Exhibit 13
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in this Registration Statement of Middlefield Banc Corp. on Form S-8 of our report dated January 14, 2005, appearing in the Annual Report on Form 10-K of Middlefield Banc Corp. for the year ended December 31, 2004.
Wexford, PA
March 28, 2005
31
MIDDLEFIELD BANC CORP.
CONSOLIDATED BALANCE SHEET
| December 31, | ||||||||
| 2004 | 2003 | |||||||
| ASSETS | ||||||||
| Cash and due from banks | $ | 5,311,776 | $ | 3,956,453 | ||||
| Federal funds sold | — | 930,000 | ||||||
| Cash and cash equivalents | 5,311,776 | 4,886,453 | ||||||
| Interest-bearing deposits in other institutions | 614,506 | 539,147 | ||||||
| Investment securities available for sale | 57,240,965 | 49,966,511 | ||||||
| Investment securities held to maturity (estimated market value of $243,810 and $1,915,366) | 221,412 | 1,858,904 | ||||||
| Loans | 215,653,283 | 192,880,153 | ||||||
| Less allowance for loan losses | 2,623,431 | 2,521,270 | ||||||
| Net loans | 213,029,852 | 190,358,883 | ||||||
| Premises and equipment | 6,617,594 | 6,807,930 | ||||||
| Bank-owned life insurance | 5,424,304 | 5,202,385 | ||||||
| Accrued interest and other assets | 2,753,577 | 2,749,235 | ||||||
| TOTAL ASSETS | $ | 291,213,986 | $ | 262,369,448 | ||||
| LIABILITIES | ||||||||
| Deposits: | ||||||||
| Noninterest-bearing demand | $ | 36,331,809 | $ | 29,423,027 | ||||
| Interest-bearing demand | 8,817,873 | 7,369,754 | ||||||
| Money market | 15,666,730 | 15,708,932 | ||||||
| Savings | 75,280,343 | 69,570,895 | ||||||
| Time | 103,788,696 | 97,767,302 | ||||||
| Total deposits | 239,885,451 | 219,839,910 | ||||||
| Short-term borrowings | 1,871,763 | 444,819 | ||||||
| Other borrowings | 23,683,324 | 17,665,661 | ||||||
| Accrued interest and other liabilities | 951,424 | 914,744 | ||||||
| TOTAL LIABILITIES | 266,391,962 | 238,865,134 | ||||||
| STOCKHOLDERS’ EQUITY | ||||||||
| Common stock, no par value; 5,000,000 shares authorized, 1,355,488 and 1,279,128 shares issued | 12,815,927 | 10,038,156 | ||||||
| Retained earnings | 15,004,552 | 15,085,868 | ||||||
| Accumulated other comprehensive income (loss) | (28,682 | ) | 125,199 | |||||
| Treasury stock, at cost (89,333 and 55,309 shares) | (2,969,773 | ) | (1,744,909 | ) | ||||
| TOTAL STOCKHOLDERS’ EQUITY | 24,822,024 | 23,504,314 | ||||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 291,213,986 | $ | 262,369,448 | ||||
See accompanying notes to consolidated financial statements.
32
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF INCOME
| Year Ended December 31, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| INTEREST AND DIVIDEND INCOME | ||||||||||||
| Interest and fees on loans | $ | 13,617,560 | $ | 12,846,525 | $ | 12,340,920 | ||||||
| Interest-bearing deposits in other institutions | 5,641 | 17,188 | 48,293 | |||||||||
| Federal funds sold | 50,608 | 48,947 | 64,994 | |||||||||
| Investment securities: | ||||||||||||
| Taxable | 1,400,063 | 1,196,221 | 1,190,508 | |||||||||
| Tax-exempt | 604,399 | 486,485 | 424,357 | |||||||||
| Other dividend income | 54,265 | 51,797 | 50,891 | |||||||||
| Total interest and dividend income | 15,732,536 | 14,647,163 | 14,119,963 | |||||||||
| INTEREST EXPENSE | ||||||||||||
| Deposits | 4,905,899 | 4,905,826 | 5,478,030 | |||||||||
| Short-term borrowings | 2,180 | 4,048 | 7,175 | |||||||||
| Other borrowings | 860,819 | 815,033 | 662,881 | |||||||||
| Total interest expense | 5,768,898 | 5,724,907 | 6,148,086 | |||||||||
| NET INTEREST INCOME | 9,963,638 | 8,922,256 | 7,971,877 | |||||||||
| Provision for loan losses | 174,000 | 315,000 | 300,000 | |||||||||
| NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES | 9,789,638 | 8,607,256 | 7,671,877 | |||||||||
| NONINTEREST INCOME | ||||||||||||
| Service charges on deposit accounts | 1,402,027 | 1,033,928 | 955,121 | |||||||||
| Investment securities gains (losses), net | (98,375 | ) | 542 | — | ||||||||
| Earnings on bank-owned life insurance | 221,919 | 202,385 | — | |||||||||
| Other income | 253,660 | 191,289 | 188,096 | |||||||||
| Total noninterest income | 1,779,231 | 1,428,144 | 1,143,217 | |||||||||
| NONINTEREST EXPENSE | ||||||||||||
| Salaries and employee benefits | 3,442,262 | 3,085,451 | 2,523,433 | |||||||||
| Occupancy | 494,759 | 403,591 | 357,500 | |||||||||
| Equipment | 356,346 | 333,163 | 324,659 | |||||||||
| Data processing costs | 538,349 | 470,393 | 427,164 | |||||||||
| Professional fees | 252,731 | 218,838 | 246,285 | |||||||||
| Ohio state franchise tax | 285,050 | 265,050 | 250,050 | |||||||||
| Advertising | 253,858 | 168,849 | 65,263 | |||||||||
| Postage and freight | 178,717 | 161,632 | 140,628 | |||||||||
| Other expense | 1,163,634 | 998,483 | 871,357 | |||||||||
| Total noninterest expense | 6,965,706 | 6,105,450 | 5,206,339 | |||||||||
| Income before income taxes | 4,603,163 | 3,929,950 | 3,608,755 | |||||||||
| Income taxes | 1,330,000 | 1,131,330 | 1,107,806 | |||||||||
| NET INCOME | $ | 3,273,163 | $ | 2,798,620 | $ | 2,500,949 | ||||||
| EARNINGS PER SHARE | ||||||||||||
| Basic | $ | 2.54 | $ | 2.19 | $ | 1.95 | ||||||
| Diluted | 2.51 | 2.18 | 1.95 | |||||||||
See accompanying notes to consolidated financial statements.
33
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
| Accumulated | ||||||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||||||
| Common Stock | Retained | Comprehensive | Treasury | Stockholders’ | Comprehensive | |||||||||||||||||||||||
| Shares | Amount | Earnings | Income (Loss) | Stock | Equity | Income | ||||||||||||||||||||||
| Balance, December 31, 2001 | 1,148,676 | $ | 6,287,011 | $ | 14,842,519 | $ | 133,717 | $ | (1,476,440 | ) | $ | 19,786,807 | ||||||||||||||||
| Net income | 2,500,949 | 2,500,949 | $ | 2,500,949 | ||||||||||||||||||||||||
| Other comprehensive income: | ||||||||||||||||||||||||||||
| Unrealized gain on available-for-sale securities net of taxes of $176,033 | 341,711 | 341,711 | 341,711 | |||||||||||||||||||||||||
| Comprehensive income | $ | 2,842,660 | ||||||||||||||||||||||||||
| Exercise of stock options | 988 | 23,509 | 23,509 | |||||||||||||||||||||||||
| Sale of treasury stock | 795 | 17,225 | 18,020 | |||||||||||||||||||||||||
| Purchase of treasury stock | (204,070 | ) | (204,070 | ) | ||||||||||||||||||||||||
| Five percent stock dividend (including cash paid for fractional shares) | 54,997 | 1,429,662 | (1,434,607 | ) | (4,945 | ) | ||||||||||||||||||||||
| Dividend reinvestment plan | 4,462 | 142,178 | 142,178 | |||||||||||||||||||||||||
| Cash dividends ($.64 per share) | (857,751 | ) | (857,751 | ) | ||||||||||||||||||||||||
| Balance, December 31, 2002 | 1,209,123 | 7,883,155 | 15,051,110 | 475,428 | (1,663,285 | ) | 21,746,408 | |||||||||||||||||||||
| Net income | 2,798,620 | 2,798,620 | $ | 2,798,620 | ||||||||||||||||||||||||
| Other comprehensive loss: | ||||||||||||||||||||||||||||
| Unrealized loss on available-for-sale securities net of tax benefit of $180,421 | (350,229 | ) | (350,229 | ) | (350,229 | ) | ||||||||||||||||||||||
| Comprehensive income | $ | 2,448,391 | ||||||||||||||||||||||||||
| Exercise of stock options | 847 | 19,916 | 19,916 | |||||||||||||||||||||||||
| Common stock issued | 5,612 | 170,513 | 170,513 | |||||||||||||||||||||||||
| Purchase of treasury stock | (81,624 | ) | (81,624 | ) | ||||||||||||||||||||||||
| Five percent stock dividend (including cash paid for fractional shares) | 57,972 | 1,797,165 | (1,801,961 | ) | (4,796 | ) | ||||||||||||||||||||||
| Dividend reinvestment plan | 5,574 | 167,407 | 167,407 | |||||||||||||||||||||||||
| Cash dividends ($.75 per share) | (961,901 | ) | (961,901 | ) | ||||||||||||||||||||||||
| Balance, December 31, 2003 | 1,279,128 | 10,038,156 | 15,085,868 | 125,199 | (1,744,909 | ) | 23,504,314 | |||||||||||||||||||||
| Net income | 3,273,163 | 3,273,163 | $ | 3,273,163 | ||||||||||||||||||||||||
| Other comprehensive loss: | ||||||||||||||||||||||||||||
| Unrealized loss on available-for-sale securities, net of tax benefit of $79,272 | (153,881 | ) | (153,881 | ) | (153,881 | ) | ||||||||||||||||||||||
| Comprehensive income | $ | 3,119,282 | ||||||||||||||||||||||||||
| Exercise of stock options | 521 | 14,198 | 14,198 | |||||||||||||||||||||||||
| Common stock issued | 8,154 | 277,171 | 277,171 | |||||||||||||||||||||||||
| Purchase of treasury stock | (1,224,864 | ) | (1,224,864 | ) | ||||||||||||||||||||||||
| Five percent stock dividend (including cash paid for fractional shares) | 61,387 | 2,271,282 | (2,283,646 | ) | (12,364 | ) | ||||||||||||||||||||||
| Dividend reinvestment plan | 6,298 | 215,120 | 215,120 | |||||||||||||||||||||||||
| Cash dividends ($.83 per share) | (1,070,833 | ) | (1,070,833 | ) | ||||||||||||||||||||||||
| Balance, December 31, 2004 | 1,355,488 | $ | 12,815,927 | $ | 15,004,552 | $ | (28,682 | ) | $ | (2,969,773 | ) | $ | 24,822,024 | |||||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| Components of comprehensive income (loss): | ||||||||||||
| Change in net unrealized gain (loss) on investments available for sale | $ | (218,808 | ) | $ | (349,871 | ) | $ | 341,711 | ||||
| Realized (gains) losses included in net income, net of taxes of $33,448, $184, and $0 | 64,927 | (358 | ) | — | ||||||||
| Total | $ | (153,881 | ) | $ | (350,229 | ) | $ | 341,711 | ||||
See accompanying notes to consolidated financial statements.
