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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2005
Commission file number 0-25752
FNBH BANCORP, INC.
(Exact name of registrant as specified in its charter)
| MICHIGAN | 38-2869722 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
101 East Grand River, Howell, Michigan 48843
(Address of principal executive offices) (Zip Code)
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code:(517) 546-3150
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Common Stock, no par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2). Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. The aggregate market value of common stock held by non-affiliates as of June 30, 2005, was $98,738,510.
The number of shares of common stock (no par value) as of March 1, 2006 was 3,179,141.
Documents Incorporated by Reference:
Portions of the Corporation’s Proxy Statement for the Annual Meeting of Shareholders to be held April 12, 2006, are incorporated by reference into Parts I, II and III of this report.
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PART I
| Item 1. | Business. |
FNBH Bancorp, Inc. (the Corporation), a Michigan business corporation, is a one-bank holding company, which owns all of the outstanding capital stock of First National Bank in Howell (the “Bank”). The Corporation was formed in 1988 for the purpose of acquiring all of the stock of the Bank in a shareholder approved reorganization, which became effective in May 1989. The Corporation’s internet address is www.fnbsite.com. Through our internet website, we make available free of charge, as soon as reasonably practical after such information has been filed with the Securities and Exchange Commission, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with the Securities and Exchange Commission. Also available on our website are the respective Charters of the Board’s Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee, as well as the Company’s Code of Ethics for its Chief Executive Officer and other senior financial officers.
The Bank was originally organized in 1934 as a national banking association. As of January 31, 2006, the Bank had approximately 134 full-time and part-time employees. None of the Bank’s employees are subject to collective bargaining agreements. The Corporation does not directly employ any personnel. The Bank serves primarily five communities, Howell, Brighton, Green Oak Township, Hartland, and Fowlerville, all of which are located in Livingston County. The county has historically been rural in character but has a growing suburban population.
On November 26, 1997, H.B. Realty Co., a subsidiary of the Corporation, was established to purchase land for a future branch site of the Bank and to hold title to other Bank real estate when it is considered prudent to do so.
Bank Services
The Bank is a full-service bank offering a wide range of commercial and personal banking services. These services include checking accounts, savings accounts, certificates of deposit, commercial loans, real estate loans, installment loans, trust and investment services, collections, traveler’s checks, night depository, safe deposit box and U.S. Savings Bonds. The Bank maintains correspondent relationships with major banks in Detroit, pursuant to which the Bank engages in federal funds sale and purchase transactions, the clearance of checks and certain foreign currency transactions. The Bank also has a relationship with the Federal Home Loan Bank of Indianapolis where it makes short term investments and where it has a line of credit of $37,700,000 of which $35,900,000 is available, and $1,800,000 is funded as of year end. In addition, the Bank participates with other financial institutions to fund certain large loans which would exceed the Bank’s legal lending limit if made solely by the Bank.
The Bank’s deposits are generated in the normal course of business, and the loss of any one depositor would not have a materially adverse effect on the business of the Bank. As of December 31, 2005 and 2004, the Bank’s certificates of deposit of $100,000 or more constituted approximately 22% and 14%, respectively, of total deposit liabilities. The Bank’s deposits are primarily from its service areas, and the Bank does not seek or encourage large deposits from outside the area.
The Corporation’s cash revenues are derived primarily from dividends paid by the Bank. The Bank’s principal sources of revenue are interest and fees on loans and interest on investment securities. Interest and fees on loans constituted approximately 79% of total revenues for the period ended December 31, 2005, and 76% for the period ended December 31, 2004. Interest on investment securities, including short-term investments and certificates of deposit, constituted approximately 9% of total revenues in 2005 and 10% of total revenues in 2004. Revenues were also generated from deposit service charges and other financial service fees.
The Bank provides real estate, consumer, and commercial loans to customers in its market. As of December 31, 2005, 37% of outstanding loans were for commercial or residential construction and land development. Forty-seven percent of the Bank’s loan portfolio is in fixed rate loans. Most of these loans, approximately 97%, mature within five years of issuance. Approximately $5,000,000 in loans (or about 1.3% of the Bank’s total loan portfolio) have fixed rates with maturities exceeding five years. Fifty percent of the Bank’s interest-bearing deposits are in savings, NOW, and MMDAs, all of which are variable rate products. As of December 31, 2005, certificates of deposits totaled approximately $176,000,000 with $127,300,000 maturing within a year, and the majority of the balance maturing within a five year period.
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Requests to the Bank for credit are considered on the basis of credit worthiness of each applicant, without consideration to race, color, religion, national origin, sex, marital status, physical handicap, age, or the receipt of income from public assistance programs. Consideration is also given to the applicant’s capacity for repayment, collateral, capital and alternative sources of repayment. Loan applications are accepted at all the Bank’s offices and are approved under each lending officer’s authority. Request for loans from borrowers with aggregate indebtedness in excess of $1,500,000 are required to be presented to the Board of Directors or the Executive Committee of the Board for its review and approval.
