UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
Annual Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended | | Commission File Number |
December 31, 2005 | | 0-17262 |
S.Y. BANCORP, INC.
1040 East Main Street
Louisville, Kentucky 40206
(502) 582-2571
Incorporated in Kentucky | | | | I.R.S. No. 61-1137529 |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: | | Name of each exchange on which registered: |
9.00% Cumulative trust preferred securities and
the guarantee with respect thereto | | American Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
Common stock, no par value
Preferred Share Purchase Rights
Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act). Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act:
Large accelerated filer o | | Accelerated filer ý | | Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o Noý
The aggregate market value of registrant’s voting stock (Common Stock, no par value) held by non-affiliates of the registrant as of June 30, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter) was $283,184,000.
The number of shares of the registrant’s Common Stock, no par value, outstanding as of March 6, 2006, was 13,803,057.
Documents Incorporated By Reference
Portions of Registrant’s definitive proxy statement related to Registrant’s Annual Meeting of Shareholders to be held on April 26, 2006 (the “Proxy Statement”), are incorporated by reference into Part III of this Form 10-K.
S.Y. BANCORP, INC.
Form 10-K
Index
2
Part I
Item 1. Business
S. Y. Bancorp, Inc. (Bancorp) was incorporated in 1988 and is a Kentucky corporation headquartered in Louisville, Kentucky. Bancorp is a bank holding company registered with, and subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System. Bancorp has two subsidiaries, Stock Yards Bank & Trust Company (the Bank) and S.Y. Bancorp Capital Trust I (the Trust). The Bank is wholly owned and is a state chartered bank. Bancorp conducts no active business operations; the business of Bancorp is substantially the same as that of the Bank. The operations of the Bank are fully reflected in the consolidated financial statements of Bancorp. Accordingly, references to “Bancorp” in this document may encompass both the holding company and the Bank. The Trust is a Delaware statutory business trust that is a 100%-owned finance subsidiary of Bancorp.
Stock Yards Bank & Trust Company
Stock Yards Bank & Trust Company is the only banking subsidiary of Bancorp and was originally chartered in 1904. The Bank is headquartered in Louisville, Kentucky and provides commercial banking services in Louisville, southern Indiana and Indianapolis through 24 full service banking offices (See “ITEM 2. PROPERTIES”). The Bank is chartered under the laws of the Commonwealth of Kentucky. In addition to traditional commercial and personal banking activities, the Bank has an investment management and trust department offering a wide range of trust and investment services. This department operates under the name of Stock Yards Trust Company. The Bank also originates and sells single-family residential mortgages through its operating division of retail banking, Stock Yards Mortgage Company. Additionally, the Bank offers securities brokerage services and life insurance products through arrangements with various third party providers. See Note 21 to Bancorp’s consolidated financial statements for the year ended December 31, 2005 for information relating to the Bank’s business segments.
At December 31, 2005, the Bank had 442 full-time equivalent employees. As is typically the case with banks, employees are not subject to a collective bargaining agreement. Management of Bancorp considers the relationship with employees to be good.
Supervision and Regulation
Bank holding companies and commercial banks are extensively regulated under both federal and state law. Any change in applicable law or regulation may have a material effect on the business and prospects of Bancorp and the Bank.
Bancorp, as a registered bank holding company, is subject to the supervision of and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956. In addition, Bancorp is subject to the provisions of Kentucky’s banking laws regulating bank acquisitions and certain activities of controlling bank shareholders.
The Bank is subject to the supervision of and regular examination by the Federal Deposit Insurance Corporation and the Kentucky Department of Financial Institutions. The Federal Deposit Insurance Corporation insures the deposits of the Bank to the current maximum of $100,000 per depositor.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the 1994 Act) removed state law barriers to interstate bank acquisitions and permits the consolidation of interstate banking operations. Under the 1994 Act, adequately capitalized and managed bank holding companies may acquire banks in any state, subject to Community Reinvestment Act compliance, compliance with federal and state antitrust laws and deposit concentration limits and subject to any state laws restricting the transaction. Kentucky banks are also permitted to acquire a branch in another state if permitted by law of the other state. Kentucky currently allows out-of-state banks to enter Kentucky to provide banking services on the same terms that a Kentucky bank could enter that bank’s state.
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The Gramm-Leach-Bliley Act (the 1999 Act) repealed the Depression-era barrier between commercial and investment banking established by the Glass-Steagall Act, as well as the prohibition on the mixing of banking and insurance established by the Bank Holding Company Act of 1956. The 1999 Act allows for affiliations among banks, securities firms and insurance companies by means of a financial holding company (FHC). In most cases, the creation of an FHC is a simple election and notice to the Federal Reserve Board. The 1999 Act requires that, at the time of establishment of an FHC, all depository institutions within that corporate group must be “well managed” and “well capitalized” and must have received a rating of “satisfactory” or better under its most recent Community Reinvestment Act examination. Further, non-banking financial firms (for example an insurance company or securities firm) may establish an FHC and acquire a depository institution. While the distinction between banks and non-banking financial firms has been blurring over recent years, the 1999 Act makes it less cumbersome for banks to offer services “financial in nature” but beyond traditional commercial banking activities. Likewise, non-banking financial firms may find it easier to offer services that had, heretofore, been provided primarily by depository institutions. Management of Bancorp has chosen not to become an FHC at this time, but may chose to do so in the future.
The USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D. C. on September 11, 2001 and is intended to strengthen U.S. law enforcement’s and the intelligence community’s ability to work cohesively to combat terrorism. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including: (a) due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts for non-U.S. persons; (b) standards for verifying customer identification at account opening; (c) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (d) currency transaction reports (“CTRs”) for transactions exceeding $10,000; and (e) filing of suspicious activities reports (“SARs”) if the Bank believes a customer may be in violation of U.S. laws and regulations.
Available Information
Bancorp files reports with the SEC. Those reports include the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K and proxy statements, as well as any amendments to those reports. The public may read and copy any materials the Registrant files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. Bancorp’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are accessible at no cost on Bancorp’s web site at http://www.syb.com after they are electronically filed with or furnished to the SEC.
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Item 1A. Risk Factors
Investments in Bancorp’s common stock involve risk, and Bancorp’s profitability and success may be affected by a number of factors including those discussed below.
Fluctuations in interest rates could reduce Bancorp’s profitability.
Bancorp’s primary source of income is from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. Management expects to periodically experience “gaps” in the interest rate sensitivities of Bancorp’s assets and liabilities, meaning that either Bancorp’s interest-bearing liabilities will be more sensitive to changes in market interest rates than Bancorp’s interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to Bancorp’s position, this “gap” will work against Bancorp and Bancorp’s earnings may be negatively affected.
Fluctuations of market interest rates are affected by the following factors:
• inflation;
• recession;
• a rise in unemployment;
• tightening money supply; and
• international disorder and instability in domestic and foreign financial markets.
Bancorp’s asset-liability management strategy, which is designed to mitigate Bancorp’s risk from changes in market interest rates, may not be able to prevent changes in interest rates from having a material adverse effect on Bancorp’s results of operations and financial condition.
Competition with other financial institutions could adversely affect Bancorp’s profitability.
Bancorp faces vigorous competition from banks and other financial institutions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. Additionally, Bancorp encounters competition from both de novo and smaller community banks entering the Louisville market. Bancorp also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. This competition may reduce or limit Bancorp’s margins on banking services, reduce Bancorp’s market share and adversely affect Bancorp’s results of operations and financial condition.
The unexpected loss of key members of Bancorp’s management team may adversely affect Bancorp’s operations.
Bancorp’s success to date has been influenced strongly by Bancorp’s ability to attract and to retain senior management experienced in banking and financial services. Bancorp’s ability to retain executive officers and the current management teams of each of Bancorp’s lines of business will continue to be important to successful implementation of Bancorp’s strategies. There are no employment or non-compete agreements with any of these key employees. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on Bancorp’s business and financial results.
Bancorp’s profitability depends on local and national economic conditions.
Bancorp’s success depends on general economic conditions both locally and nationally. Most of Bancorp’s customers are in the Louisville area with a growing number of customers in the Indianapolis area. Some of Bancorp’s customers are directly impacted by the local economy while others have more national or global business dealings. Local economic conditions have an impact on the demand of Bancorp’s customers for loans, the ability of some borrowers to repay these loans, and the value of the collateral securing these loans.
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Factors influencing general national economic conditions include inflation, recession, and unemployment. As these factors impact the overall business climate, they can have a significant effect on loan demand. Loan growth is critical to Bancorp’s profitability. Significant decline in general economic conditions will negatively affect the financial results of Bancorp’s banking operations.
If Bancorp’s allowance for loan losses is not sufficient to cover actual loan losses, Bancorp’s earnings could decrease.
Bancorp’s loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. Accordingly, Bancorp may experience significant credit losses which could have a material adverse effect on operating results. Management makes various assumptions and judgments about the collectibility of Bancorp’s loan portfolio, including the creditworthiness of Bancorp’s borrowers and the value of real estate and other assets serving as collateral for repayment of many of Bancorp’s loans. In determining the size of the allowance for loan losses, management considers, among other factors, Bancorp’s loan loss experience and an evaluation of economic conditions. If Bancorp’s assumptions prove to be incorrect, Bancorp’s current allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in Bancorp’s loan portfolio. Material additions to Bancorp’s allowance would materially decrease Bancorp’s net income.
In addition, federal and state regulators periodically review Bancorp’s allowance for loan losses and may require an increase in Bancorp’s provision for loan losses or further loan charge-offs. Any increase in Bancorp’s provision for loan losses or loan charge-offs as required by these regulatory agencies could have a negative effect on net income.
An inability to maintain Bancorp’s historical growth rate may adversely impact Bancorp’s results of operations and financial condition.
To achieve growth, Bancorp has initiated internal growth programs and opened additional branches. Bancorp may not be able to sustain its historical rate of growth or obtain funding necessary to support such growth. Further, Bancorp’s inability to attract and retain experienced bankers may adversely affect Bancorp’s internal growth. A significant decrease in Bancorp’s historical rate of growth may adversely impact Bancorp’s results of operations and financial condition.
Bancorp operates in a highly regulated environment and may be adversely affected by changes in federal and local laws and regulations.
Bancorp is subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact on Bancorp’s bank and its operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect Bancorp’s powers, authority and operations, which could have a material adverse effect on Bancorp’s financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory power may have negative impact on Bancorp’s results of operations and financial condition.
Item 1B. Unresolved Staff Comments
Bancorp has no unresolved staff comments.
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Item 2. Properties
The principal offices of Bancorp and the Bank are located at 1040 East Main Street, Louisville, Kentucky. The Bank’s operations center is a part of the main office complex. In addition to the main office complex, the Bank owned seven branch properties at December 31, 2005 (two of which are located on leased land) and Bancorp owned three. The Bank also leased thirteen branch facilities. Of the twenty-four banking locations, eighteen are located in Louisville, five are located in nearby southern Indiana and one is located in Indianapolis, Indiana. See Notes 5 and 17 to Bancorp’s consolidated financial statements for the year ended December 31, 2005, for additional information relating to amounts invested in premises, equipment and lease commitments.
Item 3. Legal Proceedings
See Note 17 to Bancorp’s consolidated financial statements for the year ended December 31, 2005, for information relating to legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
None
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Executive Officers of the Registrant
The following table lists the names and ages (as of December 31, 2005) of all current executive officers of Bancorp. Each executive officer is appointed by Bancorp’s Board of Directors to serve at the discretion of the Board. There is no arrangement or understanding between any executive officer of Bancorp and any other person(s) pursuant to which he/she was or is to be selected as an officer.
Name and Age
of Executive Officer | | Position and Offices
with Bancorp |
David P. Heintzman
Age 46 | | Chairman, President, Chief Executive Officer and Director |
| | |
Kathy C. Thompson
Age 44 | | Senior Executive Vice President and Director
|
| | |
Phillip S. Smith
Age 48 | | Executive Vice President |
| | |
Gregory A. Hoeck
Age 55 | | Executive Vice President |
| | |
Nancy B. Davis
Age 50 | | Executive Vice President, Secretary, Treasurer and Chief Financial Officer |
| | |
Philip S. Poindexter
Age 39 | | Executive Vice President |
| | |
James A. Hillebrand
Age 37 | | Executive Vice President |
Mr. Heintzman was appointed Chairman and Chief Executive Officer effective January 1, 2005. Prior thereto, he served as President of Bancorp and the Bank. Mr. Heintzman joined the Bank in 1985 and has served as Treasurer, Chief Financial Officer of Bancorp and Executive Officer of the Bank.
Ms. Thompson was appointed Senior Executive Vice President in January 2005. Prior thereto, she served as Executive Vice President of Bancorp and the Bank. She joined the Bank in 1992 as Senior Vice President and is Manager of the Investment Management and Trust Department and is also responsible for the sales, service and marketing areas of the Bank.
Mr. Smith was appointed Executive Vice President of the Bank in 1996. Prior thereto, he was Senior Vice President of the Bank. He is the Chief Credit Officer of the Bank, responsible for Bank-wide lending policy and operations.
Mr. Hoeck joined the Bank as Executive Vice President in 1998. He is primarily responsible for the retail area of the Bank. Prior to joining the Bank, Mr. Hoeck was an Executive Vice President for PNC Bank and the Retail Market Manager for the Kentucky and Indiana markets.
Ms. Davis was appointed Executive Vice President of Bancorp and the Bank in 1999. Prior thereto, she was Senior Vice President of Bancorp and the Bank. She was appointed Chief Financial Officer of Bancorp in 1993.
Mr. Poindexter joined the Bank as Executive Vice President in 2004. He is the Director of Commercial Lending for the Bank. Prior to joining the Bank, Mr. Poindexter served as City Executive for BB&T, managing all commercial banking functions for the Louisville region.
Mr. Hillebrand was appointed Executive Vice President in January 2005. Prior thereto, he was Senior Vice President of the Bank. He has been primarily responsible for Private Banking since joining the Bank in 1996 and is also responsible for the Bank’s expansion efforts into the Indianapolis market.
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Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Bancorp’s common stock is traded on the NASDAQ National Market under the ticker symbol SYBT. Prior to July 2005, the stock traded on the American Stock Exchange under the symbol SYI. The table below sets forth the quarterly high and low market closing prices of Bancorp’s common stock and dividends declared per share. The payment of dividends by the Bank to Bancorp is subject to the restriction described in Note 16 to the consolidated financial statements. Management believes that Bancorp will continue to generate adequate earnings to continue to pay dividends on a quarterly basis. On December 31, 2005, Bancorp had 1,237 shareholders of record, and approximately 3,100 non objecting beneficial owners holding shares in nominee or “street name”.
| | 2005 | | 2004 | |
Quarter | | High | | Low | | Cash Dividends
Declared | | High | | Low | | Cash Dividends
Declared | |
| | | | | | | | | | | | | |
First | | $ | 25.30 | | $ | 21.82 | | $ | 0.11 | | $ | 23.78 | | $ | 20.51 | | $ | 0.08 | |
Second | | 23.49 | | 20.97 | | 0.11 | | 23.55 | | 19.45 | | 0.10 | |
Third | | 24.80 | | 22.06 | | 0.12 | | 23.90 | | 21.16 | | 0.10 | |
Fourth | | 25.50 | | 22.55 | | 0.13 | | 24.70 | | 21.88 | | 0.11 | |
| | | | | | | | | | | | | | | | | | | |
The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended December 31, 2005.
| | Total Number of
Shares Purchased | | Average Price Paid
Per Share | | Total Number of
Shares Purchased
as Part of Publicly
Announced Plan | | Maximum Number of
Shares that May
Yet Be Purchased
Under the Plan | |
| | | | | | | | | |
October 1-October 31 | | 27,100 | | $ | 22.79 | | 27,100 | | 379,936 | |
November 1-November 30 | | 16,100 | | 23.63 | | 16,100 | | 363,836 | |
December 1-December 31 | | — | | — | | — | | 363,836 | |
Total | | 43,200 | | $ | 23.10 | | 43,200 | | 363,836 | |
The Board of Directors of S.Y. Bancorp, Inc. approved a 400,000 share buyback plan in 1999. The plan had no expiration date. In February 2005, the Directors expanded this plan to allow for the repurchase of 550,000 shares between February 2005 and February 2006. In February 2006, the Board of Directors extended the term of this plan to February 2007.
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Item 6. Selected Financial Data
Selected Consolidated Financial Data
| | Years ended December 31 | |
(Dollars in thousands except per share data) | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Net interest income | | $ | 49,235 | | $ | 44,221 | | $ | 42,748 | | $ | 40,580 | | $ | 34,945 | |
Provision for loan losses | | 225 | | 2,090 | | 2,550 | | 4,500 | | 4,220 | |
Net income | | 21,644 | | 18,912 | | 17,709 | | 15,650 | | 13,542 | |
| | | | | | | | | | | |
Per share data | | | | | | | | | | | |
Net income, basic | | $ | 1.56 | | $ | 1.37 | | $ | 1.31 | | $ | 1.17 | | $ | 1.02 | |
Net income, diluted | | 1.53 | | 1.33 | | 1.27 | | 1.12 | | 0.98 | |
Cash dividends declared | | 0.47 | | 0.39 | | 0.305 | | 0.26 | | 0.225 | |
Book value | | 9.11 | | 8.36 | | 7.40 | | 6.41 | | 5.37 | |
Market value | | 25.02 | | 24.10 | | 20.56 | | 18.55 | | 16.65 | |
| | | | | | | | | | | |
Average balances | | | | | | | | | | | |
Stockholders’ equity | | $ | 121,614 | | $ | 109,414 | | $ | 93,799 | | $ | 79,417 | | $ | 66,433 | |
Assets | | 1,270,178 | | 1,148,652 | | 1,083,949 | | 998,421 | | 884,793 | |
Federal Home Loan Bank advances | | 25,809 | | 25,573 | | — | | — | | — | |
Long-term debt | | 20,769 | | 20,799 | | 20,829 | | 20,867 | | 14,336 | |
| | | | | | | | | | | |
Selected ratios | | | | | | | | | | | |
Return on average assets | | 1.70 | % | 1.65 | % | 1.63 | % | 1.57 | % | 1.53 | % |
Return on average stockholders’ equity | | 17.80 | | 17.28 | | 18.88 | | 19.71 | | 20.38 | |
Average stockholders’ equity to average assets | | 9.57 | | 9.53 | | 8.65 | | 7.95 | | 7.51 | |
Net interest rate spread | | 3.79 | | 3.82 | | 3.86 | | 3.90 | | 3.60 | |
Net interest rate margin, fully tax-equivalent | | 4.25 | | 4.20 | | 4.25 | | 4.38 | | 4.27 | |
Non-performing loans to total loans | | 0.44 | | 0.57 | | 0.55 | | 0.68 | | 0.66 | |
Non-performing assets to total assets | | 0.59 | | 0.75 | | 0.76 | | 0.58 | | 0.55 | |
Net charge offs to average loans | | 0.07 | | 0.15 | | 0.29 | | 0.47 | | 0.36 | |
Allowance for loan losses to average loans | | 1.19 | | 1.37 | | 1.38 | | 1.48 | | 1.52 | |
Per share information has been adjusted to reflect stock split effective September 2003.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion is to provide information as to the analysis of the consolidated financial condition and results of operations of S.Y. Bancorp, Inc. (Bancorp) and its wholly owned subsidiary, Stock Yards Bank & Trust Company (the Bank). Bancorp, incorporated in 1988, has no active business operations. Thus, Bancorp’s business is substantially the same as that of the Bank. The Bank has operated continuously since it opened in 1904. The Bank conducted business at one location for 85 years and then began branching. At December 31, 2005, the Bank had twenty-three full service banking locations in Louisville and southern Indiana and one full service banking location in Indianapolis, Indiana. The combined effect of added convenience with the Bank’s focus on flexible, attentive customer service has been key to the Bank’s growth and profitability. The wide range of services added by the investment management and trust department, including the brokerage department, and by the mortgage department helps support the corporate philosophy of capitalizing on full service customer relationships.
Forward-Looking Statements
This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. These forward-looking statements may be identified by the use of words such as “expect”, “anticipate”, “plan”, “foresee” or other words with similar meaning. Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to: economic conditions both generally and more specifically in the markets in which Bancorp and its subsidiaries operate; competition for the Bank’s customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations or financial condition of the Bank’s customers; or other risks detailed in Bancorp’s filings with the Securities and Exchange Commission and Item 1A of this Form 10-K all of which are difficult to predict and many of which are beyond the control of Bancorp.
Critical Accounting Policies
Bancorp has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, Bancorp makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.
