $17,000 (1.4%)or 1.4% in 2004 and an increase of $22,000 (1.8%) in 2003 over the previous year’s levels. The 2005 decrease is primarily due to a decrease in technology lease payments. The 2004 decrease is due to a decrease in furniture and equipment depreciation, computer hardware maintenance and technology lease payments. These decreases are offset by an increase in furniture and equipment service contracts and building lease payments. The 2003 increase is mainly due to a slight increase in computer hardware maintenance offset by a decrease in computer lease payments.
Other noninterest expense was $5,277,000 for 2005, $5,504,000 for 2004, and $5,912,000 for 2003, and $5,272,000 for 2002.2003. These levels represent a decrease of $227,000 or 4.1% in 2005 and a decrease of $408,000 (6.9%)or 6.9% in 2004 and an increase of $640,000 (12.1%) in 2003 over the respective previous years. Thisyear. The 2005 decrease is primarily due to a $263,000 decrease in MasterCard/VISA processing expense as a result of the Company moving its MasterCard/VISA processing to a third party in mid 2005 as mentioned above. The 2004 decrease iswas mainly due to the early prepayment penalty paid in 2003 of $715,000 to refinance $10 million in FHLB advances. This decrease iswas offset by an increase of $296,000 in the MasterCard/VISA transaction volume mentioned above from the same period of 2003. The 2003 increase is mainly due to the early prepayment penalty of $715,000 to refinance the $10 million in FHLB advances and increases of $299,000 in the MasterCard/VISA transaction volume mentioned above from the same period of 2002. The increase in MasterCard/VISA expenses resulted from the increase in fees the Company paid to its merchant processor in connection with an increase in MasterCard/VISA transactions. See “SUPERVISIONAND REGULATION—FDICFDIC INSURANCE ASSESSMENTS.”
Income Taxes
The Company’s income tax expense was $2,209,000, $2,349,000 and $2,283,000 in 2005, 2004 and $2,085,000 in 2004, 2003, and 2002, respectively. These levels represent an effective tax rate on pre-tax earnings of 25.5% for 2005, 26.5% for 2004, and 29.6% for 2003, and 29.2% for 2002.2003. The effective tax rate has decreased due to the purchase of tax exempttax-exempt securities as part of the leverage transaction when the Company’s subsidiary issued trust preferred securities in November 2003. Details of the tax provision for income taxes are included in Note 11,12, “Income Tax Expense” in the Notes to the Consolidated Financial Statements included elsewhere herein.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk, with respect to the Company, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. Although the Company manages other risk, such as credit and liquidity, management considers interest rate risk to be the more significant market risk and such risk could potentially have the largest material effect on the Company’s financial condition. Further, the Company believes the potential reduction of net interest income may be more significant than the effect of reduced fair market values. The Company does not maintain a trading portfolio, or deal in international instruments; therefore, it is not exposed to risk fromrisks related to trading activities. Nor does it deal in international instruments, therefore the Company is not exposedactivities or foreign currencies.
42
Financial Statements
The Company’s interest rate risk management is the responsibility of the Asset/Liability ManagementALCO Committee. ALCO Committee (“ALCO”). ALCO has established policies and limits to monitor, measure and coordinate the Company’s sources, uses and pricing of funds.
The Company manages the relationship of interest sensitive assets to interest sensitive liabilities and the resulting effect on net interest income. The Company utilizes a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on both a rise and fall in interest rates of 200 basis points over a twelve month period. The model is based on actual repricing dates of interest sensitive assets and interest sensitive liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rates of certain assets. The assumptions are based on nationally published prepayment speeds on given assets when interest rates increase or decrease by 200 basis points or more.
Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with the Company’s interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of the Company’s earnings. ALCO Committee utilizes the results of the simulation model and the Economic Value of Equity report to quantify the estimated exposure of net interest income to a sustained change in interest rates.
The Company makes use of interest rate contracts to protect its net interest income against changes in interest rates. At year-end,December 31, 2005, the Company had an interest rate swap agreement with a notional value of $10.0 million. This contract was negotiated to protect the Company’s balance sheet against a fall or rise in interest rates. The effect of this instrument is considered in the simulation models.
Currently the Company’s income exposure to changes in interest rates is relatively low. The Company measures this exposure based on a gradual increase or decrease in interest rates of 200 basis points. Given this scenario, the Company had, at year-end, a slight exposure to rising rates and falling rates.
The following chart reflects the Company’s sensitivity to changes in interest rates as of December 31, 2004.2005. Numbers are based on the December balance sheet and assume paydowns and maturities of both assets and liabilities are reinvested based on growth assumptions provided by the Company. The same growth and interest rate assumptions are used in the base, up 200 basis points, and down 200 basis points scenarios.
INTEREST RATE RISK
Income Sensitivity Summary:Summary
Interest Rate Scenario (000)
(Dollars in thousands)
| -200 BP | Base | +200 BP | ||||||
Year 1 Net Interest Income | 13,631 | 14,790 | 14,881 | |||||
$ Change Net Interest Income | 1,159 | — | 91 | |||||
% Change Net Interest Income | (7.83 | )% | — �� | 0.62 | % |
| -200 BP | Base | +200 BP | ||||||
Year 1 Net Interest Income | 14,552 | 14,216 | 14,081 | |||||
$ Change Net Interest Income | 336 | — | (135 | ) | ||||
% Change Net Interest Income | 2.36 | % | — | (0.95 | )% |
Policy Limit 10% for +/- 200 Basis Points (BP) over 12 months.
The preceding sensitivity analysis is a modeling analysis, which changes quarterly and consists of hypothetical estimates based upon numerous assumptions, including the interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, and others. While assumptions are developed based on the current economic and market conditions, management cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that ALCO Committee might take in responding to or anticipating changes in interest rates. See the “INTEREST SENSITIVITY ANALYSIS” table.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Financial Statements and Supplementary Data contained within this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Director of Financial Operations (DFO), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and DFO, concluded that the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the CEO and DFO, as appropriate, to allow timely decisions regarding disclosure. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the end of the period covered by this report.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is set forth under the headings “Proposal One: Election of Directors—Directors - Information about Nominees for Directors and Executive Officers,” “Additional Information Concerning the Company’s Board of Directors and Committees,” “Executive Officers - General” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934” in the definitive proxy statement for the Company’s Annual Meeting to be held on May 10, 2005,Proxy Statement, and is incorporated herein by reference.
The Board of Directors has adopted a Code of Conduct and Ethics applicable to the Company’s directors, officers and employees, including the Company’s principal executive officer, principal financial officer, and principal accounting officer, controller and other senior financial officers. Upon request, the Company will provide a copy of its Code of Conduct and Ethics, without charge, to any person. Written requests for a copy of the Company’s Code of Conduct may be sent to Auburn National Bancorporation, Inc., 100 N. Gay Street, Auburn, Alabama 36830, Attention: Marla Kickliter, Vice President of Compliance and Internal Audit. Requests may also be made via telephone by contacting Marla Kickliter, Vice President of Compliance and Internal Audit, or Laura Carrington, Vice President of Human Resources, at (334) 821-9200.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is set forth under the headings “Additional Information Concerning the Company’s Board of Directors and Committees – Board Compensation,” “Executive Officers,” “Compensation Committee Report” and “Performance Graph” in the definitive proxy statement for the Company’s Annual Meeting to be held on May 10, 2005,Proxy Statement, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth under the headings “Proposal One: Election of Directors—Directors - Information about Nominees for Directors and Executive Officers” and “Principal Shareholders” in the definitive proxy statement for the Company’s Annual Meeting to be held on May 10, 2005,Proxy Statement, and is incorporated herein by reference.
44
Securities Authorized for Issuance Under Equity Compensation PlansPlan Information
| Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||
Equity compensation plans approved by security holders | 3,900 | $ | 12.81 | — | |||
Equity compensation plans not approved by security holders | — | — | — | ||||
Total | 3,900 | $ | 12.81 | — | |||
| Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||
Equity compensation plans approved by security holders | 2,000 | $ | 13.39 | — | |||
Equity compensation plans not approved by security holders | — | — | — | ||||
Total | 2,000 | $ | 13.39 | — | |||
The Company’s Long Term Incentive Plan expired on May 10, 2004. No new plans have been issued.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth under the heading “Certain Transactions and Business Relationships” in the definitive proxy statement for the Company’s Annual Meeting to be held on May 10, 2005,Proxy Statement, and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this item is set forth under the heading “Independent Public Accountants” in the definitive proxy statement for the Company’s Annual Meeting to be held on May 10, 2005,Proxy Statement, and is incorporated herein by reference.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| (a) | List of all Financial Statements | |||
The following consolidated financial statements and report of independent registered public accounting firm of the Company are included in this Annual Report on Form 10-K: | ||||
Consolidated Balance Sheets as of December 31, | ||||
Consolidated Statement of Earnings for the years ended December 31, 2005, 2004, | ||||
| (b) | Exhibits | |||||||||
3.1. | Certificate of Incorporation of Auburn National Bancorporation, Inc. (incorporated by reference from Registrant’s Form 10-Q dated June 20, 2002 (File No. 000-26486)). | |||||||||
45
| 3.2. | Bylaws of Auburn National Bancorporation, Inc. (incorporated by reference from Registrant’s Annual Report on Form 10K, dated March 30, 2004 (File No. 000-26486)). | |||||
| *10.1. | Auburn National Bancorporation, Inc. 1994 Long-Term Incentive Plan (incorporated by reference from Registrant’s Registration Statement on Form SB-2 (File No. 33-86180)). | |||||
| 10.2. | Lease and Equipment Purchase Agreement, dated September 15, 1987 (incorporated by reference from Registrant’s Registration Statement on Form SB-2 (File No. 33-86180)). | |||||
| *10.3. | Summary of Descriptions of Director and Executive | |||||
| 21.1 | Subsidiaries of Registrant | |||||
| 23.1 | Consent of Independent Registered Public Accounting Firm | |||||
| 31.1 | Certification signed by the Chief Executive Officer pursuant to SEC Rule 13a-14(a). | |||||
| 31.2 | Certification signed by the Director of Financial Operations pursuant to SEC Rule 13a-14(a). | |||||
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002 by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board. | |||||
| 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002 by C. Wayne Alderman, Director of Financial Operations. | |||||
| * | Indicates management contracts and compensatory plans and arrangements |
| (c) | Financial Statement Schedules |
All financial statement schedules required pursuant to this item were either included in the financial information set forth in (a) above or are inapplicable and therefore have been omitted.
46
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
(With Independent Auditors’ Report Thereon)
47
Report of Independent Registered Public Accounting Firm
The Board of Directors
Auburn National Bancorporation, Inc.:
We have audited the accompanying consolidated balance sheets of Auburn National Bancorporation, Inc. and subsidiary (the Company) as of December 31, 20042005 and 2003,2004, and the related consolidated statements of earnings, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three–year period ended December 31, 2004.2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Auburn National Bancorporation, Inc. and subsidiary as of December 31, 20042005 and 2003,2004, and the results of their operations and their cash flows for each of the years in the three–year period ended December 31, 20042005 in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Birmingham, Alabama
March 18, 200524, 2006
48
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 20042005 and 20032004
| 2004 | 2003 | ||||||
| Assets | |||||||
Cash and due from banks (note 2) | $ | 9,037,412 | 12,270,957 | ||||
Federal funds sold | 17,394,000 | 14,067,000 | |||||
Cash and cash equivalents | 26,431,412 | 26,337,957 | |||||
Interest-earning deposits with other banks | 705,296 | 265,729 | |||||
Investment securities held to maturity (fair value of $822,290 and $1,276,720 for December 31, 2004 and 2003, respectively) (note 3) | 808,607 | 1,237,764 | |||||
Investment securities available for sale (note 3) | 281,390,464 | 284,081,123 | |||||
Loans (notes 4) | 258,942,834 | 257,092,056 | |||||
Less allowance for loan losses | (3,455,515 | ) | (4,312,554 | ) | |||
Loans, net | 255,487,319 | 252,779,502 | |||||
Premises and equipment, net (note 5) | 2,679,305 | 2,876,052 | |||||
Rental property, net (note 6) | 1,330,180 | 1,427,285 | |||||
Other assets (note 3) | 22,328,726 | 21,109,501 | |||||
Total assets | $ | 591,161,309 | 590,114,913 | ||||
| Liabilities and Stockholders’ Equity | |||||||
Deposits: | |||||||
Noninterest-bearing | $ | 65,363,613 | 60,507,145 | ||||
Interest-bearing (note 7) | 363,975,157 | 373,534,995 | |||||
Total deposits | 429,338,770 | 434,042,140 | |||||
Securities sold under agreements to repurchase (note 8) | 7,612,922 | 6,654,332 | |||||
Other borrowed funds (note 9) | 98,223,505 | 98,372,188 | |||||
Note payable to trust (note 10) | 7,217,000 | 7,217,000 | |||||
Accrued expenses and other liabilities | 4,264,864 | 3,421,369 | |||||
Total liabilities | 546,657,061 | 549,707,029 | |||||
Stockholders’ equity (notes 16 and 17): | |||||||
Preferred stock of $0.01 par value. Authorized 200,000 shares; issued shares – none | — | — | |||||
Common stock of $0.01 par value. Authorized 8,500,000 shares; issued 3,957,135 shares | 39,571 | 39,571 | |||||
Additional paid-in capital | 3,723,578 | 3,712,246 | |||||
Retained earnings | 42,669,061 | 38,092,829 | |||||
Accumulated other comprehensive loss, net of tax | (361,109 | ) | (828,816 | ) | |||
Less treasury stock, at cost – 110,274 shares and 64,567 shares for December 31, 2004 and 2003, respectively | (1,566,853 | ) | (607,946 | ) | |||
Total stockholders’ equity | 44,504,248 | 40,407,884 | |||||
Commitments and contingencies (note 14) | |||||||
Total liabilities and stockholders’ equity | $ | 591,161,309 | 590,114,913 | ||||
| 2005 | 2004 | ||||||
| Assets | |||||||
Cash and due from banks (note 2) | $ | 13,704,096 | 9,037,412 | ||||
Federal funds sold | 10,237,409 | 17,394,000 | |||||
Cash and cash equivalents | 23,941,505 | 26,431,412 | |||||
Interest-earning deposits with other banks | 2,140,856 | 705,296 | |||||
Investment securities held to maturity (fair value of $636,962 and $822,290 for December 31, 2005 and 2004, respectively) (note 3) | 633,478 | 808,607 | |||||
Investment securities available for sale (note 3) | 274,327,424 | 281,390,464 | |||||
Loans held for sale (note 4) | 1,400,269 | 7,813,539 | |||||
Loans (note 4) | 282,059,247 | 251,129,295 | |||||
Less allowance for loan losses | (3,843,374 | ) | (3,455,515 | ) | |||
Loans, net | 278,215,873 | 247,673,780 | |||||
Premises and equipment, net (note 5) | 2,428,619 | 2,679,305 | |||||
Rental property, net (note 6) | 1,236,583 | 1,330,180 | |||||
Other assets (note 3) | 23,829,154 | 22,328,726 | |||||
Total assets | $ | 608,153,761 | 591,161,309 | ||||
| Liabilities and Stockholders’ Equity | |||||||
Deposits: | |||||||
Noninterest-bearing | $ | 70,784,282 | 65,363,613 | ||||
Interest-bearing (note 7) | 384,211,006 | 363,975,157 | |||||
Total deposits | 454,995,288 | 429,338,770 | |||||
Securities sold under agreements to repurchase (note 8) | 1,731,391 | 7,612,922 | |||||
Other borrowed funds (note 9) | 98,205,256 | 98,223,505 | |||||
Note payable to trust (note 10) | 7,217,000 | 7,217,000 | |||||
Accrued expenses and other liabilities | 2,050,348 | 4,264,864 | |||||
Total liabilities | 564,199,283 | 546,657,061 | |||||
Stockholders’ equity (notes 16 and 17): | |||||||
Preferred stock of $0.01 par value. Authorized 200,000 shares; issued shares – none | — | — | |||||
Common stock of $0.01 par value. Authorized 8,500,000 shares; issued 3,957,135 shares | 39,571 | 39,571 | |||||
Additional paid-in capital | 3,734,425 | 3,723,578 | |||||
Retained earnings | 46,918,896 | 42,669,061 | |||||
Accumulated other comprehensive loss, net of tax | (3,981,772 | ) | (361,109 | ) | |||
Less treasury stock, at cost – 162,119 shares and 110,274 shares for December 31, 2005 and 2004, respectively | (2,756,642 | ) | (1,566,853 | ) | |||
Total stockholders’ equity | 43,954,478 | 44,504,248 | |||||
Commitments and contingencies (note 14) | |||||||
Total liabilities and stockholders’ equity | $ | 608,153,761 | 591,161,309 | ||||
See accompanying notes to consolidated financial statements.