As described in more detail below, the Bank’s cumulative one year gap ratio of rate sensitive assets to rate sensitive liabilities at December 31, 2005, was 17% asset sensitive, compared to 42% asset sensitive at December 31, 2004. See discussion and table under “Quantitative and Qualitative Disclosures about Market Risk” in Item 7A below.
The Bank sells participations in commercial loans to other financial institutions approved by the Bank for the purpose of meeting legal lending limit requirements or loan concentration considerations. The Bank regularly sells fixed rate residential mortgages to the Federal Home Loan Mortgage Corporation (Freddie Mac) while retaining servicing on the sold loans. Those residential real estate mortgage loan requests that do not meet Freddie Mac criteria are reviewed by the Bank for approval and, if approved, are retained in the Bank’s loan portfolio. The Bank also may purchase loans which meet its normal credit standards.
The Bank’s investment policy is designed to provide a framework within which the Bank may maximize earnings potential by acquiring assets designed to enhance profitability, absorb excess funds, provide liquidity, maintain a high credit quality, implement interest rate risk measures, provide collateral for pledging, generate a favorable return on investments, and provide tax-exempt income as appropriate. Safety, liquidity, and interest rate risk standards will not be compromised in favor of increased return. When making investment decisions, the Bank considers investment type, credit quality (including maximum credit exposure to one obligor at any one time) and maturity of investments. Consideration is also given to each investment’s risk-weight as determined by regulatory Risk-Based Capital Guidelines.
The portfolio must be coordinated with the overall asset/liability management of the balance sheet. The use of the investment portfolio for market oriented trading activities or speculative purposes are expressly prohibited unless otherwise approved by the Board of Directors. Investments are acquired for which the Bank has both the ability and intent to hold to maturity. Specific limits determine the types, maturities, and amounts of securities the Bank intends to hold. Guidelines on liquidity requirements, as well as an acknowledgement of the Bank’s credit profile and capital position may affect the Bank’s ability to hold securities to maturity. It is not the intention of management to profit from short-term securities price movements. Business reasons for securities purchases and sales will be noted at the time of the transaction. All securities dealers effecting transactions in securities held or purchased by the Bank must be approved by the Board of Directors.
Bank Competition
The Bank has nine offices within the five communities it serves, all of which are located in Livingston County, Michigan. Four of the offices, including the main office, are located in Howell. There are two facilities in Brighton, and one each in Green Oak Township, Hartland, and Fowlerville. See “Properties” below for more detail on these facilities. Within these communities, its principal competitors are Fifth Third Bank, National City Bank, Republic Bank, Comerica Bank and LaSalle Bank. Each of these financial institutions, which are headquartered in larger metropolitan areas, has significantly greater assets and financial resources than the Corporation. Among the principal competitors in the communities in which the Bank operates, the Bank is the only financial institution with a local community headquarters. Based on deposit information as of June 30, 2005, the Bank holds approximately 22.55% of local deposits, compared to approximately 14.61% held by Fifth Third Bank, approximately 10.80% held by National City, approximately 9.74% held by Republic Bank, approximately 9.11% held by Comerica Bank, and approximately 8.07% held by LaSalle Bank. Information as to asset size of competitor financial institutions is derived from publicly available reports filed by and with regulatory agencies. Within the Bank’s markets, Fifth Third Bank maintains five branch offices, National City Bank operates seven branch offices, Republic Bank has five branch offices, Comerica has six branch offices, and LaSalle Bank has three branch offices. Management is not aware of any plans by these financial institutions to expand their presence in the Bank’s market. The Bank also competes with savings and loan associations, credit unions, mortgage banking companies and various other financial service providers.
The financial services industry continues to become increasingly competitive. Principal methods of competition include loan and deposit pricing, advertising and marketing programs, and the types and quality of services provided. The deregulation of the financial services industry and the easing of restrictions on bank and holding company activities have led to increased competition among banks and other financial service providers for funds, loans, and a broad array of other
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financial services. There has been increased competition within the Bank’s market over the past few years as new branches are built to meet the needs of the growing population in the county. Management continues to evaluate the opportunities for the expansion of products and services.