Management has identified the accounting policy related to the allowance and provision for loan losses as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors. Since the application of this policy requires significant management assumptions and estimates, it could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Assumptions include many factors such as changes in borrowers’ financial condition which can change quickly or historical loss ratios related to certain loan portfolios which may or may not be indicative of future losses. To the extent that management’s assumptions prove incorrect, the results from operations could be materially affected by a higher provision for loan losses. The accounting policy related to the allowance and provision for loan losses is applicable to the commercial banking segment of Bancorp. The impact and any associated risks related to this policy on Bancorp’s business operations are discussed in the “Allowance for Loan Losses” section below.
Additionally, management has identified the accounting policy related to accounting for income taxes as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in Bancorp’s financial statements or tax returns. Fluctuations in the actual outcome of these future tax
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consequences, including the effects of IRS examinations and examinations by other state agencies, could materially impact Bancorp’s financial position and its results from operations. Additional information regarding income taxes is discussed in the “Income Taxes” section below and note 7 to the consolidated financial statements.
Overview of 2005
The following discussion should be read in conjunction with Bancorp’s consolidated financial statements and accompanying notes and other schedules presented elsewhere in this report.
The 2005 business environment was influenced by a continuation of improving local economic trends and a rising interest rate environment. With solid growth from all areas of the Bank, Bancorp completed its eighteenth consecutive year of higher earnings.
As is the case with most banks, the primary source of Bancorp’s revenue is net interest income and fees from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and the interest rates earned on those loans are critical to overall profitability. Similarly deposit volume is crucial to funding loans, and rates paid on deposits directly impact profitability. Business volumes are influenced by overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.
Loan volume increased during 2005 and was crucial to growth in interest income. Deposits grew in support of loan growth. Net interest margin improved as Bancorp was able to hold down deposit costs even as market interest rates rose.
Distinguishing Bancorp from other similarly sized community banks is its diverse revenue stream. Non-interest income as a percentage of total revenues continued over 34% in 2005 and proved key to earnings growth. Stock Yards Trust Company maintained new business growth in 2005, and revenues increased accordingly. Also, increases in revenues from bankcard transactions, brokerage activity and gains on sales of mortgage loans offset a decline in service charges on deposit accounts.
Results in 2005 were also positively affected by a significantly lower provision for loan losses. Non-performing loans and net charge-offs reached their lowest level since 2000. Bancorp’s process of evaluating the inherent risk in the portfolio considered this data and other information in the evaluation of the risk in the loan portfolio to determine the required balance in the allowance for loan losses account and the corresponding provision for loan losses.
Challenges for 2006 could include net interest margin contraction, loan growth and credit quality.
• Having benefited from loan rates repricing more quickly than deposit rates, market conditions could reverse, and lagging deposit costs could increase more than loan rates to impact net interest margin negatively.
• To achieve our goals for 2006, net loan growth must exceed that of 2005.
• The extremely low levels of charge offs and excellent asset quality may not be sustainable, and the provision for loan losses will respond to the credit quality of the loan portfolio.
Not a part of core earnings, but noteworthy for 2006, are unamortized debt issuance costs related to trust preferred securities. That debt is callable by Bancorp at management’s discretion beginning mid 2006, and if called, unamortized pre-tax debt issuance costs of approximately $879,000 would be expensed. Also as noted herein, Bancorp will begin recognizing expense for stock options in accordance with SFAS No. 123(R), Share-Based Payment, which is effective January 1, 2006. As detailed under the caption “Non-Interest Income and Non-Interest Expenses” and in Note 15 to the consolidated financial statements, Bancorp accelerated the vesting of stock options in 2005 to reduce expense related to these options in 2006 through
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2009. Bancorp expects approximately $300,000 of non-cash compensation expense for 2006 related primarily to 2006 option grants.
The following sections will provide more details on subjects presented in this overview.
Results of Operations
Net income was $21,644,000 or $1.53 per share on a diluted basis for 2005 compared to $18,912,000 or $1.33 per share for 2004 and $17,709,000 or $1.27 per share for 2003. The increase in 2005 net income was attributable to growth in net interest income and non-interest income and a significant reduction in the provision for loan losses, all of which were partially offset by increased non-interest expenses and taxes. Earnings include an 11.2% increase in fully taxable equivalent net interest income and a 9.9% increase in non-interest income. Non-interest income improved mainly due to a 14.7% increase in income from investment management and trust. Non-interest expenses increased 14.1% primarily from salaries and benefits and other non-interest expenses. The provision for loan losses was down 89.2% for the year as credit quality continued to improve.
The following paragraphs provide a more detailed analysis of the significant factors affecting operating results.
Net Interest Income
Net interest income, the most significant component of Bancorp’s earnings, is total interest income less total interest expense. Net interest spread is the difference between the taxable equivalent rate earned on average interest earning assets and the rate expensed on average interest bearing liabilities. Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average earning assets. Net interest margin is affected by both the interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders’ equity. The level of net interest income is determined by the mix and volume of interest earning assets, interest bearing deposits and interest bearing liabilities and by changes in interest rates. The discussion that follows is based on tax-equivalent interest data.
Comparative information regarding net interest income follows:
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | | 2005/2004
Change | | 2004/2003
Change | |
| | | | | | | | | | | |
Net interest income, tax-equivalent basis | | $ | 50,131 | | $ | 45,091 | | $ | 43,480 | | 11.2 | % | 3.7 | % |
Net interest spread | | 3.79 | % | 3.82 | % | 3.86 | % | (3 | )bp | (4 | )bp |
Net interest margin | | 4.25 | % | 4.20 | % | 4.25 | % | 5 | bp | (5 | )bp |
Average earning assets | | $ | 1,178,922 | | $ | 1,074,845 | | $ | 1,022,438 | | 9.7 | % | 5.1 | % |
Five year treasury bond at year end | | 4.36 | % | 3.61 | % | 3.22 | % | 75 | bp | 39 | bp |
Average five year treasury bond | | 4.04 | % | 3.42 | % | 2.93 | % | 62 | bp | 49 | bp |
Prime rate at year end | | 7.25 | % | 5.25 | % | 4.00 | % | 200 | bp | 125 | bp |
Average prime rate | | 6.19 | % | 4.34 | % | 4.12 | % | 185 | bp | 22 | bp |
bp = basis point = 1/100th of a percent
Although the average prime rate increased 185 basis points in 2005 compared to the previous year, net interest margin increased 5 basis points and net interest spread decreased 3 basis points.
Prime rate is included above to provide a general indication of the interest rate environment in which the Bank operated. A large portion of the Bank’s variable rate loans are indexed to the Bank’s prime rate and reprice as the prime rate changes, unless they reach a contractual floor or ceiling. Many fixed rate loans are indexed to the five year Treasury bond. The flattening of the Treasury yield curve negatively impacted interest spreads despite the Bank’s asset sensitive position in 2005.
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The competitive environment held average loan yields to an increase of 45 basis points. Average interest costs on interest bearings deposits increased 55 basis points as Bancorp grew average interest bearing deposits $86,600,000, or 11.7%.
Management believes that interest rate increases in 2006 could have a positive impact on both spread and margin, while a decrease in interest rates could have a negative impact on net interest spread and margin. During the rising rate environment of 2005, Bancorp was able to hold interest costs on deposits but believes that due to competitive pressures it will see a gradual increase in these deposit rates in 2006.
Asset/Liability Management and Interest Rate Risk
Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity while attempting to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.
Interest Rate Simulation Sensitivity Analysis
Bancorp uses an earnings simulation model to estimate and evaluate the impact of changing interest rates on earnings. The simulation model is designed to reflect the dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments in a one year forecast. By estimating the effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. The simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results. The December 31, 2005 simulation analysis indicates that an increase in interest rates of 100 to 200 basis points would have a positive effect on net interest income, and a decrease of 100 to 200 basis points in interest rates would have a negative effect on net interest income. These estimates are summarized below.
| | Net Interest
Income %
Change | |
| | | |
Increase 200 bp | | 5.17 | |
Increase 100 bp | | 2.57 | |
Decrease 100 bp | | (2.55 | ) |
Decrease 200 bp | | (5.10 | ) |
To assist in achieving a desired level of interest rate sensitivity, management has in the past entered into derivative financial instruments that are designed to mitigate the effect of changes in interest rates. Derivative financial instruments can be a cost and capital efficient method of modifying interest rate risk sensitivity. Based upon management’s assessment of interest rate sensitivity, Bancorp had no derivative financial instruments during fiscal years 2005 or 2004.
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The following table presents the increases in net interest income due to changes in rate and volume computed on a tax-equivalent basis and indicates how net interest income in 2005 and 2004 was impacted by volume increases and the higher average interest rate environment. The tax-equivalent adjustments are based on a 35% federal tax rate. The change in interest due to both rate and volume has been allocated to the change due to rate and the change due to volume in proportion to the relationship of the absolute dollar amounts of the change in each.
Taxable Equivalent Rate/Volume Analysis
| | 2005/2004 | | 2004/2003 | |
| | | | Increase (Decrease) | | | | Increase (Decrease) | |
| | | | Due to | | | | Due to | |
(In thousands) | | Net Change | | Rate | | Volume | | Net Change | | Rate | | Volume | |
| | | | | | | | | | | | | |
Interest income | | | | | | | | | | | | | |
Loans | | $ | 10,801 | | $ | 4,359 | | $ | 6,442 | | $ | 1,069 | | $ | (2,651 | ) | $ | 3,720 | |
Federal funds sold | | 343 | | 324 | | 19 | | (182 | ) | 21 | | (203 | ) |
Mortgage loans held for sale | | 121 | | 23 | | 98 | | (535 | ) | (48 | ) | (487 | ) |
Securities | | | | | | | | | | | | | |
Taxable | | 288 | | 570 | | (282 | ) | 195 | | (413 | ) | 608 | |
Tax-exempt | | 276 | | (95 | ) | 371 | | 11 | | (132 | ) | 143 | |
Total interest income | | 11,829 | | 5,181 | | 6,648 | | 558 | | (3,223 | ) | 3,781 | |
| | | | | | | | | | | | | |
Interest expense | | | | | | | | | | | | | |
Deposits | | | | | | | | | | | | | |
Interest bearing demand deposits | | 574 | | 812 | | (238 | ) | 22 | | (105 | ) | 127 | |
Savings deposits | | 96 | | 95 | | 1 | | 51 | | 41 | | 10 | |
Money market deposits | | 2,888 | | 2,225 | | 663 | | 388 | | 360 | | 28 | |
Time deposits | | 2,498 | | 610 | | 1,888 | | (2,318 | ) | (1,297 | ) | (1,021 | ) |
Securities sold under agreements to repurchase and federal funds purchased | | 540 | | 503 | | 37 | | 260 | | 105 | | 155 | |
Other short-term borrowings | | 20 | | 21 | | (1 | ) | 1 | | — | | 1 | |
Federal Home Loan Bank advances | | 173 | | 168 | | 5 | | 545 | | — | | 545 | |
Long-term debt | | — | | 3 | | (3 | ) | (2 | ) | 1 | | (3 | ) |
| | | | | | | | | | | | | |
Total interest expense | | 6,789 | | 4,437 | | 2,352 | | (1,053 | ) | (895 | ) | (158 | ) |
| | | | | | | | | | | | | |
Net interest income | | $ | 5,040 | | $ | 744 | | $ | 4,296 | | $ | 1,611 | | $ | (2,328 | ) | $ | 3,939 | |
Bancorp’s net interest income increased $5,040,000 for the year ending December 31, 2005 compared to the same period of 2004 while 2004 compared to 2003 saw a $1,611,000 increase. Net interest income for the year 2005 compared to 2004 was positively impacted by a significant increase in volume and, to a lesser degree, an increase in rate. Although interest rates increased in 2005, which increased interest income, the effect on interest income was somewhat offset by an increase in expense from an increase in deposit rates. If the yield curve remains flat or inverts and if deposit rates continue to increase due to market competition, this could cause a decrease in net interest spread. Strong loan growth accounted for $6,442,000 of the increase in interest income due to volume which was somewhat offset by money market and time deposit growth which increased interest expense by $2,551,000 for the year of 2005 compared to 2004.
For the year 2004 compared to 2003, loan growth generated an increase of $3,720,000 in interest income. The decrease in average deposits lowered interest expense and increased net interest income.
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Provision for Loan Losses
In determining the provision for loan losses charged to expense, management considers many factors. Among these are the quality and underlying collateral of the loan portfolio, previous loss experience, the size and composition of the loan portfolio, changes in lending personnel and an assessment of the impact of current economic conditions on borrowers’ ability to pay. The provision for loan losses is summarized below:
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Provision for loan losses | | $ | 225 | | $ | 2,090 | | $ | 2,550 | |
Allowance to loans at year end | | 1.14 | % | 1.27 | % | 1.33 | % |
Allowance to average loans for year | | 1.19 | % | 1.37 | % | 1.38 | % |
| | | | | | | | | | |
The provision for loan losses decreased during 2005 in response to Bancorp’s assessment of inherent risk in the loan portfolio. Non-performing loans and net charge-offs reached their lowest year-end totals since 2000, pointing to outstanding loan quality during 2005. As loans have grown and the provision for loan losses has decreased, the relationship of the allowance to loans at year end and to average loans has decreased. See “Financial Condition-Non-performing Loans and Assets” for further discussion of non-performing loans. See “Financial Condition-Summary of Loan Loss Experience” for further discussion of loans charged off during the year.
The Bank’s loan portfolio is diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers in the Louisville, Kentucky metropolitan area. The adequacy of the allowance is monitored on an ongoing basis and it is the opinion of management that the balance of the allowance for loan losses at December 31, 2005 is adequate to absorb losses inherent in the loan portfolio as of the financial statement date. See “Financial Condition-Allowance for Loan Losses” for more information on the allowance for loan losses.
Non-Interest Income and Non-Interest Expenses
The following table provides a comparison of the components of non-interest income for 2005, 2004 and 2003. The table shows the dollar and percentage change from 2004 to 2005 and from 2003 to 2004. Below the table is a discussion of significant changes and trends.
| | | | | | | | 2005/2004 | | 2004/2003 | |
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | | Change | | % | | Change | | % | |
| | | | | | | | | | | | | | | |
Non-interest income | | | | | | | | | | | | | | | |
Investment management and trust services | | $ | 10,813 | | $ | 9,427 | | $ | 8,301 | | $ | 1,386 | | 14.7 | % | $ | 1,126 | | 13.6 | % |
Service charges on deposit accounts | | 8,426 | | 8,890 | | 8,487 | | (464 | ) | -5.2 | % | 403 | | 4.7 | % |
Bankcard transaction revenue | | 1,704 | | 1,262 | | 1,013 | | 442 | | 35.0 | % | 249 | | 24.6 | % |
Gains on sales of mortgage loans held for sale | | 1,391 | | 1,064 | | 2,552 | | 327 | | 30.7 | % | (1,488 | ) | -58.3 | % |
Gains on sales of securities available for sale | | — | | — | | 10 | | — | | — | | (10 | ) | 100.0 | % |
Brokerage commissions and fees | | 2,055 | | 1,675 | | 1,272 | | 380 | | 22.7 | % | 403 | | 31.7 | % |
Other | | 2,733 | | 2,358 | | 2,863 | | 375 | | 15.9 | % | (505 | ) | -17.6 | % |
| | | | | | | | | | | | | | | |
| | $ | 27,122 | | $ | 24,676 | | $ | 24,498 | | $ | 2,446 | | 9.9 | % | $ | 178 | | 0.7 | % |
| | | | | | | | | | | | | | | | | | | | | | |
Total non-interest income increased 9.9% for the year ending December 31, 2005 compared to the same period for 2004. The largest component of non-interest income is investment management and trust services. This area of the Bank continues to grow through attraction of new business and customer retention. At December 31, 2005 assets under management totaled $1.4 billion compared to $1.3 billion at December 31, 2004 and $1.2 billion as of December 31, 2003. Because assets under management are expressed in terms of fair value, increases in market value of existing accounts during the last two years and the attraction of new
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business have both served to increase assets under management. Growth in the department’s assets consisted primarily of personal trust accounts during both 2005 and 2004.
Service charges on deposit accounts decreased $464,000, or 5.2%, for the year ending December 31, 2005 compared to the same period a year ago. Several factors contributed to the decline including lower overdraft activity levels compared to the prior year and the impact of free business checking. Additionally, the impact of higher interest rates on commercial analysis accounts served to increase earnings credits which are used to offset service charges.
Bankcard transaction revenue primarily represents income that the Bank derives from customers’ use of debit cards. As the popularity of these cards has grown during 2005 and 2004, there have been increases in the number of transactions by existing cardholders as customers recognize the convenience that the cards offer. The growth rate of this account was slowed during 2003 by a class action lawsuit brought by several retail merchants against VISA®USA and MasterCard® challenging rules imposed by VISA and MasterCard governing the acceptance of debit and credit cards by merchants. The lawsuit resulted in a reduction of interchange rates effective August 1, 2003 and established that rates on and after January 2004 would be established from time to time reflecting competitive considerations. Although the fees per transaction have been reduced, the Bank expects fees to continue to grow as volume growth should offset any rate reduction.
The Bank operates a mortgage banking company within its retail banking division of the Bank. This division originates residential mortgage loans and sells the loans in the secondary market. The division offers conventional, VA and FHA financing, as well as a program for low-income first time home buyers. Loans are made for both the purchase of and refinancing of homes. Virtually all loans originated by the mortgage banking company are sold in the secondary market with servicing rights released. Interest rates on the loans sold are locked with the buyer and investor, thus Bancorp bears no interest rate risk related to these loans. Interest rates on conventional mortgage loans directly impact the volume of business transacted by the mortgage banking division. Record low mortgage rates in the first three quarters of 2003 led to record volume, while higher rates in late 2003 and in 2004 and 2005 led to an industry-wide slowdown in loan volume during 2004 and 2005. However, as a result of the addition of loan originators, mortgage volume in 2005 improved.
Brokerage commissions and fees increased during 2005 and 2004 as the sales efforts of our brokers helped to spur investor activity and resulted in higher brokerage commission levels. Bancorp continues to be pleased to offer a full compliment of financial services to its customer base and feels that brokerage services are a key component of that strategy.
Other non-interest income increased during 2005 primarily as a result of increased income related to the purchase of two bank-owned life insurance (“BOLI”) policies during the second half of 2004. The BOLI policies were purchased to help offset increasing employee benefit costs. A total premium of $20 million, invested in the third quarter of 2004, generated income of $882,000 and $342,000 during 2005 and 2004, respectively. Contributing factors to the decrease in non-interest income for 2004 compared to 2003 included the decrease related to mortgage refinancing fees and related income such as title insurance. There were also a few one time items during 2003, the most significant being income of $256,000 related to the demutualization of an insurance company which held policies related to a defined benefit retirement plan for certain key officers. See Note 14 to Bancorp’s consolidated financial statements for further discussion of the defined benefit retirement plan.
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The following table provides a comparison of the components of non-interest expenses for 2005, 2004 and 2003. The table shows the dollar and percentage change from 2004 to 2005 and from 2003 to 2004. Below the table is a discussion of significant changes and trends.
| | | | | | | | 2005/2004 | | 2004/2003 | |
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | | Change | | % | | Change | | % | |
| | | | | | | | | | | | | | | |
Non-interest expense | | | | | | | | | | | | | | | |
Salaries and employee benefits | | $ | 24,358 | | $ | 21,652 | | $ | 21,624 | | $ | 2,706 | | 12.5 | % | $ | 28 | | 0.1 | % |
Net occupancy expense | | 3,444 | | 3,027 | | 2,623 | | 417 | | 13.8 | % | 404 | | 15.4 | % |
Data processing expense | | 3,668 | | 3,419 | | 3,372 | | 249 | | 7.3 | % | 47 | | 1.4 | % |
Furniture and equipment expense | | 1,191 | | 1,178 | | 1,062 | | 13 | | 1.1 | % | 116 | | 10.9 | % |
State bank taxes | | 1,742 | | 1,196 | | 1,188 | | 546 | | 45.7 | % | 8 | | 0.7 | % |
Other | | 10,209 | | 8,621 | | 8,756 | | 1,588 | | 18.4 | % | (135 | ) | -1.5 | % |
| | | | | | | | | | | | | | | |
| | $ | 44,612 | | $ | 39,093 | | $ | 38,625 | | $ | 5,519 | | 14.1 | % | $ | 468 | | 1.2 | % |
Salaries and benefits are the largest component of non-interest expenses. Increases in personnel expense rose in part from increases in regular salaries during 2005 and 2004. Base salaries increased 6% in 2005 as a result of annual review increases and an increase in the number of full-time equivalent employees. In 2004 Bancorp paid minimal bonuses as Bancorp did not reach the annual minimum target of 10% for earnings growth. However, with earnings improvement, this bonus resumed in 2005. Also contributing to the 2005 increase was Bancorp’s self-funded health insurance plan. The plan had experienced better than expected claims experience in 2004, but returned to more normal levels in 2005. The Bank continues to add employees to support growth. At December 31, 2005, the Bank had 442 full-time equivalent employees compared to 416 at the same date in 2004 and 385 for 2003. There are no significant obligations for post-retirement or post-employment benefits.