34
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
| Year Ended December 31, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| OPERATING ACTIVITIES | ||||||||||||
| Net income | $ | 3,273,163 | $ | 2,798,620 | $ | 2,500,949 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Provision for loan losses | 174,000 | 315,000 | 300,000 | |||||||||
| Depreciation and amortization | 403,916 | 377,547 | 354,550 | |||||||||
| Amortization of premium and discount on investment securities | 260,198 | 259,890 | 159,047 | |||||||||
| Amortization of net deferred loan costs (fees) | (134,758 | ) | (117,524 | ) | (76,684 | ) | ||||||
| Investment securities (gains) losses, net | 98,375 | (542 | ) | — | ||||||||
| Earnings on bank-owned life insurance | (221,919 | ) | (202,385 | ) | — | |||||||
| Deferred income taxes | (33,704 | ) | (69,934 | ) | (72,302 | ) | ||||||
| Decrease (increase) in accrued interest receivable | (75,303 | ) | (11,796 | ) | 34,337 | |||||||
| Decrease in accrued interest payable | (25,617 | ) | (77,862 | ) | (121,258 | ) | ||||||
| Other, net | 299,533 | 184,433 | 124,129 | |||||||||
| Net cash provided by operating activities | 4,017,884 | 3,455,447 | 3,202,768 | |||||||||
| INVESTING ACTIVITIES | ||||||||||||
| Decrease (increase) in interest-bearing deposits in other institutions, net | (75,359 | ) | 32,822 | 668,238 | ||||||||
| Investment securities available for sale: | ||||||||||||
| Proceeds from repayments and maturities | 14,857,656 | 16,167,324 | 10,006,949 | |||||||||
| Purchases | (27,638,162 | ) | (32,985,572 | ) | (24,359,041 | ) | ||||||
| Proceeds from sales | 4,912,619 | 1,991,917 | — | |||||||||
| Investment securities held to maturity: | ||||||||||||
| Proceeds from repayments and maturities | 1,639,200 | 4,370,070 | 3,960,491 | |||||||||
| Increase in loans, net | (22,710,211 | ) | (17,913,713 | ) | (22,099,859 | ) | ||||||
| Purchase of Federal Home Loan Bank stock | (53,300 | ) | (52,000 | ) | (189,700 | ) | ||||||
| Purchase of bank-owned life insurance | — | (5,000,000 | ) | — | ||||||||
| Purchase of premises and equipment | (213,580 | ) | (704,746 | ) | (590,483 | ) | ||||||
| Net cash used for investing activities | (29,281,137 | ) | (34,093,898 | ) | (32,603,405 | ) | ||||||
| FINANCING ACTIVITIES | ||||||||||||
| Net increase in deposits | 20,045,541 | 32,455,416 | 20,001,766 | |||||||||
| Increase (decrease) in short-term borrowings, net | 1,426,944 | (340,959 | ) | 125,100 | ||||||||
| Proceeds from other borrowings | 9,000,000 | 5,000,000 | 7,000,000 | |||||||||
| Repayment of other borrowings | (2,982,337 | ) | (3,024,392 | ) | (611,281 | ) | ||||||
| Purchase of treasury stock | (1,224,864 | ) | (81,624 | ) | (204,070 | ) | ||||||
| Sale of treasury stock | — | — | 18,020 | |||||||||
| Exercise of stock options | 14,198 | 19,916 | 23,509 | |||||||||
| Common stock issued | 277,171 | 170,513 | — | |||||||||
| Proceeds from dividend reinvestment plan | 215,120 | 167,407 | 142,178 | |||||||||
| Cash dividends | (1,083,197 | ) | (966,697 | ) | (862,696 | ) | ||||||
| Net cash provided by financing activities | 25,688,576 | 33,399,580 | 25,632,526 | |||||||||
| Increase (decrease) in cash and cash equivalents | 425,323 | 2,761,129 | (3,768,111 | ) | ||||||||
| CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | 4,886,453 | 2,125,324 | 5,893,435 | |||||||||
| CASH AND CASH EQUIVALENTS AT END OF YEAR | $ | 5,311,776 | $ | 4,886,453 | $ | 2,125,324 | ||||||
| SUPPLEMENTAL INFORMATION | ||||||||||||
| Cash paid during the year for: | ||||||||||||
| Interest on deposits and borrowings | $ | 5,794,515 | $ | 5,802,769 | $ | 6,269,344 | ||||||
| Income taxes | 1,280,000 | 1,295,000 | 1,054,000 | |||||||||
See accompanying notes to consolidated financial statements.
MIDDLEFIELD BANC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
A summary of the significant accounting and reporting policies applied in the presentation of the accompanying financial statements follows:
Nature of Operations and Basis of Presentation
Middlefield Banc Corp. (the “Company”) is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (the “Bank”). The Bank is a state-chartered bank located in Ohio. The Company and its subsidiary derive substantially all of their income from banking and bank-related services which includes interest earnings on residential real estate, commercial mortgage, commercial and consumer financings, as well as interest earnings on investment securities and deposit services to its customers through five locations. The Company is supervised by the Board of Governors of the Federal Reserve System, while the Bank is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Ohio Division of Financial Institutions.
The consolidated financial statements of the Company include its wholly owned subsidiary, the Bank. Significant intercompany items have been eliminated in preparing the consolidated financial statements.
The financial statements have been prepared in conformity with U.S. generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ significantly from those estimates.
Investment Securities
Investment securities are classified at the time of purchase, based on management’s intention and ability, as securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost adjusted for amortization of premium and accretion of discount, which are computed using a level yield method and recognized as adjustments of interest income. Certain other debt securities have been classified as available for sale to serve principally as a source of liquidity. Unrealized holding gains and losses for available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax, until realized. Realized security gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned.
Common stock of the Federal Home Loan Bank (“FHLB”) represents ownership in an institution that is wholly owned by other financial institutions. This equity security is accounted for at cost and classified with other assets.
Loans
Loans are reported at their principal amount net of the allowance for loan losses. Interest income is recognized as income when earned on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Interest received on nonaccrual loans is recorded as income against principal according to management’s judgment as to the collectibility of such principal.
| 1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Loans (Continued)
Loan origination fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related loan’s yield. Management is amortizing these amounts over the contractual life of the related loans.
Allowance for Loan Losses
The allowance for loan losses represents the amount which management estimates is adequate to provide for probable loan losses inherent in its loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan losses is established through a provision for loan losses which is charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance for loan losses, which encompasses the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term.
A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance homogeneous loans that are to be collectively evaluated. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. All loans identified as impaired are evaluated independently by management. The Company estimates credit losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if the loan repayment is expected to come from the sale or operation of such collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until such time, an allowance for loan losses is maintained for estimated losses. Cash receipts on impaired loans are applied first to accrued interest receivable unless otherwise required by the loan terms, except when an impaired loan is also a nonaccrual loan, in which case the portion of the payment related to interest is recognized as income.
Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.
Premises and Equipment
Premises and equipment are stated at cost net of accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, which range from 3 to 20 years for furniture, fixtures, and equipment and 3 to 40 years for buildings and leasehold improvements. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized.
Bank-Owned Life Insurance (BOLI)
The Company purchased life insurance policies on certain key employees. BOLI is recorded at its cash surrender value or the amount that can be realized.
| 1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Income Taxes
The Company and the Bank file a consolidated federal income tax return. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Earnings Per Share
The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share are calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options, warrants, and convertible securities are adjusted in the denominator.
Stock Options
The Company maintains a stock option plan for key officers, employees, and nonemployee directors. Had compensation expense for the stock option plans been recognized in accordance with the fair value accounting provisions of FAS No. 123,Accounting for Stock-Based Compensation,net income applicable to common stock, basic, and diluted net income per common share for the year ended December 31 would have been as follows:
| 2004 | 2003 | 2002 | ||||||||||
| Net income as reported: | $ | 3,273,163 | $ | 2,798,620 | $ | 2,500,949 | ||||||
| Less pro forma expense related to option | 57,308 | 52,459 | 52,434 | |||||||||
| Pro forma net income | $ | 3,215,855 | $ | 2,746,161 | $ | 2,448,515 | ||||||
| Basic net income per common share: | ||||||||||||
| As reported | $ | 2.54 | $ | 2.19 | $ | 1.95 | ||||||
| Pro forma | 2.49 | 2.14 | 1.91 | |||||||||
| Diluted net income per common share: | ||||||||||||
| As reported | $ | 2.51 | $ | 2.18 | $ | 1.95 | ||||||
| Pro forma | 2.47 | 2.14 | 1.91 | |||||||||
For purposes of computing pro forma results, the Company estimated the fair values of stock options using the Black-Scholes option-pricing model. The model requires the use of subjective assumptions that can materially affect fair value estimates. Therefore, the pro forma results are estimates of results of operations as if compensation expense had been recognized for the stock option plans. The fair value of each stock option granted was estimated using the following weighted-average assumptions:
| Expected | ||||||||||||||||
| Grant | Dividend | Risk-Free | Expected | Expected | ||||||||||||
| Year | Yield | Interest Rate | Volatility | Life (in years) | ||||||||||||
| 2000 | 2.50 | % | 5.29 | % | 5.00 | % | 9.95 | |||||||||
| 2002 | 2.72 | 4.19 | 27.04 | 9.94 | ||||||||||||
| 2003 | 2.72 | 4.25 | 14.00 | 9.94 | ||||||||||||
| 2004 | 2.39 | 4.00 | 8.79 | 9.94 | ||||||||||||
| 1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) |
Cash Flow Information
The Company has defined cash and cash equivalents as those amounts included in the Consolidated Balance Sheet captions “Cash and due from banks” and “Federal funds sold.”
Advertising Costs
Advertising costs are expensed as the costs are incurred. Advertising expenses amounted to $253,858, $168,849, and $65,263 for 2004, 2003, and 2002, respectively.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“FAS”) No. 123 (Revised 2004),Share-Based Payment. The statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity or liability instruments issued. FAS No. 123 (Revised 2004) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The Company will adopt FAS No. 123 (Revised 2004) on July 1, 2005, and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
In October 2003, the American Institute of Certified Public Accountants issued SOP 03-3,Accounting for Loans or Certain Debt Securities Acquired in a Transfer.SOP 03-3 applies to a loan that is acquired where it is probable, at acquisition, that a transferee will be unable to collect all contractually required payments receivable. SOP 03-3 requires the recognition, as accretable yield, of the excess of all cash flows expected at acquisition over the investor’s initial investment in the loan as interest income on a level-yield basis over the life of the loan. The amount by which the loan’s contractually required payments exceed the amount of its expected cash flows at acquisition may not be recognized as an adjustment to yield, a loss accrual, or a valuation allowance for credit risk. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. Early adoption is permitted. The adoption of SOP 03-3 is not expected to have a material impact on the consolidated financial statements.
Reclassification of Comparative Amounts
Certain items previously reported have been reclassified to conform to the current year’s format. Such reclassifications did not affect net income or stockholders’ equity.
| 2. | EARNINGS PER SHARE |
There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.
| 2004 | 2003 | 2002 | ||||||||||
| Weighted-average common shares outstanding | 1,346,482 | 1,335,283 | 1,328,683 | |||||||||
| Average treasury stock shares | (55,588 | ) | (54,833 | ) | (47,786 | ) | ||||||
| Weighted-average common shares and common stock equivalents used to calculate basic earnings per share | 1,290,894 | 1,280,450 | 1,280,897 | |||||||||
| Additional common stock equivalents (stock options) used to calculate diluted earnings per share | 11,734 | 3,520 | 2,094 | |||||||||
| Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share | 1,302,628 | 1,283,970 | 1,282,991 | |||||||||
Options to purchase 10,552 shares of common stock at prices from $26.78 to $27.43 per share were outstanding during 2002 but were not included in the computation of diluted earnings per share because to do so would have been antidilutive. In 2004 and 2003, there were no options to purchase shares of common stock that were anti-dilutive.
| 3. | STOCK DIVIDEND |
The Board of Directors approved a 5 percent stock dividend to stockholders of record as of December 1, 2004, payable December 15, 2004. As a result of the dividend, 61,387 additional shares of the Company’s common stock were issued, common stock was increased by $2,271,282, and retained earnings decreased by $2,283,646.
The Board of Directors approved a 5 percent stock dividend to stockholders of record as of December 3, 2003, payable December 12, 2003. As a result of the dividend, 57,972 additional shares of the Company’s common stock were issued, common stock was increased by $1,797,165, and retained earnings decreased by $1,801,961.
The Board of Directors approved a 5 percent stock dividend to stockholders of record as of June 1, 2002, payable June 14, 2002. As a result of the dividend, 54,997 additional shares of the Company’s common stock were issued; common stock was increased by $1,429,662, and retained earnings decreased by $1,434,607.