49
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Earnings
Years ended December 31, 2005, 2004, 2003, and 20022003
| 2004 | 2003 | 2002 | |||||
Interest and dividend income: | |||||||
Loans, including fees | $ | 15,806,642 | 16,299,018 | 18,459,669 | |||
Investment securities: | |||||||
Taxable | 9,821,817 | 8,224,739 | 8,872,169 | ||||
Tax-exempt | 1,417,907 | 313,880 | 172,171 | ||||
Federal funds sold | 118,321 | 92,498 | 213,999 | ||||
Interest-earning deposits with other banks | 12,634 | 10,002 | 33,848 | ||||
Total interest and dividend income | 27,177,321 | 24,940,137 | 27,751,856 | ||||
Interest expense: | |||||||
Deposits (note 7) | 8,124,708 | 8,547,949 | 10,173,324 | ||||
Securities sold under agreements to repurchase and federal funds purchased (note 8) | 32,032 | 47,901 | 53,192 | ||||
Other borrowings (note 9) | 4,351,595 | 2,825,987 | 2,954,947 | ||||
Total interest expense | 12,508,335 | 11,421,837 | 13,181,463 | ||||
Net interest income | 14,668,986 | 13,518,300 | 14,570,393 | ||||
Provision for loan losses (note 4) | 600,000 | 675,000 | 1,680,000 | ||||
Net interest income after provision For loan losses | 14,068,986 | 12,843,300 | 12,890,393 | ||||
Noninterest income: | |||||||
Service charges on deposit accounts | 1,489,612 | 1,496,680 | 1,398,490 | ||||
Investment securities gains, net (note 3) | 733,428 | 994,699 | 492,776 | ||||
Other (note 18) | 4,692,022 | 4,281,260 | 3,501,038 | ||||
Total noninterest income | 6,915,062 | 6,772,639 | 5,392,304 | ||||
Noninterest expense: | |||||||
Salaries and benefits (note 13) | 5,386,800 | 4,751,166 | 4,642,133 | ||||
Net occupancy expense | 1,234,234 | 1,251,128 | 1,229,416 | ||||
Other (note 18) | 5,504,002 | 5,911,690 | 5,271,840 | ||||
Total noninterest expense | 12,125,036 | 11,913,984 | 11,143,389 | ||||
Earnings before income taxes | 8,859,012 | 7,701,955 | 7,139,308 | ||||
Income tax expense (note 12) | 2,349,236 | 2,283,435 | 2,084,653 | ||||
Net earnings | $ | 6,509,776 | 5,418,520 | 5,054,655 | |||
Earnings per share – basic | 1.68 | 1.39 | 1.30 | ||||
Earnings per share – diluted | 1.68 | 1.39 | 1.30 | ||||
Weighted average shares outstanding – basic | 3,870,198 | 3,894,969 | 3,894,649 | ||||
Weighted average shares outstanding – diluted | 3,871,273 | 3,895,728 | 3,894,925 | ||||
| 2005 | 2004 | 2003 | |||||
Interest and dividend income: | |||||||
Loans, including fees | $ | 18,389,970 | 15,806,642 | 16,299,018 | |||
Investment securities: | |||||||
Taxable | 9,475,483 | 9,821,817 | 8,224,739 | ||||
Tax-exempt | 1,857,737 | 1,417,907 | 313,880 | ||||
Federal funds sold | 260,989 | 118,321 | 92,498 | ||||
Interest-earning deposits with other banks | 38,204 | 12,634 | 10,002 | ||||
Total interest and dividend income | 30,022,383 | 27,177,321 | 24,940,137 | ||||
Interest expense: | |||||||
Deposits (note 7) | 10,519,733 | 8,124,708 | 8,547,949 | ||||
Securities sold under agreements to repurchase and federal funds purchased (note 8) | 90,871 | 32,032 | 47,901 | ||||
Other borrowings (note 9) | 4,710,160 | 4,351,595 | 2,825,987 | ||||
Total interest expense | 15,320,764 | 12,508,335 | 11,421,837 | ||||
Net interest income | 14,701,619 | 14,668,986 | 13,518,300 | ||||
Provision for loan losses (note 4) | 485,000 | 600,000 | 675,000 | ||||
Net interest income after provision for loan losses | 14,216,619 | 14,068,986 | 12,843,300 | ||||
Noninterest income: | |||||||
Service charges on deposit accounts | 1,497,117 | 1,489,612 | 1,496,680 | ||||
Investment securities gains, net (note 3) | 11,306 | 733,428 | 994,699 | ||||
Other (note 18) | 4,762,226 | 4,692,022 | 4,281,260 | ||||
Total noninterest income | 6,270,649 | 6,915,062 | 6,772,639 | ||||
Noninterest expense: | |||||||
Salaries and benefits (note 13) | 5,453,386 | 5,386,800 | 4,751,166 | ||||
Net occupancy expense | 1,078,826 | 1,234,234 | 1,251,128 | ||||
Other (note 18) | 5,276,577 | 5,504,002 | 5,911,690 | ||||
Total noninterest expense | 11,808,789 | 12,125,036 | 11,913,984 | ||||
Earnings before income taxes | 8,678,479 | 8,859,012 | 7,701,955 | ||||
Income tax expense (note 12) | 2,208,916 | 2,349,236 | 2,283,435 | ||||
Net earnings | $ | 6,469,563 | 6,509,776 | 5,418,520 | |||
Earnings per share – basic | 1.69 | 1.68 | 1.39 | ||||
Earnings per share – diluted | 1.69 | 1.68 | 1.39 | ||||
Weighted average shares outstanding – basic | 3,830,002 | 3,870,198 | 3,894,969 | ||||
Weighted average shares outstanding – diluted | 3,830,794 | 3,871,273 | 3,895,728 | ||||
See accompanying notes to consolidated financial statements.
50
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
Years ended December 31, 2005, 2004, 2003, and 20022003
Comprehensive income | Common stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive income (loss) | Treasury Stock | Total | |||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||
Balances at December 31, 2001 | 3,957,135 | 39,571 | 3,707,472 | 31,202,869 | 1,436,880 | (552,859 | ) | 35,833,933 | |||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net earnings | $ | 5,054,655 | — | — | — | 5,054,655 | — | — | 5,054,655 | ||||||||||||||
Other comprehensive income due to unrealized gain on investment securities available for sale, net (note 11) | 405,219 | — | — | — | — | 405,219 | — | 405,219 | |||||||||||||||
Total comprehensive income | $ | 5,459,874 | |||||||||||||||||||||
Cash dividends paid ($0.44 per share) | — | — | — | (1,713,654 | ) | — | — | (1,713,654 | ) | ||||||||||||||
Sale of treasury stock (200 shares) | — | — | 971 | — | — | 1,300 | 2,271 | ||||||||||||||||
Balances at December 31, 2002 | 3,957,135 | 39,571 | 3,708,443 | 34,543,870 | 1,842,099 | (551,559 | ) | 39,582,424 | |||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net earnings | $ | 5,418,520 | — | — | — | 5,418,520 | — | — | 5,418,520 | ||||||||||||||
Other comprehensive loss due to unrealized loss on investment securities available for sale, net (note 11) | (2,670,915 | ) | — | — | — | — | (2,670,915 | ) | — | (2,670,915 | ) | ||||||||||||
Total comprehensive income | $ | 2,747,605 | |||||||||||||||||||||
Cash dividends paid ($0.48 per share) | — | — | — | (1,869,561 | ) | — | — | (1,869,561 | ) | ||||||||||||||
Purchase of treasury stock (3,000 shares) | — | — | — | — | — | (61,262 | ) | (61,262 | ) | ||||||||||||||
Sale of treasury stock (750 shares) | — | — | 3,803 | — | — | 4,875 | 8,678 | ||||||||||||||||
Balances at December 31, 2003 | 3,957,135 | 39,571 | 3,712,246 | 38,092,829 | (828,816 | ) | (607,946 | ) | 40,407,884 | ||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net earnings | $ | 6,509,776 | — | — | — | 6,509,776 | — | — | 6,509,776 | ||||||||||||||
Other comprehensive gain due to unrealized gain on investment securities available for sale and derivatives, net (note 11) | 467,707 | — | — | — | — | 467,707 | — | 467,707 | |||||||||||||||
Total comprehensive income | $ | 6,977,483 | |||||||||||||||||||||
Cash dividends paid ($0.50 per share) | — | — | — | (1,933,544 | ) | — | — | (1,933,544 | ) | ||||||||||||||
Purchase of treasury stock (47,782 shares) | — | — | — | — | — | (972,394 | ) | (972,394 | ) | ||||||||||||||
Sale of treasury stock (2,075 shares) | — | — | 11,332 | — | — | 13,487 | 24,819 | ||||||||||||||||
Balances at December 31, 2004 | 3,957,135 | $ | 39,571 | 3,723,578 | 42,669,061 | (361,109 | ) | (1,566,853 | ) | 44,504,248 | |||||||||||||
| Common stock | |||||||||||||||||||||||
Comprehensive income | Shares | Amount | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Treasury stock | Total | ||||||||||||||||
Balances at December 31, 2002 | 3,957,135 | 39,571 | 3,708,443 | 34,543,870 | 1,842,099 | (551,559 | ) | 39,582,424 | |||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net earnings | $ | 5,418,520 | — | — | — | 5,418,520 | — | — | 5,418,520 | ||||||||||||||
Other comprehensive loss due to unrealized loss on investment securities available for sale, net | (2,670,915 | ) | — | — | — | — | (2,670,915 | ) | — | (2,670,915 | ) | ||||||||||||
Total comprehensive income | $ | 2,747,605 | |||||||||||||||||||||
Cash dividends paid ($0.48 per share) | — | — | — | (1,869,561 | ) | — | — | (1,869,561 | ) | ||||||||||||||
Purchase of treasury stock (3,000 shares) | — | — | — | — | — | (61,262 | ) | (61,262 | ) | ||||||||||||||
Sale of treasury stock (750 shares) | — | — | 3,803 | — | — | 4,875 | 8,678 | ||||||||||||||||
Balances at December 31, 2003 | 3,957,135 | 39,571 | 3,712,246 | 38,092,829 | (828,816 | ) | (607,946 | ) | 40,407,884 | ||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net earnings | $ | 6,509,776 | — | — | — | 6,509,776 | — | — | 6,509,776 | ||||||||||||||
Other comprehensive income due to unrealized income on investment securities available for sale and derivatives, net (note 11) | 467,707 | — | — | — | — | 467,707 | — | 467,707 | |||||||||||||||
Total comprehensive income | $ | 6,977,483 | |||||||||||||||||||||
Cash dividends paid ($0.50 per share) | — | — | — | (1,933,544 | ) | — | — | (1,933,544 | ) | ||||||||||||||
Purchase of treasury stock (3,000 shares) | — | — | — | — | — | (972,394 | ) | (972,394 | ) | ||||||||||||||
Sale of treasury stock (750 shares) | — | — | 11,332 | — | — | 13,487 | 24,819 | ||||||||||||||||
Balances at December 31, 2004 | 3,957,135 | 39,571 | 3,723,578 | 42,669,061 | (361,109 | ) | (1,566,853 | ) | 44,504,248 | ||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net earnings | $ | 6,469,563 | — | — | — | 6,469,563 | — | — | 6,469,563 | ||||||||||||||
Other comprehensive loss due to unrealized loss on investment securities available for sale and derivatives, net (note 11) | (3,620,663 | ) | — | — | — | — | (3,620,663 | ) | — | (3,620,663 | ) | ||||||||||||
Total comprehensive income | $ | 2,848,900 | |||||||||||||||||||||
Cash dividends paid ($0.58 per share) | — | — | — | (2,219,728 | ) | — | — | (2,219,728 | ) | ||||||||||||||
Purchase of treasury stock (53,745 shares) | — | — | — | — | — | (1,202,139 | ) | (1,202,139 | ) | ||||||||||||||
Sale of treasury stock (1,900 shares) | — | — | 10,847 | — | — | 12,350 | 23,197 | ||||||||||||||||
Balances at December 31, 2005 | 3,957,135 | $ | 39,571 | 3,734,425 | 46,918,896 | (3,981,772 | ) | (2,756,642 | ) | 43,954,478 | |||||||||||||
See accompanying notes to consolidated financial statements.