Additionally, in late December of 2005, Bancorp accelerated the vesting of all employees’ stock options, which resulted in additional non-cash expense of approximately $32,000. By vesting these stock options early, Bancorp will avoid recognizing approximately $1,000,000 in expense over what would have been future vesting periods of one to four years. These options had been granted to 77 executive and senior officers and all were cumulatively in-the-money by approximately $579,000. In accordance with SFAS No. 123R, the fair value of stock options granted beginning January 1, 2006 will result in recognition of non-cash compensation expense. See Note 15 to Bancorp’s consolidated financial statements for further discussion of stock options.
Net occupancy expense has increased as the Bank has added banking centers. During 2004, the Bank opened two locations. It opened four locations in 2003. In addition, in June 2004, the Bank’s Indianapolis, Indiana location was converted from a loan production office into a full service branch and was moved to a new location. In 2003, the Investment Management and Trust department relocated to new office space. At December 31, 2005 the Bank had twenty-four banking center locations including the main office.
Data processing expense rose as the Bank continues to update computer equipment and software as technology advances. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense. Furniture and fixtures expense has also increased with the addition of banking centers. State bank taxes are based primarily on average capital and deposit levels, and these taxes have increased as capital and deposit totals have grown. Also in the third quarter of 2005, Bancorp re-evaluated state tax accruals and adjusted expenses accordingly.
Other non-interest expenses increased for the year ending December 31, 2005 compared to the same period of 2004 by $1,588,000. In late 2005 Bancorp made an additional $500,000 contribution to the Bank’s charitable
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foundation for continuing support of non-profit and community-oriented organizations in the Bancorp’s markets. The Bank formed this foundation in 1999 to promote a variety of charitable works. Legal and professional expenses increased mainly due to expenses related to listing on the NASDAQ and computer network consulting services. Also 2005 included an increase primarily due to expensing of obsolete or replaced equipment, facilities, equipment and software. In 2004, the decline in other expenses primarily related to a decline in mortgage banking activity offsetting increases in various expenses related to the Bank’s growth including advertising and marketing.
Income Taxes
A three year comparison of income tax expense and effective tax rate follows:
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Income tax expense | | $ | 9,876 | | $ | 8,802 | | $ | 8,362 | |
Effective tax rate | | 31.3 | % | 31.8 | % | 32.1 | % |
| | | | | | | | | | |
Bancorp’s overall tax rate has fallen due to increased investment in transactions that generate low income housing tax credits. As Bancorp continues to review its tax strategy and invest in these transactions, its 2006 effective tax rate should remain near the current level.
Financial Condition
Earning Assets and Interest Bearing Liabilities
Summary information with regard to Bancorp’s financial condition follows:
| | | | | | | | 2005/2004 | | 2004/2003 | |
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | | Change | | % | | Change | | % | |
| | | | | | | | | | | | | | | |
Average earning assets | | $ | 1,178,922 | | $ | 1,074,845 | | $ | 1,022,438 | | $ | 104,077 | | 9.7 | % | $ | 52,407 | | 5.1 | % |
Average interest bearing liabilities | | 954,726 | | 865,086 | | 832,310 | | 89,640 | | 10.4 | % | 32,776 | | 3.9 | % |
Average total assets | | 1,270,178 | | 1,148,652 | | 1,083,949 | | 121,526 | | 10.6 | % | 64,703 | | 6.0 | % |
Total year end assets | | 1,330,438 | | 1,212,015 | | 1,118,521 | | 118,423 | | 9.8 | % | 93,494 | | 8.4 | % |
| | | | | | | | | | | | | | | | | | | | |
The Bank has experienced steady growth in earning assets over the last several years. Growth of average earning assets occurred primarily in the area of loans. From 2004 to 2005, average loans increased 11.1%. More specifically, period end commercial and industrial loans increased 4.5%, construction loans increased 54.3% and consumer loans increased 18.4%. Real estate loans, Bancorp’s largest loan category, decreased 2.4%. During 2004, average loans increased 7.1% and average taxable securities grew 17.0%.
The increase in average interest bearing liabilities from 2004 to 2005 occurred primarily in money market deposits, savings and time deposits. Total interest bearing accounts increased 11.7% and non-interest bearing accounts grew 9.7%. Bancorp held the average cost of the interest bearing deposits to 2.30%, a 55 basis point increase from 1.75% for 2004. In addition, Bancorp continued to utilize fixed rate advances from the Federal Home Loan Bank during 2005 as a more favorably priced alternative to time deposits. Bancorp had an average of $25,809,000 in outstanding advances in 2005 compared to $25,573,000 and $0 in 2004 and 2003, respectively.
The growth in various types of interest bearing checking accounts in 2004 can be attributed to the Bank’s continued expansion in its primary market. On the other hand, average time deposits shrunk by 9.0% during 2004 as Bancorp utilized less expensive sources of funds. Based on slower than expected loan growth during the year and the availability of cheaper funding sources, Bancorp intentionally let some of the time deposits portfolio run off during 2004.
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Average Balances and Interest Rates – Taxable Equivalent Basis
| | Year 2005 | | Year 2004 | | Year 2003 | |
(Dollars in thousands) | | Average
Balances | | Interest | | Average
Rate | | Average Balances | | Interest | | Average
Rate | | Average
Balances | | Interest | | Average
Rate | |
| | | | | | | | | | | | | | | | | | | |
Earning assets | | | | | | | | | | | | | | | | | | | |
Federal funds sold | | $ | 16,057 | | $ | 515 | | 3.21 | % | $ | 14,604 | | $ | 172 | | 1.18 | % | $ | 31,911 | | $ | 354 | | 1.11 | % |
Mortgage loans held for sale | | 5,902 | | 334 | | 5.66 | % | 4,137 | | 213 | | 5.15 | % | 13,535 | | 748 | | 5.53 | % |
Securities | | | | | | | | | | | | | | | | | | | |
Taxable | | 102,509 | | 4,126 | | 4.03 | % | 110,283 | | 3,873 | | 3.51 | % | 93,882 | | 3,686 | | 3.93 | % |
Tax-exempt | | 35,895 | | 1,958 | | 5.45 | % | 29,162 | | 1,682 | | 5.77 | % | 26,777 | | 1,671 | | 6.24 | % |
FHLB stock | | 3,298 | | 165 | | 5.00 | % | 3,157 | | 130 | | 4.12 | % | 3,034 | | 122 | | 4.02 | % |
Loans, net of unearned income | | 1,015,261 | | 66,141 | | 6.51 | % | 913,502 | | 55,340 | | 6.06 | % | 853,299 | | 54,271 | | 6.36 | % |
| | | | | | | | | | | | | | | | | | | |
Total earning assets | | 1,178,922 | | 73,239 | | 6.21 | % | 1,074,845 | | 61,410 | | 5.71 | % | 1,022,438 | | 60,852 | | 5.95 | % |
| | | | | | | | | | | | | | | | | | | |
Less allowance for loan losses | | 12,662 | | | | | | 12,592 | | | | | | 11,971 | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | 1,166,260 | | | | | | 1,062,253 | | | | | | 1,010,467 | | | | | |
| | | | | | | | | | | | | | | | | | | |
Non-earning assets | | | | | | | | | | | | | | | | | | | |
Cash and due from banks | | 34,485 | | | | | | 32,257 | | | | | | 30,201 | | | | | |
Premises and equipment | | 25,913 | | | | | | 25,503 | | | | | | 23,784 | | | | | |
Accrued interest receivable and other assets | | 43,520 | | | | | | 28,639 | | | | | | 19,497 | | | | | |
| | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,270,178 | | | | | | $ | 1,148,652 | | | | | | $ | 1,083,949 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year 2005 | | Year 2004 | | Year 2003 | |
(Dollars in thousands) | | Average Balances | | Interest | | Average Rate | | Average Balances | | Interest | | Average Rate | | Average Balances | | Interest | | Average Rate | |
| | | | | | | | | | | | | | | | | | | |
Interest bearing liabilities | | | | | | | | | | | | | | | | | | | |
Deposits | | | | | | | | | | | | | | | | | | | |
Interest bearing demand deposits | | $ | 242,769 | | $ | 2,830 | | 1.17 | % | $ | 269,120 | | $ | 2,256 | | 0.84 | % | $ | 254,273 | | $ | 2,234 | | 0.88 | % |
Savings deposits | | 47,081 | | 217 | | 0.46 | % | 46,797 | | 121 | | 0.26 | % | 41,657 | | 70 | | 0.17 | % |
Money market deposits | | 166,458 | | 3,902 | | 2.34 | % | 112,643 | | 1,014 | | 0.90 | % | 108,029 | | 626 | | 0.58 | % |
Time deposits | | 371,700 | | 12,093 | | 3.25 | % | 312,848 | | 9,595 | | 3.07 | % | 343,872 | | 11,913 | | 3.46 | % |
Securities sold under agreements to repurchase and federal funds purchased | | 79,170 | | 1,457 | | 1.84 | % | 76,173 | | 917 | | 1.20 | % | 62,599 | | 657 | | 1.05 | % |
Other short-term borrowings | | 970 | | 29 | | 2.99 | % | 1,133 | | 9 | | 0.79 | % | 1,051 | | 8 | | 0.76 | % |
FHLB advances | | 25,809 | | 718 | | 2.78 | % | 25,573 | | 545 | | 2.13 | % | — | | — | | — | |
Long-term debt | | 20,769 | | 1,862 | | 8.97 | % | 20,799 | | 1,862 | | 8.95 | % | 20,829 | | 1,864 | | 8.95 | % |
| | | | | | | | | | | | | | | | | | | |
Total interest bearing liabilities | | 954,726 | | 23,108 | | 2.42 | % | 865,086 | | 16,319 | | 1.89 | % | 832,310 | | 17,372 | | 2.09 | % |
| | | | | | | | | | | | | | | | | | | |
Non-interest bearing liabilities | | | | | | | | | | | | | | | | | | | |
Non-interest bearing demand deposits | | 169,971 | | | | | | 155,005 | | | | | | 140,239 | | | | | |
Accrued interest payable and other liabilities | | 23,867 | | | | | | 19,147 | | | | | | 17,601 | | | | | |
| | | | | | | | | | | | | | | | | | | |
Total liabilities | | 1,148,564 | | | | | | 1,039,238 | | | | | | 990,150 | | | | | |
| | | | | | | | | | | | | | | | | | | |
Stockholders’ equity | | 121,614 | | | | | | 109,414 | | | | | | 93,799 | | | | | |
| | | | | | | | | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 1,270,178 | | | | | | $ | 1,148,652 | | | | | | $ | 1,083,949 | | | | | |
| | | | | | | | | | | | | | | | | | | |
Net interest income | | | | $ | 50,131 | | | | | | $ | 45,091 | | | | | | $ | 43,480 | | | |
| | | | | | | | | | | | | | | | | | | |
Net interest spread | | | | | | 3.79 | % | | | | | 3.82 | % | | | | | 3.86 | % |
| | | | | | | | | | | | | | | | | | | |
Net interest margin | | | | | | 4.25 | % | | | | | 4.20 | % | | | | | 4.25 | % |
Notes:
• Yields on municipal securities have been computed on a fully tax-equivalent basis using the federal income tax rate of 35%.
• The approximate tax-equivalent adjustments to interest income were $896,000, $870,000 and $732,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
• Average balances for loans include the principal balance of non-accrual loans.
• Loan interest income includes loan fees and is computed on a fully tax-equivalent basis using the federal income tax rate of 35%.
• Loan fees, net of deferrals, included in interest income amounted to $1,054,000, $1,591,000 and $1,484,000 in 2005, 2004 and 2003, respectively.
20
Securities
The primary purpose of the securities portfolio is to provide another source of interest income, as well as liquidity management. In managing the composition of the balance sheet, Bancorp seeks a balance between earnings sources and credit and liquidity considerations.
Securities intended to be held until maturity are carried at amortized cost. Securities available for sale include securities that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and prepayment risk changes. Securities available for sale are carried at fair value with unrealized gains or losses, net of tax effect, included in stockholders’ equity.
The carrying value of securities is summarized as follows:
| | December 31 | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Securities available for sale | | | | | | | |
U.S. Treasury and federal agency obligations | | $ | 105,188 | | $ | 70,536 | | $ | 91,238 | |
Mortgage-backed securities | | 19,619 | | 21,571 | | 26,335 | |
Obligations of states and political subdivisions | | 30,224 | | 32,074 | | 33,071 | |
Other | | 1,919 | | 1,983 | | 1,950 | |
| | $ | 156,950 | | $ | 126,164 | | $ | 152,594 | |
| | | | | | | |
Securities held to maturity | | | | | | | |
Mortgage-backed securities | | $ | 133 | | $ | 294 | | $ | 618 | |
Obligations of states and political subdivisions | | 3,991 | | 4,989 | | 5,297 | |
| | $ | 4,124 | | $ | 5,283 | | $ | 5,915 | |
The maturity distribution and weighted average interest rates of debt securities at December 31, 2005, are as follows:
| | Within one year | | After one but within
five years | | After five but within
ten years | | After ten years | |
(Dollars in thousands) | | Amount | | Rate | | Amount | | Rate | | Amount | | Rate | | Amount | | Rate | |
| | | | | | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | | | | | | |
U.S. Treasury and federal agencies | | $ | 29,437 | | 4.16 | % | $ | 61,783 | | 3.65 | % | $ | 13,968 | | 4.85 | % | $ | — | | — | |
Mortgage-backed securities | | — | | — | | 3,812 | | 4.08 | % | 11,560 | | 4.30 | % | 4,247 | | 4.90 | % |
Obligations of states and political subdivisions | | 1,439 | | 5.69 | % | 13,175 | | 4.41 | % | 12,796 | | 6.75 | % | 2,814 | | 7.69 | % |
Other | | 618 | | 9.00 | % | — | | — | | — | | — | | 1,301 | | 7.76 | % |
| | $ | 31,494 | | 4.33 | % | $ | 78,770 | | 3.80 | % | $ | 38,324 | | 5.29 | % | $ | 8,362 | | 6.25 | % |
| | | | | | | | | | | | | | | | | |
Securities held to maturity | | | | | | | | | | | | | | | | | |
Mortgage-backed securities | | $ | 14 | | 7.10 | % | $ | — | | — | | $ | 58 | | 6.50 | % | $ | 61 | | 5.94 | % |
Obligations of states and political subdivisions | | 930 | | 6.58 | % | 3,061 | | 6.68 | % | — | | — | | — | | — | |
| | $ | 944 | | 6.59 | % | $ | 3,061 | | 6.68 | % | $ | 58 | | 6.50 | % | $ | 61 | | 5.94 | % |
21
Loan Portfolio
Bancorp’s primary source of income is interest on loans. The composition of loans as of the end of the last five years follows:
| | December 31 | |
(In thousands) | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Commercial and industrial | | $ | 225,369 | | $ | 215,755 | | $ | 189,477 | | $ | 175,002 | | $ | 154,965 | |
Construction and development | | 126,961 | | 82,261 | | 53,506 | | 34,910 | | 55,944 | |
Real estate mortgage | | 524,755 | | 537,491 | | 500,610 | | 484,330 | | 422,290 | |
Consumer | | 176,786 | | 149,334 | | 142,560 | | 124,331 | | 144,242 | |
| | $ | 1,053,871 | | $ | 984,841 | | $ | 886,153 | | $ | 818,573 | | $ | 777,441 | |
Real estate mortgage loans are comprised primarily of owner occupied commercial properties, investment commercial properties and residential properties.
The following tables detail the amounts of commercial and industrial loans, and construction and development loans at December 31, 2005, which based on remaining scheduled repayments of principal, are due in the periods indicated. Also shown are the commercial and industrial loans due after one year classified according to sensitivity to changes in interest rates.
| | Maturing | |
(In thousands) | | Within one year | | After one but
within five years | | After five years | | Total | |
| | | | | | | | | |
Commercial and industrial | | $87,659 | | $106,402 | | $31,308 | | $225,369 | |
Construction and development | | 61,028 | | 56,684 | | 9,249 | | 126,961 | |
| | Interest Sensitivity | |
(In thousands) | | Fixed rate | | Variable rate | |
| | | | | |
Due after one but within five years | | $ | 56,119 | | $ | 50,283 | |
Due after five years | | 21,255 | | 10,053 | |
| | $ | 77,374 | | $ | 60,336 | |
22
Non-performing Loans and Assets
Information summarizing non-performing assets, including non-accrual loans follows:
| | December 31 | |
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Non-accrual loans | | $ | 3,709 | | $ | 4,944 | | $ | 4,417 | | $ | 4,840 | | $ | 3,775 | |
Loans past due 90 days or more and still accruing | | 891 | | 696 | | 433 | | 754 | | 1,346 | |
| | | | | | | | | | | |
Non-performing loans | | $ | 4,600 | | $ | 5,640 | | $ | 4,850 | | $ | 5,594 | | $ | 5,121 | |
| | | | | | | | | | | |
Foreclosed real estate | | 3,226 | | 3,284 | | 3,633 | | 310 | | 63 | |
Other foreclosed property | | 40 | | 113 | | — | | 88 | | — | |
| | | | | | | | | | | |
Non-performing assets | | $ | 7,866 | | $ | 9,037 | | $ | 8,483 | | $ | 5,992 | | $ | 5,184 | |
| | | | | | | | | | | |
Non-performing loans as a percentage of total loans | | 0.44 | % | 0.57 | % | 0.55 | % | 0.68 | % | 0.66 | % |
Non-performing assets as a percentage of total assets | | 0.59 | % | 0.75 | % | 0.76 | % | 0.58 | % | 0.55 | % |
Allowance for loan losses as a percentage of non-performing loans | | 262 | % | 222 | % | 243 | % | 209 | % | 214 | % |
Non-performing loans as a percentage of total loans decreased 13 basis points compared to the prior year. The overall level of non-performing loans as a percentage of total loans at December 31, 2005 is lower than the level seen over the last four years.
The threshold at which loans are generally transferred to non-accrual of interest status is 90 days past due unless they are well secured and in the process of collection. Interest income recorded on non-accrual loans for was $127,000, $144,000, and $127,000 for 2005, 2004, and 2003, respectively. Interest income that would have been recorded if non-accrual loans were on a current basis in accordance with their original terms was $382,000, $257,000, and $285,000 for 2005, 2004, and 2003, respectively.
In addition to the non-performing loans discussed above, there were loans for which payments were current or less than 90 days past due where borrowers are experiencing significant financial difficulties. These loans totaled approximately $6,211,000, $5,234,000, and $722,000 at December 31, 2005, 2004, and 2003, respectively. These loans are monitored by management and considered in determining the level of the allowance for loan losses. Management believes these loans currently do not present significant exposure to loss.
Non-performing assets as a percentage of total assets decreased 16 basis point from 2004 to 2005. The decrease in non-performing assets as a percentage of total assets was the result of the decrease in non-performing loans. Foreclosed real estate primarily consists of property that secured one former loan made up of a residential subdivision development that has required several years for full disposition due to the nature of the property. Some costs were capitalized as lots were made ready for sale, and partial dispositions of this real estate occurred during 2005 and 2004 as lots were sold. This asset is periodically evaluated for impairment. No impairment charges have been recorded.
Allowance for Loan Losses
An allowance for loan losses has been established to provide for loans that may not be fully repaid. The allowance for loan losses is increased by provisions charged to expense and decreased by charge-offs, net of recoveries. Loans are charged off by management when deemed uncollectible; however, collection efforts continue and future recoveries may occur.
23
Bancorp’s lending policies and procedures center on controlling credit risk and include procedures to identify and measure this risk. These procedures begin with lenders assigning a risk rating to each of their credits, and this rating is confirmed in the loan approval process. Internal loan review, through a year-round process of examining individually significant obligor relationships as well as a sample of each lender’s portfolio, tests the reliability of these risk assessments. Additionally, a review of this process is an integral part of regulatory bank examinations.
Adversely rated credits are included on a loan watch list. This list also includes loans requiring closer monitoring due to borrower’s circumstances. However, these loans have generally not reached a level of adversity which would cause them to be criticized credits by regulators. Loans are added to the watch list when circumstances are detected which might affect the borrower’s ability to comply with terms of the loan. This could include any of the following:
• Delinquency of a scheduled loan payment,
• Deterioration in the borrower’s financial condition identified in a review of periodic financial statements,
• Decrease in the value of collateral securing the loan, or
• Change in the economic environment in which the borrower operates.