Fractional shares paid were paid in cash. All average shares outstanding and all per share amounts included in the financial statements are based on the increased number of shares after giving retroactive effects to the stock dividend.
| 4. | INVESTMENT SECURITIES AVAILABLE FOR SALE |
The amortized cost and estimated market values of securities available for sale are as follows:
| 2004 | ||||||||||||||||
| Gross | Gross | Estimated | ||||||||||||||
| Amortized | Unrealized | Unrealized | Market | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| U.S. government agency securities | $ | 5,273,091 | $ | 70,704 | $ | (17,637 | ) | $ | 5,326,158 | |||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Taxable | 748,196 | — | (11,129 | ) | 737,067 | |||||||||||
| Tax-exempt | 21,239,335 | 303,433 | (65,776 | ) | 21,476,992 | |||||||||||
| Mortgage-backed securities | 29,625,481 | 80,530 | (403,583 | ) | 29,302,428 | |||||||||||
| Total debt securities | 56,886,103 | 454,667 | (498,125 | ) | 56,842,645 | |||||||||||
| Equity securities | 398,320 | — | — | 398,320 | ||||||||||||
| Total | $ | 57,284,423 | $ | 454,667 | $ | (498,125 | ) | $ | 57,240,965 | |||||||
| 2003 | ||||||||||||||||
| Gross | Gross | Estimated | ||||||||||||||
| Amortized | Unrealized | Unrealized | Market | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| U.S. government agency securities | $ | 6,061,807 | $ | 132,978 | $ | (17,744 | ) | $ | 6,177,041 | |||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Taxable | 209,534 | 6,195 | — | 215,729 | ||||||||||||
| Tax-exempt | 14,564,866 | 324,412 | (48,570 | ) | 14,840,708 | |||||||||||
| Corporate securities | 349,910 | 9,059 | — | 358,969 | ||||||||||||
| Mortgage-backed securities | 28,590,695 | 112,244 | (328,875 | ) | 28,374,064 | |||||||||||
| Total | $ | 49,776,812 | $ | 584,888 | $ | (395,189 | ) | $ | 49,966,511 | |||||||
The amortized cost and estimated market value of debt securities at December 31, 2004, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| Estimated | ||||||||
| Amortized | Market | |||||||
| Cost | Value | |||||||
| Due in one year or less | $ | 3,264,867 | $ | 3,264,939 | ||||
| Due after one year through five years | 8,292,750 | 8,411,921 | ||||||
| Due after five years through ten years | 11,492,322 | 11,588,142 | ||||||
| Due after ten years | 33,836,164 | 33,577,643 | ||||||
| Total | $ | 56,886,103 | $ | 56,842,645 | ||||
Investment securities with an approximate carrying value of $21,669,555 and $21,323,044 at December 31, 2004 and 2003, respectively, were pledged to secure deposits and other purposes as required by law.
| 4. | INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) |
The following is a summary of proceeds received, gross gains, and gross losses realized on the sale of investment securities available for sale for the years ended December 31, 2004 and 2003. The Company had no sales in 2002.
| 2004 | 2003 | |||||||
| Proceeds from sales | $ | 4,912,619 | $ | 1,991,917 | ||||
| Gross gains | — | 6,350 | ||||||
| Gross losses | 98,375 | 5,808 | ||||||
| 5. | INVESTMENT SECURITIES HELD TO MATURITY |
The amortized cost and estimated market values of investment securities held to maturity are as follows:
| 2004 | ||||||||||||||||
| Gross | Gross | Estimated | ||||||||||||||
| Amortized | Unrealized | Unrealized | Market | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Tax-exempt | $ | 221,412 | $ | 22,398 | $ | — | $ | 243,810 | ||||||||
| 2003 | ||||||||||||||||
| Gross | Gross | Estimated | ||||||||||||||
| Amortized | Unrealized | Unrealized | Market | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Taxable | $ | 945,234 | $ | 17,769 | $ | — | $ | 963,003 | ||||||||
| Tax-exempt | 913,670 | 38,693 | — | 952,363 | ||||||||||||
| Total | $ | 1,858,904 | $ | 56,462 | $ | — | $ | 1,915,366 | ||||||||
The amortized cost and estimated market value of debt securities at December 31, 2004, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| Estimated | ||||||||
| Amortized | Market | |||||||
| Cost | Value | |||||||
| Due after one year through five years | $ | 121,412 | $ | 128,224 | ||||
| Due after five years through ten years | 100,000 | 115,586 | ||||||
| Total | $ | 221,412 | $ | 243,810 | ||||
Investment securities held to maturity with carrying values of approximately $89,915 and $685,186 and estimated market values of approximately $93,545 and $704,240 at December 31, 2004 and 2003, respectively, were pledged to secure public deposits and other purposes required by law.
| 6. | UNREALIZED LOSSES ON SECURITIES |
The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2004.
| Less than Twelve Months | Twelve Months or Greater | Total | ||||||||||||||||||||||
| Estimated | Gross | Estimated | Gross | Estimated | Gross | |||||||||||||||||||
| Market | Unrealized | Market | Unrealized | Market | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| U.S. government agency securities | $ | 1,488,594 | $ | (7,817 | ) | $ | 981,563 | $ | (9,820 | ) | $ | 2,470,157 | $ | (17,637 | ) | |||||||||
| Obligations of states and political subdivisions | 5,227,264 | (33,724 | ) | 1,673,533 | (43,181 | ) | 6,900,797 | (76,905 | ) | |||||||||||||||
| Mortgage-backed securities | 7,922,125 | (76,319 | ) | 11,860,073 | (327,264 | ) | 19,782,198 | (403,583 | ) | |||||||||||||||
| Total | $ | 14,637,983 | $ | (117,860 | ) | $ | 14,515,169 | $ | (380,265 | ) | $ | 29,153,152 | $ | (498,125 | ) | |||||||||
The policy of the Company is to recognize an other-than-temporary impairment on equity securities where the fair value has been significantly below cost for three consecutive quarters. For fixed maturity investments with unrealized losses due to interest rates where the Company has the positive intent and ability to hold the investment for a period of time sufficient to allow a market recovery, declines in value below cost are not assumed to be other than temporary. The Company reviews its position quarterly and has asserted that at December 31, 2004, the declines outlined in the above table represent temporary declines and the Company does have the intent and ability either to hold those securities to maturity or to allow a market recovery.
The Company has concluded that any impairment of its investment securities portfolio is not other than temporary but is the result of interest rate changes, sector credit rating changes, or Company-specific rating changes that are not expected to result in the noncollection of principal and interest during the period.
| 7. | LOANS |
Major classifications of loans are summarized as follows:
| 2004 | 2003 | |||||||
| Commercial and industrial | $ | 52,148,055 | $ | 42,063,086 | ||||
| Real estate - construction | 3,143,706 | 3,433,614 | ||||||
| Real estate - mortgage: | ||||||||
| Residential | 147,425,466 | 134,007,401 | ||||||
| Commercial | 7,026,582 | 7,865,893 | ||||||
| Consumer installment | 5,909,474 | 5,510,159 | ||||||
| 215,653,283 | 192,880,153 | |||||||
| Less allowance for loan losses | 2,623,431 | 2,521,270 | ||||||
| Net loans | $ | 213,029,852 | $ | 190,358,883 | ||||
The Company’s primary business activity is with customers located within its local trade area, eastern Geauga County, and contiguous counties to the north, east, and south. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio at December 31, 2004 and 2003, loans outstanding to individuals and businesses are dependent upon the local economic conditions in its immediate trade area.
| 8. | ALLOWANCE FOR LOAN LOSSES |
Changes in the allowance for loan losses for the years ended December 31 are as follows:
| 2004 | 2003 | 2002 | ||||||||||
| Balance, January 1 | $ | 2,521,270 | $ | 2,300,485 | $ | 2,062,252 | ||||||
| Add: | ||||||||||||
| Provisions charged to operations | 174,000 | 315,000 | 300,000 | |||||||||
| Recoveries | 46,643 | 49,942 | 57,388 | |||||||||
| Less loans charged off | 118,482 | 144,157 | 119,155 | |||||||||
| Balance, December 31 | $ | 2,623,431 | $ | 2,521,270 | $ | 2,300,485 | ||||||
9. PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
| 2004 | 2003 | |||||||
| Land and land improvements | $ | 1,295,938 | $ | 1,295,938 | ||||
| Building and leasehold improvements | 6,859,242 | 6,815,018 | ||||||
| Furniture , fixtures, and equipment | 2,826,230 | 2,656,874 | ||||||
| 10,981,410 | 10,767,830 | |||||||
| Less accumulated depreciation and amortization | 4,363,816 | 3,959,900 | ||||||
| Total | $ | 6,617,594 | $ | 6,807,930 | ||||
Depreciation and amortization charged to operations was $403,916 in 2004, $377,547 in 2003, and $354,550 in 2002.
| 10. | OTHER ASSETS |
The components of other assets are as follows:
| 2004 | 2003 | |||||||
| FHLB stock | $ | 1,351,000 | $ | 1,297,700 | ||||
| Accrued interest on investment securities | 274,740 | 281,438 | ||||||
| Accrued interest on loans | 531,086 | 449,085 | ||||||
| Deferred tax asset, net | 450,449 | 337,471 | ||||||
| Other | 146,302 | 383,541 | ||||||
| Total | $ | 2,753,577 | $ | 2,749,235 | ||||
| 11. | DEPOSITS |
Time deposits at December 31, 2004, mature $46,060,731, $19,443,146, $17,726,866, $11,638,696, and $8,919,257 during 2005, 2006, 2007, 2008, and 2009, respectively.
Time deposits include certificates of deposit in denominations of $100,000 or more. Such deposits aggregated $21,920,929 and $18,834,869 at December 31, 2004 and 2003, respectively.
Maturities on time deposits of $100,000 or more at December 31, 2004, are as follows:
| Within three months | $ | 1,940,752 | ||
| Beyond three but within six months | 1,095,092 | |||
| Beyond six but within twelve months | 6,120,363 | |||
| Beyond one year | 12,764,722 | |||
| Total | $ | 21,920,929 | ||
| 12. | SHORT-TERM BORROWINGS |
The outstanding balances and related information of short-term borrowings which includes securities sold under agreements to repurchase and federal funds purchased are summarized as follows:
| 2004 | 2003 | |||||||
| Balance at year-end | $ | 1,871,763 | $ | 444,819 | ||||
| Average balance outstanding | 298,500 | 726,874 | ||||||
| Maximum month-end balance | 2,057,054 | 2,327,544 | ||||||
| Weighted-average rate at year-end | 3.80 | % | 0.23 | % | ||||
| Weighted-average rate during the year | 0.73 | 0.56 | ||||||
Average balances outstanding during the year represent daily average balances, and average interest rates represent interest expense divided by the related average balance.
The Company maintains a $4,000,000 line of credit at an adjustable rate, currently 5.5 percent, from Lorain National Bank. At December 31, 2004, the Company had outstanding borrowings of $1,200,000. At December 31, 2003, there were no outstanding balances of this line.
| 13. | OTHER BORROWINGS |
Other borrowings consist of advances from the FHLB as follows:
| Weighted- | Stated interest | |||||||||||||||||||||||||||
| Maturity range | average | rate range | ||||||||||||||||||||||||||
| Description | from | to | interest rate | from | to | 2004 | 2003 | |||||||||||||||||||||
| Fixed rate | 08/09/05 | 09/13/07 | 3.45 | % | 3.34 | % | 3.87 | % | $ | 3,035,000 | $ | 1,560,000 | ||||||||||||||||
| Fixed rate amortizing | 07/01/07 | 02/01/23 | 3.44 | 2.70 | 6.40 | 12,648,324 | 8,105,661 | |||||||||||||||||||||
| Convertible | 09/04/08 | 07/28/10 | 5.43 | 4.53 | 6.45 | 8,000,000 | 8,000,000 | |||||||||||||||||||||
| $ | 23,683,324 | $ | 17,665,661 | |||||||||||||||||||||||||
| 13. | OTHER BORROWINGS (Continued) |
The scheduled maturities of advances outstanding are as follows:
| 2004 | ||||||||
| Year Ending | Weighted- | |||||||
| December 31, | Amount | Average Rate | ||||||
| 2005 | $ | 3,998,870 | 3.35 | % | ||||
| 2006 | 3,128,697 | 3.42 | ||||||
| 2007 | 3,931,213 | 3.32 | ||||||
| 2008 | 7,403,604 | 4.72 | ||||||
| 2009 | 1,040,328 | 3.19 | ||||||
| Beyond 2009 | 4,180,612 | 4.74 | ||||||
| $ | 23,683,324 | 4.02 | % | |||||
The Bank entered into a ten-year “Convertible Select” fixed commitment advance arrangement with the FHLB. Rates may be reset at the FHLB’s discretion on a quarterly basis based on the three-month LIBOR rate. At each rate change the Bank may exercise a put option and satisfy the obligation without penalty.