51
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2005, 2004, 2003, and 20022003
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||
Net earnings | $ | 6,509,776 | 5,418,520 | 5,054,655 | $ | 6,469,563 | 6,509,776 | 5,418,520 | ||||||||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||||||||||
Depreciation and amortization | 492,732 | 557,146 | 490,749 | 444,200 | 492,732 | 557,146 | ||||||||||||||
Net amortization of investment security discounts/premiums | 1,246,042 | 1,711,893 | 603,075 | 994,182 | 1,246,042 | 1,711,893 | ||||||||||||||
Provision for loan losses | 600,000 | 675,000 | 1,680,000 | 485,000 | 600,000 | 675,000 | ||||||||||||||
Deferred tax (benefit) expense | (1,079,698 | ) | 427,704 | 313,362 | (1,639,770 | ) | (1,079,698 | ) | 427,704 | |||||||||||
Loans originated for resale | (63,708,998 | ) | (107,507,779 | ) | (66,842,809 | ) | (86,399,869 | ) | (63,708,998 | ) | (107,507,779 | ) | ||||||||
Proceeds from sale of loans originated for resale | 66,309,410 | 108,656,026 | 70,358,000 | 87,109,550 | 66,309,410 | 108,656,026 | ||||||||||||||
Loss on sale of premises and equipment | 2,305 | 34,693 | 44,522 | 2,661 | 2,305 | 34,693 | ||||||||||||||
Loss (gain) on sale and calls of investment securities | 183,633 | (994,699 | ) | (492,776 | ) | |||||||||||||||
(Gain) loss on sale and calls of investment securities | (11,306 | ) | 183,633 | (994,699 | ) | |||||||||||||||
Gain on exchange of privately-held stock investment | (917,061 | ) | — | — | — | (917,061 | ) | — | ||||||||||||
Loss on sale of other real estate | 6,984 | 70,694 | 73,350 | |||||||||||||||||
Decrease (increase) in interest receivable | 68,748 | (273,677 | ) | 132,080 | ||||||||||||||||
(Gain) loss on sale of other real estate | (15,428 | ) | 6,984 | 70,694 | ||||||||||||||||
(Increase) decrease in interest receivable | (253,802 | ) | 68,748 | (273,677 | ) | |||||||||||||||
Decrease (increase) in other assets | 991,820 | (346,683 | ) | (1,003,800 | ) | 1,058,393 | 991,820 | (346,683 | ) | |||||||||||
Decrease in interest payable | (247,079 | ) | (74,947 | ) | (491,587 | ) | ||||||||||||||
Increase (decrease) in accrued expenses and other liabilities | 1,954,272 | (448,037 | ) | 943,907 | ||||||||||||||||
Increase (decrease) in interest payable | 234,986 | (247,079 | ) | (74,947 | ) | |||||||||||||||
(Decrease) increase in accrued expenses and other liabilities | (601,732 | ) | 1,954,272 | (448,037 | ) | |||||||||||||||
Net cash provided by operating activities | 12,412,886 | 7,905,854 | 10,862,728 | 7,876,628 | 12,412,886 | 7,905,854 | ||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||
Proceeds from sales of investment securities available for sale | 77,533,760 | 82,443,026 | 16,892,073 | 33,346,426 | 77,533,760 | 82,443,026 | ||||||||||||||
Proceeds from maturities/calls/paydowns of investment securities available for sale | 40,209,751 | 116,628,669 | 62,340,614 | 38,879,781 | 40,209,751 | 116,628,669 | ||||||||||||||
Purchases of investment securities available for sale | (115,486,766 | ) | (305,345,720 | ) | (126,415,939 | ) | (72,388,252 | ) | (115,486,766 | ) | (305,345,720 | ) | ||||||||
Proceeds from maturities/calls/paydowns of investment securities held to maturity | 428,908 | 6,704,668 | 8,304,280 | 174,900 | 428,908 | 6,704,668 | ||||||||||||||
Net (increase) decrease in loans | (6,196,353 | ) | 801,520 | 4,850,211 | (25,609,338 | ) | (6,196,353 | ) | 801,520 | |||||||||||
Purchases of premises and equipment | (135,073 | ) | (140,658 | ) | (386,030 | ) | (59,494 | ) | (135,073 | ) | (140,658 | ) | ||||||||
Proceeds from sale of premises and equipment and other real estate | 279,051 | 711,094 | 1,585,380 | 385,763 | 279,051 | 711,094 | ||||||||||||||
Additions to rental property | (11,499 | ) | (5,806 | ) | (82,255 | ) | (15,129 | ) | (11,499 | ) | (5,806 | ) | ||||||||
Net (increase) decrease in interest-earning deposits with other banks | (439,567 | ) | 332,691 | 255,341 | (1,435,560 | ) | (439,567 | ) | 332,691 | |||||||||||
Proceeds from sale of privately-held stock investment | (1,044,061 | ) | — | — | — | (1,044,061 | ) | — | ||||||||||||
Investment in FHLB stock | (683,000 | ) | (2,240,000 | ) | — | (3,700 | ) | (683,000 | ) | (2,240,000 | ) | |||||||||
Net cash used in investing activities | (5,544,849 | ) | (100,110,516 | ) | (32,656,325 | ) | (26,724,603 | ) | (5,544,849 | ) | (100,110,516 | ) | ||||||||
52
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2005, 2004, 2003, and 20022003
| 2004 | 2003 | 2002 | ||||||||
Cash flows from financing activities: | ||||||||||
Net increase in noninterest-bearing deposits | $ | 4,856,468 | 7,387,766 | 4,868,707 | ||||||
Net (decrease) increase in interest-bearing deposits | (9,559,838 | ) | 31,463,010 | 20,655,143 | ||||||
Net increase (decrease) in securities sold under agreements to repurchase | 958,590 | (5,335,002 | ) | 1,853,456 | ||||||
Borrowings from FHLB | 10,000,000 | 55,000,000 | — | |||||||
Repayments to FHLB | (10,018,250 | ) | (10,043,250 | ) | (118,251 | ) | ||||
Repayments of other borrowed funds | (130,433 | ) | (21,045 | ) | (26,507 | ) | ||||
Proceeds from the note payable to Trust | — | 7,217,000 | — | |||||||
Purchase of treasury stock | (972,394 | ) | (61,262 | ) | — | |||||
Sale of treasury stock | 24,819 | 8,678 | 2,271 | |||||||
Dividends paid | (1,933,544 | ) | (1,869,561 | ) | (1,713,654 | ) | ||||
Net cash (used in) provided by financing activities | (6,774,582 | ) | 83,746,334 | 25,521,165 | ||||||
Net increase (decrease) in cash and cash equivalents | 93,455 | (8,458,328 | ) | 3,727,568 | ||||||
Cash and cash equivalents at beginning of year | 26,337,957 | 34,796,285 | 31,068,717 | |||||||
Cash and cash equivalents at end of year | $ | 26,431,412 | 26,337,957 | 34,796,285 | ||||||
Supplemental information on cash payments: | ||||||||||
Interest paid | $ | 12,755,414 | 11,496,784 | 13,854,400 | ||||||
Income taxes paid | 1,843,388 | 1,918,796 | 2,189,835 | |||||||
Supplemental information on noncash transactions: | ||||||||||
Real estate acquired through foreclosure | 338,825 | 185,236 | 1,192,893 | |||||||
Loans to facilitate the sale of other real estate | — | 333,800 | — | |||||||
| 2005 | 2004 | �� | 2003 | |||||||
Cash flows from financing activities: | ||||||||||
Net increase in noninterest-bearing deposits | $ | 5,420,669 | 4,856,468 | 7,387,766 | ||||||
Net increase (decrease) in interest-bearing deposits | 20,235,849 | (9,559,838 | ) | 31,463,010 | ||||||
Net (decrease) increase in securities sold under agreements to repurchase | (5,881,531 | ) | 958,590 | (5,335,002 | ) | |||||
Borrowings from FHLB | 28,000,000 | 10,000,000 | 55,000,000 | |||||||
Repayments to FHLB | (28,018,249 | ) | (10,018,250 | ) | (10,043,250 | ) | ||||
Repayments of other borrowed funds | — | (130,433 | ) | (21,045 | ) | |||||
Proceeds from the note payable to Trust | — | — | 7,217,000 | |||||||
Purchase of treasury stock | (1,202,139 | ) | (972,394 | ) | (61,262 | ) | ||||
Sale of treasury stock | 23,197 | 24,819 | 8,678 | |||||||
Dividends paid | (2,219,728 | ) | (1,933,544 | ) | (1,869,561 | ) | ||||
Net cash provided by (used in) financing activities | 16,358,068 | (6,774,582 | ) | 83,746,334 | ||||||
Net (decrease) increase in cash and cash equivalents | (2,489,907 | ) | 93,455 | (8,458,328 | ) | |||||
Cash and cash equivalents at beginning of year | 26,431,412 | 26,337,957 | 34,796,285 | |||||||
Cash and cash equivalents at end of year | $ | 23,941,505 | 26,431,412 | 26,337,957 | ||||||
Supplemental information on cash payments: | ||||||||||
Interest paid | $ | 15,085,778 | 12,755,414 | 11,496,784 | ||||||
Income taxes paid | 3,292,413 | 1,843,388 | 1,918,796 | |||||||
Supplemental information on noncash transactions: | ||||||||||
Real estate acquired through foreclosure | 285,834 | 338,825 | 185,236 | |||||||
Loans to facilitate the sale of other real estate | — | — | 333,800 | |||||||
Loans held for sale transferred to loan portfolio | 5,766,585 | — | — | |||||||
See accompanying notes to consolidated financial statements.
53
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (1) | Summary of Significant Accounting Policies |
Auburn National Bancorporation, Inc. (the Company) provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its subsidiary, AuburnBank (the Bank). The Company and the Bank are subject to competition from other financial institutions. The Company and the Bank are also subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory authorities. The Company does not have any segments other than banking that are considered material.
The accounting policies followed by the Company and its subsidiary and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practice within the banking industry. Certain principles which significantly affect the determination of financial position, results of operations and cash flows are summarized below.
| (a) | Basis of Financial Statement Presentation |
The consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near–term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties that serve as collateral.
Management believes that the allowance for losses on loans is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The Bank’s real estate loans are secured by real estate located principally in Lee County, Alabama and surrounding areas. In addition, the foreclosed real estate owned by the Bank is typically located in this same area. Accordingly, the ultimate collectibility of a substantial portion of the Bank’s loan portfolio and the recovery of real estate owned are susceptible to changes in market conditions in this area.
| (b) | Principles of Consolidation |
The consolidated financial statements include the accounts of the Company and its subsidiary, AuburnBank.
(Continued)54
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (c) | Cash Equivalents |
Cash equivalents include amounts due from banks and federal funds sold. Federal funds are generally sold for one–day periods.
| (d) | Investment Securities |
The Company accounts for investment securities under the provisions of Statement of Financial Accounting Standards (SFAS) No. 115,Accounting for Certain Investments in Debt and Equity Securities whereby investment securities are classified in one of three portfolios: (i) trading account securities, (ii) held to maturity securities, and (iii) securities available for sale. Trading account securities are stated at fair value. The Company does not have trading account securities. Investment securities held to maturity are those for which the Company has both the intent and ability to hold until maturity and are stated at cost adjusted for amortization of premiums and accretion of discounts. Investment securities available for sale are stated at fair value with any unrealized gains and losses reported as a separate component of stockholders’ equity, net of taxes, until realized.
Accretion of discounts and amortization of premiums are calculated using a method that approximates the effective interest method over the anticipated life of the security, taking into consideration prepayment assumptions. Gains and losses from the sale of investment securities are computed under the specific identification method.
A decline in the fair value below cost of any available for sale or held to maturity security that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security.
| (e) | Loans |
Loans that the Company has the intent and ability to hold for the foreseeable future or until maturity are recorded at principal amounts outstanding, net of unearned income and allowance for loan losses. Interest on loans is credited to income on the effective interest method. Throughout the periods of 2002-2005, the Company has reported its interest income on loans based on the effective interest method. In its annual report on Form 10-K for the year ended December 31, 2004, it was incorrectly stated in the footnotes to the financial statements that the Company used the simple interest method.
method of recording interest income on loans. The Company actually used and continues to use the effective interest method of reporting interest income, which is the appropriate method under GAAP.
It is the policy of the Company to discontinue the accrual of interest when principal or interest payments become more than ninety days delinquent. When a loan is placed on a nonaccrual basis, any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are recorded on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
55
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
The Company accounts for impaired loans in accordance with SFAS No. 114,Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures. Under the provisions of SFAS No. 114 and SFAS No. 118, management considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
agreement. A loan is also considered impaired if its terms are modified in a troubled debt restructuring and the restructuring agreement specifies an interest rate below the rate that the Company is willing to accept for a new loan with comparable risk. When a loan is considered impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the note’s effective interest rate, unless the loan is collateral–dependent, for which the fair value of the collateral is used to determine the amount of impairment. Impairment losses are included in the allowance for loan losses through the provision for loan losses. Impaired loans are charged to the allowance when such loans are deemed to be uncollectible. Subsequent recoveries are added to the allowance.
When a loan is considered impaired, cash receipts are applied under the contractual terms of the loan agreement, first to principal and then to interest income. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has not been recognized. Any further cash receipts are recorded as recoveries of any amount previously charged off.
The Company originates mortgage loans to be held for sale only for loans that have been pre–approved by the investor. The Company bears minimal interest rate risk on these loans. Such loans are stated at the lower of cost or aggregate fair value.
| (f) | Allowance for Loan Losses |
The amount of provision for loan losses charged to earnings is based on actual loss experience, periodic specific reviews of significant and nonperforming loan relationships, and management’s evaluation of the loan portfolio under current economic conditions. Such provisions, adjusted for loan charge–offs and recoveries, comprise the allowance for loan losses. Provision amounts are largely determined based on loan classifications determined through credit quality reviews using estimated loss factors based on historical loss experience. Such loss factors are adjusted periodically based on changes in loss experience.
Loans are charged against the allowance when management determines such loans to be uncollectible. Subsequent recoveries are credited to the allowance.
| (g) | Premises and Equipment |
Land is stated at cost. Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed principally on a straight–line method for buildings, furniture, fixtures, and equipment over the estimated useful lives of the assets, which range from three to 39 years.
56
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
| (h) | Rental Property |
Rental property consists of land, buildings, and furniture, fixtures, and equipment which are rented by the Company to the Bank and the general public.to unrelated other parties. Rental property is stated at cost less accumulated depreciation. Depreciation is computed principally on a straight–line method for buildings, furniture, fixtures, and equipment over the shorter of estimated useful lives of the assets or the lease period.
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
| (i) | Other Real Estate |
Real estate acquired through foreclosure or in lieu of foreclosure is carried at the lower of cost or fair value, as determined by independent appraisals, adjusted for estimated selling costs. Any write–down at the time of foreclosure is charged to the allowance for loan losses. Subsequent declines in fair value below acquisition cost and gains or losses on the sale of these properties are credited or charged to earnings.
| (j) | Derivative Financial Instruments and Hedging Activities |
As part of its overall interest rate risk management activities, the Company utilizes derivative instruments (i) to modify the repricing characteristics of assets and liabilities and (ii) to hedge the fair value risk of fixed–rate liabilities. The primary instruments utilized by the Company are interest rate swaps and interest rate floor and cap arrangements. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. Entering into interest rate swap agreements involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts but also the risk associated with the movements in interest rates. These risks are considered in the Bank’s overall asset liability management program. Notional principal amounts often are used to express the volume of these transactions; however, the amounts potentially subject to credit risk are much smaller. The Bank utilizes periodic financial statements issued by the counterparty to analyze the creditworthiness of the counterparty prior to entering into a contract and to monitor changes in the financial condition of the counterparty throughout the term of the contract.
The fair value of these derivative financial instruments is based on dealer quotes or third–party financial models and are recorded as assets or liabilities and are recognized on the balance sheet at their fair value. Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge along with the gain or loss on the hedged asset or liability that are attributable to the risk being hedged is recognized in earnings in the period of change. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is recorded initially as a component of accumulated other comprehensive income, and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness, as well as the ineffective portion of the gain or loss, are reported in earnings immediately. If the derivative instrument is not designated as a hedge, the gain or loss would be recognized in earnings in each period. The net settlement on the Company’s fair value hedges is recorded in earnings on an accrual basis.