Loans on the watch list require detailed status reports, including recommended corrective actions, prepared by the responsible loan officer every three months. These reports are reviewed by management. The watch list is also discussed in quarterly meetings with the Board Loan Committee.
Downgrades of loan risk ratings may be initiated by the responsible loan officer, internal loan review, or the credit analyst department at any time. Upgrades of risk ratings may only be made with the concurrence of management and internal loan review generally at the time of quarterly watch list review meetings.
In determining the allowance and related provision for loan losses, three principal elements are considered:
• Specific allocations based upon probable losses identified during the ongoing review of the loan portfolio.
• Allocations for loans not reviewed are based principally on historical charge-off information by loan type.
• Additional allowance allocations based on subjective factors.
The first element reflects management’s estimate of probable losses based upon a systematic review of specific loans. Loans are reviewed and, if necessary, assigned a loss allocation. These estimates are based primarily upon discounted collateral exposure, but other objective factors such as payment history and financial condition of the borrower or guarantor may be used as well.
The second element estimates losses for the portion of the portfolio not specifically reviewed. These loans are totaled by loan category, and are assigned a loss allocation factor based upon the Bank’s historical net charge offs by loan type.
The third element is based on factors not necessarily associated with a specific credit or loan category and represents management’s attempt to ensure that the overall allowance for loan losses appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. Management considers a number of subjective factors, including local and general economic business factors and trends, portfolio concentrations, and changes in the size, mix and general terms of the loan portfolio.
Based on this quantitative and qualitative analysis, provisions are made to the allowance for loan losses. Such provisions are reflected as a charge against current earnings in Bancorp’s consolidated statements of income.
The allocation of the allowance for loan losses by loan category is a result of the analysis above. The same procedures used to determine requirements for the allowance for loan losses establish the distribution of the allowance by loan category. The distribution of the allowance will change from period to period due to
24
changes in the identified risk in each loan in the portfolio, changes in the aggregate loan balances by loan category, and changes in management’s view of the subjective factors noted above.
The method of calculating the allowance requirements has not changed significantly over time. The reallocations among different categories of loans between periods are the result of the redistribution of the individual loans that comprise the aggregate portfolio as described above. However, the perception of risk with respect to particular loans within the portfolio will change over time as a result of the characteristics and performance of those loans, overall economic and market trends, and the actual and expected trends in non-performing loans.
The adequacy of the allowance for loan losses is monitored by the internal loan review staff and reported quarterly to the Audit Committee of the Board of Directors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of Bancorp’s allowance for loan losses. Such agencies may require Bancorp to make additional provisions to the allowance based upon their judgments about information available to them at the time of their examinations. Management believes that the allowance for loan losses is adequate to absorb probable inherent losses on existing loans that may become uncollectible. See “Provision for Loan Losses” for further discussion of the allowance for loan losses.
Summary of Loan Loss Experience
The following table summarizes average loans outstanding, changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category and additions to the allowance charged to expense.
| | Year ended December 31 | |
(Dollars in thousands) | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Average loans | | $ | 1,015,261 | | $ | 913,502 | | $ | 853,299 | | $ | 792,770 | | $ | 721,576 | |
| | | | | | | | | | | |
Balance of allowance for loan losses at beginning of year | | $ | 12,521 | | $ | 11,798 | | $ | 11,705 | | $ | 10,965 | | $ | 9,331 | |
Loans charged off | | | | | | | | | | | |
Commercial and industrial | | 300 | | 703 | | 467 | | 1,736 | | 1,203 | |
Construction and development | | — | | — | | 986 | | — | | — | |
Real estate mortgage | | 241 | | 583 | | 690 | | 602 | | 327 | |
Consumer | | 822 | | 793 | | 1,071 | | 1,628 | | 1,259 | |
| | | | | | | | | | | |
Total loans charged off | | 1,363 | | 2,079 | | 3,214 | | 3,966 | | 2,789 | |
| | | | | | | | | | | |
Recoveries of loans previously charged off | | | | | | | | | | | |
Commercial and industrial | | 207 | | 236 | | 115 | | 37 | | 32 | |
Construction and development | | — | | — | | — | | — | | — | |
Real estate mortgage | | 78 | | 11 | | 254 | | 9 | | — | |
Consumer | | 367 | | 465 | | 388 | | 160 | | 171 | |
| | | | | | | | | | | |
Total recoveries | | 652 | | 712 | | 757 | | 206 | | 203 | |
| | | | | | | | | | | |
Net loans charged off | | 711 | | 1,367 | | 2,457 | | 3,760 | | 2,586 | |
Additions to allowance charged to expense | | 225 | | 2,090 | | 2,550 | | 4,500 | | 4,220 | |
| | | | | | | | | | | |
Balance at end of year | | $ | 12,035 | | $ | 12,521 | | $ | 11,798 | | $ | 11,705 | | $ | 10,965 | |
| | | | | | | | | | | |
Ratio of net charge-offs during year to average loans | | 0.07 | % | 0.15 | % | 0.29 | % | 0.47 | % | 0.36 | % |
25
The overall decrease in charge-offs during 2005 can be attributed primarily to the commercial and industrial portfolio and real estate mortgages. See “Provision for Loan Losses” for discussion of the provision for loan losses.
The following table sets forth the allocation of the allowance for loan losses for the loan categories shown. Although specific allocations exist, the entire allowance is available to absorb losses in any particular loan category.
| | December 31 | |
(In thousands) | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Commercial and industrial | | $ | 3,762 | | $ | 4,366 | | $ | 4,085 | | $ | 4,550 | | $ | 2,936 | |
Construction and development | | 744 | | 687 | | 1,887 | | 572 | | 1,066 | |
Real estate mortgage | | 2,712 | | 2,500 | | 1,598 | | 2,350 | | 3,024 | |
Consumer | | 2,074 | | 2,011 | | 1,571 | | 1,607 | | 1,779 | |
Unallocated | | 2,743 | | 2,957 | | 2,657 | | 2,626 | | 2,160 | |
| | $ | 12,035 | | $ | 12,521 | | $ | 11,798 | | $ | 11,705 | | $ | 10,965 | |
The changes in the allocation of the allowance from year to year in various categories are influenced greatly by the level of net charge-offs in the respective categories and other factors including, but not limited to, risk allocations tied to specific loans or groups of loans and changes in overall qualitative allocations.
The unallocated allowance is based upon management’s evaluation of various conditions, the effects of which are not directly measured in the determination of the allocated allowance. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific credits. The conditions evaluated in connection with the unallocated allowance may include factors such as economic conditions and forecasts, the adequacy of loan policies and internal controls, the experience of the lending staff, bank regulatory examination results, and changes in the composition of the portfolio.
The ratio of loans in each category to total outstanding loans is as follows:
| | December 31 | |
| | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Commercial and industrial | | 21.4 | % | 21.9 | % | 21.4 | % | 21.4 | % | 19.6 | % |
Construction and development | | 12.0 | % | 8.3 | % | 6.0 | % | 4.3 | % | 7.2 | % |
Real estate mortgage | | 49.8 | % | 54.6 | % | 56.5 | % | 59.1 | % | 65.1 | % |
Consumer | | 16.8 | % | 15.2 | % | 16.1 | % | 15.2 | % | 8.1 | % |
| | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Selected ratios relating to the allowance for loan losses follow:
| | Years ended December 31 | |
| | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Provision for loans losses to average loans | | 0.02 | % | 0.23 | % | 0.30 | % |
Net charge-offs to average loans | | 0.07 | % | 0.15 | % | 0.29 | % |
Allowance for loan losses to average loans | | 1.19 | % | 1.37 | % | 1.38 | % |
Allowance for loan losses to year end loans | | 1.14 | % | 1.27 | % | 1.33 | % |
26
Deposits
Bancorp’s core deposits consist of non-interest and interest bearing demand deposits, savings deposits, certificates of deposit under $100,000, certain certificates of deposit over $100,000 and IRAs. These deposits, along with other borrowed funds, are used by Bancorp to support its asset base. By adjusting rates offered to depositors, Bancorp is able to influence the amounts of deposits needed to meet its funding requirements. The average amount of deposits in the Bank and average rates paid on such deposits for the years indicated are summarized as follows:
| | Years ended December 31 | |
| | 2005 | | 2004 | | 2003 | |
(Dollars in thousands) | | Average
Balance | | Average
Rate | | Average
Balance | | Average
Rate | | Average
Balance | | Average
Rate | |
Non-interest bearing demand deposits | | $ | 169,971 | | — | | $ | 155,005 | | — | | $ | 140,239 | | — | |
Interest bearing demand deposits | | 242,769 | | 1.17 | % | 269,120 | | 0.84 | % | 254,273 | | 0.88 | % |
Savings deposits | | 47,081 | | 0.46 | % | 46,797 | | 0.26 | % | 41,657 | | 0.17 | % |
Money market deposits | | 166,458 | | 2.34 | % | 112,643 | | 0.90 | % | 108,029 | | 0.58 | % |
Time deposits | | 371,700 | | 3.25 | % | 312,848 | | 3.07 | % | 343,872 | | 3.46 | % |
| | $ | 997,979 | | | | $ | 896,413 | | | | $ | 888,070 | | | |
Maturities of time deposits of $100,000 or more outstanding at December 31, 2005, are summarized as follows:
(In thousands) | | Amount | |
| | | |
3 months or less | | $ | 25,768 | |
Over 3 through 6 months | | 12,533 | |
Over 6 through 12 months | | 25,553 | |
Over 12 months | | 60,220 | |
| | | |
| | $ | 124,074 | |
Short-Term Borrowings
Securities sold under agreements to repurchase represent short-term borrowings from commercial customers as part of a cash management service. These agreements generally have maturities of one to four days from the transaction date.
Information regarding securities sold under agreements to repurchase follows:
| | Years ended December 31 | |
| | 2005 | | 2004 | | 2003 | |
(Dollars in thousands) | | Amount | | Rate | | Amount | | Rate | | Amount | | Rate | |
| | | | | | | | | | | | | |
Securities sold under agreements to repurchase | | | | | | | | | | | | | |
Year end | | $ | 79,886 | | 2.17 | % | $ | 72,084 | | 1.42 | % | $ | 66,102 | | 0.95 | % |
Average during year | | 78,360 | | 1.83 | % | 70,593 | | 1.18 | % | 61,571 | | 1.05 | % |
Maximum month end balance during year | | 87,987 | | | | 85,395 | | | | 71,748 | | | |
| | | | | | | | | | | | | | | | |
27
Subordinated Debentures
Subordinated debentures are long term debt and consist primarily of a trust preferred security issued in June 2001. The trust preferred security has a coupon of 9% and is callable in June 2006. If Bancorp’s management would decide to call the security, Bancorp would incur pre-tax expense of approximately $879,000 due to the write-off of debt issuance costs. See Note 11 for further information regarding subordinated debentures.
Liquidity
The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet the demand is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Management prefers to focus on transaction accounts and full service relationships with customers.
Bancorp’s Asset/Liability Committee is primarily made up of senior management and has direct oversight responsibility for Bancorp’s liquidity position and profile. A combination of daily, weekly and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, and exposure to contingent draws on Bancorp’s liquidity.
The Bank has a number of sources of funds to meet liquidity needs on a daily basis. The deposit base, including consumer and commercial deposits are a principal source of funds. The majority of these deposits come from long-term customers and is a stable source of funds. The Bank has no brokered deposits, and has an insignificant amount of deposits on which the rate paid exceeded the market rate by more than 50 basis points when the account was established. In addition, federal funds purchased are an available source of liquidity.
Other sources of funds available to meet daily needs include the sales of securities under agreements to repurchase and funds made available under a treasury tax and loan note agreement with the federal government. Also, the Bank is a member of the Federal Home Loan Bank of Cincinnati (FHLB). As a member of the FHLB, the Bank has access to credit products of the FHLB. At December 31, 2005, the amount of available credit from the FHLB totaled $76 million. Bancorp’s ability to borrow from the FHLB has been reduced by the Bank’s use of fixed rate advances. See Note 10 for further information regarding advances from the Federal Home Loan Bank. Additionally, the Bank has federal funds purchased lines with correspondent banks totaling $58 million. Bancorp can also borrow from the Federal Reserve Bank of St. Louis based upon its asset size. Bancorp has in the past had a line of credit with a correspondent bank and management believes it has the ability to restore a line of credit with an outside bank at any time.
Bancorp’s liquidity depends primarily on the dividends paid to it as the sole shareholder of the Bank. As discussed in Note 16 to Bancorp’s consolidated financial statements, the Bank may pay up to $21,878,000 in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank. Prior to the declaration of dividends, management considers the effect such payments will have on total stockholders’ equity and capital ratios.
Over the normal course of business, Bancorp enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through Bancorp’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of Bancorp’s liquidity.
Sources and Uses of Cash
Bancorp derives most of its cash flow from the activities of the Bank. Cash flow is provided primarily through the financing activities of the Bank which include raising deposits and the borrowing of funds from institutional sources such as fed funds purchased. These funds are then primarily used to facilitate the
28
investment activities of the Bank which include making loans and increasing the investment portfolio. Another important source of cash is from the net income of the Bank from operating activities. A portion of the net income from the Bank is also used to pay dividends to shareholders. For more specific information, see the consolidated statement of cash flows in Bancorp’s consolidated financial statements.
Commitments
In the normal course of business, Bancorp is party to activities that contain credit, market and operational risk that are not reflected in whole or in part in Bancorp’s consolidated financial statements. Such activities include: traditional off-balance sheet credit-related financial instruments, commitments under operating leases and long-term debt.
The Bank provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Summarized credit-related financial instruments, including both commitments to extend credit and letters of credit at December 31, 2005 are as follows:
| | Amount of Commitment Expiration per Period | |
(In thousands) | | Total | | Less than
1 year | | 1-3
Years | | 3-5
Years | | Over 5
Years | |
| | | | | | | | | | | |
Unused loan commitments | | $ | 308,679 | | $ | 118,466 | | $ | 54,781 | | $ | 63,808 | | $ | 71,624 | |
Standby letters of credit | | 13,453 | | 11,470 | | 1,982 | | 1 | | — | |
| | | | | | | | | | | | | | | | |
Since some of the unused commitments are expected to expire or may not be fully used, the total amount of commitments in the preceding table does not necessarily represent future cash requirements.
In addition to owned banking facilities, the Bank has entered into long-term leasing arrangements to support the ongoing activities of Bancorp. The Bank also has required future payments for a defined benefit retirement plan, long-term debt and the maturity of time deposits. See Note 8, Note 10, Note 11 and Note 14 to Bancorp’s consolidated financial statements for further information on the defined benefit retirement plan, Federal Home Loan Bank advances, subordinated debentures and time deposits.
The required payments under such commitments at December 31, 2005 are as follows:
| | Payments due by period | |
(In thousands) | | Total | | Less than
1 year | | 1-3
Years | | 3-5
Years | | Over 5
Years | |
| | | | | | | | | | | |
Operating leases | | $ | 10,039 | | $ | 1,335 | | $ | 2,327 | | $ | 1,371 | | $ | 5,006 | |
Defined benefit retirement plan | | 5,081 | | 174 | | 348 | | 323 | | 4,236 | |
Federal Home Loan Bank advances | | 40,000 | | 10,000 | | 30,000 | | — | | — | |
Subordinated debentures | | 20,769 | | — | | — | | — | | 20,769 | |
Time deposits | | 386,875 | | 195,122 | | 148,202 | | 25,228 | | 18,323 | |
| | | | | | | | | | | | | | | | |
29
Capital
Information pertaining to Bancorp’s capital balances and ratios follows:
| | Years ended December 31 | |
(Dollars in thousands, except share data) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Stockholders’ equity | | $ | 125,797 | | $ | 116,647 | | $ | 100,414 | |
Dividends per share | | $ | 0.470 | | $ | 0.390 | | $ | 0.305 | |
Tier 1 risk-based capital | | 13.44 | % | 13.64 | % | 13.46 | % |
Total risk-based capital | | 14.56 | % | 14.91 | % | 14.74 | % |
Leverage ratio | | 11.15 | % | 11.34 | % | 10.61 | % |
The increase in stockholders’ equity from 2004 to 2005 was primarily due to net income less the effect of dividends paid to shareholders. Equity was also affected to a lesser extent by shares issued for options and employee benefit plans, shares repurchased and the impact of changes in market value on the unrealized gain in the investment portfolio.
Bank holding companies and their subsidiary banks are required by regulators to meet risk-based capital standards. These standards, or ratios, measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The value of both balance sheet and off-balance sheet items are adjusted to reflect credit risks. Note 19 to the consolidated financial statements provides more details of regulatory capital requirements, as well as capital ratios of Bancorp and the Bank. Bancorp and the Bank exceed regulatory capital ratios required to be well capitalized. Management considers the effects of growth on capital ratios as it contemplates plans for expansion.
Bancorp first implemented a stock repurchase plan in 1999. The repurchased shares may be used for, among other things, issuance of shares for the stock options or employee stock ownership or purchase plans. In February 2005, the Directors expanded this plan to allow for the repurchase of 550,000 shares between February 2005 and February 2006. In February 2006, the Board of Directors extended the term of this plan to February 2007. Shares repurchased in 2005, including both the 1999 plan and 2005 expanded plan, totaled 234,264 at an average price of $23.46.
A component of equity is accumulated other comprehensive income (loss) which, for Bancorp consists of net unrealized gains or losses on securities available for sale and a minimum pension liability, both net of taxes. Accumulated other comprehensive income (loss) was ($1,197,000) and $420,000 at December 31, 2005 and 2004, respectively. The $1,617,000 decrease in accumulated other comprehensive income is primarily a reflection of the effect of the increasing interest rate environment during fiscal year 2005 on the valuation of the Bank’s portfolio of securities available for sale.
The following table presents various key financial ratios:
| | Years ended December 31 | |
| | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Return on average assets | | 1.70 | % | 1.65 | % | 1.63 | % |
Return on average stockholders’ equity | | 17.80 | % | 17.28 | % | 18.88 | % |
Dividend pay out ratio, based on basic EPS | | 30.13 | % | 28.47 | % | 23.28 | % |
Average stockholders’ equity to average assets | | 9.57 | % | 9.53 | % | 8.65 | % |
30
Recently Issued Accounting Pronouncements
In November 2003, the Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary and the measurement of an impairment loss. Certain disclosure requirements of EITF 03-1 were adopted in 2003 and Bancorp 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 in reporting periods beginning after June 15, 2004. However, in September 2004, the effective date of these provisions was delayed until the finalization of a FASB Staff Position (“FSP”) to provide additional implementation guidance. On November 3, 2005 the FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP specifically nullifies certain requirements of EITF 03-1 but carries forward the disclosure requirements. Bancorp’s disclosures in Note 3 to the consolidated financial statements incorporate the requirements of EITF No. 03-1 and the aforementioned FSPs.
In December 2004, FASB issued a revision to SFAS No. 123, Accounting for Stock-Based Compensation, SFAS No. 123(revised), Share-Based Payment. SFAS No. 123R establishes standards for the accounting for transactions in which an entity (i) exchanges its equity instruments for goods or services, or (ii) incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of the equity instruments. SFAS No. 123R eliminates the ability to account for stock-based compensation under the intrinsic value method using Accounting Practice Bulletin Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the date of the grant. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, which provided the SEC’s views on the implementation of SFAS No. 123R and their views regarding the valuation of share-based payment arrangements for public companies. SAB 107 also lays out the SEC’s positions regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. SAB 107 further discusses the valuation of share-based payment arrangement for public companies. SFAS No. 123R and SAB No. 107 are effective for the Bancorp on January 1, 2006 and must be fully implemented for any reporting periods following that date. As of January 1, 2006, Bancorp has adopted SFAS No. 123R and the “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. On December 31, 2005, Bancorp accelerated vesting on employee stock-based compensation outstanding at that date. See the information provided in the stock-based compensation section of this note to the consolidated financial statements for further discussion of the implementation of this standard. Bancorp expects the impact of adopting this statement on Bancorp’s consolidated financial statements for 2006 to be an additional compensation expense of approximately $300,000.
In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS No. 154). SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material impact on Bancorp’s consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information required by this item is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.