Advances from the FHLB maturing July 1, 2007, February 1, 2012, June 4, 2012, February 2, 2013, February 26, 2014, July 28, 2014, September 13, 2014, June 4, 2017, February 1, 2018, February 26, 2019, and February 1, 2023, require monthly principal and interest payments and an annual 20 percent paydown of outstanding principal. Monthly principal and interest payments are adjusted after each 20 percent paydown. Under terms of a blanket agreement, collateral for the FHLB borrowings are secured by certain qualifying assets of the Bank which consist principally of first mortgage loans. Under this credit arrangement, the Bank has a remaining borrowing capacity of approximately $118 million at December 31, 2004.
| 14. | OTHER LIABILITIES |
The components of other liabilities are as follows:
| 2004 | 2003 | |||||||
| Accrued interest payable | $ | 382,467 | $ | 408,084 | ||||
| Other | 568,957 | 506,660 | ||||||
| Total | $ | 951,424 | $ | 914,744 | ||||
| 15. | INCOME TAXES |
The provision for federal income taxes consists of:
| 2004 | 2003 | 2002 | ||||||||||
| Current payable | $ | 1,363,704 | $ | 1,201,264 | $ | 1,180,108 | ||||||
| Deferred | (33,704 | ) | (69,934 | ) | (72,302 | ) | ||||||
| Total provision | $ | 1,330,000 | $ | 1,131,330 | $ | 1,107,806 | ||||||
| 15. | INCOME TAXES (Continued) |
The tax effects of deductible and taxable temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
| 2004 | 2003 | |||||||
| Deferred tax assets: | ||||||||
| Allowance for loan losses | $ | 823,034 | $ | 788,299 | ||||
| Net unrealized loss on securities | 14,776 | — | ||||||
| Supplemental retirement plan | 50,764 | 37,300 | ||||||
| Gross deferred tax assets | 888,574 | 825,599 | ||||||
| Deferred tax liabilities: | ||||||||
| Deferred origination fees, net | 118,061 | 157,979 | ||||||
| Premises and equipment | 181,273 | 141,866 | ||||||
| Net unrealized gain on securities | — | 64,498 | ||||||
| Other | 138,791 | 123,785 | ||||||
| Gross deferred tax liabilities | 438,125 | 488,128 | ||||||
| Net deferred tax assets | $ | 450,449 | $ | 337,471 | ||||
No valuation allowance was established at December 31, 2004 and 2003, in view of the Company’s ability to carryback to taxes paid in previous years and certain tax strategies, coupled with the anticipated future taxable income as evidenced by the Company’s earnings potential.
The reconciliation between the federal statutory rate and the Company’s effective consolidated income tax rate is as follows:
| 2004 | 2003 | 2002 | ||||||||||||||||||||||
| % of | % of | % of | ||||||||||||||||||||||
| Pretax | Pretax | Pretax | ||||||||||||||||||||||
| Amount | Income | Amount | Income | Amount | Income | |||||||||||||||||||
| Provision at statutory rate | $ | 1,565,076 | 34.0 | % | $ | 1,336,030 | 34.0 | % | $ | 1,226,976 | 34.0 | % | ||||||||||||
| Tax-free income | (208,593 | ) | (4.5 | ) | (236,760 | ) | (6.1 | ) | (147,425 | ) | (4.1 | ) | ||||||||||||
| Nondeductible interest expense | 26,485 | 0.6 | 22,789 | 0.6 | 21,590 | 0.6 | ||||||||||||||||||
| Other | (52,968 | ) | (1.2 | ) | 9,271 | 0.3 | 6,665 | 0.2 | ||||||||||||||||
| Actual tax expense and effective rate | $ | 1,330,000 | 28.9 | % | $ | 1,131,330 | 28.8 | % | $ | 1,107,806 | 30.7 | % | ||||||||||||
| 16. | EMPLOYEE BENEFITS |
Retirement Plan
The Bank maintains a section 401(k) employee savings and investment plan for all full-time employees and officers of the Bank with more than one year of service. The Bank’s contribution to the plan is based on 50 percent matching of voluntary contributions up to 6 percent of compensation. An eligible employee can contribute up to 15 percent of salary. Employee contributions are vested at all times, and the Bank contributions are fully vested after six years beginning at the second year in 20 percent increments. Contributions for 2004, 2003, and 2002 to this plan amounted to $63,083, $56,731, and $53,268, respectively.
| 16. | EMPLOYEE BENEFITS (Continued) |
Supplemental Retirement Plan
The Bank maintains a Directors Retirement Plan to provide postretirement payments over a ten-year period to members of the Board of Directors who have completed five or more years of service. The Plan requires payment of 25 percent of the final average annual board fees paid to a director in the three years preceding the director’s retirement. The expense of the plan for the years ended December 31, 2004, 2003, and 2002, amounted to $39,600, $52,800, and $52,800, respectively.
Stock Option and Restricted Stock Plan
The Company maintains a stock option and restricted stock plan (“the Plan”) for granting incentive stock options, nonqualified stock options, and restricted stock for key officers and employees and nonemployee directors of the Company. A total of 132,972 shares of authorized and unissued or issued common stock are reserved for issuance under the Plan, which expires ten years from the date of stockholder ratification. The per share exercise price of an option granted will not be less than the fair value of a share of common stock on the date the option is granted. No option shall become exercisable earlier than one year from the date the Plan was approved by the stockholders.
The following table presents share data related to the outstanding options:
| Weighted- | Weighted- | |||||||||||||||
| Average | Average | |||||||||||||||
| Exercise | Exercise | |||||||||||||||
| 2004 | Price | 2003 | Price | |||||||||||||
| Outstanding, January 1 | 51,808 | $ | 25.85 | 33,545 | $ | 24.47 | ||||||||||
| Granted | 14,114 | 34.66 | 19,184 | 28.11 | ||||||||||||
| Exercised | (545 | ) | 25.95 | (921 | ) | 22.30 | ||||||||||
| Forfeited | — | — | — | — | ||||||||||||
| Outstanding, December 31 | 65,377 | $ | 27.75 | 51,808 | $ | 25.85 | ||||||||||
| Exercisable at year-end | 51,263 | 25.84 | 32,646 | 24.51 | ||||||||||||
The following table summarizes the characteristics of stock options at December 31, 2004:
| Outstanding | Exercisable | |||||||||||||||||||||||
| Contractual | Average | Average | ||||||||||||||||||||||
| Exercise | Average | Exercise | Exercise | |||||||||||||||||||||
| Grant Date | Price | Shares | Life | Price | Shares | Price | ||||||||||||||||||
| June 14, 1999 | $ | 27.43 | 7,668 | 4.45 | $ | 27.43 | 7,668 | $ | 27.43 | |||||||||||||||
| November 23, 1999 | 26.77 | 2,884 | 4.90 | 26.77 | 2,884 | 26.77 | ||||||||||||||||||
| December 11, 2000 | 20.73 | 11,403 | 5.95 | 20.73 | 11,403 | 20.73 | ||||||||||||||||||
| December 9, 2002 | 20.85 | 10,127 | 7.94 | 20.85 | 10,127 | 20.85 | ||||||||||||||||||
| December 8, 2003 | 28.11 | 19,181 | 8.94 | 28.11 | 19,181 | 28.11 | ||||||||||||||||||
| May 12, 2004 | 31.67 | 2,314 | 9.33 | 31.67 | — | — | ||||||||||||||||||
| December 13, 2004 | 35.25 | 11,800 | 9.95 | 35.25 | — | — | ||||||||||||||||||
| 65,377 | 51,263 | |||||||||||||||||||||||
For the years ended December 31, 2004, 2003, and 2002, the Company granted 884 shares, 110 shares, and 530 shares, respectively, of common stock. The Company recognizes compensation expense in the amount of fair value of the common stock at the grant date and as an addition to stockholders’ equity. The Company recognized compensation expense of $3,080, $3,410, and $18,020 for the years ended December 31, 2004, 2003, and 2002, respectively.
| 17. | COMMITMENTS |
In the normal course of business, there are various outstanding commitments and certain contingent liabilities which are not reflected in the accompanying consolidated financial statements. These commitments and contingent liabilities represent financial instruments with off-balance sheet risk. The contract or notional amounts of those instruments reflect the extent of involvement in particular types of financial instruments which were composed of the following:
| 2004 | 2003 | |||||||
| Commitments to extend credit | $ | 33,925,423 | $ | 29,349,316 | ||||
| Standby letters of credit | 222,675 | 67,800 | ||||||
| Total | $ | 34,148,098 | $ | 29,417,116 | ||||
These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The Company’s exposure to credit loss, in the event of nonperformance by the other parties to the financial instruments, is represented by the contractual amounts as disclosed. The Company minimizes its exposure to credit loss under these commitments by subjecting them to credit approval and review procedures and collateral requirements as deemed necessary. Commitments generally have fixed expiration dates within one year of their origination.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Performance letters of credit represent conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance-related contracts. The coverage period for these instruments is typically a one-year period with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized over the coverage period. For secured letters of credit, the collateral is typically Bank deposit instruments or customer business assets.
| 18. | REGULATORY RESTRICTIONS |
Loans
Federal law prevents the Company from borrowing from the Bank unless the loans are secured by specific obligations. Further, such secured loans are limited in amount of 10 percent of the Bank’s common stock and capital surplus.
Dividends
The Bank is subject to a dividend restriction that generally limits the amount of dividends that can be paid by an Ohio state-chartered bank. Under the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net profits for the two preceding years less any required transfers to surplus. Under this formula, the amount available for payment of dividends in 2005 was $4,114,417 plus 2005 profits retained up to the date of the dividend declaration.
| 19. | REGULATORY CAPITAL |
Federal regulations require the Company and the Bank to maintain minimum amounts of capital. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average total assets.
In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) established five capital categories ranging from “well capitalized” to “critically undercapitalized.” Should any institution fail to meet the requirements to be considered “adequately capitalized,” it would become subject to a series of increasingly restrictive regulatory actions.
As of December 31, 2004 and 2003, the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be classified as a well capitalized financial institution, Total risk-based, Tier 1 risk-based, and Tier 1 Leverage capital ratios must be at least 10 percent, 6 percent, and 5 percent, respectively.
The Company’s actual capital ratios are presented in the following table that shows the Company met all regulatory capital requirements. The capital position of the Bank does not differ significantly from the Company’s.
| 2004 | 2003 | |||||||||||||||
| Amount | Ratio | Amount | Ratio | |||||||||||||
| Total Capital (to Risk-Weighted Assets) | ||||||||||||||||
| Actual | $ | 27,231,794 | 14.28 | % | $ | 25,395,628 | 15.79 | % | ||||||||
| For Capital Adequacy Purposes | 15,251,438 | 8.00 | 12,865,299 | 8.00 | ||||||||||||
| To Be Well Capitalized | 19,064,298 | 10.00 | 16,081,624 | 10.00 | ||||||||||||
| Tier I Capital (to Risk-Weighted Assets) | ||||||||||||||||
| Actual | $ | 24,850,706 | 13.04 | % | $ | 23,379,115 | 14.54 | % | ||||||||
| For Capital Adequacy Purposes | 7,625,719 | 4.00 | 6,432,650 | 4.00 | ||||||||||||
| To Be Well Capitalized | 11,438,579 | 6.00 | 9,648,975 | 6.00 | ||||||||||||
| Tier I Capital (to Average Assets) | ||||||||||||||||
| Actual | $ | 24,850,706 | 8.51 | % | $ | 23,379,115 | 8.89 | % | ||||||||
| For Capital Adequacy Purposes | 11,678,293 | 4.00 | 10,514,492 | 4.00 | ||||||||||||
| To Be Well Capitalized | 14,597,866 | 5.00 | 13,143,115 | 5.00 | ||||||||||||
| 20. | FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS |
The estimated fair value of the Company’s financial instruments at December 31 are as follows:
| 2004 | 2003 | |||||||||||||||
| Carrying | Fair | Carrying | Fair | |||||||||||||
| Value | Value | Value | Value | |||||||||||||
| Financial assets: | ||||||||||||||||
| Cash and due from banks | $ | 5,311,776 | $ | 5,311,776 | $ | 3,956,453 | $ | 3,956,453 | ||||||||
| Federal funds sold | — | — | 930,000 | 930,000 | ||||||||||||
| Interest-bearing deposits in other institutions | 614,506 | 614,506 | 539,147 | 539,147 | ||||||||||||
| Investment securities: | ||||||||||||||||
| Available for sale | 57,240,965 | 57,240,965 | 49,966,511 | 49,966,511 | ||||||||||||
| Held to maturity | 221,412 | 243,810 | 1,858,904 | 1,915,366 | ||||||||||||
| Net loans | 213,029,852 | 219,485,000 | 190,358,883 | 199,157,402 | ||||||||||||
| Bank-Owned Life Insurance | 5,424,304 | 5,424,304 | 5,202,385 | 5,202,385 | ||||||||||||
| Federal Home Loan Bank stock | 1,351,000 | 1,351,000 | 1,297,700 | 1,297,700 | ||||||||||||
| Accrued interest receivable | 805,826 | 805,826 | 730,523 | 730,523 | ||||||||||||
| Financial liabilities: | ||||||||||||||||
| Deposits | $ | 239,885,451 | $ | 241,129,000 | $ | 219,839,910 | $ | 223,046,359 | ||||||||
| Short-term borrowings | 1,871,763 | 1,871,763 | 444,819 | 444,819 | ||||||||||||
| Other borrowings | 23,683,324 | 22,160,000 | 17,665,661 | 17,763,971 | ||||||||||||
| Accrued interest payable | 382,467 | 382,467 | 408,084 | 408,084 | ||||||||||||
Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.
Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.
If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. Since many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.
As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.
The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:
| 20. | FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS (Continued) |
Cash and Due From Banks, Federal Funds Sold, Interest-Bearing Deposits in Other Institutions, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable, and Short-Term Borrowings
The fair value is equal to the current carrying value.
Bank-Owned Life Insurance
The fair value is equal to the cash surrender value of the life insurance policies.
Investment Securities
The fair value of investment securities available for sale and held to maturity is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.
Loans, Deposits, and Other Borrowings
The fair value of loans, certificates of deposit, and other borrowings is estimated by discounting the future cash flows using a simulation model which estimates future cash flows and constructs discount rates that consider reinvestment opportunities, operating expenses, noninterest income, credit quality, and prepayment risk. Demand, savings, and money market deposit accounts are valued at the amount payable on demand as of year-end.
Commitments to Extend Credit
These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented in Note 17.
| 21. | PARENT COMPANY |
Following are condensed financial statements for the Company.
CONDENSED BALANCE SHEET
| December 31, | ||||||||
| 2004 | 2003 | |||||||
| ASSETS | ||||||||
| Cash and due from banks | $ | 229,399 | $ | 329,683 | ||||
| Interest-bearing deposits in other institutions | 614,506 | 539,147 | ||||||
| Investment securities available for sale | 398,320 | — | ||||||
| Investment in subsidiary bank | 24,779,799 | 22,635,484 | ||||||
| TOTAL ASSETS | $ | 26,022,024 | $ | 23,504,314 | ||||
| LIABILITIES | ||||||||
| Other borrowings | 1,200,000 | — | ||||||
| STOCKHOLDERS’ EQUITY | $ | 24,822,024 | $ | 23,504,314 | ||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 26,022,024 | $ | 23,504,314 | ||||
CONDENSED STATEMENT OF INCOME
| Year Ended December 31, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| INCOME | ||||||||||||
| Dividends from subsidiary bank | $ | 1,092,122 | $ | 1,044,637 | $ | 1,020,895 | ||||||
| Interest income | 5,369 | 5,179 | 6,963 | |||||||||
| Total income | 1,097,491 | 1,049,816 | 1,027,858 | |||||||||
| EXPENSES | 168,524 | 99,473 | 166,800 | |||||||||
| Income before income tax benefit | 928,967 | 950,343 | 861,058 | |||||||||
| Income tax benefit | (46,000 | ) | (32,056 | ) | (54,636 | ) | ||||||
| Income before equity in undistributed net income of subsidiary | 974,967 | 982,399 | 915,695 | |||||||||
| Equity in undistributed net income of subsidiary | 2,298,196 | 1,816,221 | 1,585,254 | |||||||||
| NET INCOME | $ | 3,273,163 | $ | 2,798,620 | $ | 2,500,949 | ||||||
| 21. | PARENT COMPANY (Continued) |
CONDENSED STATEMENT OF CASH FLOWS
| Year Ended December 31, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| OPERATING ACTIVITIES | ||||||||||||
| Net income | $ | 3,273,163 | $ | 2,798,620 | $ | 2,500,949 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Equity in undistributed net income of subsidiary | (2,298,196 | ) | (1,816,221 | ) | (1,585,254 | ) | ||||||
| Net cash provided by operating activities | 974,967 | 982,399 | 915,695 | |||||||||
| INVESTING ACTIVITIES | ||||||||||||
| Decrease (increase) in interest-bearing deposits in other institutions | (75,359 | ) | (255,178 | ) | 93,237 | |||||||
| Purchase of investment securities | (398,320 | ) | — | — | ||||||||
| Net cash provided by (used for) investing activities | (473,679 | ) | (255,178 | ) | 93,237 | |||||||
| FINANCING ACTIVITIES | ||||||||||||
| Net increase in short-term borrowings | 1,200,000 | — | — | |||||||||
| Purchase of treasury stock | (1,224,864 | ) | (81,624 | ) | (204,070 | ) | ||||||
| Sale of treasury stock | — | — | 18,020 | |||||||||
| Exercise of stock options | 14,198 | 19,916 | 23,509 | |||||||||
| Common stock issued | 277,171 | 170,513 | — | |||||||||
| Proceeds from dividend reinvestment plan | 215,120 | 167,407 | 142,178 | |||||||||
| Cash dividends | (1,083,197 | ) | (966,697 | ) | (862,696 | ) | ||||||
| Net cash used for financing activities | (601,572 | ) | (690,485 | ) | (883,059 | ) | ||||||
| Increase (decrease) in cash | (100,284 | ) | 36,736 | 125,873 | ||||||||
| CASH AT BEGINNING OF YEAR | 329,683 | 292,947 | 167,074 | |||||||||
| CASH AT END OF YEAR | $ | 229,399 | $ | 329,683 | $ | 292,947 | ||||||
| 22. | SELECTED QUARTERLY FINANCIAL DATA (Unaudited) |
| Three Months Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2004 | 2004 | 2004 | 2004 | |||||||||||||
| Total interest income | $ | 3,798,928 | $ | 3,889,197 | $ | 3,978,576 | $ | 4,065,835 | ||||||||
| Total interest expense | 1,383,071 | 1,411,961 | 1,456,471 | 1,517,395 | ||||||||||||
| Net interest income | 2,415,857 | 2,477,236 | 2,522,105 | 2,548,440 | ||||||||||||
| Provision for loan losses | 30,000 | 30,000 | 51,000 | 63,000 | ||||||||||||
| Net interest income after provision for loan losses | 2,385,857 | 2,447,236 | 2,471,105 | 2,485,440 | ||||||||||||
| Total noninterest income | 396,719 | 485,889 | 484,244 | 412,379 | ||||||||||||
| Total noninterest expense | 1,781,318 | 1,682,607 | 1,803,558 | 1,698,223 | ||||||||||||
| Income before income taxes | 1,001,258 | 1,250,518 | 1,151,791 | 1,199,596 | ||||||||||||
| Income taxes | 316,000 | 342,000 | 330,000 | 342,000 | ||||||||||||
| Net income | $ | 685,258 | $ | 908,518 | $ | 821,791 | $ | 857,596 | ||||||||
| Per share data: | ||||||||||||||||
| Net income | ||||||||||||||||
| Basic | $ | 0.53 | $ | 0.70 | $ | 0.64 | $ | 0.66 | ||||||||
| Diluted | 0.53 | 0.70 | 0.63 | 0.66 | ||||||||||||
| Average shares outstanding | ||||||||||||||||
| Basic | 1,285,676 | 1,289,441 | 1,293,649 | 1,294,890 | ||||||||||||
| Diluted | 1,292,832 | 1,297,620 | 1,301,829 | 1,309,041 | ||||||||||||
| 22. | SELECTED QUARTERLY FINANCIAL DATA (Unaudited) (Continued) |
| Three Months Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2003 | 2003 | 2003 | 2003 | |||||||||||||
| Total interest income | $ | 3,587,523 | $ | 3,626,098 | $ | 3,700,273 | $ | 3,681,472 | ||||||||
| Total interest expense | 1,451,033 | 1,450,680 | 1,430,071 | 1,393,123 | ||||||||||||
| Net interest income | 2,136,490 | 2,175,418 | 2,270,202 | 2,288,349 | ||||||||||||
| Provision for loan losses | 105,000 | 105,000 | 105,000 | — | ||||||||||||
| Net interest income after provision for loan losses | 2,031,490 | 2,070,418 | 2,165,202 | 2,288,349 | ||||||||||||
| Total noninterest income | 276,579 | 358,101 | 375,364 | 469,897 | ||||||||||||
| Total noninterest expense | 1,310,758 | 1,613,208 | 1,592,379 | 1,589,105 | ||||||||||||
| Income before income taxes | 997,311 | 815,311 | 948,187 | 1,169,141 | ||||||||||||
| Income taxes | 344,565 | 200,363 | 246,000 | 340,402 | ||||||||||||
| Net income | $ | 652,746 | $ | 614,948 | $ | 702,187 | $ | 828,739 | ||||||||
| Per share data: | ||||||||||||||||
| Net income | ||||||||||||||||
| Basic | $ | 0.51 | $ | 0.48 | $ | 0.55 | $ | 0.65 | ||||||||
| Diluted | 0.51 | 0.48 | 0.55 | 0.64 | ||||||||||||
| Average shares outstanding | ||||||||||||||||
| Basic | 1,274,964 | 1,274,760 | 1,277,766 | 1,280,421 | ||||||||||||
| Diluted | 1,277,222 | 1,278,101 | 1,281,508 | 1,284,868 | ||||||||||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The consolidated review and analysis of Middlefield Banc Corp. (“MBC” or “Company”) is intended to assist the reader in evaluating the performance of MBC for the years ended December 31, 2004 and 2003. This information should be read in conjunction with the consolidated financial statements and accompanying notes to the financial statements.
MBC is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (“Bank”). The Bank is a state-chartered bank located in Middlefield, Ohio. Middlefield and its subsidiary bank derive substantially all of their income from banking and bank-related services, including interest earnings on residential real estate, commercial mortgage, commercial, and consumer financings as well as interest earnings on investment securities and deposit services to its customers through six locations.
The Bank is subject to examination and comprehensive regulation by the FDIC and the Ohio Department of Banking. MBC is a member of the Federal Home Loan Bank (FHLB) of Cincinnati, which is one of the twelve regional banks comprising the FHLB System.
This Management Discussion and Analysis section of the Annual Report contains certain forward-looking statements. Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond Middlefield’s control. Although Middlefield believes its estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a
representation by Middlefield or any other person that the indicated results will be achieved. Investors are cautioned not to place undue reliance on forward-looking information.
These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results in these forward-looking statements.
Significant Financial Events in 2004
MBC’s board of directors declared a 5 percent share dividend for shareholders of record on December 1, 2004, and a quarterly cash dividend of $0.22 per common share. On December 15, 2004, shareholders of record received additional stock shares equal to 5% of their holdings. Payment of the fourth quarter cash dividend in the amount of $0.22 per share was on the total holdings including the share dividend. The fourth quarter cash dividend, after adjustment for the stock dividend, is 10% higher than the fourth quarter 2003 cash payout. All share and related price and dividend amounts discussed herein have been adjusted to reflect this stock dividend where applicable.
On May 12, 2004 MBC announced that its board authorized the repurchase of up to 4.99% of Middlefield Banc Corp.’s outstanding common stock. In December the Company purchased 34,000 shares of MBC stock at a price of $36.00. The total purchase amount of $1.2 million caused a 4.7% decline in the companies tier 1 capital.
Critical Accounting Policies
Allowance for loan losses
Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The Company’s allowance for loan losses provides for probable losses based upon evaluations of known, and inherent risks in the loan portfolio.
Management uses historical information to assess the adequacy of the allowance for loan losses as well as the prevailing business environment, which is affected by changing economic conditions and various external factors and which may impact the portfolio in ways currently unforeseen. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for loan losses, refer to Note 1 of “Notes to Consolidated Financial Statements” commencing on the following pages of this Annual Report.
The allowance for loan losses at December 31, 2004 totaled $2.6 million, compared to $2.5 million at December 31, 2003. The variance in the allowance from 2003 to 2004 is primarily the result of the growth of the loan portfolio of 12% for the year.
Changes in Financial Condition
General.The Company’s total assets increased $28.8 million or 11% to $291.2 million at December 31, 2004 from $262.4 million at December 31, 2003. This increase was composed of a net increase in securities of $5.6 million, net loans receivable of $22.7 million and Bank-owned life insurance of $222,000 which were partially offset by decreases in premises and equipment and Federal funds sold of $190,000 and $930,000 respectively.
The increase in the Company’s total assets reflects a corresponding increase in total liabilities of $27.5 million or 11.5% to $266.4 million at December 31, 2004 from $238.9 million at December 31, 2003 and a increase in total stockholders’ equity of $1.3 million or 5.6% to $24.8 million at December 31, 2004 from $23.5 million at December 31, 2003. The increase in total liabilities was primarily due to increases in deposits of $20 million, and other borrowed funds of $7.4 million. The net increase in total stockholders’ equity can be attributed primarily to an increase in additional paid in capital and net income offset by an increase in treasury stock of $1.2 million.
Cash on hand, Interest-earning deposits and Federal funds sold.Cash on hand, interest-earning deposits and federal funds sold represent cash equivalents which increased a combined $425,000 or 8.7% to $5.3 million at
December 31, 2004 from $4.9 million at December 31, 2003. Deposits from customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases and repayments of borrowed funds. The net increase in 2004 can be attributed principally to increases in deposits.