As of December 31, 2005 and 2004, the Company had a cash flow hedge with a notional amount of $10 million for the purpose of converting the interest payments on floating rate money market
57
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
accounts to a fixed rate. The Company will startstarted exchanging payments in March 2005 for this interest rate swap based on the three month Treasury bill investment rate. As of December 31, 2004, theThe Company recorded a liability for this swap of $8,000 and $216,000 for this swap.the years ended December 31, 2005 and 2004, respectively. This interest rate swap will mature in July 2007. There was not any material hedge ineffectiveness from this cash flow hedge recognized in the income statement. The Company had no cash flowfair value hedges at December 31, 2003.2005 and 2004.
| (k) | Income Taxes |
Income taxes are accounted for under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company files its federal income tax returns on a consolidated basis.
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
| (l) | Earnings per Share |
Basic earnings per share are computed on the weighted average number of shares outstanding in accordance with SFAS No. 128,Earnings Per Share. TheIn May 1994, the Company reserved 450,000 shares of common stock in May 1994 for issuance under stock option plans. This plan expired in May 2004. During 2003, the Company granted 4,000 options with an exercise price of $13.39 which was equal to the closing market price on the date of grant. These options expire December 31, 2006. During 2002, the Company granted 3,000 options with an exercise price of $11.35 which was equal to the closing market price on the date of grant. These options expired on December 31, 2005. No options were granted in 2005 and 2004 or years previous to 2002.
A reconciliation of the numerator and denominator of the basic EPS computation to the diluted EPS computation for the three years ended December 31 is as follows:
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||
Basic: | ||||||||||||||
Net income | $ | 6,509,776 | 5,418,520 | 5,054,655 | $ | 6,469,563 | 6,509,776 | 5,418,520 | ||||||
Average common shares Outstanding | 3,870,198 | 3,894,969 | 3,894,649 | |||||||||||
Average common shares outstanding | 3,830,002 | 3,870,198 | 3,894,969 | |||||||||||
Earnings per share | $ | 1.68 | 1.39 | 1.30 | $ | 1.69 | 1.68 | 1.39 | ||||||
Diluted: | ||||||||||||||
Net income | $ | 6,509,776 | 5,418,520 | 5,054,655 | $ | 6,469,563 | 6,509,776 | 5,418,520 | ||||||
Average common shares Outstanding | 3,870,198 | 3,894,969 | 3,894,649 | |||||||||||
Average common shares outstanding | 3,830,002 | 3,870,198 | 3,894,969 | |||||||||||
Dilutive effect of options issued | 1,075 | 759 | 276 | 792 | 1,075 | 759 | ||||||||
Average diluted shares outstanding | 3,871,273 | 3,895,728 | 3,894,925 | 3,830,794 | 3,871,273 | 3,895,728 | ||||||||
Earnings per share | $ | 1.68 | 1.39 | 1.30 | $ | 1.69 | 1.68 | 1.39 | ||||||
58
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
The Company had no options that were issued and not included in the calculation of diluted earnings per share for the years ended December 31, 2005, 2004 2003 and 2002.2003.
| (m) | Stock–based compensation |
The Company applies Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, and related Interpretations in accounting for employee stock compensation plans and, accordingly, does not recognize compensation cost for stock options granted when the option price is greater than or equal to the underlying stock price. This accounting method is referred to as the intrinsic value method. The Company provides the pro–forma disclosures of SFAS No. 123,Accounting for Stock–Based Compensation, as amended by SFAS No. 148, using the fair value method of accounting for stock–based compensation.
The Company granted 4,000 options on January 1, 2003 with an exercise price of $13.39 which was equal to the closing market price on the date of grant. Each option had a fair value of $2.02, $2.06 and $3.51 at December 31, 2005, 2004 and 2003, respectively. These options vested on the date of grant and expire on
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
December 31, 2006. During 2005, 2004 and 2003, 800, 800 and 200 options were exercised, respectively. In addition, 200 options expired in 2003. At December 31, 2004, 2,8002005, 2,000 options were outstanding with a remaining contractual life of two years.
one year.
The Company granted 3,000 options on January 1, 2002 with an exercise price of $11.35 which was equal to the closing market price on the date of grant. These options expired on December 31, 2005. Each option had a fair value of $3.51 and $5.17 at December 31, 2004 and 2003, respectively. These options vested on the date of grant and expire on December 31, 2005. During 2005, 2004 and 2003, 1,100, 1,200, and 500 options were exercised, respectively. At December 31, 2004, 1,100 options were outstanding with a remaining contractual life of one year.
The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock–based employee compensation:
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||
| (In thousands, except per share data) | (In thousands, except per share data) | |||||||||||||
Net earnings – as reported | $ | 6,509,776 | 5,418,520 | 5,054,655 | $ | 6,469,563 | 6,509,776 | 5,418,520 | ||||||
Deduct: | ||||||||||||||
Total stock–based employee compensation expense determined under fair value based method for all awards, net of related tax effects | 7,738 | 17,740 | 9,846 | 2,588 | 7,738 | 17,740 | ||||||||
Net earnings – pro forma | $ | 6,502,038 | 5,400,780 | 5,044,809 | $ | 6,466,975 | 6,502,038 | 5,400,780 | ||||||
Earnings per share – as reported | ||||||||||||||
Basic | $ | 1.68 | 1.39 | 1.30 | $ | 1.69 | 1.68 | 1.39 | ||||||
Diluted | 1.68 | 1.39 | 1.30 | 1.69 | 1.68 | 1.39 | ||||||||
Earnings per share – pro forma | ||||||||||||||
Basic | $ | 1.68 | 1.39 | 1.30 | $ | 1.69 | 1.68 | 1.39 | ||||||
Diluted | 1.68 | 1.39 | 1.30 | 1.69 | 1.68 | 1.39 | ||||||||
59
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
The fair value of the 2003 option grant iswas estimated on the date of grant using the Black–Scholes option–pricing model with the following assumptions:
| Options granted in | ||||||
| 2003 | 2002 | |||||
Expected stock price volatility | 43.08 | % | 43.08 | % | ||
Risk free interest rate | 2.90 | % | 2.65 | % | ||
Expected life of options | 2 years | 1 year | ||||
Dividend yield | 2.45 | % | 2.45 | % | ||
(Continued)
granted in 2003 | ||||
Expected stock price volatility | 33.22 | % | ||
Risk free interest rate | 4.42 | % | ||
Expected life of options | 1 year | |||
Dividend yield | 2.60 | % |
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
| (n) | Recent Accounting Pronouncements |
In March 2004, the SEC issued Staff Accounting Bulletin No. 105,Application of Accounting Principles to Loan Commitments. Current accounting guidance requires the commitment to originate mortgage loans to be held for sale be recognized on the balance sheet at fair value from inception through expiration or funding. SAB 105 requires that the fair-value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. SAB 105 was effective for commitments to originate mortgage loans to be held for sale entered into after March 31, 2004. Its adoption did not have a material impact on the Company’s consolidated balance sheets or statement of earnings.
In March 2004,On November 13, 2003, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force reached a consensus on EITF Issue No. 03-1,The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 providesThis guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. Generally, an impairment is considered other-than-temporary unless: (i) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for an anticipated recovery of fair value up to (or beyond) the cost of the investment; and (ii) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. If impairment is determinedwas to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment’s cost and its fair value. Certain disclosure requirements of EITF 03-1 were adoptedapplied in 2003 and the Company began presenting the new disclosure requirements in its consolidated financial statements for the year ended December 31, 2003. The recognition and measurement provisions were initially effective for other-than-temporary impairment evaluations performed in reporting periods beginning after June 15, 2004. However,Disclosures were effective in September 2004,annual financial statements for fiscal years ended after December 31, 2003, for investments accounted for under SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, and SFAS No. 124,Accounting for Certain Investments Held by Not-for-Profit Organizations. In 2005, the effective date of these provisions was delayed until the finalization of aFASB issued FASB Staff Position (FSP)(FSB) No 115-1,The Meaning of Other-Than-Temporary Impairment and Its Application to provide additional implementation guidance. ItsCertain Investments, which nullifies certain provisions of EITF Issue No. 03-1, while retaining the disclosure requirements that have been previously adopted by the Company. The adoption isof FSB No. 115-1 did not expected to have a material impact on the consolidated balance sheets or statement of earnings for the Company.Company’s financial statements.
Statement of Position 03-03,Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-03) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. SOP 03-03 does not apply to loans originated by the entity. SOP 03-03 is effective for loans acquired in fiscal years beginning after December 15, 2004. Early adoption is encouraged. Specific transition guidance applies to certain loans that currently are within the scope of Practice Bulletin 6,Amortization of Discounts on Certain Acquired Loans. Its adoption is not expected to have a material impact on the consolidated balance sheets or statement of earnings for the Company.
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004),Share-Based Payment (“SFAS No. 123R”), which revised SFAS No. 123,Accounting for Stock-Based Compensation. This statement supercedes APB Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25”). The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of income.
On April 14, 2005, the SEC amended Rule 4-01(a) of Regulation S-X that amended the compliance date for SFAS No. 123R. The revised statement is effective asSEC’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the first interimnext reporting period beginningthat begins after June 15, 2005. Its
On March 25, 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 provides guidance regarding the valuation of share-based
60
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
payment arrangements, the classification of compensation expense, financial measures which do not follow accounting principles generally accepted in the United States (“GAAP”), first-time adoption of SFAS No. 123R in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R and disclosures in Management’s Discussion and Analysis subsequent to adoption to SFAS No. 123R. The Company adopted SFAS 123R on January 1, 2006 and its adoption did not have a material impact on the consolidated balance sheets or statements of earnings for the Company.
Statement of Position 03-03,Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-03) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. SOP 03-03 does not apply to loans originated by the entity. SOP 03-03 was effective for loans acquired in fiscal years beginning after December 15, 2004. Early adoption was encouraged. Specific transition guidance applies to certain loans that currently are within the scope of Practice Bulletin 6,Amortization of Discounts on Certain Acquired Loans. The Company does not believe the determination of the impact on its financial statements will be meaningful until the Company completes a business combination with a financial institution and/or acquires a future loan portfolio.
In May 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 replaced APB Opinion No. 20,Accounting Changes, and SFAS No. 3Reporting Accounting Changes in Interim Financial Statements and changes in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle by requiring retrospective application to prior period financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expectedexpect the impact of SFAS No. 154 to have a material impact on the consolidated balance sheets or statement of earnings for the Company.
| (o) | Reclassifications |
Certain 20032004 and 20022003 amounts have been reclassified to conform to the 20042005 presentation.
| (2) | Cash and Due from Banks |
The Bank is required to maintain certain average cash reserve balances in accordance with Federal Reserve Board requirements. There were no required balances as of December 31, 2005 and 2004.
61
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003.2003
| (3) | Investment Securities |
The amortized cost and fair value of investment securities at December 31, 2004,2005, were as follows:
| Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||
Investment securities held to maturity: | |||||||||
State and political subdivisions | 362,000 | — | — | 362,000 | |||||
Mortgage-backed securities | 446,607 | 13,683 | — | 460,290 | |||||
| $ | 808,607 | 13,683 | — | 822,290 | |||||
Investment securities available for sale: | |||||||||
U.S. government agencies, excluding mortgage-backed securities | $ | 58,024,567 | 132,203 | 356,255 | 57,800,515 | ||||
State and political subdivisions | 41,570,722 | 839,681 | 21,730 | 42,388,673 | |||||
Corporate securities | 6,216,239 | 96,451 | — | 6,312,690 | |||||
Collateralized mortgage obligations | 17,632,426 | 4,168 | 123,327 | 17,513,267 | |||||
Mortgage-backed securities | 158,332,360 | 313,364 | 1,270,405 | 157,375,319 | |||||
| $ | 281,776,314 | 1,385,867 | 1,771,717 | 281,390,464 | |||||
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||
Investment securities held to maturity: | |||||||||
State and political subdivisions | $ | 355,000 | — | — | 355,000 | ||||
Mortgage-backed securities | 278,478 | 3,505 | 21 | 281,962 | |||||
| $ | 633,478 | 3,505 | 21 | 636,962 | |||||
Investment securities available for sale: | |||||||||
U.S. government agencies, excluding mortgage-backed securities | $ | 62,733,001 | 5,625 | 1,303,263 | 61,435,363 | ||||
State and political subdivisions | 48,888,702 | 371,986 | 223,081 | 49,037,607 | |||||
Corporate securities | 10,171,066 | 58,858 | 9,819 | 10,220,105 | |||||
Collateralized mortgage obligations | 17,036,006 | 938 | 487,540 | 16,549,404 | |||||
Mortgage-backed securities | 142,126,936 | 20,070 | 5,062,061 | 137,084,945 | |||||
| $ | 280,955,711 | 457,477 | 7,085,764 | 274,327,424 | |||||
The composition of the investment securities with an unrealized loss position at December 31, 20042005 is shown below including the investment securities with an unrealized loss of less than twelve months and twelve months or longer.
Investments With an Unrealized Loss of Less than 12 Months | Investments With an 12 Months or Longer | ||||||||
Fair value | Unrealized losses | Fair value | Unrealized losses | ||||||
U.S. government agencies, excluding | |||||||||
mortgage-backed securities | $ | 19,115,985 | 192,414 | 7,819,688 | 163,841 | ||||
State and political subdivisions | 5,198,813 | 21,730 | — | — | |||||
Collateralized mortgage obligations | 11,713,310 | 123,327 | — | — | |||||
Mortgage-backed securities | 77,772,894 | 544,534 | 32,972,741 | 725,871 | |||||
| $ | 113,801,002 | 882,005 | 40,792,429 | 889,712 | |||||
Investments With an than 12 Months | Investments With an 12 Months or Longer | Total | |||||||||||
Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | ||||||||
U.S. government agencies, excluding mortgage-backed securities | $ | 15,278,527 | 188,598 | 43,151,212 | 1,114,665 | 58,429,739 | 1,303,263 | ||||||
State and political subdivisions | 19,013,670 | 213,141 | 509,330 | 9,940 | 19,523,000 | 223,081 | |||||||
Corporate securities | 1,000,000 | 9,819 | — | — | 1,000,000 | 9,819 | |||||||
Collateralized mortgage obligations | 7,605,956 | 150,329 | 8,666,958 | 337,211 | 16,272,914 | 487,540 | |||||||
Mortgage-backed securities | 47,299,320 | 1,255,935 | 86,933,037 | 3,806,147 | 134,232,357 | 5,062,082 | |||||||
| $ | 90,197,473 | 1,817,822 | 139,260,537 | 5,267,963 | 229,458,010 | 7,085,785 | |||||||
Management evaluates securities when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than costs, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The declines in fair value noted above were attributable to increases in interest rates and not attributable to credit quality. Since the Company has the ability and intent to hold all of these investments until a market price recovery or maturity, these investments were not considered other-than-temporarily impaired.