31
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements of Bancorp and report of independent auditors are included below:
32
Consolidated Balance Sheets
| | December 31, | |
(Dollars in thousands) | | 2005 | | 2004 | |
| | | | | |
Assets | | | | | |
Cash and due from banks | | $ | 34,082 | | $ | 31,030 | |
Federal funds sold | | 9,957 | | 517 | |
Mortgage loans held for sale | | 7,444 | | 5,528 | |
Securities available for sale (amortized cost $158,371 in 2005 and $125,013 in 2004) | | 156,950 | | 126,164 | |
Securities held to maturity (approximate fair value $4,180 in 2005 and $5,465 in 2004) | | 4,124 | | 5,283 | |
Federal Home Loan Bank stock | | 3,391 | | 3,226 | |
Loans | | 1,053,871 | | 984,841 | |
Less allowance for loan losses | | 12,035 | | 12,521 | |
Net loans | | 1,041,836 | | 972,320 | |
Premises and equipment | | 25,187 | | 26,266 | |
Accrued interest receivable and other assets | | 47,467 | | 41,681 | |
| | | | | |
Total assets | | $ | 1,330,438 | | $ | 1,212,015 | |
| | | | | |
Liabilities | | | | | |
Deposits | | | | | |
Non-interest bearing | | $ | 180,628 | | $ | 159,342 | |
Interest bearing | | 850,729 | | 790,741 | |
Total deposits | | 1,031,357 | | 950,083 | |
| | | | | |
Securities sold under agreements to repurchase and federal funds purchased | | 79,886 | | 73,284 | |
Other short-term borrowings | | 2,139 | | 1,176 | |
Accrued interest payable and other liabilities | | 30,490 | | 20,026 | |
Federal Home Loan Bank advances | | 40,000 | | 30,000 | |
Subordinated debentures | | 20,769 | | 20,799 | |
| | | | | |
Total liabilities | | 1,204,641 | | 1,095,368 | |
| | | | | |
Stockholders’ equity | | | | | |
Preferred stock, no par value; 1,000,000 shares authorized; no shares issued or outstanding | | — | | — | |
Common stock, no par value; 20,000,000 shares authorized; issued and outstanding 13,815,837 shares in 2005 and 13,948,981 shares in 2004 | | 6,931 | | 7,373 | |
Additional paid-in capital | | 14,773 | | 18,684 | |
Retained earnings | | 105,290 | | 90,170 | |
Accumulated other comprehensive (loss) income | | (1,197 | ) | 420 | |
| | | | | |
Total stockholders’ equity | | 125,797 | | 116,647 | |
| | | | | |
Total liabilities and stockholders’ equity | | $ | 1,330,438 | | $ | 1,212,015 | |
See accompanying notes to consolidated financial statements.
33
Consolidated Statements of Income
| | Years Ended December 31, | |
(In thousands, except per share data) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Interest income | | | | | | | |
Loans | | $ | 65,835 | | $ | 54,726 | | $ | 54,025 | |
Federal funds sold | | 515 | | 172 | | 354 | |
Mortgage loans held for sale | | 334 | | 213 | | 748 | |
Securities | | | | | | | |
Taxable | | 4,291 | | 4,003 | | 3,808 | |
Tax-exempt | | 1,368 | | 1,426 | | 1,185 | |
| | | | | | | |
Total interest income | | 72,343 | | 60,540 | | 60,120 | |
| | | | | | | |
Interest expense | | | | | | | |
Deposits | | 19,042 | | 12,986 | | 14,843 | |
Securities sold under agreements to repurchase and federal funds purchased | | 1,457 | | 917 | | 657 | |
Other short-term borrowings | | 29 | | 9 | | 8 | |
Federal Home Loan Bank advances | | 718 | | 545 | | — | |
Subordinated debentures | | 1,862 | | 1,862 | | 1,864 | |
| | | | | | | |
Total interest expense | | 23,108 | | 16,319 | | 17,372 | |
Net interest income | | 49,235 | | 44,221 | | 42,748 | |
| | | | | | | |
Provision for loan losses | | 225 | | 2,090 | | 2,550 | |
Net interest income after provision for loan losses | | 49,010 | | 42,131 | | 40,198 | |
| | | | | | | |
Non-interest income | | | | | | | |
Investment management and trust services | | 10,813 | | 9,427 | | 8,301 | |
Service charges on deposit accounts | | 8,426 | | 8,890 | | 8,487 | |
Bankcard transaction revenue | | 1,704 | | 1,262 | | 1,013 | |
Gains on sales of mortgage loans held for sale | | 1,391 | | 1,064 | | 2,552 | |
Gains on sales of securities available for sale | | — | | — | | 10 | |
Brokerage commissions and fees | | 2,055 | | 1,675 | | 1,272 | |
Other | | 2,733 | | 2,358 | | 2,863 | |
Total non-interest income | | 27,122 | | 24,676 | | 24,498 | |
| | | | | | | |
Non-interest expense | | | | | | | |
Salaries and employee benefits | | 24,358 | | 21,652 | | 21,624 | |
Net occupancy expense | | 3,444 | | 3,027 | | 2,623 | |
Data processing expense | | 3,668 | | 3,419 | | 3,372 | |
Furniture and equipment expense | | 1,191 | | 1,178 | | 1,062 | |
State bank taxes | | 1,742 | | 1,196 | | 1,188 | |
Other | | 10,209 | | 8,621 | | 8,756 | |
| | | | | | | |
Total non-interest expense | | 44,612 | | 39,093 | | 38,625 | |
| | | | | | | |
Income before income taxes | | 31,520 | | 27,714 | | 26,071 | |
Income tax expense | | 9,876 | | 8,802 | | 8,362 | |
Net income | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
Net income per share, basic | | $ | 1.56 | | $ | 1.37 | | $ | 1.31 | |
Net income per share, diluted | | $ | 1.53 | | $ | 1.33 | | $ | 1.27 | |
See accompanying notes to consolidated financial statements.
34
Consolidated Statements of Changes in Stockholders’ Equity
| | Three Years Ended December 31, 2005 | |
| | Common Stock | | Additional Paid-In Capital | | Retained
Earnings | | Accumulated
Other
Comprehensive
Income (Loss) | | Total | |
(In thousands, except per share data) | | Number of
Shares | | Amount | | | | | |
| | | | | | | | | | | | | |
Balance December 31, 2002 | | 13,433 | | $ | 5,858 | | $ | 14,889 | | $ | 63,081 | | $ | 2,239 | | $ | 86,067 | |
Net income | | — | | — | | — | | 17,709 | | — | | 17,709 | |
Change in other comprehensive loss, net of tax | | — | | — | | — | | — | | (765 | ) | (765 | ) |
Shares issued for stock options exercised and employee benefit plans | | 145 | | 274 | | 1,301 | | — | | — | | 1,575 | |
Cash dividends, $0.305 per share | | — | | — | | — | | (4,131 | ) | — | | (4,131 | ) |
Shares repurchased | | (2 | ) | (4 | ) | (37 | ) | — | | — | | (41 | ) |
| | | | | | | | | | | | | |
Balance December 31, 2003 | | 13,576 | | $ | 6,128 | | $ | 16,153 | | $ | 76,659 | | $ | 1,474 | | $ | 100,414 | |
| | | | | | | | | | | | | |
Net income | | — | | — | | — | | 18,912 | | — | | 18,912 | |
Change in other comprehensive loss, net of tax | | — | | — | | — | | — | | (1,054 | ) | (1,054 | ) |
Shares issued for stock options exercised and employee benefit plans | | 384 | | 1,295 | | 2,709 | | — | | — | | 4,004 | |
Cash dividends, $0.39 per share | | — | | — | | — | | (5,401 | ) | — | | (5,401 | ) |
Shares repurchased | | (11 | ) | (50 | ) | (178 | ) | — | | — | | (228 | ) |
| | | | | | | | | | | | | |
Balance December 31, 2004 | | 13,949 | | $ | 7,373 | | $ | 18,684 | | $ | 90,170 | | $ | 420 | | $ | 116,647 | |
Net income | | — | | — | | — | | 21,644 | | — | | 21,644 | |
Change in other comprehensive loss, net of tax | | — | | — | | — | | — | | (1,617 | ) | (1,617 | ) |
Non-cash compensation expense from early vesting of stock options, net of tax | | — | | — | | 32 | | — | | — | | 32 | |
Shares issued for stock options exercised and employee benefit plans | | 101 | | 337 | | 774 | | — | | — | | 1,111 | |
Cash dividends, $0.47 per share | | — | | — | | — | | (6,524 | ) | — | | (6,524 | ) |
Shares repurchased | | (234 | ) | (779 | ) | (4,717 | ) | — | | — | | (5,496 | ) |
| | | | | | | | | | | | | |
Balance December 31, 2005 | | 13,816 | | $ | 6,931 | | $ | 14,773 | | $ | 105,290 | | $ | (1,197 | ) | $ | 125,797 | |
See accompanying notes to consolidated financial statements.
35
Consolidated Statements of Comprehensive Income
| | Years Ended December 31 | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Net income | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
| | | | | | | |
Other comprehensive (loss) income, net of tax: | | | | | | | |
Unrealized (losses) gains on securities available for sale: | | | | | | | |
Unrealized holding losses arising during the period (net of tax of $899, $556, and $327, respectively) | | (1,669 | ) | (1,035 | ) | (661 | ) |
Reclassification adjustment for gains included in net income (net of tax of $4) | | — | | — | | (7 | ) |
Minimum pension liability adjustment (net of tax of $28, $10, and $52, respectively) | | 52 | | (19 | ) | (97 | ) |
| | | | | | | |
Other comprehensive loss | | (1,617 | ) | (1,054 | ) | (765 | ) |
| | | | | | | |
Comprehensive income | | $ | 20,027 | | $ | 17,858 | | $ | 16,944 | |
See accompanying notes to consolidated financial statements.
36
Consolidated Statements of Cash Flows
| | Years Ended December 31 | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Operating activities | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
Net income | | | | | | | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities | | | | | | | |
Provision for loan losses | | 225 | | 2,090 | | 2,550 | |
Depreciation, amortization and accretion, net | | 3,257 | | 3,168 | | 2,921 | |
Provision for deferred income taxes (benefit) | | (56 | ) | (130 | ) | 402 | |
Gains on sales of securities available for sale | | — | | — | | (10 | ) |
Gains on sales of mortgage loans held for sale | | (1,391 | ) | (1,064 | ) | (2,552 | ) |
Loss on the disposal of premises and equipment | | 115 | | 5 | | 9 | |
Loss on the sale of other real estate | | 43 | | 204 | | 233 | |
Bank owned life insurance | | 881 | | 342 | | — | |
Origination of mortgage loans held for sale | | (115,962 | ) | (95,937 | ) | (238,155 | ) |
Proceeds from sales of mortgage loans held for sale | | 115,437 | | 94,630 | | 265,084 | |
Non cash compensation expense from early vesting of stock options, net of tax | | 32 | | — | | — | |
Income tax benefit of stock options exercised | | 260 | | 794 | | 370 | |
Increase in accrued interest receivable and other assets | | (5,010 | ) | (2,460 | ) | (9,626 | ) |
Increase (decrease) in accrued interest payable and other liabilities | | 9,373 | | (2,712 | ) | 4,560 | |
Net cash provided by operating activities | | 28,848 | | 17,842 | | 43,495 | |
| | | | | | | |
Investing activities | | | | | | | |
Purchases of securities available for sale | | (84,062 | ) | (91,872 | ) | (146,867 | ) |
Proceeds from sales of securities available for sale | | — | | — | | 1,014 | |
Proceeds from maturities of securities available for sale | | 50,497 | | 116,480 | | 107,340 | |
Proceeds from maturities of securities held to maturity | | 1,164 | | 631 | | 3,467 | |
Net increase in loans | | (70,963 | ) | (99,579 | ) | (65,462 | ) |
Purchases of premises and equipment | | (2,257 | ) | (4,550 | ) | (5,465 | ) |
Purchase of bank-owned life insurance | | — | | (20,000 | ) | — | |
Proceeds from sales of other real estate | | 1,363 | | 1,177 | | 1,108 | |
Net cash used in investing activities | | (104,258 | ) | (97,713 | ) | (104,865 | ) |
| | | | | | | |
Financing activities | | | | | | | |
Net increase in deposits | | 81,274 | | 68,217 | | 20,779 | |
Net increase (decrease) in securities sold under agreements to repurchase and federal funds purchased | | 6,602 | | (18,818 | ) | 39,443 | |
Net increase (decrease) in other short-term borrowings | | 963 | | (56 | ) | (1,425 | ) |
Repayments of subordinated debentures | | (30 | ) | (30 | ) | (30 | ) |
Repayments of Federal Home Loan Bank advances | | (10,000 | ) | — | | — | |
Proceeds from Federal Home Loan Bank advances | | 20,000 | | 30,000 | | — | |
Proceeds from stock options | | 851 | | 3,210 | | 1,205 | |
Common stock repurchases | | (5,496 | ) | (228 | ) | (41 | ) |
Cash dividends paid | | (6,262 | ) | (4,953 | ) | (3,985 | ) |
Net cash provided by financing activities | | 87,902 | | 77,342 | | 55,946 | |
| | | | | | | |
Net increase (decrease) in cash and cash equivalents | | 12,492 | | (2,529 | ) | (5,424 | ) |
| | | | | | | |
Cash and cash equivalents at beginning of year | | 31,547 | | 34,076 | | 39,500 | |
| | | | | | | |
Cash and cash equivalents at end of year | | $ | 44,039 | | $ | 31,547 | | $ | 34,076 | |
Supplemental cash flow information: | | | | | | | |
Income tax payments | | $ | 10,305 | | $ | 7,525 | | $ | 7,700 | |
Cash paid for interest | | 22,891 | | 16,215 | | 17,522 | |
Supplemental non-cash activity: | | | | | | | |
Transfers from loans to other real estate owned | | $ | 1,222 | | $ | 476 | | $ | 4,575 | |
See accompanying notes to consolidated financial statements.
37
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Principles of Consolidation and Nature of Operations
The consolidated financial statements include the accounts of S.Y. Bancorp, Inc. (Bancorp) and its wholly owned subsidiary, Stock Yards Bank & Trust Company (the Bank). Significant intercompany transactions and accounts have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the 2005 presentation.
The Bank is engaged in commercial banking services and trust and investment management services. The Bank’s primary market area is Louisville, Kentucky and surrounding communities including southern Indiana. A secondary market is Indianapolis, Indiana where the Bank has one full service private banking office.
Basis of Financial Statement Presentation and Use of Estimates
The consolidated financial statements of Bancorp and its subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and conform to predominant practices within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and income tax assets, estimated liabilities and expense.
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks and federal funds sold.
Securities
Securities intended to be held until maturity are carried at amortized cost. Securities available for sale include securities that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and prepayment risk changes. Securities available for sale are carried at fair value with unrealized gains or losses, net of tax effect, included in stockholders’ equity. Amortization of premiums and accretion of discounts are recorded using the interest method over the life of the security. Gains or losses on sales of securities are computed on a specific identification cost basis for securities. For securities for which impairment is other than temporary, losses are reflected in operations and a new cost basis is established.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or market value on an individual loan basis. Gains on sales of mortgage loans are recorded at the time of disbursement by an investor at the difference between the sales proceeds and the loan’s carrying value net of any origination costs. All mortgage servicing rights are released upon sale of the related loan.
Loans
Loans are stated at the unpaid principal balance less net deferred loan fees or costs. Loan fees, net of any costs, are deferred over the life of the related loan. Interest income on loans is recorded on the accrual basis except for those loans in a non-accrual income status. Loans are placed in a non-accrual income status when the prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more unless such a loan is well secured and in the process of collection. Interest received on non-accrual loans is generally applied to principal. Non-accrual loans may be returned to accrual status once principal recovery is reasonably assured.
38
Loans are classified as impaired when it is probable the Bank will be unable to collect interest and principal according to the terms of the loan agreement. These loans are measured based on the present value of future cash flows discounted at the loans’ effective interest rate or at the estimated fair value of the loans’ collateral, if applicable. Generally, impaired loans do not accrue interest.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level that adequately provides for probable losses inherent in the loan portfolio. Management determines the adequacy of the allowance based on reviews of individual credits and the underlying collateral, recent loss experience, current economic conditions, the risk characteristics of the various loan categories and such other factors that, in management’s judgment, deserve current recognition in estimating loan losses. The allowance for loan losses is increased by the provision for loan losses and reduced by net loan charge-offs.
Various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of Bancorp’s allowance for loan losses. Such agencies may require Bancorp to make additional provisions to the allowance based upon their judgments about information available to them at the time of their examinations.
Premises and Equipment
Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation of premises and equipment is computed using straight-line methods over the estimated useful lives of the assets ranging from 3 to 39 years. Leasehold improvements are amortized on the straight-line method over the terms of the related leases, including renewals, or over the useful lives of the improvements, whichever is shorter. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.
Other Assets
Bancorp ceased the amortization of goodwill effective January 1, 2002 in accordance with generally accepted accounting principles. The amount of goodwill impairment, if any, is measured and evaluated annually for potential impairment. No impairment charges have been recorded.
Other real estate is carried at the lower of cost or estimated fair value minus estimated selling costs. Any write downs to fair value at the date of acquisition are charged to the allowance for loan losses. In certain situations, improvements to prepare assets for sale are capitalized if those costs increase the estimated fair value of the asset. Expenses incurred in maintaining assets, write downs to reflect subsequent declines in value, and realized gains or losses are reflected in operations and are included in non-interest income and expense. At December 31, 2005 and 2004, other real estate owned was $3,226,000 and $3,284,000, respectively.
Bank-owned life insurance is carried at net realizable value less any applicable surrender charges.
Securities Sold Under Agreements to Repurchase
Bancorp enters into sales of securities under agreement to repurchase as a specified future date. Such repurchase agreements are considered financing agreements and, accordingly, the obligation to repurchase assets sold is reflected as a liability in the consolidated balance sheets of Bancorp. Repurchase agreements are collateralized by debt securities which are under the control of Bancorp.
Repurchased Shares of Common Stock
The repurchase of Bancorp’s common stock is recorded at cost, and repurchased shares return to the status of authorized, but unissued. Amounts recorded in common stock are based on the stated value of the shares, as there is no par value. Residual amounts are recorded in additional paid in capital.
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Income Taxes
Bancorp accounts for income taxes using the asset and liability method. The objective of the asset and liability method is to establish deferred tax assets and liabilities for temporary differences between the financial reporting and the tax bases of Bancorp’s assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of income in the period that includes the enactment date. Bancorp invests in certain low-income housing projects that yield investment tax credits and tax deductible losses. These tax benefits are recognized in income tax expense using an effective yield method over the life of the investment.
Net Income Per Share
Basic net income per common share is determined by dividing net income by the weighted average number of shares of common stock outstanding. Diluted net income per share is determined by dividing net income by the weighted average number of shares of common stock outstanding plus the weighted average number of shares that would be issued upon exercise of dilutive options, assuming proceeds are used to repurchase shares pursuant to the treasury stock method.
Comprehensive Income
Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. For Bancorp, this includes net income, changes in unrealized gains and losses on available for sale investment securities, net of taxes, and minimum pension liability adjustments, net of taxes.
Segment Information
The Bank provides a broad range of financial services to individuals, corporations and others through its twenty-four full service banking locations. These services include lending, receiving deposits, providing cash management services, safe deposit box rental, mortgage lending and investment management and trust activities. The Bank’s chief decision makers monitor the results of the various banking products and services and accordingly, the Bank’s operations are considered by management to be aggregated in two reportable operating segments: commercial banking and investment management and trust.
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Stock-Based Compensation
As permitted by Statement of Financial Accounting Standards (SFAS) No. 148, Bancorp continued to apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock-Based Compensation,” by expensing only the intrinsic value of any share-based awards and elected to disclose pro forma net income and earnings per share amounts as if the fair-value based method had been applied in measuring compensation costs. Bancorp has measured compensation cost for stock-based compensation plans as the difference between the exercise price of the options granted and the fair market value of Bancorp’s stock at the grant date. Bancorp has disclosed below pro forma net income and earnings per share as if compensation was measured at the date of grant based on the fair value of the award and recognized over the service period.
Bancorp’s as reported and pro forma information for the years ended December 31 follow:
(In thousands, except per share data) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Net income, as reported | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
Plus non-cash compensation expense | | 32 | | — | | — | |
Less stock-based compensation expense determined under fair value method | | 1,439 | | 680 | | 614 | |
| | | | | | | |
Pro forma net income | | $ | 20,237 | | $ | 18,232 | | $ | 17,095 | |
| | | | | | | |
Basic EPS: | | | | | | | |
As reported | | $ | 1.56 | | $ | 1.37 | | $ | 1.31 | |
Pro forma | | 1.46 | | 1.32 | | 1.27 | |
Diluted EPS: | | | | | | | |
As reported | | 1.53 | | 1.33 | | 1.27 | |
Pro forma | | 1.43 | | 1.29 | | 1.22 | |
The Board of Directors of Bancorp accelerated the vesting of all employee stock options outstanding on December 31, 2005. This action resulted in two financial reporting implications. First, the remaining fair value of all outstanding stock options was recognized in 2005 as part of the pro-forma footnote disclosures above. Second, Bancorp recognized $32,000 of compensation expense in the fourth quarter of 2005 based on an estimate of costs of those awards that would have expired unexercisable pursuant to original terms using a forfeiture rate based on historical experience.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used:
| | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Assumptions Used in Option Valuation | | | | | | | |
Dividend yield | | 1.56 | % | 1.70 | % | 1.48 | % |
Expected volatility | | 16.60 | % | 16.72 | % | 17.78 | % |
Risk free interest rate | | 4.13 | % | 4.12 | % | 4.00 | % |
Expected life of options (in years) | | 7.0 | | 7.0 | | 7.0 | |
As of January 1, 2006, Bancorp has adopted SFAS No. 123R and the “modified prospective” method in which compensation cost is recognized beginning with the effective date for all share-based payments granted after the effective date and for all awards granted prior to the effective date of SFAS No. 123R that remain unvested on the effective date. Because vesting was accelerated for all employee options outstanding at December 31, 2005, only options held by non-employee directors remain unvested as of the effective date.