Growth of Corporation
The following table sets forth certain information regarding the growth of the Corporation:
| Balances as of December 31, | ||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
| Total Assets | $ | 477,225 | $ | 456,910 | $ | 450,342 | $ | 420,686 | $ | 392,978 | ||||||||||
| Loans | 372,855 | 357,377 | 347,086 | 327,117 | 286,280 | |||||||||||||||
| Securitites | 62,373 | 64,348 | 55,435 | 44,611 | 55,989 | |||||||||||||||
| Noninterest-Bearing Deposits | 71,415 | 71,785 | 69,234 | 62,232 | 62,938 | |||||||||||||||
| Interest-Bearing Deposits | 350,670 | 327,478 | 329,839 | 311,840 | 288,731 | |||||||||||||||
| Total Deposits | 422,086 | 399,263 | 399,073 | 374,072 | 351,669 | |||||||||||||||
| Shareholders’ Equity | 49,446 | 45,716 | 41,235 | 37,580 | 32,404 | |||||||||||||||
Through 2005, the Bank operated nine branch facilities: one in downtown Howell, one at Lake Chemung (five miles east of downtown Howell), one is a grocery store branch located west of downtown Howell, two in Brighton (one on the east side and one on the west side), one in Hartland, one in the village of Fowlerville, one in Genoa Township, and one in Green Oak Township, which is 11 miles southwest of downtown Howell. In the time period presented, the Bank’s deposits grew due to general growth in the county and increased usage of the wholesale funding market.
Supervision and Regulation
The following is a summary of certain statutes and regulations affecting the Corporation and the Bank. This summary is qualified in its entirety by such statutes and regulations. A change in applicable laws or regulations may have a material effect on the Corporation, the Bank and the business of the Corporation and the Bank.
General
Financial institutions and their holding companies are extensively regulated under federal and state law. Consequently, the growth and earnings performance of the Corporation and the Bank can be affected not only by management decisions and general economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the FDIC, the Office of the Comptroller of the Currency (“OCC”), the Internal Revenue Service, and state taxing authorities. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions and their holding companies regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, lending activities and practices, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Corporation and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the depositors of the Bank, and the public, rather than shareholders of the Corporation. Federal law and regulations establish supervisory standards applicable to the lending activities of the Bank, including internal controls, credit underwriting, loan documentation and loan-to-value ratios for loans secured by real property.
The Corporation
General. The Corporation is a bank holding company and, as such, is registered with, and subject to regulation by, the Federal Reserve Board under the Bank Holding Company Act, as amended (the “BHCA”). Under the BHCA, the Corporation is subject to periodic examination by the Federal Reserve Board, and is required to file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal Reserve Board may require.
In accordance with Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Corporation might not do so absent
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such policy. In addition, if the Bank’s capital becomes impaired, the OCC may require the Bank to restore its capital by a special assessment upon the Corporation as the Bank’s sole shareholder. If the Corporation were to fail to pay any such assessment, the directors of the Bank would be required, under federal law, to sell the shares of the Bank’s stock owned by the Corporation at public auction and use the proceeds of the sale to restore the Bank’s capital.
Investments and Activities. In general, any direct or indirect acquisition by the Corporation of any voting shares of any bank which would result in the Corporation’s direct or indirect ownership or control of more than 5% of any class of voting shares of such bank, and any merger or consolidation of the Corporation with another bank company, will require the prior written approval of the Federal Reserve Board under the BHCA.
The merger or consolidation of an existing bank subsidiary of the Corporation with another bank, or the acquisition by such a subsidiary of assets of another bank, or the assumption of liability by such a subsidiary to pay any deposits in another bank, will require the prior written approval of the responsible federal depository institution regulatory agency under the Bank Merger Act. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the BHCA and/or the OCC, may be required.
With certain limited exceptions, the BHCA prohibits any bank holding company from engaging, either directly or indirectly through a subsidiary, in any activity other than managing or controlling Bank unless the proposed non-banking activity is one that the Federal Reserve Board has determined to be so closely related to banking or managing or controlling Bank as to be a proper incident thereto. Under current Federal Reserve Board regulations, such permissible non-banking activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. Well-capitalized and well-managed bank holding companies may engagede novoin certain types of non-banking activities without prior notice to, or approval of, the Federal Reserve Board, provided that written notice of the new activity is given to the Federal Reserve Board within 10 business days after the activity is commenced. If a bank holding company wishes to engage in a non-banking activity by acquiring a going concern, prior notice and/or prior approval will be required, depending upon the activities in which the company to be acquired is engaged, the size of the company to be acquired and the financial and managerial condition of the acquiring bank holding company.
Eligible bank holding companies that elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance activities and any other activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank or financial holding companies. While the Corporation believes it is eligible to elect to operate as a financial holding company, as of the date of this filing, it has not applied for approval to operate as a financial holding company.
Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish additional bank or non-bank businesses. The Federal Reserve Board’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a leverage capital requirement expressed as a percentage of total average assets, and (ii) a risk-based requirement expressed as a percentage of total risk-weighted assets. The leverage capital requirement consists of a minimum ratio of Tier 1 capital (which consists principally of shareholders’ equity) to total average assets of 3% for the most highly rated companies, with minimum requirements of 4% to 5% for all others. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital.
The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels may be required if warranted by the particular circumstances or risk profiles of individual banking organizations. The Federal Reserve Board has not advised the Corporation of any specific minimum Tier 1 Capital leverage ratio applicable to it.