(Continued)62
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
The amortized cost and fair value of investment securities at December 31, 2003 were as follows:
Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||
Investment securities held to maturity: | |||||||||
State and political subdivisions | 370,000 | — | — | 370,000 | |||||
Collateralized mortgage obligations | — | — | — | — | |||||
Mortgage-backed securities | 867,764 | 38,956 | — | 906,720 | |||||
| $ | 1,237,764 | 38,956 | — | 1,276,720 | |||||
Investment securities available for sale: | |||||||||
U.S. government agencies, excluding mortgage-backed securities | $ | 62,866,562 | 205,551 | 405,486 | 62,666,627 | ||||
State and political subdivisions | 27,892,370 | 277,557 | 93,787 | 28,076,140 | |||||
Corporate securities | 5,221,236 | 65,308 | 9,014 | 5,277,530 | |||||
Collateralized mortgage obligations | 16,139,661 | 23,986 | 79,746 | 16,083,901 | |||||
Mortgage-backed securities | 172,319,223 | 359,500 | 1,459,968 | 171,218,755 | |||||
Equity securities | 1,023,432 | — | 265,262 | 758,170 | |||||
| $ | 285,462,484 | 931,902 | 2,313,263 | 284,081,123 | |||||
As of December 31, 2003, the Company had one investment which had been in an unrealized loss position greater than one year in which the Company decided not to write down to its fair value because of management’s belief that the impairment was temporary. The Company owned 52,396 shares of Concord EFS stock. On December 31, 2003, the stock had a fair value of $265,000 below historical cost. The Company believed the decrease was due to the past uncertainties from the proposed merger of Concord and First Data which closed in February 2004. Based on the a review of analysts’ expectations, the Company’s management believed that Concord was well positioned with healthy market shares in the grocery, trucking and benefits payment sectors with a large book of recurring revenues. The Company expected that the merger should strengthen First Data’s merchant processing payment processing, electronic payments and debit card businesses and that steadily improving economic conditions should positively impact First Data’s 2004 operations. Although First Data’s stock price remained relatively stable in 2004, the Company sold the stock during2005, 2004, and realized a loss of $214,818.
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
The amortized cost and fair value of investment securities at December 31, 2004 were as follows:
Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||
Investment securities held to maturity: | |||||||||
State and political subdivisions | $ | 362,000 | — | — | 362,000 | ||||
Mortgage-backed securities | 446,607 | 13,683 | — | 460,290 | |||||
| $ | 808,607 | 13,683 | — | 822,290 | |||||
Investment securities available for sale: | |||||||||
U.S. government agencies, excluding mortgage-backed securities | $ | 58,024,567 | 132,203 | 356,255 | 57,800,515 | ||||
State and political subdivisions | 41,570,722 | 839,681 | 21,730 | 42,388,673 | |||||
Corporate securities | 6,216,239 | 96,451 | — | 6,312,690 | |||||
Collateralized mortgage obligations | 17,632,426 | 4,168 | 123,327 | 17,513,267 | |||||
Mortgage-backed securities | 158,332,360 | 313,364 | 1,270,405 | 157,375,319 | |||||
| $ | 281,776,314 | 1,385,867 | 1,771,717 | 281,390,464 | |||||
63
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
The amortized cost and fair value of investment securities at December 31, 2005, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Amortized cost | Fair value | ||||
Investment securities held to maturity: | |||||
Due after ten years | $ | 362,000 | 362,000 | ||
Mortgage-backed securities | 446,607 | 460,290 | |||
Total | $ | 808,607 | 822,290 | ||
Investment securities available for sale: | |||||
Due after one year through five years | 27,373,396 | 27,246,517 | |||
Due after five years through ten years | 21,078,746 | 21,143,610 | |||
Due after ten years | 51,143,147 | 51,799,060 | |||
Subtotal | 99,595,289 | 100,189,187 | |||
Corporate securities | 6,216,239 | 6,312,690 | |||
Mortgage-backed securities | 158,332,360 | 157,375,319 | |||
Collateralized mortgage obligations | 17,632,426 | 17,513,268 | |||
Total | $ | 281,776,314 | 281,390,464 | ||
Amortized cost | Fair value | ||||
Investment securities held to maturity: | |||||
Due after ten years | $ | 355,000 | 355,000 | ||
Mortgage-backed securities | 278,478 | 281,962 | |||
Total | $ | 633,478 | 636,962 | ||
Investment securities available for sale: | |||||
Due after one year through five years | $ | 38,376,163 | 37,562,396 | ||
Due after five years through ten years | 24,704,654 | 24,276,655 | |||
Due after ten years | 48,540,886 | 48,633,919 | |||
Subtotal | 111,621,703 | 110,472,970 | |||
Corporate securities | 10,171,066 | 10,220,105 | |||
Mortgage-backed securities | 142,126,936 | 137,084,945 | |||
Collateralized mortgage obligations | 17,036,006 | 16,549,404 | |||
Total | $ | 280,955,711 | 274,327,424 | ||
Proceeds from the sale of investment securities available for sale during the years ended December 31, 2005, 2004, and 2003 were $33,346,426, $77,533,760, and 2002 were $77,533,760, $82,443,026, and $16,892,073, respectively. Gross gains of $123,208, $405,507, $1,125,798, and $492,776$1,125,798 were realized on the sales for the years ended December 31, 2005, 2004, 2003, and 2002,2003, respectively. Gross losses of $111,902, $589,140 $131,099 and $32,571$131,099 were realized on the sales for the years ended December 31, 2005, 2004 2003 and 2002,2003, respectively. In addition, the Company sold a privately-held investment in 2004 for a realized gain of $917,061.
Also in 2004, the Company sold its ownership in First Data stock and realized a loss of $214,818.
Investment securities with an aggregate fair value of $218,575,811$192,188,818 and $209,285,826$218,575,811 at December 31, 20042005 and 2003,2004, respectively, were pledged to secure public and trust deposits as required by law and for other purposes.
The Company maintains a diversified investment portfolio, including held to maturity and available–for–sale securities, with limited concentration in any given region, industry, or economic characteristic.
Included in other assets is stock in the Federal Home Loan Bank (FHLB) of Atlanta. FHLB stock is carried at cost, has no contractual maturity, has no quoted fair value, and no ready market exists. The investment in the stock is required of every member of the FHLB system. The investment in the stock was $5,595,200$5,598,900 and $4,912,200$5,595,200 at December 31, 20042005 and 2003,2004, respectively.
(Continued)64
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (4) | Loans |
At December 31, 20042005 and 2003,2004, the composition of the loan portfolio was as follows:
| 2004 | 2003 | ||||
Commercial, financial, and agricultural | $ | 49,757,919 | 54,998,933 | ||
Leases – commercial | 5,397,519 | 6,630,351 | |||
Real estate – construction: | |||||
Commercial | 944,673 | 2,098,839 | |||
Residential | 5,426,195 | 4,865,773 | |||
Real estate – mortgage: | |||||
Commercial | 136,036,617 | 122,397,493 | |||
Residential | 42,545,143 | 41,987,725 | |||
Real estate – held for sale | 7,813,539 | 12,439,618 | |||
Consumer installment | 11,021,229 | 11,673,324 | |||
Total loans | 258,942,834 | 257,092,056 | |||
Less allowance for loan losses | 3,455,515 | 4,312,554 | |||
Loans, net | $ | 255,487,319 | 252,779,502 | ||
| 2005 | 2004 | ||||
Commercial, financial, and agricultural | $ | 51,490,822 | 49,757,919 | ||
Leases – commercial | 1,488,292 | 5,397,519 | |||
Real estate – construction: | |||||
Commercial | 2,039,161 | 944,673 | |||
Residential | 8,832,065 | 5,426,195 | |||
Real estate – mortgage: | |||||
Commercial | 148,118,376 | 136,036,617 | |||
Residential | 59,756,144 | 42,545,143 | |||
Consumer installment | 10,334,387 | 11,021,229 | |||
Total loans | 282,059,247 | 251,129,295 | |||
Less allowance for loan losses | 3,843,374 | 3,455,515 | |||
Loans, net | $ | 278,215,873 | 247,673,780 | ||
During 20042005 and 2003,2004, certain executive officers and directors of the Company and the Bank, including companies with which they are associated, were loan customers of the Bank. Total loans outstanding to these persons at December 31, 20042005 and 20032004 amounted to $5,628,300$5,375,880 and $5,703,828,$5,628,084, respectively. The change from 20032004 to 20042005 reflects payments of $4,391,573$6,908,305 and advances of $4,316,045.$6,656,101. In management’s opinion, these loans were made in the ordinary course of business at normal credit terms, including interest rate and collateral requirements, and do not represent more than normal credit risk.
A summary of the transactions in the allowance for loan losses for the years ended December 31, 2005, 2004, 2003, and 20022003 is as follows:
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||||||||
Balance at beginning of year | $ | 4,312,554 | 5,104,165 | 5,339,945 | $ | 3,455,515 | 4,312,554 | 5,104,165 | ||||||||||||
Provision charged to earnings | 600,000 | 675,000 | 1,680,000 | 485,000 | 600,000 | 675,000 | ||||||||||||||
Loan recoveries | 309,042 | 110,813 | 357,341 | 258,654 | 309,042 | 110,813 | ||||||||||||||
Loans charged off | (1,766,081 | ) | (1,577,424 | ) | (2,273,121 | ) | (355,795 | ) | (1,766,081 | ) | (1,577,424 | ) | ||||||||
Balance at end of year | $ | 3,455,515 | 4,312,554 | 5,104,165 | $ | 3,843,374 | 3,455,515 | 4,312,554 | ||||||||||||
The Company had no impaired loans at December 31, 2005. At December 31, 2004, and 2003, the Company had $677,252 and $471,441, respectively, of impaired loans. Impaired loans at December 31, 2004 and 2003 in the amount of $677,252 and $471,441, respectively, havewith a related valuation allowance of $176,860 and $309,181 at December 31, 2004 and 2003, respectively.
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
$176,860.
For the years ended December 31, 2005, 2004 2003, and 2002,2003, the average recorded investment in impaired loans was $85,561, $339,593 and $1,408,378, respectively. The Company did not recognize any interest income on impaired loans in 2005 and $7,394,190, respectively.2004. The amount of interest income on impaired loans recognized during 2004, 2003 and 2002 amounted to $0, $48,817$48,817.
65
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and $135,385, respectively.
2003
Nonperforming loans, consisting of loans on nonaccrual status and accruing loans past due greater than 90 days, amounted to $710,649$108,441 and $1,704,080$710,649 at December 31, 20042005 and 2003,2004, respectively. Nonaccrual loans were $710,649$108,441 and $1,704,080,$710,649, at December 31, 20042005 and 2003,2004, respectively. Interest that would have been recorded on nonaccrual loans had they been in accruing status was approximately $36,000, $92,000 and $180,000, in 2005, 2004, and $462,000, in 2004, 2003, and 2002, respectively.
The Company had no real estate acquired by foreclosure at December 31, 2005. The Company had approximately $105,000 in real estate acquired by foreclosure at December 31, 2004. The Company had no real estate acquired by foreclosure at December 31, 2003.
The Company originates real estate mortgage loans which are sold in the secondary market. The Company retains the servicing for residential real estate loans that are sold to FNMA. The Company’s loan servicing portfolio consisted of 1,499 loans with an outstanding balance of $152,790,298; 1,518 loans with an outstanding balance of $154,020,527;$154,020,527 and 1,409 loans with an outstanding balance of $139,684,559, and 1,188 loans with an outstanding balance of $107,671,929, as of December 31, 2005, 2004, 2003, and 2002,2003, respectively.
| (5) | Premises and Equipment |
Premises and equipment at December 31, 20042005 and 20032004 are summarized as follows:
| 2004 | 2003 | 2005 | 2004 | |||||||
Land | $ | 407,747 | 407,747 | $ | 407,747 | 407,747 | ||||
Buildings | 3,002,703 | 2,970,259 | 3,047,875 | 3,002,703 | ||||||
Furniture, fixtures, and equipment | 3,587,476 | 3,766,484 | 3,327,058 | 3,587,476 | ||||||
Total premises and equipment | 6,997,926 | 7,144,490 | 6,782,680 | 6,997,926 | ||||||
Less accumulated depreciation | 4,318,621 | 4,268,438 | 4,354,061 | 4,318,621 | ||||||
| $ | 2,679,305 | 2,876,052 | $ | 2,428,619 | 2,679,305 | |||||
| (6) | Rental Property |
Rental property at December 31, 20042005 and 20032004 are summarized as follows:
| 2004 | 2003 | 2005 | 2004 | |||||||
Land | $ | 390,900 | 390,900 | $ | 390,900 | 390,900 | ||||
Buildings | 2,201,144 | 2,189,646 | 2,207,869 | 2,201,144 | ||||||
Furniture, fixtures, and equipment | 218,333 | 218,333 | 226,737 | 218,333 | ||||||
Total rental property | 2,810,377 | 2,798,879 | 2,825,506 | 2,810,377 | ||||||
Less accumulated depreciation | 1,480,197 | 1,371,594 | 1,588,923 | 1,480,197 | ||||||
| $ | 1,330,180 | 1,427,285 | $ | 1,236,583 | 1,330,180 | |||||
(Continued)66
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (7) | Interest–Bearing Deposits |
At December 31, 20042005 and 2003,2004, the composition of interest–bearing deposits was as follows:
| 2004 | 2003 | ||||
NOW | $ | 64,938,344 | 87,352,561 | ||
Money market | 96,983,400 | 78,881,031 | |||
Savings | 19,656,254 | 18,026,285 | |||
Certificates of deposit under $100,000 | 87,183,821 | 85,400,560 | |||
Certificates of deposit and other time deposits of $100,000 and over | 95,213,338 | 103,874,558 | |||
| $ | 363,975,157 | 373,534,995 | |||
| 2005 | 2004 | ||||
NOW | $ | 68,203,383 | 64,938,344 | ||
Money market | 115,415,273 | 96,983,400 | |||
Savings | 19,572,723 | 19,656,254 | |||
Certificates of deposit under $100,000 | 84,966,427 | 87,183,821 | |||
Certificates of deposit and other time deposits of $100,000 and over | 96,053,200 | 95,213,338 | |||
| $ | 384,211,006 | 363,975,157 | |||
Interest expense on certificates of deposit and other time deposits of $100,000 and over amounted to approximately $2,518,000, $2,322,000, and $2,954,000, in 2005, 2004, and $3,029,000, in 2004, 2003, and 2002, respectively.
The following table presents the maturities of certificates of deposit and other time deposits of $100,000 or more at December 31, 2004.2005:
Years ending December 31: | |||
2005 | $ | 50,777,806 | |
2006 | 15,758,299 | ||
2007 | 9,985,747 | ||
2008 | 5,278,918 | ||
2009 | 13,412,568 | ||
Thereafter | — | ||
| $ | 95,213,338 | ||
Years ending December 31: | |||
2006 | $ | 44,619,238 | |
2007 | 21,224,211 | ||
2008 | 10,416,325 | ||
2009 | 12,103,012 | ||
2010 | 7,690,414 | ||
Thereafter | — | ||
| $ | 96,053,200 | ||
During 20042005 and 2003,2004, certain executive officers and directors of the Company and Bank, including companies with which they are associated, were deposit customers of the Bank. Total deposits of these persons at December 31, 20042005 and 20032004 amounted to $12,919,323$11,142,655 and $10,964,149,$12,919,323, respectively.