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Recently Issued Accounting Pronouncements
In November 2003, the Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary and the measurement of an impairment loss. Certain disclosure requirements of EITF 03-1 were adopted in 2003 and Bancorp 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 in reporting periods beginning after June 15, 2004. However, in September 2004, the effective date of these provisions was delayed until the finalization of a FASB Staff Position (“FSP”) to provide additional implementation guidance. On November 3, 2005 the FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP specifically nullifies certain requirements of EITF 03-1 but carries forward the disclosure requirements. Bancorp’s disclosures in Note 3 to the consolidated financial statements incorporate the requirements of EITF No. 03-1 and the aforementioned FSPs.
In December 2004, FASB issued a revision to SFAS No. 123, Accounting for Stock-Based Compensation, SFAS No. 123(revised), Share-Based Payment. SFAS No. 123R establishes standards for the accounting for transactions in which an entity (i) exchanges its equity instruments for goods or services, or (ii) incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of the equity instruments. SFAS No. 123R eliminates the ability to account for stock-based compensation under the intrinsic value method using APB No. 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the date of the grant. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, which provided the SEC’s views on the implementation of SFAS No. 123R and their views regarding the valuation of share-based payment arrangements for public companies. SAB 107 also lays out the SEC’s positions regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. SAB 107 further discusses the valuation of share-based payment arrangement for public companies. SFAS No. 123R and SAB No. 107 are effective for Bancorp on January 1, 2006 and must be fully implemented for any reporting periods following that date. As of January 1, 2006, Bancorp has adopted SFAS No. 123R and the “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. On December 31, 2005, Bancorp accelerated vesting on employee stock-based compensation outstanding at that date. See the information provided in the stock-based compensation section of this note to the consolidated financial statements for further discussion of the implementation of this standard.
In May 2005, FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS No. 154). SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material impact on Bancorp’s consolidated financial statements.
(2) Restrictions on Cash and Due from Banks
The Bank is required to maintain an average reserve balance in cash or with the Federal Reserve Bank relating to customer deposits. The amount of those required reserve balances was approximately $13,357,000 and $12,059,000 at December 31, 2005 and 2004, respectively.
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(3) Securities
The amortized cost, unrealized gains and losses, and approximate fair value of securities available for sale follow:
| | Amortized
Cost | | Unrealized | | Approximate
Fair Value | |
(In thousands) | | | Gains | | Losses | | |
| | | | | | | | | |
December 31, 2005 | | | | | | | | | |
U.S. Treasury and federal agencies | | $ | 106,655 | | $ | 86 | | $ | 1,553 | | $ | 105,188 | |
Mortgage-backed securities | | 20,001 | | 94 | | 476 | | 19,619 | |
Obligations of states and political subdivisions | | 29,846 | | 729 | | 351 | | 30,224 | |
Other | | 1,869 | | 50 | | — | | 1,919 | |
| | | | | | | | | |
| | $ | 158,371 | | $ | 959 | | $ | 2,380 | | $ | 156,950 | |
| | | | | | | | | |
December 31, 2004 | | | | | | | | | |
U.S. Treasury and federal agencies | | $ | 70,613 | | $ | 572 | | $ | 649 | | $ | 70,536 | |
Mortgage-backed securities | | 21,568 | | 164 | | 161 | | 21,571 | |
Obligations of states and political subdivisions | | 30,963 | | 1,214 | | 103 | | 32,074 | |
Other | | 1,869 | | 114 | | — | | 1,983 | |
| | | | | | | | | |
| | $ | 125,013 | | $ | 2,064 | | $ | 913 | | $ | 126,164 | |
Other consists of trust preferred securities of other bank holding companies.
The amortized cost, unrealized gains and losses, and approximate fair value of securities held to maturity follow:
| | Amortized
Cost | | Unrealized | | Approximate
Fair Value | |
(In thousands) | | | Gains | | Losses | | |
| | | | | | | | | |
December 31, 2005 | | | | | | | | | |
Mortgage-backed securities | | $ | 133 | | $ | 3 | | $ | 1 | | $ | 135 | |
Obligations of states and political subdivisions | | 3,991 | | 54 | | — | | 4,045 | |
| | | | | | | | | |
| | $ | 4,124 | | $ | 57 | | $ | 1 | | $ | 4,180 | |
| | | | | | | | | |
December 31, 2004 | | | | | | | | | |
Mortgage-backed securities | | $ | 294 | | $ | 9 | | $ | — | | $ | 303 | |
Obligations of states and political subdivisions | | 4,989 | | 173 | | — | | 5,162 | |
| | | | | | | | | |
| | $ | 5,283 | | $ | 182 | | $ | — | | $ | 5,465 | |
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A summary of debt securities as of December 31, 2005 based on maturity is presented below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.
| | Securities
Available for Sale | | Securities
Held to Maturity | |
(In thousands) | | Amortized
Cost | | Approximate
Fair Value | | Amortized Cost | | Approximate
Fair Value | |
| | | | | | | | | |
Due within one year | | $ | 31,531 | | $ | 31,494 | | $ | 944 | | $ | 948 | |
Due after one year through five years | | 80,477 | | 78,770 | | 3,061 | | 3,112 | |
Due after five year through ten years | | 38,224 | | 38,324 | | 58 | | 60 | |
Due after ten years | | 8,139 | | 8,362 | | 61 | | 60 | |
| | | | | | | | | |
| | $ | 158,371 | | $ | 156,950 | | $ | 4,124 | | $ | 4,180 | |
Securities with a carrying value of approximately $108,932,000 at December 31, 2005 and $99,509,000 at December 31, 2004 were pledged to secure the accounts of commercial depositors in cash management accounts, public deposits and certain borrowings.
At year end 2005 and 2004, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.
Securities with unrealized losses at December 31, 2005 and 2004, not recognized in income are as follows:
| | Less than 12 months | | 12 months or more | | Total | |
(In thousands) | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | |
| | | | | | | | | | | | | |
December 31, 2005 | | | | | | | | | | | | | |
U.S. Treasury and federal agencies | | $ | 40,402 | | $ | 334 | | $ | 37,285 | | $ | 1,219 | | $ | 77,687 | | $ | 1,553 | |
Mortgage-backed securities | | 3,483 | | 66 | | 11,999 | | 410 | | 15,482 | | 476 | |
Obligations of states and political subdivisions | | 3,490 | | 77 | | 8,033 | | 274 | | 11,523 | | 351 | |
| | | | | | | | | | | | | |
Total temporarily impaired securities | | $ | 47,375 | | $ | 477 | | $ | 57,317 | | $ | 1,903 | | $ | 104,692 | | $ | 2,380 | |
| | | | | | | | | | | | | |
December 31, 2004 | | | | | | | | | | | | | |
U.S. Treasury and federal agencies | | $ | 26,638 | | $ | 404 | | $ | 11,771 | | $ | 245 | | $ | 38,409 | | $ | 649 | |
Mortgage-backed securities | | 8,137 | | 35 | | 7,291 | | 126 | | 15,428 | | 161 | |
Obligations of states and political subdivisions | | 2,712 | | 15 | | 5,494 | | 88 | | 8,206 | | 103 | |
| | | | | | | | | | | | | |
Total temporarily impaired securities | | $ | 37,487 | | $ | 454 | | $ | 24,556 | | $ | 459 | | $ | 62,043 | | $ | 913 | |
Unrealized losses on Bancorp’s bond portfolio have not been recognized in income because the bonds are of high credit quality, management has the intent and the ability hold for the foreseeable future, and the decline in fair values is largely due to an increase in interest rates from the purchase date. The fair value is expected to recover as the securities reach their maturity date and/or interest rates decline. These investments consist of 47 separate investment positions as of December 31, 2005 and 2004 that are not considered other-than-temporarily impaired.
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(4) Loans
The composition of loans follows:
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Commercial and industrial | | $ | 225,369 | | $ | 215,755 | |
Construction and development | | 126,961 | | 82,261 | |
Real estate mortgage | | 524,755 | | 537,491 | |
Consumer | | 176,786 | | 149,334 | |
| | | | | |
| | $ | 1,053,871 | | $ | 984,841 | |
The Bank’s credit exposure is diversified with secured and unsecured loans to individuals, small businesses and corporations. No specific industry concentration exceeds ten percent of loans. While the Bank has a diversified loan portfolio, a customer’s ability to honor contracts is somewhat dependent upon the economic stability and geographic region and/or industry in which that customer does business. Loans outstanding and related unfunded commitments are primarily concentrated within the Bank’s market areas, which encompasses Louisville, Kentucky and surrounding communities including southern Indiana along with Indianapolis, Indiana.
Information about impaired loans follows:
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Principal balance of impaired loans | | $ | 3,709 | | $ | 4,944 | |
Impaired loans with a valuation allowance | | 1,875 | | 2,725 | |
Amount of valuation allowance | | 916 | | 812 | |
Impaired loans with no valuation allowance | | 1,834 | | 2,219 | |
Average balance of impaired loans for year | | 4,486 | | 4,241 | |
| | | | | | | |
Interest income on non-accrual loans (cash basis) was $127,000, $144,000 and $127,000 in 2005, 2004, and 2003, respectively. Interest income that would have been recorded if non-accrual loans were on a current basis in accordance with their original terms was $382,000, $257,000 and $285,000 in 2005, 2004 and 2003, respectively.
Non-performing loans include the balance of impaired loans plus any loans over ninety days past due and still accruing interest. Loans past due more than ninety days or more and still accruing interest amounted to $891,000 in 2005 and $696,000 in 2004.
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Loans to directors and their associates, including loans to companies for which directors are principal owners, and executive officers are presented in the following table. Included in new loans and repayments are advances and repayments on lines of credit.
| | Year Ended December 31, | |
Loans to directors and executive officers | | 2005 | | 2004 | |
(in thousands) | | | | | |
Balance as of January 1 | | $ | 5,370 | | $ | 6,909 | |
New loans | | 41,254 | | 34,570 | |
Repayments | | 40,378 | | 36,109 | |
| | | | | |
Balance as of December 31 | | $ | 6,246 | | $ | 5,370 | |
| | | | | |
Deposit balances of directors and executive officers as of December 31 | | $ | 2,216 | | $ | 1,959 | |
An analysis of the changes in the allowance for loan losses for the years ended December 31, 2005, 2004, and 2003 follows:
| | Year Ended December 31, | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Balance at January 1 | | $ | 12,521 | | $ | 11,798 | | $ | 11,705 | |
Provision for loan losses | | 225 | | 2,090 | | 2,550 | |
Loans charged off | | 1,363 | | 2,079 | | 3,214 | |
Recoveries | | 652 | | 712 | | 757 | |
| | | | | | | |
Net loan charge-offs | | 711 | | 1,367 | | 2,457 | |
| | | | | | | |
Balance at December 31 | | $ | 12,035 | | $ | 12,521 | | $ | 11,798 | |
(5) Premises and Equipment
A summary of premises and equipment follows:
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Land | | $ | 4,586 | | $ | 3,576 | |
Buildings and improvements | | 20,483 | | 20,338 | |
Furniture and equipment | | 16,860 | | 16,772 | |
Construction in progress | | 205 | | 155 | |
| | | | | |
| | 42,134 | | 40,841 | |
| | | | | |
Accumulated depreciation and amortization | | 16,947 | | 14,575 | |
| | | | | |
| | $ | 25,187 | | $ | 26,266 | |
Depreciation expense related to premises and equipment was $3,221,000 in 2005, $3,064,000 in 2004 and $2,692,000 in 2003.
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(6) Accrued Interest Receivable and Other Assets
A summary of the major components of accrued interest receivable and other assets follows:
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Cash surrender value of life insurance | | $ | 24,464 | | $ | 23,060 | |
Other real estate owned and other foreclosed property | | 3,266 | | 3,397 | |
Accrued interest receivable | | 5,951 | | 4,533 | |
Net deferred tax asset | | 4,460 | | 3,533 | |
Trust preferred securities issuance costs | | 897 | | 932 | |
Goodwill | | 682 | | 682 | |
Other | | 7,747 | | 5,544 | |
| | | | | |
| | $ | 47,467 | | $ | 41,681 | |
(7) Income Taxes
Income taxes consist of the following:
| | Year Ended December 31, | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Expense (benefit) applicable to operations: | | | | | | | |
Current | | $ | 9,932 | | $ | 8,932 | | $ | 7,960 | |
Deferred | | (56 | ) | (130 | ) | 402 | |
| | | | | | | |
Total applicable to operations | | 9,876 | | 8,802 | | 8,362 | |
| | | | | | | |
Charged (credited) to stockholders’ equity: | | | | | | | |
Unrealized loss on securities available for sale | | (899 | ) | (556 | ) | (327 | ) |
Stock options exercised | | (260 | ) | (794 | ) | (370 | ) |
Minimum pension liability adjustment | | 28 | | (10 | ) | (52 | ) |
| | | | | | | |
| | $ | 8,745 | | $ | 7,442 | | $ | 7,613 | |
An analysis of the difference between the statutory and effective tax rates follows:
| | Year Ended December 31, | |
| | 2005 | | 2004 | | 2003 | |
| | | | | | | |
U.S. federal income tax rate | | 35.0 | % | 35.0 | % | 35.0 | % |
Tax exempt interest income | | (2.2 | )% | (2.6 | )% | (2.0 | )% |
Other, net | | (1.5 | )% | (0.6 | )% | (0.9 | )% |
| | | | | | | |
| | 31.3 | % | 31.8 | % | 32.1 | % |
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The effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows:
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Deferred tax assets | | | | | |
Allowance for loan losses | | $ | 4,212 | | $ | 4,382 | |
Deferred compensation | | 1,411 | | 1,020 | |
Other | | 185 | | 465 | |
| | | | | |
Total deferred tax assets | | 5,808 | | 5,867 | |
| | | | | |
Deferred tax liabilities | | | | | |
Securities | | 102 | | 900 | |
Property and equipment | | 976 | | 1,357 | |
Other | | 270 | | 77 | |
| | | | | |
Total deferred tax liabilities | | 1,348 | | 2,334 | |
| | | | | |
Net deferred tax asset | | $ | 4,460 | | $ | 3,533 | |
No valuation allowance for deferred tax assets was recorded as of December 31, 2005 and 2004 because Bancorp has sufficient prior taxable income to allow for utilization of the deductible temporary differences within the carryback period. Management believes that it is more likely than not that all of the deferred tax assets will be realized.
(8) Deposits
The composition of interest bearing deposits follows:
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Interest bearing demand | | $ | 235,871 | | $ | 267,461 | |
Savings | | 48,707 | | 44,540 | |
Money market | | 179,276 | | 141,200 | |
Time deposits greater than $100 | | 124,074 | | 103,026 | |
Other time deposits | | 262,801 | | 234,514 | |
| | | | | |
| | $ | 850,729 | | $ | 790,741 | |
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Interest expense related to certificates of deposit and other time deposits in denominations of $100,000 or more was $3,915,000, $3,087,000, and $3,483,000, respectively, for the years ended December 31, 2005, 2004 and 2003.
At December 31, 2005, the scheduled maturities of time deposits were as follows:
(In thousands) | | | |
| | | |
2006 | | $ | 195,122 | |
2007 | | 123,115 | |
2008 | | 25,087 | |
2009 | | 25,228 | |
2010 | | 17,561 | |
Thereafter | | 762 | |
| | | |
| | $ | 386,875 | |
(9) Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are a funding source of the Bank and are primarily used by commercial customers for cash management services. Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Information concerning securities sold under agreements to repurchase is summarized as follows:
| | December 31, | |
(Dollars in thousands) | | 2005 | | 2004 | |
| | | | | |
Average balance during the year | | $ | 78,360 | | $ | 70,593 | |
Average interest rate during the year | | 1.83 | % | 1.18 | % |
Maximum month-end balance during the year | | $ | 87,987 | | $ | 85,395 | |
(10) Advances from the Federal Home Loan Bank
The Bank has an agreement with the Federal Home Loan Bank of Cincinnati (FHLB) that enables the Bank to borrow up to $76 million under terms to be established at the time of the advance. Advances from the FHLB are collateralized by certain first mortgage loans under a blanket mortgage collateral agreement and FHLB stock. The Bank had three fixed rate non-callable advances under this agreement totaling $40 million and $30 million as of December 31, 2005 and 2004, respectively. The Bank views the borrowings as a low cost alternative to higher cost certificates of deposit to fund loan growth.
The following is a summary of the contractual maturities and average rates:
| | December 31, 2005 | | December 31, 2004 | |
(In thousands) | | Advance | | Rate | | Advance | | Rate | |
| | | | | | | | | |
2005 | | | | | | $ | 10,000 | | 1.52 | % |
2006 | | $ | 10,000 | | 2.16 | % | 10,000 | | 2.16 | % |
2007 | | 10,000 | | 2.73 | % | 10,000 | | 2.73 | % |
2008 | | 20,000 | | 4.83 | % | — | | — | |
| | $ | 40,000 | | 3.64 | % | $ | 30,000 | | 2.14 | % |
The Bank also has a standby letter of credit from the FHLB for $20 million outstanding at December 31, 2005. Under Kentucky law, customer cash balances in Investment Management and Trust accounts, may be retained as deposits in the Bank. As a part of this transaction, Kentucky law requires these deposits above the
49
$100,000 per account protection provided by the FDIC, to be backed by some form of collateral. The standby letter of credit from the FHLB collateralizes these accounts.
(11) Subordinated Debentures
On June 1, 2001, S.Y. Bancorp Capital Trust I (the Trust), a Delaware statutory business trust and 100%-owned finance subsidiary of Bancorp, issued $20.0 million of 9.00% Cumulative Trust Preferred Securities (the Securities) which mature on June 30, 2031. However, prior redemption is permitted under certain circumstances, such as changes in tax or regulatory capital rules. Proceeds from issuance of the securities, net of underwriting fees and offering expenses were $18.9 million. The principal asset of the Trust is a $20.0 million subordinated debenture of Bancorp. The subordinated debenture also bears interest at the rate of 9.00% and matures June 30, 2031, subject to prior redemption under certain circumstances. Bancorp owns all the common securities of the Trust.
The securities, the assets of the Trust, and the common securities issued by the Trust are redeemable in whole or in part on or after June 30, 2006, or at any time in whole, but not in part, from the date of issuance upon the occurrence of certain events. The Securities are included in Tier 1 capital for regulatory capital adequacy determination purposes, subject to certain limitations.
The obligations of Bancorp with respect to the issuance of the Securities constitute a full, irrevocable and unconditional guarantee on a subordinated basis by Bancorp of the Trust’s obligation with respect to the Securities.
Subject to certain circumstances, Bancorp may defer subordinated debenture interest payments, which could result in a deferral of distribution payments on the related Securities and, with certain exceptions, prevent Bancorp from declaring or paying cash distributions on Bancorp’s common stock or debt securities that rank pari passu or junior to the subordinated debenture.
The Bank had subordinated debentures outstanding amounting to $150,000 at December 31, 2005 and $180,000 at December 31, 2004. Interest due on these debentures is at a variable rate equal to one percent less than the Bank’s prime rate adjusted annually on January 1. For 2005, the rate on these debentures was 4.25%, while in 2004 the rate was 3.00%. The debentures are subordinated to the claims of creditors and depositors of the Bank and are subject to redemption by the Bank at the principal amount outstanding, upon the earlier of the death of the registered owners, or an event of default by the registered owners with respect to loans from the Bank. While the debentures mature in 2049, the owners may redeem the debentures at any time.
(12) Preferred Stock
At Bancorp’s Annual Meeting of Shareholders held in April 2003, the shareholders approved an amendment to the Articles of Incorporation to create a class of preferred stock and authorize 1,000,000 shares of this preferred stock with no par value. The relative rights, preferences and other terms of this stock or any series within the class will be determined by the board of directors prior to any issuance. Some of this preferred stock will be used in connection with a shareholders’ rights plan upon the occurrence of certain triggering events. None of this stock had been issued as of December 31, 2005.