Securities.The Company’s loan and securities portfolios represent its two largest balance sheet asset classifications, respectively. The Company’s securities portfolio increased a net $5.6 million or 10.9% to $57.5 million at December 31, 2004 from $51.8 million at December 31, 2003. During 2004, the Company recorded purchases of available for sale securities of $27.6 million, consisting primarily of mortgage-backed securities and municipal bonds. Partially offsetting the purchases were $16.5 million of maturities and repayments of principal, and $4.9 million of securities sold. The Company’s deposits and borrowings primarily fund the securities portfolio.
Loans receivable.The loans receivable category consists primarily of single family mortgage loans used to purchase or refinance personal residences located within the Company’s market area and commercial real estate loans used to finance properties that are used in the borrowers businesses or to finance investor-owned rental properties, and to a lesser extent commercial and consumer loans. Net loans receivable increased $22.7 million or 11.9% to $213 million at December 31, 2004 from $190.4 million at December 31, 2003. Included in this increase were increases in mortgage loans of $12.6 million or 8.9% and commercial and industrial loans of $10.1 million or 23.9%,, which were partially offset by a decrease in real estate construction loans of $290,000. The result was a decrease to the yield on the Company’s loan portfolio from 6.99% in 2003 to 6.67% in 2004.
FHLB stock.FHLB stock increased $53,000 or 4.1% to $1,351,000 at December 31, 2004 from $1,298,000 at December 31, 2003, primarily as a result of the increase in FHLB advances to $23.7 million at December 31, 2004 from $17.7 million at December 31, 2003.
Premises and equipment.Premises and equipment decreased $190,000 or 2.8% to $6.6 million at December 31, 2004 from $6.8 million at December 31, 2003. This decrease can be attributed to normal yearly depreciation.
Bank owned life insurance.Bank owned life insurance (BOLI) is universal life insurance, purchased by the Bank, on the lives of the Bank’s officers. The beneficial aspects of these universal life insurance policies are tax-free earnings and a tax-free death benefit, which are realized by the Bank as the owner of the policies. BOLI increased by $222,000 to $5.4 million as of December 31, 2004 from $5.2 million at the end of 2003 as a result of the earnings of the underlying insurance policies.
Deposits.The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds totaling $239.9 million or 90.1% of the Company’s total funding sources at December 31, 2004. Total deposits increased $20 million or 9.1% to $239.9 million at December 31, 2004 from $219.8 million at December 31, 2003. For the year, the Company’s noninterest-bearing demand deposits increased $6.9 million or 23.5%, time deposits increased $6.0 million or 6.2%, and savings deposits increased $5.7 million or 8.2%.
Borrowed funds.The Company utilizes short and long-term borrowings as another source of funding used for asset growth and liquidity needs. These borrowings primarily include FHLB advances and repurchase agreement borrowings. Borrowed funds increased $7.4 million or 41% to $25.6 million at December 31, 2004 from $18.1 million at December 31, 2003. FHLB advances increased $6.0 million or 34% and repurchase agreements decreased $343,000 or 77%. The increase in borrowed funds for the year reflects the Company’s decision to complement deposits in the support of asset growth.
Stockholders’ equity.Stockholders’ equity increased by $1.3 million or 5.6% to $24.8 million at December 31, 2004 from $23.5 million at December 31, 2003. The net increase in total stockholders’ equity can be attributed primarily to an increase in additional paid in capital of $2.8 million and net income of $3.3 million, offset by an increase in treasury stock of $1.2 million. These items were also partially offset by a decrease in accumulated other comprehensive income of $154,000.
Changes in Results of Operations
2004 Results Compared to 2003 Results
General.The Company reported net income of $3.3 million and $2.8 million for 2004 and 2003, respectively. The $475,000 or 17% increase in net income between 2004 and 2003 can primarily be attributed to a increase in interest income of $1.1 million, and an increase in non-interest income of $351,000, which were partially offset by a increase in interest expense of $44,000 and an increase in non-interest expense of $860,000. Basic earnings per share increased by $.33 a share or 15% to $2.51 at December 31, 2004 from $2.18 at December 31, 2003.
Average Balance Sheet and Yield/Rate Analysis.The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include non-accrual loans and exclude the allowance for loan losses, and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis utilizing a federal tax rate of 34%.
| For the Year Ended Dec 31, | ||||||||||||||||||||||||||||||||||||
| 2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||||||
| Average | Average | Average | Average | Average | Average | |||||||||||||||||||||||||||||||
| Balance | Interest | Yield/Cost | Balance | Interest | Yield/Cost | Balance | Interest | Yield/Cost | ||||||||||||||||||||||||||||
| (Dollars in thousands) | (Dollars in thousands) | (Dollars in thousands) | ||||||||||||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||||||||||||||
| Loans receivable | $ | 204,191 | $ | 13,618 | 6.67 | % | $ | 183,683 | $ | 12,847 | 6.99 | % | $ | 163,828 | $ | 12,341 | 7.53 | % | ||||||||||||||||||
| Investments securities | 54,413 | 2,004 | 4.25 | % | 45,011 | 1,683 | 4.30 | % | 35,169 | 1,615 | 5.21 | % | ||||||||||||||||||||||||
| Interest-bearing deposits with other banks | 5,723 | 111 | 1.94 | % | 6,883 | 117 | 1.70 | % | 6,116 | 164 | 2.68 | % | ||||||||||||||||||||||||
| Total interest-earning assets | 264,327 | 15,733 | 6.07 | % | 235,577 | 14,647 | 6.32 | % | 205,113 | 14,120 | 6.99 | % | ||||||||||||||||||||||||
| Noninterest-earning assets | 15,030 | 12,327 | 8,368 | |||||||||||||||||||||||||||||||||
| Total assets | $ | 279,357 | $ | 247,904 | $ | 213,481 | ||||||||||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||
| Interest - bearing demand deposits | $ | 8,759 | 56 | 0.64 | % | $ | 8,623 | 61 | 0.71 | % | $ | 7,905 | 109 | 1.38 | % | |||||||||||||||||||||
| Money market deposits | 15,145 | 277 | 1.83 | % | 13,355 | 259 | 1.94 | % | 9,090 | 199 | 2.19 | % | ||||||||||||||||||||||||
| Savings deposits | 73,067 | 1,030 | 1.41 | % | 57,413 | 828 | 1.44 | % | 46,045 | 948 | 2.06 | % | ||||||||||||||||||||||||
| Certificates of deposit | 103,022 | 3,543 | 3.44 | % | 98,512 | 3,758 | 3.81 | % | 89,857 | 4,222 | 4.70 | % | ||||||||||||||||||||||||
| Borrowings | 20,630 | 863 | 4.18 | % | 19,635 | 819 | 4.17 | % | 14,258 | 670 | 4.70 | % | ||||||||||||||||||||||||
| Total interest-bearing liabilities | 220,623 | 5,769 | 2.61 | % | 197,538 | 5,725 | 2.90 | % | 167,155 | 6,148 | 3.68 | % | ||||||||||||||||||||||||
| Noninterest-bearing liabilities | ||||||||||||||||||||||||||||||||||||
| Other liabilities | 34,236 | 27,773 | 25,621 | |||||||||||||||||||||||||||||||||
| Stockholders’ equity | 24,498 | 22,594 | 20,705 | |||||||||||||||||||||||||||||||||
| Total liabilities and stockholders’ equity | $ | 279,357 | $ | 247,905 | $ | 213,481 | ||||||||||||||||||||||||||||||
| Net interest income | $ | 9,964 | $ | 8,922 | $ | 7,972 | ||||||||||||||||||||||||||||||
| Interest rate spread (1) | 3.46 | % | 3.42 | % | 3.31 | % | ||||||||||||||||||||||||||||||
| Net yield on interest-earning assets (2) | 3.89 | % | 3.89 | % | 3.99 | % | ||||||||||||||||||||||||||||||
| Ratio of average interest-earning assets to average interest-bearing liabilities | 119.81 | % | 119.26 | % | 122.71 | % | ||||||||||||||||||||||||||||||
| (1) | Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. | |
| (2) | Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets. |
Rate/Volume Analysis. The following table sets forth certain information regarding the changes in our interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume (changes in average
volume multiplied by prior year rate), and (2) changes in rates (changes in rate multiplied by prior year average volume). Increases and decreases due to both rate and volume have been allocated proportionally to the change due to volume and the change due to rate.
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||
| 2004 vs. 2003 | 2003 vs. 2002 | |||||||||||||||||||||||
| Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||||||
| Due to | Due to | |||||||||||||||||||||||
| Volume | Rate | Total | Volume | Rate | Total | |||||||||||||||||||
| (In Thousands) | (In Thousands) | |||||||||||||||||||||||
| Interest income: | ||||||||||||||||||||||||
| Loans Receivable | $ | 1,434 | $ | -663 | $ | 771 | $ | 1,235 | $ | -729 | $ | 506 | ||||||||||||
| Investment securities | 404 | -83 | 321 | 182 | -114 | 68 | ||||||||||||||||||
| Other interest-earning assets | -20 | 14 | -6 | 24 | -71 | -47 | ||||||||||||||||||
| Total interest-earning assets | 1,818 | -732 | 1,086 | 1,441 | -914 | 527 | ||||||||||||||||||
| Interest expense: | ||||||||||||||||||||||||
| Interest-bearing demand | 1 | -6 | -5 | 11 | -59 | -48 | ||||||||||||||||||
| Money market | 35 | -17 | 18 | 79 | -19 | 60 | ||||||||||||||||||
| Savings | 226 | -24 | 202 | 563 | -683 | -120 | ||||||||||||||||||
| Certificates | 172 | -387 | -215 | 487 | -951 | -464 | ||||||||||||||||||
| Other interest-bearing liabilities | 42 | 2 | 44 | 212 | -63 | 149 | ||||||||||||||||||
| Total interest-bearing liabilities | 669 | -625 | 44 | 1,352 | -1,775 | -423 | ||||||||||||||||||
| Change in net interest income | $ | 1,149 | $ | -107 | $ | 1,042 | $ | 89 | $ | 861 | $ | 950 | ||||||||||||
Net interest income.Net interest income, which is the Company’s largest revenue source, is the difference between interest income on earning assets and interest expense paid on liabilities. Net interest income is affected by the changes in interest rates and the composition of interest earning assets and liabilities. Net interest income increased considerably by $1.0 million or 11.7% to $10 million for 2004, compared to $8.9 million for 2003. This increase in net interest income can be attributed to an increase in interest income of approximately $1.1 million, offset partially by a increase in interest expense of $44,000.
Interest income.Interest income increased $1.1 million or 7.4% to $15.7 million for 2004, compared to $14.6 million for 2003. This increase in interest income can be attributed to a increase in interest earned on loans receivable of $771,000 and interest earned on securities of $322,000.
Interest earned on loans receivable increased $771,000 or 6.0% to $13.6 million for 2004, compared to $12.8 million for 2003. This increase was primarily attributable to a increase in the average balance of loans outstanding of $20.5 million or 11.2% to $204.2 million for the year ended December 31, 2004 as compared to $183.7 million for the year ended December 31, 2003. An offset to the growth was a decline in the yield on loans to 6.67% for 2004, compared to 6.99% for 2003.
Interest earned on securities increased $322,000 or 19.1% to $2.0 million for 2004, compared to $1.7 million for 2003. This increase was primarily attributable to an increase in the average balance of securities of $9.4 million to $54.4 million for the year ended December 31, 2004 as compared to $45.0 million for the year ended December 31, 2003.
Interest expense.Interest expense increased slightly by $44,000 or less than 1% to $5.8 million for 2004, compared to $5.7 million for 2003. This increase in interest expense can be attributed to an increase in the average balance of interest-bearing liabilities of $23.1 million to $220.6 million for the year ended December 31, 2004 as compared to $197.5 million for the year ended December 31, 2003. Interest incurred on deposits stayed the same at $4.9 million for both 2004 and 2003. This lack of change was due to a shift in deposit growth from certificates to lower cost savings and demand deposit accounts along with an 11.7% increase in average interest-bearing liabilities. Interest incurred on FHLB advances, repurchase agreements and other borrowings increased $44,000 or 5.4% to $863,000 for 2004, compared to $819,000 million for 2003. This slight increase was primarily attributable to an increase in the average balance of FHLB advances.