Dividends. The Corporation is an entity separate and distinct from the Bank. Most of the Corporation’s revenues are received by it in the form of dividends paid by the Bank. Thus, the Corporation’s ability to pay dividends to its shareholders is indirectly limited by statutory restrictions on the Bank’s ability to pay dividends as described below. Further, in a policy statement, the Federal Reserve Board has expressed its view that a bank holding company
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experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. Additionally, the Federal Reserve Board possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by Bank and bank holding companies. Similar enforcement powers over the Bank are possessed by the FDIC. The “prompt corrective action” provisions of federal law and regulation authorizes the Federal Reserve Board to restrict the payment of dividends by the Corporation for an insured bank which fails to meet specified capital levels.
In addition to the restrictions on dividends imposed by the Federal Reserve Board, the Michigan Business Corporation Act provides that dividends may be legally declared or paid only if after the distribution a corporation, such as the Corporation, can pay its debts as they come due in the usual course of business and its total assets equal or exceed the sum of its liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of any holders of preferred stock whose preferential rights are superior to those receiving the distribution. The Corporation’s Articles of Incorporation do not authorize the issuance of preferred stock and there are no current plans to seek such authorization.
The Corporation’s common stock is registered with the Securities and Exchange Commission (“SEC”) under the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As a result, the Corporation is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act. The Sarbanes-Oxley Act of 2002 provides for numerous changes to the reporting, accounting, corporate governance and business practices of companies as well as financial and other professionals who have involvement with the U.S. public securities markets. The Corporation’s securities are not listed for trading on any national or regional securities exchange.
The Bank
General. The Bank is organized as a national banking association and is, therefore, regulated and supervised by the OCC. The deposit accounts of the Bank are insured by the Bank Insurance Fund (the “BIF”) of the FDIC. Consequently, the Bank is also subject to the provisions of the Federal Deposit Insurance Act. The Bank is subject to the examination, supervision, reporting and enforcement requirements of the OCC as its primary federal regulator. The OCC and the federal and state laws applicable to the Bank and its operations, extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of non-interest bearing reserves on deposit accounts, and the safety and soundness of banking practices.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, based upon their respective levels of capital and results of supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.
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The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires the FDIC to establish assessment rates at levels which will maintain the Deposit Insurance Fund at a mandated reserve ratio of not less than 1.25% of estimated insured deposits. For several years, the BIF reserve ratio has been at or above the mandated ratio and assessments have ranged from 0% of deposits for institutions in the lowest risk category, such as the Bank, to .27% of deposits in the highest risk category.
FICO Assessments.The Bank, as a member of the BIF, is subject to assessments to cover the payments on outstanding obligations of the Financing Corporation (“FICO”). FICO was created to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the predecessor to the FDIC’s Savings Association Insurance Fund (the “SAIF”) which insures the deposits of thrift institutions. From now until the maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on apro ratabasis. It is estimated that FICO assessments during this period will be less than 0.025% of deposits.
OCC Assessments.National Banks are required to pay supervisory fees to the OCC to fund the operations of the OCC. The amount of supervisory fees paid by a national bank is based upon the bank’s total assets, as reported to the OCC.
Capital Requirements. The OCC has established the following minimum capital standards for national banks: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated Bank with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions.
Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, or “critically undercapitalized”. Federal regulations define these capital categories as follows:
| Total | Tier 1 | |||||
| Risk-Based | Risk-Based | |||||
| Capital Ratio | Capital Ratio | Leverage Ratio | ||||
| Well capitalized | 10% or above | 6% or above | 5% or above | |||
| Adequately capitalized | 8% or above | 4% or above | 4% or above | |||
| Undercapitalized | Less than 8% | Less than 4% | Less than 4% | |||
| Significantly undercapitalized | Less than 6% | Less than 3% | Less than 3% | |||
| Critically undercapitalized | — | — | A ratio of tangible equity to total assets of 2% or less |
As of December 31, 2005, each of the Bank’s ratios exceeded minimum requirements for the well capitalized category.
Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent Bank; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.
In general, a depository institution may be reclassified to a lower category than is indicated by its capital levels if the appropriate federal depository institution regulatory agency determines the institution to be otherwise in an unsafe or unsound condition or to be engaged in an unsafe or unsound practice. This could include a failure by the institution, following receipt of a less-than-satisfactory rating on its most recent examination report, to correct the deficiency.
Dividends. Under federal law, the Bank is restricted as to the maximum amount of dividends it may pay on its common stock to the Corporation. The Bank may not pay dividends except out of undivided net profits then on hand after deducting its losses and bad debts. In addition, the Bank is required by federal law to obtain the prior approval of the OCC for the declaration or payment of a dividend, if the total of all dividends declared by the Bank’s Board of Directors in any
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year will exceed the total of (i) the Bank’s retained net income (as defined and interpreted by regulation) for that year plus (ii) the retained net income for the preceding two years, less any required transfers to surplus. Federal law generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Further, federal regulatory agencies can prohibit a banking institution or bank holding company from engaging in unsafe and unsound business practices and could prohibit payment of dividends if such payment could be deemed an unsafe and unsound business practice.