50
(13) Net Income per Share and Common Stock Dividends
The following table reflects the numerators (net income) and denominators (average shares outstanding) for the basic and diluted net income per share computations:
(In thousands, except per share data) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Net income, basic and diluted | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
| | | | | | | |
Average shares outstanding for basic EPS calculation | | 13,888 | | 13,797 | | 13,481 | |
Effect of dilutive securities | | 227 | | 372 | | 494 | |
| | | | | | | |
Average shares outstanding including dilutive securities | | 14,115 | | 14,169 | | 13,975 | |
| | | | | | | |
Net income per share, basic | | $ | 1.56 | | $ | 1.37 | | $ | 1.31 | |
| | | | | | | |
Net income per share, diluted | | $ | 1.53 | | $ | 1.33 | | $ | 1.27 | |
(14) Employee Benefit Plans
The Bank has a combined employee stock ownership (“ESOP”) and 401(k) profit sharing plan and a non-qualified deferred compensation plan. Both plans are defined contribution plans. The ESOP/401(k) plan is available to all employees meeting certain eligibility requirements. The non-qualified plan is for certain key officers. Expenses of the plans for 2005, 2004, and 2003 were $1,104,000, $1,067,000, and $980,000, respectively. Contributions are made in accordance with the terms of the plan. As of December 31, 2005 and 2004, the ESOP/401(k) plan held 359,118 and 343,570, respectively, shares of Bancorp stock.
In addition the Bank has non-qualified “excess” plans into which directors and certain senior officers may defer director fees or salary. The Bank makes no contributions to these plans.
The Bank also sponsors an unfunded, non-qualified, defined benefit retirement plan for certain key officers. Benefits vest based on years of service. Bancorp uses a December 31 measurement date for this plan. At December 31, 2005 and 2004, the accumulated benefit obligation for the plan included in other liabilities in the consolidated financial statements was $2,113,000 and $2,133,000, respectively. A discount rate of 5.75% was used in 2005 and 2004 in determining the actuarial present value of the projected benefit obligation.
Information about the components of the net periodic benefit cost of the defined benefit plan follows:
| | December 31, | |
(Dollars in thousands) | | 2005 | | 2004 | |
| | | | | |
Components of net periodic benefit cost: | | | | | |
Service cost | | $ | — | | $ | — | |
Interest cost | | 117 | | 118 | |
Expected return on plan assets | | — | | — | |
Amortization of prior service cost | | — | | — | |
Amortization of net losses | | 28 | | 33 | |
| | | | | |
Net periodic benefit cost | | $ | 145 | | $ | 151 | |
51
The following table sets forth the plan’s benefit obligations, the fair value of plan assets and funded status at December 31, 2005 and 2004:
(Dollars in thousands) | | 2005 | | 2004 | |
| | | | | |
Pension Benefits | | | | | |
Benefit obligation at December 31 | | $ | 2,113 | | $ | 2,133 | |
Fair value of plan assets at December 31 | | — | | — | |
| | | | | |
Funded status | | (2,113 | ) | (2,133 | ) |
| | | | | |
Benefit costs recognized and accrued in the consolidated financial statements | | $ | 1,690 | | $ | 1,629 | |
The following table sets forth additional information concerning Bancorp’s unfunded, non-qualified, defined benefit retirement plan as of December 31, 2005 and 2004:
(Dollars in thousands) | | 2005 | | 2004 | |
| | | | | |
Pension Benefits | | | | | |
Benefit cost | | $ | 145 | | $ | 151 | |
Employer contribution | | — | | — | |
Employee contribution | | — | | — | |
Benefits paid | | 90 | | 90 | |
| | | | | | | |
The benefits expected to be paid in each year from 2006 to 2010 are $174,000, $174,000, $174,000, $174,000 and $149,000, respectively. The aggregate benefits expected to be paid beyond 2010 are $4,236,000. The expected benefits to be paid are based on the same assumptions used to measure the Bank’s benefit obligation at December 31, 2005.
There are no significant obligations for other post-retirement and post-employment benefits.
52
(15) Stock Options
In 1995, shareholders approved a stock incentive plan. Under this plan there were a total of 1,560,000 shares of common stock reserved for issuance of stock options to Bank employees and non-employee directors. This plan expired in 2005. At the 2005 annual meeting, shareholders approved the 2005 Stock Incentive Plan under which 700,000 shares of common stock were reserved for issuance of stock based awards.
As of December 31, 2005, there were 698,500 shares available for future awards. Options granted which do not vest immediately are subject to a vesting schedule of 20% per year. All outstanding options were granted at an exercise price equal to the market value of common stock at the time of grant and expire ten years after the grant date. Activity with respect to outstanding options follows:
(In thousands, except per share data) | | Share
options | | Weighted
average
exercised
price per
share | |
| | | | | |
Outstanding at December 31, 2002 | | 1,098 | | $ | 10.36 | |
Granted | | 142 | | 21.15 | |
Exercised | | (110 | ) | 5.26 | |
Forfeited | | (4 | ) | 14.16 | |
| | | | | |
Outstanding at December 31, 2003 | | 1,126 | | 12.27 | |
Granted | | 177 | | 23.82 | |
Exercised | | (335 | ) | 6.56 | |
Forfeited | | (50 | ) | 17.52 | |
| | | | | |
Outstanding at December 31, 2004 | | 918 | | 16.22 | |
Granted | | 3 | | 22.61 | |
Exercised | | (91 | ) | 6.56 | |
Forfeited | | (28 | ) | 21.45 | |
| | | | | |
Outstanding at December 31, 2005 | | 802 | | $ | 17.16 | |
The weighted average fair values of options granted in 2005, 2004 and 2003 were $5.13, $5.27 and $5.00, respectively.
The Board of Directors of Bancorp accelerated the vesting of all employee stock options outstanding on December 31, 2005. This action resulted in two financial reporting implications. First, the remaining fair value of all outstanding employee stock options was recognized in 2005 as part of the pro-forma footnote disclosures above. Second, Bancorp recognized $32,000 of compensation expense in the fourth quarter of 2005 based on an estimate of costs of those awards that would have expired unexercisable pursuant to original terms using a forfeiture rate based on historical experience. By vesting these stock options early, Bancorp will avoid recognizing approximately $1,000,000 in expense over what would have been future vesting periods of one to four years. These options had been granted to 77 executive and senior officers and all were in-the-money cumulatively by approximately $579,000 at the time of vesting. 8,000 options will continue to vest on their original terms. These options have been granted to non-employee directors and require approval by stockholders to amend the vesting schedule. No such approval was requested nor is expected to be sought.
53
Options outstanding at December 31, 2005 were as follows:
(in thousands, except per share data)
Option price per
share | | Expiration | | Number of
options
outstanding | | Options
exercisable | | Weighted
average
exercise
price | |
| | | | | | | | | |
$ | 7.250 | | 2007 | | 32 | | 32 | | $ | 7.25 | |
| 10.250 | | 2008 | | 32 | | 32 | | 10.25 | |
| 11.969-12.00 | | 2009 | | 49 | | 49 | | 11.97 | |
| 10.125-10.5 | | 2010 | | 152 | | 152 | | 10.39 | |
| 16.80 | | 2011 | | 130 | | 130 | | 16.80 | |
| 19.55 | | 2012 | | 120 | | 120 | | 19.55 | |
| 18.95-21.18 | | 2013 | | 120 | | 118 | | 21.14 | |
| 21.26-23.95 | | 2014 | | 164 | | 159 | | 23.83 | |
| 21.74-24.11 | | 2015 | | 3 | | 2 | | 22.61 | |
| | | | | | | | | |
| | | | 802 | | 794 | | $ | 17.16 | |
(16) Dividend Restriction
Bancorp’s principal source of funds is dividends received from the Bank. Under applicable banking laws, bank regulatory authorities must approve the declaration of dividends in any year if such dividends are in an amount in excess of the sum of net income of that year and retained earnings of the preceding two years. At January 1, 2006, the retained earnings of the Bank available for payment of dividends without regulatory approval were approximately $21,878,000.
(17) Commitments and Contingent Liabilities
As of December 31, 2005, the Bank had various commitments and contingent liabilities outstanding that arose in the normal course of business, such as standby letters of credit and commitments to extend credit, which are not reflected in the consolidated financial statements. In management’s opinion, commitments to extend credit of $322,132,000, including standby letters of credit of $13,453,000, represent normal banking transactions, and no significant losses are anticipated to result therefrom. This total is comprised largely of unused lines of credit for business and consumer customers, as well as unfunded portions of construction and development loans. The Bank’s maximum exposure to credit loss in the event of nonperformance by the other party to these commitments is represented by the contractual amount of these instruments. The Bank uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. At December 31, 2005, no amounts have been accrued in the consolidated financial statements relating to these instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since some of the unused commitments are expected to expire or may not be fully used, the total amount of commitments in the preceding table does not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Standby letters of credit generally have maturities of up to five years.
54
The Bank leases certain facilities, improvements and equipment under non-cancelable operating leases. Future minimum lease commitments for these leases are $1,335,000 in 2006; $1,262,000 in 2007; $1,065,000 in 2008; $724,000 in 2009; $647,000 in 2010 and $5,006,000 in the aggregate thereafter. Rent expense, net of sublease income, was $1,290,000 in 2005, $1,179,000 in 2004, and $969,000 in 2003.
Also, as of December 31, 2005, there were pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate result of these legal actions and proceedings will not have a material adverse effect on the consolidated financial position or results of operations of Bancorp.
(18) Fair Value of Financial Instruments
The estimated fair values of financial instruments at December 31 are as follows:
| | 2005 | | 2004 | |
(In thousands) | | Carrying
Amount | | Fair Value | | Carrying
Amount | | Fair Value | |
| | | | | | | | | |
Financial assets | | | | | | | | | |
Cash and short-term investments | | $ | 44,039 | | $ | 44,039 | | $ | 31,547 | | $ | 31,547 | |
Mortgage loans held for sale | | 7,444 | | 7,444 | | 5,528 | | 5,529 | |
Securities | | 161,074 | | 161,130 | | 131,447 | | 131,629 | |
Federal Home Loan Bank stock | | 3,391 | | 3,391 | | 3,226 | | 3,226 | |
Loans, net | | 1,041,836 | | 997,226 | | 972,320 | | 986,623 | |
Accrued interest receivable | | 5,951 | | 5,951 | | 4,533 | | 4,533 | |
| | | | | | | | | |
Financial liabilities | | | | | | | | | |
Deposits | | $ | 1,031,357 | | $ | 1,031,357 | | $ | 950,083 | | $ | 951,951 | |
Short-term borrowings | | 82,025 | | 82,025 | | 74,460 | | 74,460 | |
Long-term borrowings | | 60,769 | | 60,933 | | 50,799 | | 51,407 | |
Accrued interest payable | | 577 | | 577 | | 360 | | 360 | |
| | | | | | | | | |
Off balance sheet financial instruments | | | | | | | | | |
Commitments to extend credit | | — | | — | | — | | — | |
Standby letters of credit | | — | | (202 | ) | — | | (207 | ) |
Management used the following methods and assumptions to estimate the fair value of each class of financial instrument for which it is practicable to estimate the value.
Cash, Short-Term Investments, Federal Home Loan Bank Stock, Accrued Interest Receivable/Payable and Short-Term Borrowings
For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Securities
For securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities or dealer quotes.
Mortgage loans held for sale
The fair value of mortgage loans held for sale is determined by market quotes for each loan based on loan type, term and size.
55
Loans, net
The fair value of loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposits
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-rate certificates of deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. If the discounted future cash flows are less than the current value, Bancorp utilizes the current payable instead of the present value of contracted maturities at the current origination rate.
Long-term Borrowings
Rates currently available to Bancorp for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Commitments to Extend Credit and Standby Letters of Credit
The fair values of commitments to extend credit are estimated using fees currently charged to enter into similar agreements and the creditworthiness of the customers. The fair values of standby letters of credit are based on fees currently charged for similar agreements or the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
Limitations
The fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market exists for a significant portion of Bancorp’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
(19) Regulatory Matters
Bancorp and the Bank are subject to various capital requirements prescribed by banking regulations and administered by federal banking agencies. Under these requirements, Bancorp and the Bank must meet minimum amounts and percentages of Tier I and total capital, as defined, to risk weighted assets and Tier I capital to average assets. Risk weighted assets are determined by applying certain risk weightings prescribed by the regulations to various categories of assets and off-balance sheet commitments. Capital and risk weighted assets may be further subject to qualitative judgments by regulators as to components, risk weighting and other factors. Failure to meet the capital requirements can result in certain mandatory, and possibly discretionary, corrective actions prescribed by the regulations or determined to be necessary by the regulators, which could materially affect the consolidated financial statements. Management believes Bancorp and the Bank met all capital requirements to which they were subject as of December 31, 2005.
As of December 2005 and 2004, the Bank’s primary regulator categorized the Bank as well capitalized under the regulatory framework. There are no conditions or events since those notifications that management believes have changed the Bank’s categories.
56
A summary of Bancorp’s and the Bank’s capital ratios at December 31, 2005 and 2004 follows:
December 31, 2005
| | Actual | | Minimum For
Adequate | | Minimum For Well
Capitalized | |
(Dollars in thousands) | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio | |
| | | | | | | | | | | | | |
Total risk-based capital (1) | | | | | | | | | | | | | |
Consolidated | | $ | 158,222 | | 14.56 | % | $ | 86,935 | | 8.00 | % | $ | 108,669 | | 10.00 | % |
Bank | | 147,066 | | 13.62 | % | 86,409 | | 8.00 | % | 108,011 | | 10.00 | % |
| | | | | | | | | | | | | |
Tier I risk-based capital (1) | | | | | | | | | | | | | |
Consolidated | | 146,037 | | 13.44 | % | 43,468 | | 4.00 | % | 65,202 | | 6.00 | % |
Bank | | 134,881 | | 12.49 | % | 43,204 | | 4.00 | % | 64,806 | | 6.00 | % |
| | | | | | | | | | | | | |
Leverage (2) | | | | | | | | | | | | | |
Consolidated | | $ | 146,037 | | 11.15 | % | $ | 39,281 | | 3.00 | % | $ | 65,468 | | 5.00 | % |
Bank | | 134,881 | | 10.35 | % | 39,089 | | 3.00 | % | 65,148 | | 5.00 | % |
December 31, 2004
| | Actual | | Minimum For
Adequate | | Minimum For Well
Capitalized | |
(Dollars in thousands) | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio | |
| | | | | | | | | | | | | |
Total risk-based capital (1) | | | | | | | | | | | | | |
Consolidated | | $ | 147,786 | | 14.91 | % | $ | 79,336 | | 8.00 | % | $ | 99,170 | | 10.00 | % |
Bank | | 135,748 | | 13.79 | % | 78,756 | | 8.00 | % | 98,445 | | 10.00 | % |
| | | | | | | | | | | | | |
Tier I risk-based capital (1) | | | | | | | | | | | | | |
Consolidated | | 135,217 | | 13.64 | % | 39,668 | | 4.00 | % | 59,502 | | 6.00 | % |
Bank | | 123,260 | | 12.52 | % | 39,378 | | 4.00 | % | 59,067 | | 6.00 | % |
| | | | | | | | | | | | | |
Leverage (2) | | | | | | | | | | | | | |
Consolidated | | $ | 135,217 | | 11.34 | % | $ | 35,780 | | 3.00 | % | $ | 59,633 | | 5.00 | % |
Bank | | 123,260 | | 10.38 | % | 35,617 | | 3.00 | % | 59,362 | | 5.00 | % |
(1) Ratio is computed in relation to risk-weighted assets.
(2) Ratio is computed in relation to average assets.
57
(20) S.Y. Bancorp, Inc. (parent company only)
Condensed Balance Sheets
| | December 31, | |
(In thousands) | | 2005 | | 2004 | |
| | | | | |
Assets | | | | | |
Cash on deposit with subsidiary bank | | $ | 2,312 | | $ | 2,270 | |
Investment in and receivable from subsidiaries | | 139,721 | | 131,018 | |
Securities available for sale (amortized cost of $1,250 in 2005 and 2004) | | 1,298 | | 1,363 | |
Other assets | | 4,709 | | 5,233 | |
| | | | | |
Total assets | | $ | 148,040 | | $ | 139,884 | |
| | | | | |
Liabilities and stockholders’ equity | | | | | |
Other liabilities | | $ | 1,624 | | $ | 2,618 | |
Subordinated debentures | | 20,619 | | 20,619 | |
Stockholders’ equity | | 125,797 | | 116,647 | |
| | | | | |
Total liabilities and stockholders’ equity | | $ | 148,040 | | $ | 139,884 | |
Condensed Statements of Income
| | Years ended December 31, | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Income - Dividends and interest from subsidiaries | | $ | 11,541 | | $ | 6,807 | | $ | 8,099 | |
Income - Interest income from securities | | 101 | | 101 | | 103 | |
Income - other | | — | | 11 | | — | |
Expenses | | 2,325 | | 2,252 | | 2,157 | |
Income before income taxes and equity in undistributed net income of subsidiaries | | 9,317 | | 4,667 | | 6,045 | |
Income tax benefit | | 759 | | 730 | | 700 | |
Income before equity in undistributed net income of subsidiaries | | 10,076 | | 5,397 | | 6,745 | |
Equity in undistributed net income of subsidiaries | | 11,568 | | 13,515 | | 10,964 | |
| | | | | | | |
Net income | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
58
Condensed Statements of Cash Flows
| | Years ended December 31, | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Operating activities | | | | | | | |
Net income | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | |
Equity in undistributed net income of subsidiaries | | (11,568 | ) | (13,515 | ) | (10,964 | ) |
Decrease (increase) in receivable from subsidiaries | | 1,281 | | (1,553 | ) | (1,910 | ) |
Non-cash compensations expense from early vesting of stock options, net of tax | | 32 | | — | | — | |
Income tax benefit of stock options exercised | | 260 | | 794 | | 370 | |
Increase (decrease) in other assets | | 560 | | (596 | ) | (2,394 | ) |
(Decrease) increase in other liabilities | | (736 | ) | (1,137 | ) | 650 | |
| | | | | | | |
Net cash provided by operating activities | | 11,473 | | 2,905 | | 3,461 | |
| | | | | | | |
Financing activities | | | | | | | |
Proceeds from stock options | | 851 | | 3,210 | | 1,205 | |
Common stock repurchases | | (5,496 | ) | (228 | ) | (41 | ) |
Cash dividends paid | | (6,786 | ) | (4,953 | ) | (3,985 | ) |
| | | | | | | |
Net cash used in financing activities | | (11,431 | ) | (1,971 | ) | (2,821 | ) |
| | | | | | | |
Net increase in cash | | 42 | | 934 | | 640 | |
Cash at beginning of year | | 2,270 | | 1,336 | | 696 | |
| | | | | | | |
Cash at end of year | | $ | 2,312 | | $ | 2,270 | | $ | 1,336 | |
59
(21) Segments
The Bank’s, and thus Bancorp’s principal activities include commercial banking and investment management and trust. Commercial banking provides a full range of loans and deposit products to individual consumers and businesses. Investment management and trust provides wealth management services, estate planning and administration, retirement plan management and custodian or trustee services.
The financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method. Income taxes are allocated based on the effective federal income tax rate adjusted for any tax exempt activity. All tax exempt activity and provision for loan losses have been allocated to the commercial banking segment. The measurement of the performance of the business segments is based on the management structure of the Bank and is not necessarily comparable with similar information for any other financial institution. The information presented is also not necessarily indicative of the segments’ operations if they were independent entities.
Principally, all of the net assets of S.Y. Bancorp, Inc. are involved in the commercial banking segment. Bancorp has goodwill of $682,000 related to the purchase of bank in southern Indiana in 1996. This purchase facilitated Bancorp’s expansion in southern Indiana. This goodwill has been assigned to the commercial banking segment.