(Continued)67
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (8) | Securities Sold Under Agreements to Repurchase |
The securities sold under agreements to repurchase at December 31, 2005, 2004 2003 and 20022003 are collateralized by obligations of the U.S. Government or its corporations and agencies, state and municipal securities, or mortgage–backed securities, which are held by independent trustees. The following summarizes pertinent data related to the securities sold under agreements to repurchase as of and for the years ended December 31, 2005, 2004, 2003, and 2002.2003.
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||||||||
Weighted average borrowing rate at year end | 2.23 | % | 0.89 | % | 1.19 | % | 3.91 | % | 2.23 | % | 0.89 | % | ||||||||
Weighted average borrowing rate during the year | 1.20 | % | 1.02 | % | 1.60 | % | 3.18 | % | 1.20 | % | 1.02 | % | ||||||||
Average daily balance during the year | $ | 2,524,643 | 3,192,075 | 3,265,000 | $ | 2,502,058 | 2,524,643 | 3,192,075 | ||||||||||||
Maximum month-end balance during the year | 7,612,922 | 8,492,969 | 11,989,000 | 4,078,104 | 7,612,922 | 8,492,969 | ||||||||||||||
| (9) | Other Borrowed Funds |
Other borrowed funds at December 31, 20042005 and 20032004 consisted of the following:
Maturity Dates | Weighted Average Interest rate | 2004 | 2003 | Maturity Dates | Weighted Average Interest rate | 2005 | 2004 | |||||||||||||
Federal Home Loan Bank borrowings: | ||||||||||||||||||||
Fixed rate | 2008-2017 | 5.53 | % | $ | 15,223,505 | 241,755 | 2009-2017 | 5.41 | % | $ | 10,205,256 | 15,223,505 | ||||||||
LIBOR-based floating rate | 2008-2014 | 4.14 | % | 83,000,000 | 98,000,000 | |||||||||||||||
Notes payable | — | 130,433 | ||||||||||||||||||
Convertible - Libor based | 2008-2015 | 4.00 | % | 88,000,000 | 83,000,000 | |||||||||||||||
| $ | 98,223,505 | 98,372,188 | $ | 98,205,256 | 98,223,505 | |||||||||||||||
(Continued)68
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
Required annual principal payments on long–term debt for years subsequent to December 31, 20042005 are as follows:
| FHLB Borrowings | FHLB Borrowings | |||||
2005 | $ | 18,250 | ||||
2006 | 18,250 | $ | 18,250 | |||
2007 | 18,250 | 18,250 | ||||
2008 | 25,018,250 | 10,018,250 | ||||
2009 | 15,018,250 | 15,018,250 | ||||
2010 | 10,018,250 | |||||
Thereafter | 58,132,255 | 63,114,006 | ||||
Total | $ | 98,223,505 | $ | 98,205,256 | ||
On February 11, 2004, the FHLB increased theThe Bank’s available line towith the FHLB is 30% of the Bank’s total assets from 25%. Based on these availabilities, the Bank had a line of credit ofor $181,880,000 at December 31, 2005 and $176,816,000 at December 31, 20042004. The Bank’s remaining available line was $83,675,000 and $146,868,000$78,592,000 at December 31, 2003.2005 and 2004, respectively. Interest expense on FHLB advances was $4,281,410, $4,045,403, and $2,770,890 in 2005, 2004, and $2,946,247 in 2004, 2003, and 2002, respectively. The advances and line of credit are collateralized by the Bank’s investment in the stock of the FHLB, all eligible first mortgage residential loans, and investment securities with a lendable collateral value totaling $78,286,571, which are sufficient to draw the full line of credit.securities.
| (10) | Note Payable to Trust |
In November, 2003, theThe Company establishedowns Auburn National Bancorporation Capital Trust I (“Trust”), a wholly-owned statutory business trust. The Company is the sole sponsor of the trust and owns $217,000 of the Trust’s common securities. The Trust was created for the exclusive purpose of issuing 30-year capital trust preferred securities (“Trust Preferred Securities”) in the aggregate amount of $7,000,000 and using the proceeds from the issuance of the common and preferred securities to purchase $7,217,000 of junior subordinated debentures (“Note Payable to Trust”) issued by The Bankers Bank.the Company. The sole asset of the Trust is the Note Payable to Trust. The Company’s $217,000 investment in the Trust is included in other assets in the accompanying consolidated balance sheet and the $7,217,000 obligation of the Company is included in notes payable.
The Trust Preferred Securities bear a floating interest rate equal to the prime rate of interest plus 0.125% set at the end of each quarter and mature on December 31, 2033.reset quarterly. Distributions are payable quarterly. The Trust Preferred Securities are subject to mandatory redemption upon repayment of the Note Payable to Trust at their stated maturity date or their earlier redemption in an amount equal to their liquidation amount plus accumulated and unpaid distributions to the date of redemption. The Company guarantees the payment of distributions and payments for redemption or liquidation of the Trust Preferred Securities to the extent of funds held by the Trust. The Company’s obligations under the Note Payable to Trust together with the guarantee and other back-up obligations, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of the Trust under the Trust Preferred Securities.
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
The Note Payable to the Trust is unsecured, bear anbears interest at a rate equal to the prime rate of interest plus 0.125% set at the end of each quarterreset quarterly and maturematures on December 31, 2033. Interest is payable quarterly. The Company may defer the payment of interest at any time for a period not exceeding 20 consecutive quarters provided that
69
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
the deferral period does not extend past the stated maturity. During any such deferral period, distributions on the Trust Preferred Securities will also be deferred and the Company’s ability to pay dividends on ourits common shares will be restricted.
Subject to approval by the Federal Reserve Bank of Atlanta, the Trust Preferred Securities may be redeemed prior to maturity at our option on or after December 31, 2008. The Trust Preferred Securities may also be redeemed at any time in whole (but not in part) in the event of unfavorable changes in laws or regulations that result in (1) the Trust becoming subject to federal income tax on income received on the Note Payable to Trust, (2) interest payable by the parent company on the Note Payable to Trust becoming non-deductible for federal tax purposes, (3) the requirement for the Trust to register under the Investment Company Act of 1940, as amended, or (4) loss of the ability to treat the Trust Preferred Securities as “Tier I capital” under the Federal Reserve capital adequacy guidelines.
The Trust Preferred Securities currently qualify as Tier I capital under regulatory interpretations. On March 1, 2005, the Federal Reserve Board announced changes to its capital adequacy rules including the capital treatment of trust preferred securities. The Federal Reserve’s new rules, which will taketook effect in early April of 2005, would permitpermitted the Company to continue to treat its outstanding trust preferred securities as Tier 1 Capital for the first 25 years of the 30 year term of the related junior subordinated notes. During the last five years preceding maturity, the amount included as capital will decline by 20% per year. We believe that theThe Federal Reserve’s final rule with respect to the capital treatment of trust preferred securities willdid not adversely affect ourthe Company and Bank’s regulatory capital and that the Company and the Bank’s capital ratios will remainremained at an adequate level to allow the Company and the Bank to continue to be “well capitalized” under applicable banking regulations.
The condensed financial information for the Trust is presented as follows:70
Auburn National Bancorporation Capital Trust I
Condensed Balance Sheets
December 31, 2004 and 2003
| 2004 | 2003 | ||||
| Assets | |||||
Investment in subordinated debentures issued by the Company | $ | 7,217,000 | 7,217,000 | ||
Total assets | $ | 7,217,000 | 7,217,000 | ||
| Liabilities and Stockholders’ Equity | |||||
Total Liabilities | $ | — | — | ||
Stockholders’ equity: | |||||
Trust preferred securities | 7,000,000 | 7,000,000 | |||
Common stock (100% owned by the Company) | 217,000 | 217,000 | |||
Total stockholders’ equity | 7,217,000 | 7,217,000 | |||
Total liabilities and stockholders’ equity | $ | 7,217,000 | 7,217,000 | ||
(Continued)
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
Auburn National Bancorporation Capital Trust I
Condensed Statements of Earnings
Years ended December 31,2005, 2004, and 2003
| 2004 | 2003 | ||||
| Income | |||||
Interest income from subordinated debentures issued by the Company | $ | 301,875 | 45,719 | ||
Net Income | $ | 301,875 | 45,719 | ||
| (11) | Other Comprehensive Income (Loss) |
The following table sets forth the amounts of other comprehensive income (loss) included in stockholders’ equity along with the related tax effect for the years ended December 31, 2005, 2004, 2003, and 2002.2003.
Pretax amount | Tax (expense) benefit | Net of tax amount | ||||||||||||||||||
2005: | ||||||||||||||||||||
Net unrealized holding losses on investment securities available for sale arising during the year | $ | (6,231,131 | ) | 2,492,452 | (3,738,679 | ) | ||||||||||||||
Reclassification adjustment for net gains realized in net income | 11,306 | (4,522 | ) | 6,784 | ||||||||||||||||
| (6,242,437 | ) | 2,496,974 | (3,745,463 | ) | ||||||||||||||||
Net unrealized holding gain on derivatives used as cash flow hedges arising during the year | 208,000 | (83,200 | ) | 124,800 | ||||||||||||||||
Other comprehensive loss | $ | (6,034,437 | ) | 2,413,774 | (3,620,663 | ) | ||||||||||||||
| Pretax amount | Tax (expense) benefit | Net of tax amount | ||||||||||||||||||
2004: | ||||||||||||||||||||
Net unrealized holding gains on investment securities available for sale arising during the year | $ | 1,728,939 | (691,575 | ) | 1,037,364 | $ | 1,728,939 | (691,575 | ) | 1,037,364 | ||||||||||
Reclassification adjustment for net gains realized in net income | 733,428 | (293,371 | ) | 440,057 | 733,428 | (293,371 | ) | 440,057 | ||||||||||||
| 995,511 | (398,204 | ) | 597,307 | 995,511 | (398,204 | ) | 597,307 | |||||||||||||
Net unrealized holding losses on derivatives used as cash flow hedges arising during the year | (216,000 | ) | 86,400 | (129,600 | ) | (216,000 | ) | 86,400 | (129,600 | ) | ||||||||||
Other comprehensive income | $ | 779,511 | (311,804 | ) | 467,707 | $ | 779,511 | (311,804 | ) | 467,707 | ||||||||||
2003: | ||||||||||||||||||||
Net unrealized holding loss on investment securities available for sale arising during the year | $ | (3,456,827 | ) | 1,382,731 | (2,074,096 | ) | ||||||||||||||
Net unrealized holding losses on investment securities available for sale arising during the year | $ | (3,456,827 | ) | 1,382,731 | (2,074,096 | ) | ||||||||||||||
Reclassification adjustment for net gains realized in net income | 994,699 | (397,880 | ) | 596,819 | 994,699 | (397,880 | ) | 596,819 | ||||||||||||
Other comprehensive loss | $ | (4,451,526 | ) | 1,780,611 | (2,670,915 | ) | $ | (4,451,526 | ) | 1,780,611 | (2,670,915 | ) | ||||||||
2002: | ||||||||||||||||||||
Net unrealized holding gains on investment securities available for sale arising during the year | $ | 1,168,140 | (467,255 | ) | 700,885 | |||||||||||||||
Reclassification adjustment for net gains realized in net income | 492,776 | (197,110 | ) | 295,666 | ||||||||||||||||
Other comprehensive income | $ | 675,364 | (270,145 | ) | 405,219 | |||||||||||||||
(Continued)71
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (12) | Income Tax Expense |
Total income tax expense (benefit) for the years ended December 31, 2005, 2004, 2003, and 20022003 was allocated as follows:
| 2004 | 2003 | 2002 | ||||||
Income from continuing operations | $ | 2,349,236 | 2,283,435 | 2,084,653 | ||||
Stockholders’ equity, for accumulated other comprehensive income (loss) | 311,804 | (1,780,611 | ) | 270,145 | ||||
| 2005 | 2004 | 2003 | |||||||
Income from continuing operations | $ | 2,208,916 | 2,349,236 | 2,283,435 | |||||
Stockholders’ equity, for accumulated other comprehensive (loss) income | (2,413,774 | ) | 311,804 | (1,780,611 | ) | ||||
For the years ended December 31, 2005, 2004, 2003, and 20022003 the components of income tax expense from continuing operations were as follows:
| 2004 | 2003 | 2002 | |||||||
Current income tax expense: | |||||||||
Federal | $ | 3,141,152 | 1,794,625 | 1,771,291 | |||||
State | 287,782 | 61,106 | — | ||||||
Total | 3,428,934 | 1,855,731 | 1,771,291 | ||||||
Deferred income tax expense (benefit): | |||||||||
Federal | (974,782 | ) | 347,100 | 364,702 | |||||
State | (104,916 | ) | 80,604 | (51,340 | ) | ||||
Total | (1,079,698 | ) | 427,704 | 313,362 | |||||
| $ | 2,349,236 | 2,283,435 | 2,084,653 | ||||||
| 2005 | 2004 | 2003 | |||||||
Current income tax expense: | |||||||||
Federal | $ | 3,409,223 | 3,141,152 | 1,794,625 | |||||
State | 439,463 | 287,782 | 61,106 | ||||||
Total | 3,848,686 | 3,428,934 | 1,855,731 | ||||||
Deferred income tax (benefit) expense: | |||||||||
Federal | (1,480,834 | ) | (974,782 | ) | 347,100 | ||||
State | (158,936 | ) | (104,916 | ) | 80,604 | ||||
Total | (1,639,770 | ) | (1,079,698 | ) | 427,704 | ||||
| $ | 2,208,916 | 2,349,236 | 2,283,435 | ||||||
Total income tax expense differed from the amount computed by applying the statutory federal income tax rate of 34% to pretax earnings as follows:
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||||||||
Income tax expense at statutory rate | $ | 3,012,064 | 2,618,665 | 2,427,365 | $ | 2,950,683 | 3,012,064 | 2,618,665 | ||||||||||||
Increase (decrease) resulting from: | ||||||||||||||||||||
Tax-exempt interest | (450,857 | ) | (98,484 | ) | (58,281 | ) | (581,760 | ) | (450,857 | ) | (98,484 | ) | ||||||||
State income taxes net of Federal income tax effect | 120,692 | 93,529 | (33,884 | ) | 185,148 | 120,692 | 93,529 | |||||||||||||
Low-income housing credit | (227,823 | ) | (227,823 | ) | (227,823 | ) | (227,823 | ) | (227,823 | ) | (227,823 | ) | ||||||||
Dividends received deduction | (20,208 | ) | (8,610 | ) | (9,525 | ) | (5,224 | ) | (20,208 | ) | (8,610 | ) | ||||||||
Bank owned life insurance | (171,020 | ) | (171,360 | ) | (171,818 | ) | (156,060 | ) | (171,020 | ) | (171,360 | ) | ||||||||
Other | 86,388 | 77,518 | 158,619 | 43,952 | 86,388 | 77,518 | ||||||||||||||
| $ | 2,349,236 | 2,283,435 | 2,084,653 | $ | 2,208,916 | 2,349,236 | 2,283,435 | |||||||||||||
(Continued)72
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 20042005 and 20032004 are presented below:
| 2004 | 2003 | ||||||
Deferred tax assets: | |||||||
Loans, principally due to allowance for loan losses | $ | 746,658 | 620,219 | ||||
Principal amortization of leases | 1,093,472 | 638,613 | |||||
Unrealized loss on investment securities available for sale | 154,339 | 552,543 | |||||
Unrealized loss on derivatives | 86,400 | — | |||||
Other | 299,585 | 81,428 | |||||
Total gross deferred tax assets before valuation allowance | 2,380,454 | 1,892,803 | |||||
Valuation allowance | — | — | |||||
Total deferred tax assets | 2,380,454 | 1,892,803 | |||||
Deferred tax liabilities: | |||||||
Premises and equipment, principally due to differences in depreciation | 2,410,724 | 2,225,368 | |||||
Investments, principally due to discount accretion | 214,499 | 180,908 | |||||
Basis difference in equity investment | — | 363,257 | |||||
FHLB stock dividend | 18,616 | 16,792 | |||||
Prepaid expenses | 125,402 | 68,624 | |||||
Loans, principally due to differences in deferred loan fees | 64,581 | 69,921 | |||||
Deferred REIT income | 271,512 | 543,024 | |||||
Other | 108,202 | 25,885 | |||||
Total deferred tax liabilities | 3,213,536 | 3,493,779 | |||||
Net deferred tax liability | $ | (833,082 | ) | (1,600,976 | ) | ||
| 2005 | 2004 | |||||
Deferred tax assets: | ||||||
Loans, principally due to allowance for loan losses | $ | 1,116,213 | 746,658 | |||
Principal amortization of leases | 2,535,796 | 1,093,472 | ||||
Unrealized loss on investment securities available for sale | 2,651,313 | 154,339 | ||||
Unrealized loss on derivatives | 3,200 | 86,400 | ||||
Other | 152,776 | 299,585 | ||||
Total gross deferred tax assets before valuation allowance | 6,459,298 | 2,380,454 | ||||
Valuation allowance | — | — | ||||
Total deferred tax assets | 6,459,298 | 2,380,454 | ||||
Deferred tax liabilities: | ||||||
Premises and equipment, principally due to differences in depreciation | 2,700,988 | 2,410,724 | ||||
Investments, principally due to discount accretion | 265,945 | 214,499 | ||||
FHLB stock dividend | 18,616 | 18,616 | ||||
Prepaid expenses | 103,634 | 125,402 | ||||
Loans, principally due to differences in deferred loan fees | 55,779 | 64,581 | ||||
Deferred REIT income | — | 271,512 | ||||
Other | 93,874 | 108,202 | ||||
Total deferred tax liabilities | 3,238,836 | 3,213,536 | ||||
Net deferred tax asset (liability) | $ | 3,220,462 | (833,082 | ) | ||
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projection for future taxable income over the periods which the temporary differences resulting in the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.