Insider Transactions. The Bank is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Corporation or its subsidiaries, on investments in the stock or other securities of the Corporation or its subsidiaries and the acceptance of the stock or other securities of the Corporation or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Corporation and its subsidiaries, to principal shareholders of the Corporation, and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Corporation or one of its subsidiaries or a principal shareholder of the Corporation may obtain credit from Bank with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines to promote the safety and soundness of federally insured depository institutions. These guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
Consumer Protection Laws. The Bank’s businesses include making a variety of types of loans to individuals. In making these loans, the Bank is subject to State usury and regulatory laws and to various federal statutes, including the privacy of consumer financial information provisions of the Gramm-Leach-Bliley Act and regulations promulgated there under, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and the Home Mortgage Disclosure Act, and the regulations promulgated there under, which prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs, and regulate the mortgage loan servicing activities of the Bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. In receiving deposits, the Bank is subject to extensive regulation under State and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Bank and its directors and officers.
| Item 1A. | Risk Factors. |
We are in the business of lending, which involves substantial credit risk, and our allowance for loan losses may not be sufficient to cover actual loan losses.
If our loan customers do not repay their loans according to their respective terms, and if we are unable to collect on the loans through foreclosure of any collateral securing repayment, we may experience significant credit losses, which could have a material adverse effect on our operating results. We have established an allowance for loan losses that is intended to approximate credit losses and prevent negative effects on our operating results as a result of loan losses. In determining the size of the allowance, we make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In doing so, we rely primarily on our experience and our evaluation of current economic conditions. If our assumptions or judgments prove to be incorrect, our current allowance for loan losses may not be sufficient to cover certain loan losses inherent in our loan portfolio, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease our net income.
As of December 31, 2005, approximately 82% of the Bank’s loan portfolio is commercial loans. Of these, approximately 49% are loans made for land development, single family home construction and leasing of commercial properties. Commercial loans are generally viewed as having more inherent risk of default than residential mortgages or consumer loans. Also, the commercial loan balance per borrower is generally greater then that of a residential mortgage loan or consumer loan, inferring higher potential losses on an individual loan basis.
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In addition, federal regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs required by these regulatory agencies could have a material adverse effect on our results of operations and financial condition.
Fluctuations in interest rates could reduce our profitability.
We realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. Our interest income and interest expense are affected by general economic conditions and by the policies of regulatory authorities. While we have taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that these measures will be effective in avoiding undue interest rate risk. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will work against us, and our earnings may be negatively affected.
We rely heavily on our management team, including our loan officers, and the unexpected loss of key employees may adversely affect our operations.
As a community bank, our success depends largely on our ability to attract and to retain key employees who are experienced in banking and financial services and who have developed relationships within the communities served by our Bank. Our ability to retain these key employees will continue to be important to our business and financial results. The unexpected loss of services of any key personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business and financial results.
Competition with other financial institutions and financial service providers could adversely affect our profitability.
We face vigorous competition from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions. Many of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems, and a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, and insurance companies, which are not subject to the same degree of regulation as that imposed on bank holding companies. As a result, these non-bank competitors may have an advantage over us in providing certain services, and this competition may reduce or limit our margins on banking services, reduce our market share, and adversely affect our results of operations and financial condition.
As a community bank, our financial condition is dependent, in part, on the general economic condition of the communities we serve.
Our operations are primarily limited to Livingston County and surrounding areas; and, therefore, our success depends to a great extent upon the general economic conditions of such region. In general, the economy of the State of Michigan has suffered in recent years as a result of the struggling automotive industry and other factors. Unlike larger banks that are more geographically diversified, our loan portfolio, the ability of the borrowers to repay these loans and the value of the collateral securing these loans will be impacted, to a greater extent, by local economic conditions. In addition, a general downturn in the national economy may impact our operations.
We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision, and examination by federal banking authorities. Any change in applicable legislation could have a substantial impact on us and our bank and its operations. Additional legislation may be enacted or adopted in the future that could significantly affect our powers, authority, and operations, which could increase our costs of doing business and, as a result, give an advantage to our competitors who may not be subject to similar legislative and regulatory requirements. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory power may have a negative impact on our results of operations and financial condition.
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We may face challenges in managing our operational risks as we grow.
Like other financial services companies, we face a number of operational risks, including the potential for processing errors, internal or external fraud, failure of computer systems, and external events beyond our control such as natural disasters. Acts of fraud are difficult to detect and deter, and we cannot assure investors that our risk management procedures and controls will prevent losses from fraudulent activity. Our growth may strain our existing managerial resources and internal monitoring, accounting, and reporting systems.