Selected financial information by business segment follows:
| | Years ended December 31, | |
(In thousands) | | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Net interest income | | | | | | | |
Commercial banking | | $ | 49,079 | | $ | 43,604 | | $ | 41,717 | |
Investment management and trust | | 156 | | 617 | | 1,031 | |
| | | | | | | |
Total net interest income | | $ | 49,235 | | $ | 44,221 | | $ | 42,748 | |
| | | | | | | |
Non-interest income | | | | | | | |
Commercial banking | | $ | 16,309 | | $ | 15,249 | | $ | 16,197 | |
Investment management and trust | | 10,813 | | 9,427 | | 8,301 | |
| | | | | | | |
Total non-interest income | | $ | 27,122 | | $ | 24,676 | | $ | 24,498 | |
| | | | | | | |
Non-interest expenses | | | | | | | |
Commercial banking | | $ | 38,836 | | $ | 33,965 | | $ | 33,740 | |
Investment management and trust | | 5,776 | | 5,128 | | 4,885 | |
| | | | | | | |
Total non-interest expenses | | $ | 44,612 | | $ | 39,093 | | $ | 38,625 | |
| | | | | | | |
Income Taxes | | | | | | | |
Commercial banking | | $ | 8,058 | | $ | 7,081 | | $ | 6,806 | |
Investment management and trust | | 1,818 | | 1,721 | | 1,556 | |
| | | | | | | |
Total income taxes | | $ | 9,876 | | $ | 8,802 | | $ | 8,362 | |
| | | | | | | |
Net income | | | | | | | |
Commercial banking | | $ | 18,269 | | $ | 15,717 | | $ | 14,818 | |
Investment management and trust | | 3,375 | | 3,195 | | 2,891 | |
| | | | | | | |
Total net income | | $ | 21,644 | | $ | 18,912 | | $ | 17,709 | |
60
(22) Quarterly Operating Results (unaudited)
Following is a summary of quarterly operating results (unaudited) for 2005 and 2004:
(In thousands, except per | | 2005 | | 2004 | |
share data) | | 4th Qtr. | | 3rd Qtr. | | 2nd Qtr. | | 1st Qtr. | | 4th Qtr. | | 3rd Qtr. | | 2nd Qtr. | | 1st Qtr. | |
| | | | | | | | | | | | | | | | | |
Interest income | | $ | 19,702 | | $ | 18,561 | | $ | 17,631 | | $ | 16,449 | | $ | 15,891 | | $ | 15,121 | | $ | 14,737 | | $ | 14,791 | |
Interest expense | | 6,595 | | 5,833 | | 5,490 | | 5,190 | | 4,589 | | 4,193 | | 3,696 | | 3,841 | |
| | | | | | | | | | | | | | | | | |
Net interest income | | 13,107 | | 12,728 | | 12,141 | | 11,259 | | 11,302 | | 10,928 | | 11,041 | | 10,950 | |
| | | | | | | | | | | | | | | | | |
Provision for loan losses | | — | | — | | — | | 225 | | 600 | | 180 | | 810 | | 500 | |
Net interest income after provision | | 13,107 | | 12,728 | | 12,141 | | 11,034 | | 10,702 | | 10,748 | | 10,231 | | 10,450 | |
Non-interest income | | 6,938 | | 6,818 | | 6,871 | | 6,495 | | 6,201 | | 6,235 | | 6,553 | | 5,687 | |
Non-interest expenses | | 11,978 | | 10,939 | | 11,088 | | 10,607 | | 9,761 | | 9,702 | | 10,032 | | 9,598 | |
| | | | | | | | | | | | | | | | | |
Income before income taxes | | 8,067 | | 8,607 | | 7,924 | | 6,922 | | 7,142 | | 7,281 | | 6,752 | | 6,539 | |
Income tax expense | | 2,543 | | 2,756 | | 2,432 | | 2,145 | | 2,228 | | 2,310 | | 2,173 | | 2,091 | |
| | | | | | | | | | | | | | | | | |
Net income | | $ | 5,524 | | $ | 5,851 | | $ | 5,492 | | $ | 4,777 | | $ | 4,914 | | $ | 4,971 | | $ | 4,579 | | $ | 4,448 | |
| | | | | | | | | | | | | | | | | |
Basic earnings per share | | $ | 0.40 | | $ | 0.42 | | $ | 0.40 | | $ | 0.34 | | $ | 0.35 | | $ | 0.36 | | $ | 0.33 | | $ | 0.33 | |
Diluted earnings per share | | 0.39 | | 0.41 | | 0.39 | | 0.34 | | 0.35 | | 0.35 | | 0.32 | | 0.32 | |
Note: The sum of basic and diluted earnings per share of each of the quarters in 2005 and 2004 may not add to the year to date amount reported in Bancorp’s consolidated financial statements due to rounding.
61
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
S.Y. Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of S.Y. Bancorp, Inc. and subsidiary as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of S.Y. Bancorp, Inc. and subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of S.Y. Bancorp, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting,
Louisville, Kentucky
March 14, 2006
62
Management’s Report on Consolidated Financial Statements
The accompanying consolidated financial statements and other financial data were prepared by the management of S.Y. Bancorp, Inc. (Bancorp), which has the responsibility for the integrity of the information presented. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles and, as such, include amounts that are the best estimates and judgments of management with consideration given to materiality.
Management is further responsible for maintaining a system of internal controls designed to provide reasonable assurance that the books and records reflect the transactions of Bancorp and that its established policies and procedures are carefully followed. Management believes that Bancorp’s system, taken as a whole, provides reasonable assurance that transactions are executed in accordance with management’s general or specific authorization; transactions are recorded as necessary to permit preparation of financial statements in conformity with U.S. generally accepted accounting principles and to maintain accountability for assets; access to assets is permitted only in accordance with management’s general or specific authorization, and the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.
Management also seeks to assure the objectivity and integrity of Bancorp’s financial data by the careful selection and training of qualified personnel, an internal audit function and organizational arrangements that provide an appropriate division of responsibility.
Bancorp’s independent auditors, KPMG LLP, have audited the consolidated financial statements. Their audit was conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States) which provides for consideration of Bancorp’s internal controls to the extent necessary to determine the nature, timing, and extent of their audit tests.
The Board of Directors pursues its oversight role for the consolidated financial statements through the Audit Committee. The Audit Committee meets periodically and privately with management, the internal auditors, and the independent auditors to review matters relating to financial reporting, the internal control systems, and the scope and results of audit efforts. The internal and independent auditors have unrestricted access to the Audit Committee, with and without the presence of management, to discuss accounting, auditing, and financial reporting matters. The Audit Committee also recommends the appointment of the independent auditors to Board of Directors, and ultimately has sole authority to appoint or replace the independent auditors.
/s/ David P. Heintzman | |
David P. Heintzman |
Chairman, President and Chief Executive Officer |
|
/s/ Nancy B. Davis | |
Nancy B. Davis |
Executive Vice President |
and Chief Financial Officer |
63
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Bancorp maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is required to disclose in the reports it files with the Securities and Exchange Commission (SEC), and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on their evaluation of Bancorp’s disclosure controls and procedures which took place as of December 31, 2005, the Chief Executive and Chief Financial Officers believe that these controls and procedures are effective to ensure that Bancorp is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods.
Based on the evaluation of Bancorp’s disclosure controls and procedures by the Chief Executive and Chief Financial Officers, no changes occurred during the fiscal quarter ended December 31, 2005 in Bancorp’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Bancorp’s internal control over financial reporting.
Item 9B. Other Information
None
64
Management’s Report on Internal Control Over Financial Reporting
The management of S.Y. Bancorp, Inc and subsidiary (Bancorp) is responsible for establishing and maintaining adequate internal control over financial reporting. Bancorp’s internal control over financial reporting is a process designed under the supervision of Bancorp’s Chief Executive Officer and Chief Financial Officer, and effected by Bancorp’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. This process includes those policies and procedures that:
1. Pertain to the maintenance of records, that in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Bancorp;
2. Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of Bancorp are being made only in accordance with authorizations of management and directors of Bancorp; and
3. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Bancorp’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
Management has assessed the effectiveness of its internal control over financial reporting as of December 31, 2005, based on the control criteria established in a report entitled Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on such assessment, management has concluded that Bancorp’s internal control over financial reporting is effective as of December 31, 2005.
KPMG LLP, the independent registered public accounting firm that audited the consolidated financial statements of Bancorp included in this Annual Report on Form 10-K, has issued an attestation report on management’s assessment of the effectiveness of Bancorp’s internal control over financial reporting as of December 31, 2005. The report expresses unqualified opinions on management’s assessment and on the effectiveness of Bancorp’s internal control over financial reporting as of December 31, 2005.
/s/ David P. Heintzman | |
David P. Heintzman |
Chairman, President and Chief Executive Officer |
|
/s/ Nancy B. Davis | |
Nancy B. Davis |
Executive Vice President |
and Chief Financial Officer |
65
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
S.Y. Bancorp, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that S.Y. Bancorp, Inc. and subsidiary (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that S.Y. Bancorp, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, S.Y. Bancorp, Inc., maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of S.Y. Bancorp, Inc. and subsidiary as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 14, 2006 expressed an unqualified opinion on those consolidated financial statements.
Louisville, Kentucky
March 14, 2006
66
Part III
Item 10. Directors and Executive Officers of the Registrant
Information regarding the directors and executive officers of Bancorp is incorporated herein by reference to the discussion under the heading, “ITEM 1. ELECTION OF DIRECTORS,” and SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE in Bancorp’s Proxy Statement for the 2006 Annual Meeting of Shareholders and the section captioned EXECUTIVE OFFICERS OF THE REGISTRANT in this Form 10-K.
Information regarding principal occupation of directors of Bancorp follows:
David H. Brooks – Retired, Former Chairman and Chief Executive Officer, S.Y. Bancorp, Inc. and Stock Yards Bank & Trust Company;
James E. Carrico – Managing Director, Acordia of Kentucky;
Charles R. Edinger, III – Vice President, J. Edinger & Son. Inc.;
Stanley A. Gall, M.D. – Professor of Obstetrics and Gynecology, University of Louisville;
David P. Heintzman – Chairman, President and Chief Executive Officer, S.Y. Bancorp, Inc. and Stock Yards Bank & Trust Company;
Carl G. Herde – Vice President of Finance and CFO, Baptist Healthcare System, Inc.;
Bruce P. Madison – President and CEO, Plumbers Supply Company, Inc.;
Nicholas X. Simon – President and CEO, Publishers Printing Company, LLC;
Norman Tasman – President, Tasman Industries Inc. and Tasman Hide Processing Inc.;
Robert L. Taylor – Professor of Management and Dean Emeritus, College of Business and Public Administration, University of Louisville;
Kathy C. Thompson – Senior Executive Vice President, S.Y. Bancorp, Inc. and Stock Yards Bank & Trust Company.
The Board of Directors of Bancorp has adopted a code of ethics for its chief executive officer and financial executives. A copy of the code of ethics is filed as an exhibit to this Annual Report.
Item 11. Executive Compensation
Information regarding the compensation of Bancorp’s executive officers and directors is incorporated herein by reference to the discussion under the headings, “EXECUTIVE COMPENSATION AND OTHER INFORMATION – REPORT ON EXECUTIVE COMPENSATION” and “CORPORATE GOVERNANCE AND RELATED MATTERS – BOARD OF DIRECTORS’ MEETINGS, COMMITTEES AND FEES” in Bancorp’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
Information appearing under the headings “REPORT ON EXECUTIVE COMPENSATION” and “Shareholder Return Performance Graph” in the section entitled “EXECUTIVE COMPENSATION AND OTHER INFORMATION” in Bancorp’s Proxy Statement for the 2006 Annual Meeting of Shareholders shall not be deemed to be incorporated by reference in this report, notwithstanding any general statement contained herein incorporating portions of such Proxy Statement by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated herein by reference to the discussion under the headings, “ITEM 1. ELECTION OF DIRECTORS” and “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT,” in Bancorp’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
67
Equity Compensation Plan Information
The following table furnishes common shares authorized for issuance under equity compensation plans. Bancorp has currently only issued stock options as equity compensation. The 1995 Stock Incentive Plan does include stock appreciation rights; however, it does not contain provisions for stock warrants. The 2005 Stock Incentive Plan includes provisions for options, restricted stock and stock appreciation rights. For further information on stock options see note 15 to the consolidated financial statements in this Form 10-K.
Plan Category | | Number of securities
to be issued upon
exercise of
outstanding options | | Weighted-
average
exercise price
of outstanding
options | | Number of securities
remaining available for
future issuance under
equity compensation
plans |
Equity compensation plans approved by shareholders | | 802,040 | | $ | 17.16 | | 698,500 |
| | | | | | |
Equity compensation plans not approved by shareholders | | — | | — | | — |
| | | | | | | |
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated herein by reference to the discussion under the heading, “TRANSACTIONS WITH MANAGEMENT AND OTHERS,” in Bancorp’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated herein by reference to the discussion under the heading, “Fees Billed to S.Y. Bancorp by KPMG LLP During Fiscal Year Ended December 31, 2005,” in Bancorp’s Proxy Statement for the 2006 Annual Meeting of Shareholders.
Part IV
Item 15. Exhibits and Financial Statement Schedules
(a) 1. The following financial statements are included in this Form 10-K:
(a) 2. List of Financial Statement Schedules
Schedules to the consolidated financial statements of Bancorp are omitted since they are either not required under the related instructions, are inapplicable, or the required information is shown in the consolidated financial statements or notes thereto.
68
(a) 3. List of Exhibits
3.1 | | Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on January 12, 1988. Exhibit 3.1 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.2 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on May 8, 1989. Exhibit 3.2 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.3 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on June 30, 1994. Exhibit 3.3 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.4 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on April 29, 1998. Exhibit 3.4 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.5 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on April 23, 2003. Exhibit 3.5 to Annual Report on Form 10-K for the year ended December 31, 2003, of Bancorp is incorporated by reference herein. |
3.6 | | Bylaws of Bancorp, as amended, currently in effect. Exhibit 3.5 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
4.1 | | Rights agreement dated as of April 23, 2003, between S.Y. Bancorp, Inc. and Wachovia Bank, National Association, as rights agent. Exhibit 1 to Form 8-A filed April 23, 2003, is incorporated by reference herein. |
10.1* | | S.Y. Bancorp, Inc. Stock Option Plan as amended. Exhibit 10.1 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
10.2* | | Stock Yards Bank & Trust company Senior Officers Security Plan adopted December 23, 1980. Exhibit 10.2 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
10.3* | | Stock Yards Bank & Trust Company Executive Nonqualified “Excess” Plan available to directors and certain management employees. |
10.4* | | Form of Adoption Agreement for Stock Yards Bank Director’s Deferred Compensation Plan between Stock Yards Bank & Trust Company and certain directors. |
10.5* | | Form of Adoption Agreement for Stock Yards Bank Executive Nonqualified “Excess” Plan between Stock Yards Bank & Trust Company and certain executive officers. |
10.6* | | Stock Yards Bank & Trust Company 2005 Restated Senior Officers Security Plan Exhibit 10.1 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.7* | | 2005 Restated Senior Executive Severance Agreement dated as of April 22, 2005 between Stock Yards Bank & Trust Company and David P. Heintzman, Exhibit 10.2 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.8* | | 2005 Restated Senior Executive Severance Agreement dated as of April 22, 2005 between Stock Yards Bank & Trust Company and Kathleen C. Thompson, Exhibit 10.3 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.9* | | 2005 Restated Senior Executive Severance Agreement dated as of April 22, 2005 between Stock Yards Bank & Trust Company and Nancy B. Davis, Exhibit 10.4 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.10* | | S.Y. Bancorp, Inc. 2005 Stock Incentive Plan. Exhibit 10.1 to Form 8-K filed May 2, 2005, is incorporated by reference herein. |
14 | | Code of Ethics for the Chief Executive Officer and Financial Executives. |
21 | | Subsidiaries of the Registrant. |
69
23 | | Consent of Independent Registered Public Accounting Firm. |
31.1 | | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by David P. Heintzman. |
31.2 | | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by Nancy B. Davis. |
32.1 | | Certifications pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by David P. Heintzman. |
32.2 | | Certifications pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Nancy B. Davis. |
* Indicates matters related to executive compensation.
Copies of the foregoing Exhibits will be furnished to others upon request and payment of Bancorp’s reasonable expenses in furnishing the exhibits.
(b) Exhibits
The exhibits listed in response to Item 15(a) 3 are filed or furnished as a part of this report.
(c) Financial Statement Schedules
None
Where You Can Find More Information
Bancorp is subject to the informational requirements of the Securities Exchange Act of 1934 and accordingly files its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at (800) SEC-0330 for further information on the Public Reference Room. Bancorp’s public filings are also maintained on the SEC’s Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The address of that web site is http://www.sec.gov. In addition, Bancorp’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act may be accessed free of charge through Bancorp’s web site after we have electronically filed such material with, or furnished it to, the SEC. The address of that web site is http://www.syb.com.
70
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.
March 14, 2006 | S.Y. BANCORP, INC. |
| | |
| BY: | /s/ David P. Heintzman | |
| | David P. Heintzman |
| | Chairman, President and
Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ David P. Heintzman | | Chairman, President, Chief Executive Officer | March 14, 2006 |
David P. Heintzman | and Director (principal executive officer) | |
| | |
/s/ Nancy B. Davis | | Executive Vice President and Chief Financial | March 14, 2006 |
Nancy B. Davis | Officer (principal financial and accounting | |
| officer) | |
| | |
/s/ David H. Brooks | | Director | March 14, 2006 |
David H. Brooks | | |
| | |
/s/ James E. Carrico | | Director | March 14, 2006 |
James E. Carrico | | |
| | |
/s/ Charles R. Edinger, III | | Director | March 14, 2006 |
Charles R. Edinger, III | | |
| | |
/s/ Stanley A. Gall, M.D. | | Director | March 14, 2006 |
Stanley A. Gall, M.D. | | |
| | |
/s/ Carl G. Herde | | Director | March 14, 2006 |
Carl G. Herde | | |
| | |
/s/ Bruce P. Madison | | Director | March 14, 2006 |
Bruce P. Madison | | |
| | |
/s/ Nicholas X. Simon | | Director | March 14, 2006 |
Nicholas X. Simon | | |
| | |
/s/ Norman Tasman | | Director | March 14, 2006 |
Norman Tasman | | |
| | |
s/ Robert L. Taylor | | Director | March 14, 2006 |
Robert L. Taylor | | |
| | |
/s/ Kathy C. Thompson | | Senior Executive Vice President and Director | March 14, 2006 |
Kathy C. Thompson | | |
71
Index to Exhibits
Exhibit Number
| | |
3.1 | | Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on January 12, 1988. Exhibit 3.1 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.2 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on May 8, 1989. Exhibit 3.2 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.3 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on June 30, 1994. Exhibit 3.3 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.4 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on April 29, 1998. Exhibit 3.4 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
3.5 | | Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on April 23, 2003. Exhibit 3.5 to Annual Report on Form 10-K for the year ended December 31, 2003, of Bancorp is incorporated by reference herein. |
3.6 | | Bylaws of Bancorp, as amended, currently in effect. Exhibit 3.5 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
4.1 | | Rights agreement dated as of April 23, 2003, between S.Y. Bancorp, Inc. and Wachovia Bank, National Association, as rights agent. Exhibit 1 to Form 8A filed April 23, 2003, is incorporated by reference herein. |
10.1* | | S.Y. Bancorp, Inc. Stock Option Plan as amended. Exhibit 10.1 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
10.2* | | Stock Yards Bank & Trust company Senior Officers Security Plan adopted December 23, 1980. Exhibit 10.2 to Annual Report on Form 10-K for the year ended December 31, 2001, of Bancorp is incorporated by reference herein. |
10.3* | | Stock Yards Bank & Trust Company Executive Nonqualified “Excess” Plan available to directors and certain management employees. |
10.4* | | Form of Adoption Agreement for Stock Yards Bank Director’s Deferred Compensation Plan between Stock Yards Bank & Trust Company and certain directors. |
10.5* | | Form of Adoption Agreement for Stock Yards Bank Executive Nonqualified “Excess” Plan between Stock Yards Bank & Trust Company and certain executive officers. |
10.6* | | Stock Yards Bank & Trust Company 2005 Restated Senior Officers Security Plan Exhibit 10.1 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.7* | | 2005 Restated Senior Executive Severance Agreement dated as of April 22, 2005 between Stock Yards Bank & Trust Company and David P. Heintzman, Exhibit 10.2 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
| | |
72
10.8* | | 2005 Restated Senior Executive Severance Agreement dated as of April 22, 2005 between Stock Yards Bank & Trust Company and Kathleen C. Thompson, Exhibit 10.3 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.9* | | 2005 Restated Senior Executive Severance Agreement dated as of April 22, 2005 between Stock Yards Bank & Trust Company and Nancy B. Davis, Exhibit 10.4 to Form 8-K filed April 22, 2005, is incorporated by reference herein. |
10.10* | | S.Y. Bancorp, Inc. 2005 Stock Incentive Plan. Exhibit 10.1 to Form 8-K filed May 2, 2005, is incorporated by reference herein. |
14 | | Code of Ethics for the Chief Executive Officer and Financial Executives. |
21 | | Subsidiaries of the Registrant. |
23 | | Consent of Independent Registered Public Accounting Firm. |
31.1 | | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by David P. Heintzman. |
31.2 | | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by Nancy B. Davis. |
32.1 | | Certifications pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by David P. Heintzman. |
32.2 | | Certifications pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Nancy B. Davis. |
* Indicates matters related to executive compensation.
73