| (13) | Retirement Plans |
The Bank has a defined contribution retirement plan that covers substantially all employees. Participants become 20% vested in their accounts after two years of service and 100% vested after six years of service. Contributions to the plan are determined by the board of directors. Company contributions to the plan amounted to $119,637, $112,319, and $97,372, in 2005, 2004, and $89,353, in 2004, 2003, and 2002, respectively, and are included in salaries and benefits expense.
(Continued)73
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
(14) Guarantees, Derivatives, and Contingent Liabilities
| (14) | Guarantees, Derivatives, and Contingent Liabilities |
Off–Balance–Sheet Arrangements
The Company is a party to financial instruments with off–balance–sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such instruments involve elements of credit risk in excess of the amounts recognized in the consolidated financial statements.
The Company’s exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on–balance–sheet instruments.
The financial instruments whose contract amounts represent credit risk as of December 31, 20042005 are as follows:
Commitments to extend credit | $ | 50,336,786 | |
Standby letters of credit | 4,149,308 |
Commitments to extend credit | $ | 50,252,455 | |
Standby letters of credit | 5,788,052 |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. All guarantees expire within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary. The Company has recorded a liability for the estimated fair value of these standby letters of credit of approximately $82,000 and $68,000 at December 31, 2005 and 2004, respectively based on the fees charged for these arrangements.
(Continued)As of December 31, 2005 and 2004, the Company had a cash flow hedge with a notional amount of $10 million for the purpose of converting the interest payments on floating rate money market accounts to a fixed rate. The Company started exchanging payments in March 2005 for this interest rate swap based on the three month Treasury bill investment rate. The Company recorded a liability for this swap of $8,000 and $216,000 for the years ended December 31, 2005 and 2004, respectively. This interest rate swap will mature in July 2007. There was not any material hedge ineffectiveness from this cash flow hedge recognized in the income statement. The Company had no fair value hedges at December 31, 2005 and 2004.
74
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
Contingent Liabilities
The Company and the Bank are involved in various legal proceedings, arising in connection with their business. In the opinion of management, based upon consultation with legal counsel, the ultimate resolution of these proceedings will not have a material adverse effect upon the financial position or results of operations of the Company and Bank.
(15) Fair Value of Financial Instruments
| (15) | Fair Value of Financial Instruments |
SFAS No. 107,Disclosures about Fair Value of Financial Instruments(“SFAS 107”), requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good–faith estimate of the fair value of financial instruments held by the Company. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
(a) Cash, Cash Equivalents, and Interest–Earning Deposits with Other Banks
| (a) | Cash, Cash Equivalents, and Interest–Earning Deposits with Other Banks |
Fair value equals the carrying value of such assets.
(b) Investment Securities
| (b) | Investment Securities |
The fair value of investment securities is based on quoted market prices.
(c) Loans
| (c) | Loans, including Loans Held for Sale |
The fair value of loans is calculated using discounted cash flows. The discount rates used to determine the present value of the loan portfolio are estimated market discount rates that reflect the credit and interest rate risk inherent in the loan portfolio. The estimated maturities are based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of accrued interest approximates its fair value.
(Continued) The fair value of loans held for sale is estimated using market values.
| (d) | ||||
| Derivatives |
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(d) Derivatives
Fair value of interest rate swaps is based on prices quoted by the counterparty. These values represent the estimated amount the Company would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the creditworthiness of the counterparties.
75
(e) DepositsAUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
| (e) | Deposits |
As required by SFAS 107, the fair value of deposits with no stated maturity, such as noninterest–bearing demand deposits, NOW accounts, savings and money market deposit accounts, is equal to the carrying value. Certificates of deposit have been valued using discounted cash flows. The discount rates used are based on estimated market rates for deposits of similar remaining maturities.
(f) Short–term Borrowings
| (f) | Short–term Borrowings |
The fair values of federal funds purchased, securities sold under agreements to repurchase, and other short–term borrowings approximate their carrying value.
(g) Long–term Borrowings
| (g) | Long–term Borrowings |
The fair value of the Company’s fixed rate long–term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company’s variable rate long–term debt approximates its fair value.
The carrying value and estimated fair value of the Company’s financial instruments at December 31, 20042005 and 20032004 are as follows (in thousands):
| 2004 | 2003 | ||||||||||
Carrying amount | Estimated fair value | Carrying amount | Estimated fair value | ||||||||
Financial assets: | |||||||||||
Cash and short-term investments | $ | 27,137 | 27,137 | 26,604 | 26,604 | ||||||
Investment securities | 282,199 | 282,213 | 285,319 | 285,358 | |||||||
Loans, net of allowance for loan losses | 255,487 | 254,247 | 252,780 | 254,214 | |||||||
Financial liabilities: | |||||||||||
Deposits | 429,339 | 424,310 | 434,042 | 433,110 | |||||||
Short-term borrowings | 7,613 | 7,613 | 6,654 | 6,654 | |||||||
Long-term borrowings | 105,441 | 108,305 | 105,589 | 107,094 | |||||||
Interest rate contracts: | |||||||||||
Swaps | (216 | ) | (216 | ) | 64 | 64 | |||||
(Continued)
| 2005 | 2004 | ||||||||||||
| Carrying amount | Estimated fair value | Carrying amount | Estimated fair value | ||||||||||
Financial assets: | |||||||||||||
Cash and short-term investments | $ | 26,082 | 26,082 | 27,137 | 27,137 | ||||||||
Investment securities | 274,961 | 274,964 | 282,199 | 282,213 | |||||||||
Loans, net of allowance for loan losses (1) | 279,616 | 276,046 | 255,487 | 254,247 | |||||||||
Financial liabilities: | |||||||||||||
Deposits | 454,995 | 435,625 | 429,339 | 424,310 | |||||||||
Short-term borrowings | 1,731 | 1,731 | 7,613 | 7,613 | |||||||||
Long-term borrowings | 105,422 | 102,382 | 105,441 | 108,305 | |||||||||
Interest rate contracts: | |||||||||||||
Swaps | (8 | ) | (8 | ) | (216 | ) | (216 | ) | |||||
| (1) | includes loans held for sale |
| (16) | ||||
| Common Stock and Capital Requirements |
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(16) Common Stock and Capital Requirements
The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Bank’s assets, liabilities, and certain off–balance–sheet
76
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk–weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2004,2005, that the Company and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2004,2005, based on its most recent notification, the Bank is categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk–based, Tier I risk–based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s capital category.
(Continued)77
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
The actual capital amounts and ratios and the aforementioned minimums as of December 31, 20042005 and 20032004 are as follows (dollars in thousands):
| Actual | Minimum for capital adequacy purposes | Minimum to be well capitalized underprompt corrective action provisions | Actual | Minimum for capital adequacy purposes | Minimum to be well capitalized under prompt corrective action provisions | |||||||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||||
Auburn National Bancorporation, Inc. | ||||||||||||||||||||||||||||||||
As of December 31, 2005 | ||||||||||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 59,007 | 16.99 | % | 27,790 | 8.00 | % | N/A | N/A | |||||||||||||||||||||||
Tier I risk-based capital (to risk-weighted assets) | 55,164 | 15.88 | % | 13,895 | 4.00 | % | N/A | N/A | ||||||||||||||||||||||||
Tier I leverage capital (to average assets) | 55,164 | 9.11 | % | 24,220 | 4.00 | % | N/A | N/A | ||||||||||||||||||||||||
As of December 31, 2004 | ||||||||||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 55,428 | 17.15 | % | 25,848 | 8.00 | % | N/A | N/A | $ | 55,428 | 17.15 | % | 25,848 | 8.00 | % | N/A | N/A | ||||||||||||||
Tier I risk-based capital (to risk-weighted assets) | 51,973 | 16.09 | % | 12,924 | 4.00 | % | N/A | N/A | 51,973 | 16.09 | % | 12,924 | 4.00 | % | N/A | N/A | ||||||||||||||||
Tier I leverage capital (to average assets) | 51,973 | 8.86 | % | 23,646 | 4.00 | % | N/A | N/A | 51,973 | 8.86 | % | 23,646 | 4.00 | % | N/A | N/A | ||||||||||||||||
As of December 31, 2003 | �� | |||||||||||||||||||||||||||||||
AuburnBank | ||||||||||||||||||||||||||||||||
As of December 31, 2005 | ||||||||||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 52,279 | 16.53 | % | 25,308 | 8.00 | % | N/A | N/A | 56,846 | 16.33 | % | 27,851 | 8.00 | % | 34,813 | 10.00 | % | ||||||||||||||
Tier I risk-based capital (to risk-weighted assets) | 48,320 | 15.27 | % | 12,654 | 4.00 | % | N/A | N/A | 53,003 | 15.22 | % | 13,925 | 4.00 | % | 20,888 | 6.00 | % | |||||||||||||||
Tier I leverage capital (to average assets) | 48,320 | 8.85 | % | 23,596 | 4.00 | % | N/A | N/A | 53,003 | 8.78 | % | 24,251 | 4.00 | % | 30,314 | 5.00 | % | |||||||||||||||
AuburnBank | ||||||||||||||||||||||||||||||||
As of December 31, 2004 | ||||||||||||||||||||||||||||||||
Total capital (to risk-weighted assets) | 51,899 | 16.15 | % | 25,700 | 8.00 | % | 32,126 | 10.00 | % | 51,899 | 16.15 | % | 25,700 | 8.00 | % | 32,126 | 10.00 | % | ||||||||||||||
Tier I risk-based capital (to risk-weighted assets) | 48,443 | 15.08 | % | 12,850 | 4.00 | % | 19,275 | 6.00 | % | 48,443 | 15.08 | % | 12,850 | 4.00 | % | 19,275 | 6.00 | % | ||||||||||||||
Tier I leverage capital (to average assets) | 48,443 | 8.29 | % | 23,576 | 4.00 | % | 29,469 | 5.00 | % | 48,443 | 8.29 | % | 23,576 | 4.00 | % | 29,469 | 5.00 | % | ||||||||||||||
As of December 31, 2003 | ||||||||||||||||||||||||||||||||
Total capital (to risk-weighted assets) | 47,785 | 15.22 | % | 25,112 | 8.00 | % | 31,389 | 10.00 | % | |||||||||||||||||||||||
Tier I risk-based capital (to risk-weighted assets) | 43,857 | 13.97 | % | 12,556 | 4.00 | % | 18,834 | 6.00 | % | |||||||||||||||||||||||
Tier I leverage capital (to average assets) | 43,857 | 8.07 | % | 23,499 | 4.00 | % | 29,374 | 5.00 | % | |||||||||||||||||||||||
| (17) | Dividends from Subsidiary |
Dividends paid by the Bank are a principal source of funds available to the Company for payment of dividends to its stockholders and for other needs. Applicable federal and state statutes and regulations impose restrictions on the amounts of dividends that may be declared by the subsidiary bank. State statutes restrict the Bank from declaring dividends in excess of the sum of the current year’s earnings plus the retained net earnings from the preceding two years without prior approval. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits, and other such items. Capital adequacy considerations could further limit the availability of dividends from the Bank. At December 31, 2004,2005, the Bank could have declared additional dividends of
(Continued)78
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
approximately $11,535,000$11,744,000 without prior approval of regulatory authorities. As a result of this limitation, approximately $34,290,000$34,063,000 of the Company’s investment in the Bank was restricted from transfer in the form of dividends.