Item 1B. Unresolved Staff Comments.None.
| Item 2. | Properties. |
The Bank operates from nine facilities, located in five communities, in Livingston County, Michigan. The executive offices of the Corporation are located at the Bank’s main office, 101 East Grand River, Howell, Michigan. The Bank maintains three branches in Howell at 5990 East Grand River, 4299 East Grand River, and 2400 West Grand River. The Bank also maintains branch offices at 9911 East Grand River, Brighton, Michigan; 8080 Challis Road, Brighton, Michigan; 760 South Grand Avenue, Fowlerville, Michigan; 10700 Highland Road, Hartland, Michigan; and 9775 M-36, Whitmore Lake, Michigan. All of the offices have ATM machines and all except the West Grand River branch, which is in a grocery store, have drive up services. All of the properties are owned by the Bank except for the West Grand River branch which is leased. The lease is for 15 years, expiring September 2007. The average lease payment over the remaining life of the lease is $3,888 monthly.
| Item 3. | Legal Proceedings. |
The Corporation is not involved in any material legal proceedings. The Bank is involved in ordinary routine litigation incident to its business; however, no such proceedings are expected to result in any material adverse effect on the operations or earnings of the Bank. Neither the Bank nor the Corporation is involved in any proceedings to which any director, principal officer, affiliate thereof, or person who owns of record or beneficially more than five percent (5%) of the outstanding stock of either the Corporation or the Bank, or any associate of the foregoing, is a party or has a material interest adverse to the Corporation or the Bank.
| Item 4. | Submission of Matters to a Vote of Security Holders. |
No matters were submitted to a vote of security holders during the fourth quarter of 2005.
Additional Item –Executive Officers
Executive officers of the Corporation are appointed annually by the Board of Directors. There are no family relationships among these officers and/or the directors of the Corporation, or any arrangement or understanding between any officer and any other person pursuant to which the officer was elected.
The Corporation’s executive officers as of December 31, 2005 are as follows:
Herbert W. Bursch (Age 53), President, Chief Executive Officer, and Director of the Corporation and the Bank since May 2004; Senior Vice President, Chief Operations Officer, from February 2004 to May 2004; and Senior Vice President, Retail Banking, from December 1999 to February 2004, of the Bank.
Nancy Morgan (Age 55), Senior Vice President, Human Resources of the Bank since October 2001; and Vice President, Human Resources, of the Bank from June 1999 to October 2001.
Janice B. Trouba (Age 44), Senior Vice President, Chief Financial Officer, of the Bank since May 2003; Senior Vice President, Accounting, from October 2002 to May 2003 of the Bank; and Vice President, Accounting; Citizens Banking Corporation 1997 to October 2002.
Violet Gintsis (Age 46), Senior Vice President, Senior Lender, of the Bank since December 2005; and Vice President and Team Leader, Commercial and Business Banking; Fifth Third Bank May 2000 to December 2005.
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Susan D. Burns (Age 55), Senior Vice President, Sales and Marketing, of the Bank since July 2004; and Senior Marketing Manager, Key Bank (Michigan) from June 2000 to July 2004.
All executive officers were made officers of the Bank at their time of employment with the Bank.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
There is not an established trading market for the Corporation’s Common Stock. Information regarding its market price can be obtained on the internet at nasdaq.com, symbol FNHM. There is one market maker for the stock. There are occasional direct sales by shareholders of which the Corporation’s management is generally aware. It is the understanding of the management of the Corporation that over the last two years the Corporation’s Common Stock has sold at a premium to book value. From January 1, 2004, through December 31, 2005, there were, so far as the Corporation’s management knows, a total of 434,112 shares of the Corporation’s Common Stock sold. The price was reported to management in some of these transactions; however, there may have been other transactions involving the Corporation’s stock at prices not reported to management. During 2005, the highest and lowest prices known to management involving sales of more than 200 shares were $31.75 and $25.00 per share, respectively. To the knowledge of management, the last sale of Common Stock occurred on March 1, 2006 at a price of $26.00 per share.
As of March 1, 2006, there were approximately 915 holders of record of the Corporation’s Stock. The following table sets forth the range of high and low sales prices of the Corporation’s Common Stock during 2004 and 2005, based on information made available to the Corporation, as well as per share cash dividends declared during those periods. Although management is not aware of any transactions exceeding 200 shares at higher or lower prices, there may have been transactions at prices outside the ranges listed in the table.