Loan Loss Provision— The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan losses at an amount considered adequate to cover probable losses incurred in the normal course of lending. The provision for loan losses was $174,000 in 2004 as compared to $315,000 in 2003. The loan loss provision is based upon management’s assessment of a variety of factors, including types and amounts of nonperforming loans, historical loss experience, collectibility of collateral values and guaranties, pending legal action for collection of loans and related guaranties, and current economic conditions. The loan loss provision reflects management’s judgment of the current period cost-of-credit risk inherent in the loan portfolio. Although management believes the loan loss provision has been sufficient to maintain an adequate allowance for loan losses, actual loan losses could exceed the amounts that have been charged to operations. The change in the loan loss provision in 2004 was principally a result of an increase in loan volume during the year.
Noninterest income.Noninterest income increased $351,000 or 24.6% to $1.8 million for 2004, compared to $1.4 million for 2003. This increase can be attributed to increases in fees and service charges of $368,000 and the earnings on bank-owned life insurance of $20,000. Partially offsetting these increases were the net realized loss on sales of securities available for sale of $98,000.
Fees and service charges increased $368,000 or 35.6% to $1.4 million for 2004, compared to $1.0 million for 2003. This increase resulted from the Company introducing a new overdraft service in the second quarter of 2004.
Noninterest expense.Noninterest expenses increased $860,000 or 14.1% to $7 million for 2004, compared to $6.1 million for 2003. The growth can be attributed to increases in salaries and employee benefits, occupancy and advertising expense which, increased $357,000, $91,000 and $85,000 respectively.
Compensation and employee benefits expense increased $357,000 or 11.6% to $3.4 million for 2004, compared to $3.1 million for 2003. This increase can be attributed to increases to payroll expenses, the cost of health benefits and profit sharing expenses of $224,000, $54,000 and $49,000, respectively.
Data processing expense increased $68,000 or 14.5% to $538,000 for 2004, compared to $470,000 for 2003. The increase to data processing expense is a reflection of the Company’s commitment to continually improve technology in order to enhance service to its customer base.
Occupancy expense increased $91,000 or 22.6% to $495,000 for 2004, compared to $404,000 for 2003. The increased occupancy expense was due in part to increased utility costs as well as leasehold improvements to the Mantua facility.
Advertising expense increased $85,000 or 50.4% to $254,000 for 2004, compared to $169,000 for 2003. The increase in Advertising was due to the Company’s commitment to enhance the marketing budget for Bank promotions.
Other expenses increased $165,000 or 16.5% to $1.2 million for 2004, compared to $1.0 million for 2003. The increase to other noninterest expense is a result in part to the rising cost of examination and auditing expense brought about by the continuing regulatory burdens on the banking industry.
Provision for Income Taxes. The provision for income taxes increased $199,000 or 17.6% to $1.3 million for 2004, compared to $1.1 million for 2003. This increase was primarily the result of an increase in income before income taxes $673,000 or 17.1% to $4.6 million for 2004, compared to $3.9 million for 2003.
2003 Results Compared to 2002 Results
General.For the fifth year in a row your Company posted record earnings. Middlefield recorded net income of $2.8 million in 2003, which represents an increase of $300,000, or 11.92%, over 2002. Net income for 2002 of $2.5 million represented an increase of $230,000, or 10.1%, over 2001. Diluted earnings per share have increased each of the past two years to $2.18 per share for 2003 and $1.95 per share for 2002.
Net Interest Income— Net interest income for 2003 increased to $8.9 million, compared to $8.0 million for 2002. Interest income for 2003 was $14.6 million as compared to $14.1 million for 2002. This increase of $527,000 or 3.7% was influenced primarily by an increase in interest earned on loans receivable of $506,000, while offset by decreases in interest earned on interest-bearing deposits in other institutions, and federal funds sold, of $31,000, and $16,000 respectively. Although the 2003 rate environment was characterized by lower interest rate yields, 2003’s increase in interest income was driven by increases in average balances of interest-earning assets. The average balance of loans receivable and investment securities increased $19.9 million to $183.7 million and $9.8 million to $45.0 million, respectively, during 2003. The tax-equivalent yield on interest earning assets decreased to 6.32% for 2003 from 6.99% for 2002, and primarily resulted from a 91 basis point and 54 basis point decrease in investment securities and loans receivable, respectively. During 2003, $22.5 million in called, sold, and re-payed investment securities were reinvested at substantially lower rates. The inflow of deposits coupled with the rapid repayment of mortgage-backed securities has resulted in reinvestment options at substantially lower rates than the previous year. The lower interest rate environment resulted when interest rates were driven downward by an aggressive rate reduction policy by the Federal Reserve Board over the past few years.
Interest expense decreased $423,000 or 6.9% for 2003 to $5,725,000 from $6,148,000 for 2002. Interest expense incurred on deposits decreased $572,000 for 2003 as compared to 2002 and was primarily attributable to the current interest rate environment that resulted in a lowering of the cost of funds to 2.90% for 2003 as compared to 3.68% for 2002. Offsetting the declining rates was an increase in the average balance of interest-bearing liabilities of $30.4 million to $197.5 million for 2003. In particular, the average balance of savings and certificates of deposits increased $11.4 million and $8.7 million, respectively. Core deposit growth also was driven by a general shift in customer preference away from the equity markets and into insured bank deposits. Although the Bank reduced its costs on all deposit products during 2003, certificates of deposits were the primary target as such costs decreased by 89 basis points. Interest expense on borrowings increased to $819,000 for 2003 as compared to $670,000 for 2002 and resulted primarily from an additional $5.4 million in borrowings with the Federal Home Loan Bank in 2003. The Company borrowed from the FHLB in varying maturities at an average rate of 2.9% to lock into what management believes to be a low cost of funds.
Loan Loss Provision— The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan losses at an amount considered adequate to cover probable losses incurred in the normal course of lending. The provision for loan losses was $315,000 in 2003 as compared to $300,000 in 2002. The loan loss provision is based upon management’s assessment of a variety of factors, including types and amounts of nonperforming loans, historical loss experience, collectibility of collateral values and guaranties, pending legal action for collection of loans and related guaranties, and current economic conditions. The loan loss provision reflects management’s judgment of the current period cost-of-credit risk inherent in the loan portfolio. Although management believes the loan loss provision has been sufficient to maintain an adequate allowance for loan losses, actual loan losses could exceed the amounts that have been charged to operations. The change in the loan loss provision in 2003 was principally a result of an increase in net charge-offs to average loans during the year.
Noninterest Income. Noninterest income is made up of bank related fees and service charges, as well as other income-producing services. These include ATM/interchange income, safe deposit box rental income and other miscellaneous items. In addition the bank invested in Bank Owned Life Insurance (BOLI) in 2003. The earnings from this investment are reflected in the Company’s noninterest income. Total noninterest income increased 25% in 2003 to $1.4 million from $1.1 million for 2002. The increase is accounted for principally by the income from the purchase of bank owned life insurance (BOLI) of $202,000 in 2003. An increase in fee income from deposit accounts also contributed significantly to 2003’s increased noninterest income. Deposit account service fees have progressively increased as the number of accounts and volume of related transactions have increased.
Transaction deposit accounts grew at a steady pace in 2003 and 2002. In general, management prices deposits at rates competitive with rates offered by the other banks in Middlefield’s market, which rates tend to be somewhat lower than rates offered by thrift institutions and credit unions. Middlefield generally has not imposed service charges and fees to the same extent as other local institutions. Although a wider range of service charges and fees and higher service charges and fees would yield more income for each dollar of deposits, imposing service charges and fees on a basis equivalent to those imposed by many other area banks might adversely affect deposit growth. To promote deposit growth and provide cross-selling opportunities, Middlefield has not adopted the most aggressive fee structure. Deposit growth is generated by developing strong customer relationships and cross-selling deposit relationships to loan customers. Management intends to continue promoting demand deposit products, particularly noninterest-bearing deposit products, in order to obtain additional interest-free lendable funds.
Noninterest Expense—Noninterest expense increased 17.3% to $6.1 million for 2003 as compared to $5.2 million for 2002. Compensation and employee benefits increased $562,000, or 22.3%, primarily as a result of normal merit raises and the establishment of an employee profit sharing plan Occupancy and equipment expenses increased 8.0% or $55,000 as a result of added capital expenditures in prior years. As a result of increased transaction activity from operating a larger organization, data processing expenses increased $43,000 or 10.1% during 2003 as compared to 2002. In addition, all other expenses increased $239,000 or 15.2%. A large part of this increase of $104,000 was due to an enhanced marketing budget in 2003 to promote the bank’s new look and logo. Increases in other expense also included operating expenses that resulted from expanding into a larger organization.
Provision for Income Taxes. The provision for income taxes fluctuated in 2003, 2002, and 2001 in direct correlation to the changing level of pre-taxable income during these periods. The purchase BOLI did not materially alter the effective marginal tax rate
Asset and Liability Management
The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the repricing or maturity of its interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in strong asset/liability management in order to insulate the Company from material and prolonged increases in interest rates. As a result of this policy, the Company emphasizes a larger, more diversified portfolio of residential mortgage loans in the form of mortgage-backed securities. Mortgage-backed securities generally increase the quality of the Company’s assets by virtue of the insurance or guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company.
The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management.. This committee, which meets quarterly, generally monitors various asset and liability management policies and strategies, which were implemented by the Company over the past few years.
Interest Rate Sensitivity Simulation Analysis
The Company utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. The Asset and Liability Management Committee of the Company believes that simulation modeling enables the Company to more accurately evaluate and manage the possible effects on net interest income due to the exposure to changing market interest rates, the slope of the yield curve and different loan and mortgage-backed security prepayment and deposit decay assumptions under various interest rate scenarios.
Earnings simulation modeling, assumptions about the timing and variability of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and the assumptions about expected attrition of the core deposit portfolios. These assumptions are based on the Company’s historical experience and industry standards and are applied consistently across the different rate risk measures.
The Company has established the following guidelines for assessing interest rate risk:
Net interest income simulation.Given a 200 basis point parallel gradual increase or decrease in market interest rates, net interest income may not change by more than 10% for a one-year period.
Portfolio equity simulation.Portfolio equity is the net present value of the Company’s existing assets and liabilities. Given a 200 basis point immediate and permanent increase or decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity.
The following table presents the simulated impact of a 200 basis point upward or downward shift of market interest rates on net interest income, and the change in portfolio equity. This analysis was done assuming that the interest-earning asset and interest-bearing liability levels at December 31, 2004 remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually over a one-year period from the December 31, 2004 levels for net interest income, and portfolio equity The impact of market rate movements was developed by simulating the effects of an immediate and permanent change in rates at December 31, 2004 for portfolio equity:
| Increase | Decrease | |||||||
| +200 | -200 | |||||||
| BP | BP | |||||||
| Net interest income - increase (decrease) | 7.67 | % | (9.23 | )% | ||||
| Portfolio equity - increase (decrease) | (6.97 | )% | .20 | % | ||||
Allowance for Loan Losses. The allowance for loan losses represents the amount management estimates is adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. At December 31, 2004, Middlefield’s allowance for loan losses increased to $2.6 million from $2.5 million at December 31, 2003, and now represents 1.22% of the gross loan portfolio as compared to 1.30% for the previous period. The allowance for loan losses is established through a provision for loan losses, which is charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance for loan losses, taking into account the overall risk characteristics of the various portfolio segments, the bank’s loan loss experience, the impact of economic conditions on borrowers, and other relevant factors. The estimates used to determine the adequacy of the allowance for loan losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term. The total allowance for loan losses is a combination of a specific allowance for identified problem loans, a formula allowance, and an unallocated allowance.
The specific allowance incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (“FAS”) No. 114,Accounting by Creditors for Impairment of a Loan, and FAS No. 118,Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures. These accounting standards prescribe the measurement methods, income recognition and disclosures for impaired loans. The formula allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management’s determination of the amounts necessary for concentrations and changes in mix and volume of the loan portfolio, and consideration of historical loss experience.
The unallocated allowance is determined based upon management’s evaluation of existing economic and business conditions affecting the key lending areas of the bank and other conditions, such as new loan products, credit quality trends, collateral values, specific industry conditions within portfolio segments that existed as of the balance sheet date, and the impact of those conditions on the collectibility of the loan portfolio. Management reviews these conditions quarterly. The unallocated allowance is subject to a higher degree of uncertainty because it considers risk factors that may not be reflected in the historical loss factors.
Although management believes that it uses the best information available to make such determinations and that the allowance for loan losses was adequate at December 31, 2004, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review a bank’s loan loss allowance. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.