| (18) | Supplemental Information |
Components of other noninterest income exceeding 1% of revenues for any of the years in the three–year period ended December 31, 2004,2005, include:
| 2004 | 2003 | 2002 | |||||
Merchant discounts and fees on Master Card and Visa sales | $ | 2,185,678 | 1,915,479 | 1,493,740 | |||
Gains on the sale of mortgage loans | 348,173 | 683,989 | 364,841 | ||||
Change in cash surrender value of Bank Owned Life Insurance | 503,000 | 504,000 | 505,348 | ||||
Servicing Fees | 391,115 | 317,836 | 233,253 | ||||
| 2005 | 2004 | 2003 | |||||
Merchant discounts and fees on Master Card and Visa sales | $ | 1,902,077 | 2,195,156 | 1,915,479 | |||
Gains on the sale of mortgage loans | 669,259 | 348,173 | 683,989 | ||||
Change in cash surrender value of Bank Owned Life Insurance | 459,000 | 503,000 | 504,000 | ||||
Servicing fees | 389,185 | 391,115 | 317,836 | ||||
Components of other noninterest expense exceeding 1% of revenues for any of the years in the three–year period ended December 31, 2004,2005, include:
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||
Master Card and Visa processing fees | $ | 2,194,296 | 1,898,204 | 1,599,341 | $ | 1,931,622 | 2,194,296 | 1,898,204 | ||||||
Marketing | 304,383 | 286,060 | 459,268 | |||||||||||
Professional fees | 491,039 | 470,646 | 301,536 | |||||||||||
Penalty on early payment of FHLB advances | — | 715,000 | — | — | — | 714,623 | ||||||||
(Continued)79
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
| (19) | Parent Company Financial Information |
The condensed financial information for Auburn National Bancorporation, Inc. (Parent Company Only) is presented as follows:
Parent Company Only
Condensed Balance Sheets
December 31, 20042005 and 20032004
| 2004 | 2003 | 2005 | 2004 | |||||||||||
| Assets | ||||||||||||||
Cash and due from banks | $ | 2,144,040 | 2,182,926 | $ | 730,430 | 2,144,040 | ||||||||
Investment securities available for sale | — | 758,170 | ||||||||||||
Investment in bank subsidiary | 48,278,964 | 43,378,760 | 49,223,154 | 48,278,964 | ||||||||||
Premises and equipment, net | 24 | 823 | — | 24 | ||||||||||
Rental property, net | 1,330,180 | 1,427,285 | 1,236,583 | 1,330,180 | ||||||||||
Other assets | 225,940 | 239,251 | 429,770 | 225,940 | ||||||||||
Total assets | $ | 51,979,148 | 47,987,215 | $ | 51,619,937 | 51,979,148 | ||||||||
| Liabilities and Stockholders’ Equity | ||||||||||||||
Other borrowed funds | $ | — | 130,432 | |||||||||||
Accrued expenses and other liabilities | 257,900 | 231,899 | $ | 448,459 | 257,900 | |||||||||
Note payable to trust | 7,217,000 | 7,217,000 | 7,217,000 | 7,217,000 | ||||||||||
Total liabilities | 7,474,900 | 7,579,331 | 7,665,459 | 7,474,900 | ||||||||||
Stockholders’ equity: | ||||||||||||||
Preferred stock of $0.01 par value; Authorized 200,000 shares; issued shares – none | — | — | — | — | ||||||||||
Common stock of $0.01 par value; Authorized 8,500,000 shares; issued 3,957,135 shares | 39,571 | 39,571 | 39,571 | 39,571 | ||||||||||
Additional paid-in capital | 3,723,578 | 3,712,246 | 3,734,425 | 3,723,578 | ||||||||||
Retained earnings | 42,669,061 | 38,092,829 | 46,918,896 | 42,669,061 | ||||||||||
Accumulated other comprehensive income | (361,109 | ) | (828,816 | ) | ||||||||||
Accumulated other comprehensive loss, net of tax | (3,981,772 | ) | (361,109 | ) | ||||||||||
Less: | ||||||||||||||
Treasury stock, at cost – 110,274 shares and 64,567 shares for December 31, 2004 and 2003, respectively | (1,566,853 | ) | (607,946 | ) | ||||||||||
Treasury stock, at cost – 162,119 shares and 110,274 shares for December 31, 2005 and 2004, respectively | (2,756,642 | ) | (1,566,853 | ) | ||||||||||
Total stockholders’ equity | 44,504,248 | 40,407,884 | 43,954,478 | 44,504,248 | ||||||||||
Total liabilities and stockholders’ equity | $ | 51,979,148 | 47,987,215 | $ | 51,619,937 | 51,979,148 | ||||||||
(Continued)80
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
Parent Company Only
Condensed Statements of Earnings
Years ended December 31, 2005, 2004, 2003, and 20022003
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||||||||
Income: | ||||||||||||||||||||
Cash dividends from bank subsidiary | $ | 2,237,000 | 1,869,602 | 1,711,838 | $ | 3,199,000 | 2,237,000 | 1,869,602 | ||||||||||||
Interest on bank deposits | 29,114 | — | — | 8,810 | 29,114 | — | ||||||||||||||
Interest on investment securities: | ||||||||||||||||||||
Taxable | — | — | 32 | |||||||||||||||||
Tax-exempt | — | 5,801 | 12,011 | — | — | 5,801 | ||||||||||||||
Loss on exchange of investment securities | (214,818 | ) | — | — | — | (214,818 | ) | — | ||||||||||||
Other income | 380,869 | 387,692 | 379,108 | 380,040 | 380,869 | 387,692 | ||||||||||||||
Total income | 2,432,165 | 2,263,095 | 2,102,989 | 3,587,850 | 2,432,165 | 2,263,095 | ||||||||||||||
Expense: | ||||||||||||||||||||
Interest on borrowed funds | 306,193 | 55,097 | 8,700 | 428,750 | 306,193 | 55,097 | ||||||||||||||
Net occupancy expense | 2,306 | 1,299 | 10,165 | 1,024 | 2,306 | 1,299 | ||||||||||||||
Salaries and benefits | 4,654 | 6,437 | 3,502 | 2,185 | 4,654 | 6,437 | ||||||||||||||
Other | 398,583 | 396,687 | 395,426 | 433,556 | 398,583 | 396,687 | ||||||||||||||
Total expense | 711,736 | 459,520 | 417,793 | 865,515 | 711,736 | 459,520 | ||||||||||||||
Earnings before income tax benefit and equity in undistributed earnings of subsidiary | 1,720,429 | 1,803,575 | 1,685,196 | 2,722,335 | 1,720,429 | 1,803,575 | ||||||||||||||
Applicable income tax benefit | (197,693 | ) | (27,287 | ) | (14,079 | ) | (182,375 | ) | (197,693 | ) | (27,287 | ) | ||||||||
Earnings before equity in undistributed earnings of subsidiary | 1,918,122 | 1,830,862 | 1,699,275 | 2,904,710 | 1,918,122 | 1,830,862 | ||||||||||||||
Equity in undistributed earnings of bank subsidiary | 4,591,654 | 3,587,658 | 3,355,380 | 3,564,853 | 4,591,654 | 3,587,658 | ||||||||||||||
Net earnings | $ | 6,509,776 | 5,418,520 | 5,054,655 | $ | 6,469,563 | 6,509,776 | 5,418,520 | ||||||||||||
(Continued)81
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 2002
2003
Parent Company Only
Condensed Statements of Cash Flows
Years ended December 31, 2005, 2004, 2003, and 20022003
| 2004 | 2003 | 2002 | 2005 | 2004 | 2003 | |||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||
Net earnings | $ | 6,509,776 | 5,418,520 | 5,054,655 | $ | 6,469,563 | 6,509,776 | 5,418,520 | ||||||||||||
Adjustments to reconcile net earnings to net cash provided by operating activities | ||||||||||||||||||||
Depreciation and amortization | 109,402 | 111,855 | 123,123 | 108,750 | 109,402 | 111,855 | ||||||||||||||
Loss on exchange of investment securities | 214,818 | — | — | — | 214,818 | — | ||||||||||||||
Equity in undistributed earnings of subsidiary | (4,591,654 | ) | (3,587,658 | ) | (3,355,380 | ) | (3,564,853 | ) | (4,591,654 | ) | (3,587,658 | ) | ||||||||
(Increase) decrease in other assets | (92,794 | ) | 219,510 | (32,014 | ) | (203,830 | ) | (92,794 | ) | 219,510 | ||||||||||
Increase (decrease) in other liabilities | 26,001 | (402,772 | ) | (5,863 | ) | 190,559 | 26,001 | (402,772 | ) | |||||||||||
Net cash provided by operating activities | 2,175,549 | 1,759,455 | 1,784,521 | 3,000,189 | 2,175,549 | 1,759,455 | ||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||
Proceeds from sale of investment securities available for sale | 808,614 | — | — | — | 808,614 | — | ||||||||||||||
Proceeds from calls of investment securities held to maturity | — | 185,089 | 45,880 | — | — | 185,089 | ||||||||||||||
Issuance of subordinated note to preferred trust | — | 7,217,000 | — | — | — | 7,217,000 | ||||||||||||||
Investment in preferred trust | — | (217,000 | ) | — | — | — | (217,000 | ) | ||||||||||||
Cash dividend to Bank | — | (5,000,000 | ) | — | (1,000,000 | ) | — | (5,000,000 | ) | |||||||||||
Additions to rental property | (11,498 | ) | (5,806 | ) | (82,255 | ) | (15,129 | ) | (11,498 | ) | (5,806 | ) | ||||||||
Net cash provided by (used in) investing activities | 797,116 | 2,179,283 | (36,375 | ) | ||||||||||||||||
Net cash (used in) provided by investing activities | (1,015,129 | ) | 797,116 | 2,179,283 | ||||||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||
Repayments of other borrowed funds | (130,432 | ) | (21,046 | ) | (26,507 | ) | — | (130,432 | ) | (21,046 | ) | |||||||||
Dividends paid | (1,933,544 | ) | (1,869,561 | ) | (1,713,654 | ) | (2,219,728 | ) | (1,933,544 | ) | (1,869,561 | ) | ||||||||
Purchase of treasury stock | (972,394 | ) | (61,262 | ) | — | (1,202,139 | ) | (972,394 | ) | (61,262 | ) | |||||||||
Sale of treasury stock | 24,819 | 8,678 | 2,271 | 23,197 | 24,819 | 8,678 | ||||||||||||||
Net cash used in financing activities | (3,011,551 | ) | (1,943,191 | ) | (1,737,890 | ) | (3,398,670 | ) | (3,011,551 | ) | (1,943,191 | ) | ||||||||
Net (decrease) increase in cash and cash equivalents | (38,886 | ) | 1,995,547 | 10,256 | (1,413,610 | ) | (38,886 | ) | 1,995,547 | |||||||||||
Cash and cash equivalents at beginning of year | 2,182,926 | 187,379 | 177,123 | 2,144,040 | 2,182,926 | 187,379 | ||||||||||||||
Cash and cash equivalents at end of year | $ | 2,144,040 | 2,182,926 | 187,379 | $ | 730,430 | 2,144,040 | 2,182,926 | ||||||||||||
(Continued)82
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2005, 2004, 2003, and 20022003
(20) Quarterly Financial Data (Unaudited)
| (20) | Quarterly Financial Data (Unaudited) |
The supplemental quarterly financial data for the years ended December 31, 20042005 and 20032004 is summarized as follows:
| Quarter ended | Quarter ended | |||||||||||||||||
March 31, 2004 | June 30, 2004 | September 30, 2004 | December 31, 2004 | March 31, 2005 | June 30, 2005 | September 30, 2005 | December 31, 2005 | |||||||||||
Interest and dividend income | $ | 6,769,939 | 6,690,138 | 6,865,820 | 6,851,424 | $ | 7,039,295 | 7,329,569 | 7,668,859 | 7,984,660 | ||||||||
Interest expense | 3,137,633 | 3,043,376 | 3,135,856 | 3,191,470 | 3,358,021 | 3,697,372 | 4,000,486 | 4,264,885 | ||||||||||
Net interest income | 3,632,306 | 3,646,762 | 3,729,964 | 3,659,954 | 3,681,274 | 3,632,197 | 3,668,373 | 3,719,775 | ||||||||||
Provision for loan losses | 150,000 | 150,000 | 150,000 | 150,000 | 150,000 | 150,000 | 120,000 | 65,000 | ||||||||||
Net earnings | 1,534,635 | 1,499,215 | 1,603,060 | 1,872,866 | 1,579,461 | 1,534,533 | 1,625,534 | 1,730,035 | ||||||||||
Net earnings per share – basic and diluted | 0.39 | 0.39 | 0.41 | 0.49 | 0.41 | 0.40 | 0.42 | 0.46 | ||||||||||
| Quarter ended | Quarter ended | |||||||||||||||||
March 31, 2003 | June 30, 2003 | September 30, 2003 | December 31, 2003 | March 31, 2004 | June 30, 2004 | September 30, 2004 | December 31, 2004 | |||||||||||
Interest and dividend income | $ | 6,412,317 | 6,159,874 | 5,977,785 | 6,390,161 | $ | 6,769,939 | 6,690,138 | 6,865,820 | 6,851,424 | ||||||||
Interest expense | 2,965,087 | 2,820,413 | 2,716,802 | 2,919,535 | 3,137,633 | 3,043,376 | 3,135,856 | 3,191,470 | ||||||||||
Net interest income | 3,447,230 | 3,339,461 | 3,260,983 | 3,470,626 | 3,632,306 | 3,646,762 | 3,729,964 | 3,659,954 | ||||||||||
Provision for loan losses | 225,000 | 175,000 | 125,000 | 150,000 | 150,000 | 150,000 | 150,000 | 150,000 | ||||||||||
Net earnings | 1,342,136 | 1,317,384 | 1,318,055 | 1,440,945 | 1,534,635 | 1,499,215 | 1,603,060 | 1,872,866 | ||||||||||
Net earnings per share – basic and diluted | 0.34 | 0.34 | 0.34 | 0.37 | 0.39 | 0.39 | 0.41 | 0.49 | ||||||||||
83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Auburn, State of Alabama, on the30th day of March, 2005.2006.
| AUBURN NATIONAL BANCORPORATION, INC. | ||
| (Registrant) | ||
| By: | /S/ E. L. SPENCER, JR. | |
| E. L. Spencer, Jr. | ||
| President | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/S/ E. L. SPENCER, JR.
| President, CEO and Chairman of the Board | March 30, | ||
| E. L. Spencer, Jr. | ||||
/S/ C. WAYNE ALDERMAN
| Director of Financial Operations | March 30, | ||
| C. Wayne Alderman | ||||
/S/ ROBERT W. DUMAS
| Director | March 30, | ||
| Robert W. Dumas | ||||
/S/ TERRY W. ANDRUS
| Director | March 30, | ||
| Terry W. Andrus | ||||
/S/ DAVID E. HOUSEL
| Director | March 30, | ||
| David E. Housel | ||||
/S/ WILLIAM F. HAM, JR.
| Director | March 30, | ||
| William F. Ham, Jr. | ||||
84
AUBURN NATIONAL BANCORPORATION, INC.
EXHIBIT INDEX
Exhibit Number | Description | |
| 3.1. | Certificate of Incorporation of Auburn National Bancorporation, Inc. * | |
| 3.2. | Bylaws of Auburn National Bancorporation, Inc.** | |
| 10.1. | Auburn National Bancorporation, Inc. 1994 Long-Term Incentive Plan. *** | |
| 10.2. | Lease and Equipment Purchase Agreement, dated September 15, 1987. *** | |
| 10.3. | Summary Descriptions of Director and Executive Compensation | |
| 21.1. | Subsidiaries of Registrant | |
| 23.1. | Consent of Independent Registered Public | |
| 31.1 | Certification signed by the Chief Executive Officer pursuant to SEC Rule 13a-14(a). | |
| 31.2 | Certification signed by the Director of Financial Operations pursuant to SEC Rule 13a-14(a). | |
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002 by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board. | |
| 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002 by C. Wayne Alderman, Director of Financial Operations. | |
| * | Incorporated by reference from Registrant’s Form 10-Q dated June 20, 2002 (File No. 000-26486). |
| ** | Incorporated by reference from Registrant’s Annual Report on Form 10K, dated March 30, 2004 (File No. 000-26486). |
| *** | Incorporated by reference from Registrant’s Registration Statement on Form SB-2 (File No. 33-86180). |
8285