Sales prices, for sales involving more than 200 shares, and dividend information for the years 2004 and 2005 are as follows:
| Sale Prices | Cash Dividends Declared | |||||||
| High | Low | |||||||
| $29.98 | $ | 26.00 | $ | 0.17 | ||||
| $31.50 | $ | 27.00 | $ | 0.17 | ||||
| $31.25 | $ | 27.55 | $ | 0.19 | ||||
| $32.00 | $ | 28.50 | $ | 0.19 | ||||
| Sale Prices | Cash Dividends Declared | |||||||
| High | Low | |||||||
| $31.75 | $ | 28.05 | $ | 0.19 | ||||
| $31.00 | $ | 27.95 | $ | 0.19 | ||||
| $31.00 | $ | 27.85 | $ | 0.21 | ||||
| $27.95 | $ | 25.00 | $ | 0.21 | ||||
The holders of the Corporation’s Common Stock are entitled to dividends when, as, and if declared by the Board of Directors of the Corporation out of funds legally available for that purpose. Dividends have been paid on a quarterly basis. In determining dividends, the Board of Directors considers the earnings, capital requirements and financial condition of the Corporation and the Bank, along with other relevant factors. The Corporation’s principal source of funds for cash dividends is the dividends paid by the Bank. The ability of the Corporation and Bank to pay dividends is subject to statutory and regulatory restrictions and requirements.
The Corporation did not repurchase any of its stock during the fourth quarter of 2005, nor has the Corporation’s Board adopted or approved a stock repurchase program.
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| Item 6. | Selected Financial Data. |
| SUMMARY FINANCIAL DATA | ||||||||||||||||||||
| (in thousands, except per share data) | ||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
Income Statement Data: | ||||||||||||||||||||
| Interest income | $ | 29,315 | $ | 24,992 | $ | 24,856 | $ | 25,729 | $ | 27,095 | ||||||||||
| Interest expense | 7,054 | 5,606 | 6,167 | 8,017 | 10,861 | |||||||||||||||
| Net interest income | 22,261 | 19,386 | 18,689 | 17,712 | 16,234 | |||||||||||||||
| Provision for loan losses | 3,037 | 1,190 | 1,270 | 625 | 900 | |||||||||||||||
| Noninterest income | 3,820 | 4,110 | 3,874 | 3,621 | 3,120 | |||||||||||||||
| Noninterest expense | 13,653 | 13,287 | 12,848 | 11,775 | 11,061 | |||||||||||||||
| Income before tax | 9,391 | 9,019 | 8,445 | 8,933 | 7,393 | |||||||||||||||
| Net income | 6,507 | 6,291 | 5,891 | 6,304 | 5,220 | |||||||||||||||
Per Share Data(1): | ||||||||||||||||||||
| Basic net income per share | $ | 2.03 | $ | 1.98 | $ | 1.86 | $ | 2.00 | $ | 1.66 | ||||||||||
| Diluted net income per share | 2.03 | 1.97 | 1.86 | 2.00 | 1.66 | |||||||||||||||
| Dividends paid | 0.80 | 0.72 | 0.68 | 0.63 | 0.60 | |||||||||||||||
| Weighted average basic shares outstanding | 3,200,146 | 3,185,025 | 3,162,836 | 3,152,739 | 3,141,118 | |||||||||||||||
| Weighted average diluted shares outstanding | 3,200,518 | 3,186,142 | 3,162,836 | 3,152,739 | 3,141,118 | |||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
| Total assets | $ | 477,225 | $ | 456,910 | $ | 450,342 | $ | 420,686 | $ | 392,978 | ||||||||||
| Loans, net | 372,855 | 357,377 | 347,086 | 327,117 | 286,280 | |||||||||||||||
| Allowance for loan losses | 6,991 | 6,093 | 5,434 | 5,794 | 5,668 | |||||||||||||||
| Deposits | 422,086 | 399,263 | 399,073 | 374,072 | 351,669 | |||||||||||||||
| Shareholders’ equity | 49,446 | 45,716 | 41,235 | 37,580 | 32,404 | |||||||||||||||
Ratios: | ||||||||||||||||||||
| Dividend payout ratio | 39.15 | % | 36.34 | % | 36.51 | % | 31.40 | % | 36.12 | % | ||||||||||
| Equity to asset ratio | 10.18 | % | 9.71 | % | 9.32 | % | 8.80 | % | 8.69 | % | ||||||||||
| (1) | Per share data for 2001 — 2002 has been restated to give effect to the two-for-one stock split, payable as a dividend of one share for each share of the Corporation’s stock held of record july 1, 2002, paid July 10, 2002. |
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
This discussion provides information about the consolidated financial condition and results of operations of FNBH Bancorp, Inc. (“Corporation”) and its subsidiaries, First National Bank in Howell (“Bank”) and HB Realty Co., and should be read in conjunction with the Consolidated Financial Statements.
Included or incorporated by reference in this document are certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are based on the beliefs of the Corporation’s management as well as on assumptions made by, and information currently available to, the Corporation at the times such statements were made. Actual results could differ materially from those included in such forward-looking statements as a result of, among other things, factors set forth below in this Report generally, and certain economic and business factors, some of which may be beyond the control of the Corporation. Investors are cautioned that all forward-looking statements involve risks and uncertainty.