The following table sets forth information concerning the Middlefield’s allowance for loan losses at the dates and for the periods presented.
| For the Years Ended | ||||||||||||
| December 31, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Dollars in thousands) | ||||||||||||
| Allowance balance at beginning of period | $ | 2,521 | $ | 2,300 | $ | 2,062 | ||||||
| Loans charged off: | ||||||||||||
| Commercial and industrial | -61 | -75 | -67 | |||||||||
| Real estate-construction | ||||||||||||
| Real estate-mortgage: | ||||||||||||
| Residential | — | -32 | — | |||||||||
| Commercial | — | — | — | |||||||||
| Consumer installment | -57 | -37 | -52 | |||||||||
| Total loans charged off | -118 | -144 | -119 | |||||||||
| Recoveries of loans previously charged-off: | ||||||||||||
| Commercial and industrial | 27 | 28 | 24 | |||||||||
| Real estate-construction | — | — | — | |||||||||
| Real estate-mortgage: | — | — | — | |||||||||
| Residential | 3 | — | — | |||||||||
| Commercial | — | — | — | |||||||||
| Consumer installment | 16 | 22 | 33 | |||||||||
| Total recoveries | 46 | 50 | 57 | |||||||||
| Net loans recovered (charged off) | -72 | -94 | -62 | |||||||||
| Provision for loan losses | 174 | 315 | 300 | |||||||||
| Allowance balance at end of period | $ | 2,623 | $ | 2,521 | $ | 2,300 | ||||||
| Loans outstanding: | ||||||||||||
| Average | $ | 204,191 | $ | 183,683 | $ | 163,828 | ||||||
| End of period | 215,653 | 192,880 | 174,943 | |||||||||
| Ratio of allowance for loan losses to loans outstanding at end of period | 1.22 | % | 1.31 | % | 1.31 | |||||||
| Net recoveries (charge offs) to average loans | -0.04 | -0.05 | -0.04 | |||||||||
The following table illustrates the allocation of Middlefield’s allowance for probable loan losses for each category of loan for each reported period. The allocation of the allowance to each category is not necessarily indicative of future loss in a particular category and does not restrict our use of the allowance to absorb losses in other loan categories.
| At December 31, | ||||||||||||||||||||||||
| 2004 | 2003 | 2002 | ||||||||||||||||||||||
| Percent of | Percent of | Percent of | ||||||||||||||||||||||
| Loans in Each | Loans in Each | Loans in Each | ||||||||||||||||||||||
| Category to | Category to | Category to | ||||||||||||||||||||||
| Amount | Total Loans | Amount | Total Loans | Amount | Total Loans | |||||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||||||
| Type of Loans: | ||||||||||||||||||||||||
| Commercial and industrial | $ | 1,139 | 24.10 | % | $ | 568 | 21.81 | % | $ | 611 | 18.82 | |||||||||||||
| Real estate construction | 31 | 1.79 | 32 | 1.78 | 38 | 1.83 | ||||||||||||||||||
| Mortgage: | ||||||||||||||||||||||||
| Residential | 1,019 | 68.36 | 844 | 69.48 | 888 | 70.79 | ||||||||||||||||||
| Commercial | 145 | 3.16 | 228 | 4.08 | 230 | 5.44 | ||||||||||||||||||
| Consumer installment | 123 | 2.70 | 120 | 2.85 | 124 | 3.12 | ||||||||||||||||||
| Unallocated | 166 | — | 435 | — | 409 | — | ||||||||||||||||||
| Total | $ | 2,623 | 100 | % | $ | 2,227 | 100 | % | $ | 2,300 | 100 | |||||||||||||
Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Payments received on nonaccrual loans are recorded as income or applied against principal according to management’s judgment as to the collectibility of principal.
A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance homogeneous loans that are to be collectively evaluated. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the bank expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Management evaluates all loans identified as impaired individually. The bank estimates credit losses on impaired loans based on the present value of expected cash flows, or the fair value of the underlying collateral if loan repayment is expected to come from the sale or operation of the collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until that time, an allowance for loan losses is maintained for estimated losses.
Unless otherwise required by the loan terms, cash receipts on impaired loans are applied first to accrued interest receivable, except when an impaired loan is also a nonaccrual loan, in which case the portion of the payment related to interest is recognized as income.
Nonperforming loans as a percentage of total net loans at December 31, 2004 increased to 0.68% from 0.26% for
2003. The bank had nonaccrual loans of $279,000 and $372,000 at December 31, 2004 and 2003, respectively. Interest income recognized on nonaccrual loans during all of the periods was insignificant. Management does not believe the nonaccrual loans or any amounts classified as nonperforming had a significant effect on operations or liquidity in 2004. Furthermore, management is not aware of any trends or uncertainties related to any loans classified as doubtful or substandard that might have a material effect on earnings, liquidity, or capital resources. Management is not aware of any information pertaining to material credits that would cause it to doubt the ability of borrowers to comply with repayment terms.
The following table summarizes nonperforming assets by category.
| At December 31, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Dollars in thousands) | ||||||||||||
| Loans accounted for on a nonaccrual basis: | ||||||||||||
| Commercial and industrial | $ | — | $ | — | $ | — | ||||||
| Real estate-construction | — | — | — | |||||||||
| Real estate-mortgage: | — | |||||||||||
| Residential | 279 | 372 | 357 | |||||||||
| Commercial | — | — | — | |||||||||
| Consumer installment | — | — | — | |||||||||
| Total nonaccrual loans | 279 | 372 | 357 | |||||||||
| Accruing loans which are contractually past due 90 days or more: | ||||||||||||
| Commercial and industrial | 239 | 4 | 30 | |||||||||
| Real estate-construction | — | — | — | |||||||||
| Real estate-mortgage: | — | — | — | |||||||||
| Residential | 722 | 114 | 144 | |||||||||
| Commercial | 209 | — | — | |||||||||
| Consumer installment | 25 | 19 | 7 | |||||||||
| Total accruing loans which are contractually past due 90 days or more | 1,195 | 137 | 181 | |||||||||
| Total non - performing loans | 1,474 | 509 | 538 | |||||||||
| Real estate owned | — | — | — | |||||||||
| Other non-performing assets | — | — | — | |||||||||
| Total non-performing assets | $ | 1,474 | $ | 509 | $ | 538 | ||||||
| Total non-performing loans to total loans | 0.68 | % | 0.26 | % | 0.31 | % | ||||||
| Total non-performing loans to total assets | 0.51 | % | 0.19 | % | 0.24 | % | ||||||
| Total non-performing assets to total assets | 0.51 | % | 0.19 | % | 0.24 | % | ||||||
| (1) | Represents accruing loans delinquent greater than 90 days that are considered by management to be well secured and that are | |
| in the process of collection. | ||
Liquidity and Capital Resources
Liquidity.Liquidity management for Middlefield is measured and monitored on both a short- and long-term basis, allowing management to better understand and react to emerging balance sheet trends. After assessing actual and projected cash flow needs, management seeks to obtain funding at the most economical cost to Middlefield. Both short- and long-term liquidity needs are addressed by maturities and sales of investments securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold. The use of these resources, in conjunction with access to credit, provide the core ingredients for satisfying depositor, borrower, and creditor needs.
Middlefield’s liquid assets consist of cash and cash equivalents, which include investments in very short-term investments (i.e. federal funds sold), and investment securities classified as available for sale. The level of these assets is dependent on Middlefield’s operating, investing, and financing activities during any given period. At December 31, 2004, cash and cash equivalents totaled $5.3 million or 1.8% of total assets while investment securities classified as available for sale totaled $57.2 million or 19.7% of total assets. Management believes that the liquidity needs of Middlefield are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, FHLB advances, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable Middlefield to meet cash obligations and off-balance sheet commitments as they come due.
Operating activities provided net cash of $4.0 million, $3.5 million, and $3.2 million for 2004, 2003, and 2002, respectively, generated principally from net income of $3.3 million, $2.8 million, and $2.5 million in each of these respective periods.
Investing activities consist primarily of loan originations and repayments and investment purchases and maturities. These cash usages primarily consisted of loan originations of $22.7 million, as well as investment purchases of $27.6 million. Partially offsetting the usage of investment activities is $21.4 million of proceeds from investment security maturities, sales and repayments. For the same period ended 2003, investing activities used $34.1 million in funds, principally for the net origination of loans and the purchase of investment securities of $17.9 million and $32.9 million, respectively. During the same period ended 2002, cash usages primarily consisted of loan originations of $22.1 million, as well as investment purchases of $24.4 million.
Financing activities consist of the solicitation and repayment of customer deposits, borrowings and repayments, treasury stock activity, and the payment of dividends. During 2004, net cash provided by financing activities totaled $25.7 million, principally derived from an increase in deposit accounts in general, and savings deposits specifically. Also contributing to this influx of cash was proceeds from other borrowings of $6.0 million. During 2003, net cash provided by financing activities totaled $33.4 million, principally derived from an increase in deposit accounts. During the same period ended 2002, net cash provided by financing activities was $25.6 million, principally derived from an increase in deposit accounts.
Liquidity may be adversely affected by unexpected deposit outflows, excessive interest rates paid by competitors, and similar matters. Management monitors projected liquidity needs and determines the level desirable, based in part on Middlefield’s commitment to make loans, as well as management’s assessment of Middlefield’s ability to generate funds. Middlefield anticipates that it will have sufficient liquidity to satisfy estimated short-term and long-term funding needs.
Capital Resources. Middlefield’s primary source of capital has been retained earnings. Historically, Middlefield has generated net retained income to support normal growth and expansion. Management has developed a capital planning policy to not only ensure compliance with regulations, but also to ensure capital adequacy for future expansion.
Middlefield is subject to federal regulations imposing minimum capital requirements. Management monitors both Middlefield’s and the Bank’s Total risk-based, Tier I risk-based and Tier I leverage capital ratios to assess
compliance with regulatory guidelines. At December 31, 2004, both Middlefield and the Bank exceeded the minimum risk-based and leverage capital ratio requirements. Middlefield’s Total risk-based, Tier I risk-based and Tier I leverage ratios were 14.28%, 13.04%, and 8.51%, and the Bank’s were 14.28%, 13.02%, and 8.51%, respectively, at December 31, 2004.
The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments.
Contractual Obligations:
Contractual Obligations
The following table discloses our contractual obligations and commitments as of December 31, 2004:
| Less Than | After | |||||||||||||||||||
| Total | 1 Year | 1 - 3 Years | 4 - 5 Years | 5 Years | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Short-term borrowings | $ | 1,872 | $ | 1,872 | $ | — | $ | — | $ | — | ||||||||||
| Federal Home Loan Bank advances | 23,683 | 3,999 | 7,060 | 8,444 | 4,180 | |||||||||||||||
| Total | $ | 25,555 | $ | 5,871 | $ | 7,060 | $ | 8,444 | $ | 4,180 | ||||||||||
| Total | ||||||||||||||||||||
| Amounts | Less Than | After | ||||||||||||||||||
| Committed | 1 Year | 1 - 3 Years | 4 - 5 Years | 5 Years | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Standby letters of credit | $ | 223 | $ | 223 | $ | — | $ | — | $ | — | ||||||||||
| Other commitments to extend credit (1) | 33,925 | 33,925 | — | — | — | |||||||||||||||
| Total | $ | 34,148 | $ | 34,148 | $ | — | $ | — | $ | — | ||||||||||
| (1) | Represents amounts committed to customers. |
Commitments to extend credit, include loan commitments, standby letters of credit and do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.
Market for Middlefield’s Common Equity and Related Stockholder Matters
Middlefield had approximately 787 stockholders of record as of February 17, 2005. There is no established market for Middlefield common stock. The stock is traded very infrequently. Bid prices are quoted from time to time on the National Quotation Bureau’s “pink sheets” under the symbol “MBCN.” The following table shows the high and low bid prices of and cash dividends paid on Middlefield common stock in 2004 and 2003, adjusted for stock splits and stock dividends. This information does not reflect retail mark-up, markdown or commissions, and does not necessarily represent actual transactions.
| Cash Dividends | ||||||||||||
| High Bid | Low Bid | per share | ||||||||||
| 2004 | ||||||||||||
| First Quarter | $ | 30.707 | $ | 30.581 | $ | 0.200 | ||||||
| Second Quarter | $ | 31.390 | $ | 30.829 | $ | 0.200 | ||||||
| Third Quarter | $ | 33.880 | $ | 33.676 | $ | 0.210 | ||||||
| Fourth Quarter | $ | 35.836 | $ | 35.815 | $ | 0.220 | ||||||
| 2003 | ||||||||||||
| First Quarter | $ | 27.665 | $ | 24.943 | $ | 0.182 | ||||||
| Second Quarter | $ | 28.118 | $ | 26.304 | $ | 0.182 | ||||||
| Third Quarter | $ | 28.617 | $ | 27.220 | $ | 0.190 | ||||||
| Fourth Quarter | $ | 29.524 | $ | 27.643 | $ | 0.200 | ||||||