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FINANCIAL CONDITION
At year end 2005, total assets were $477,225,000 representing a 4.4% increase from the prior year when assets were $456,910,000. Investment securities decreased $2 million (3.1%) to $62,373,000 while gross loans increased $15.5 million (4.3%) to $372,855,000. Deposits increased $22.8 million (5.7%) to $422,086,000. Stockholders’ equity increased $3.7 million (8.2%) to $49,446,000.
Securities
During 2005, securities decreased due to higher loan demand in the first two quarters of 2005. Purchased certificates of deposit increased $1.1 million in 2005 compared to 2004. At year end the Bank had $4,820,000 million in short term investments, a decrease of $860,000 million from the $5,680,000 reported the previous year.
The following table sets forth the book value of held to maturity securities and the fair value of available for securities at December 31:
| (in thousands) | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
Held to maturity: | ||||||||||||
| States and political subdivisions | $ | 16,426 | $ | 16,009 | $ | 15,051 | ||||||
Available for sale: | ||||||||||||
| U.S. Treasury and government agencies | $ | 31,384 | $ | 29,738 | $ | 22,151 | ||||||
| Corporate securities | 1,005 | 1,038 | 4,637 | |||||||||
| Mortgage-backed securities | 12,405 | 16,432 | 12,513 | |||||||||
| FRB Stock | 44 | 44 | 44 | |||||||||
| FHLBI Stock | 1,109 | 1,087 | 1,039 | |||||||||
| Total | $ | 45,947 | $ | 48,339 | $ | 40,384 | ||||||
The following table sets forth contractual maturities of securities (at amortized costs) at December 31, 2005 and the weighted average yield of such securities:
| (dollars in thousands) | ||||||||||||||||||||||||||||||||
| Maturing After | Maturing After | |||||||||||||||||||||||||||||||
| Maturing Within | One But Within | Five But Within | Maturing After | |||||||||||||||||||||||||||||
| One Year | Five Years | Ten Years | Ten Years | |||||||||||||||||||||||||||||
| Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||||
Held to maturity | ||||||||||||||||||||||||||||||||
| States and political subdivisions | $ | 2,385 | 6.89 | % | $ | 7,307 | 6.49 | % | $ | 1,882 | 5.91 | % | $ | 4,852 | 6.45 | % | ||||||||||||||||
| Tax equivalent adjustment for calculations of yield | $ | 46 | $ | 142 | $ | 37 | $ | 94 | ||||||||||||||||||||||||
Available for sale | ||||||||||||||||||||||||||||||||
| U.S. Agency | $ | 7,238 | 3.43 | % | $ | 24,857 | 3.37 | % | $ | — | — | $ | — | — | ||||||||||||||||||
| Corporate bonds | 1,000 | 6.10 | % | — | — | — | — | — | — | |||||||||||||||||||||||
| Mortgage backed securities | 170 | 5.50 | % | 2,421 | 5.00 | % | 1,591 | 4.00 | % | 8,437 | 5.65 | % | ||||||||||||||||||||
| FRB Stock | — | — | — | — | — | — | 44 | 6.00 | % | |||||||||||||||||||||||
| FHLBI Stock | — | — | — | — | — | — | 1,109 | 4.29 | % | |||||||||||||||||||||||
| Total | $ | 8,408 | 3.79 | % | $ | 27,278 | 3.51 | % | $ | 1,591 | 4.00 | % | $ | 9,590 | 5.49 | % | ||||||||||||||||
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The rates set forth in the tables above for obligations of state and political subdivisions have been restated on a fully tax equivalent basis assuming a 34% marginal tax rate. The amount of the adjustment is as follows:
| Rate on Tax | ||||||||||||
| Tax-Exempt Rate | Adjustment | Equivalent Basis | ||||||||||
| Under 1 year | 4.95 | % | 1.94 | % | 6.89 | % | ||||||
| 1-5 years | 4.55 | % | 1.94 | % | 6.49 | % | ||||||
| 5-10 years | 3.97 | % | 1.94 | % | 5.91 | % | ||||||
| 10 years or more | 4.51 | % | 1.94 | % | 6.45 | % | ||||||
The following table shows the percentage composition of the securities portfolio as of December 31:
| 2005 | 2004 | 2003 | ||||||||||
| U.S. Treasury & agency securities | 50.3 | % | 46.2 | % | 39.9 | % | ||||||
| Agency mortgage backed securities | 19.9 | % | 25.5 | % | 22.6 | % | ||||||
| Tax exempt obligations of states and political subdivisions | 26.3 | % | 24.9 | % | 27.1 | % | ||||||
| Corporate bonds | 1.6 | % | 1.6 | % | 8.4 | % | ||||||
| Other | 1.9 | % | 1.8 | % | 2.0 | % | ||||||
| Total securities | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
Loans
The loan personnel of the Bank are committed to making quality loans that produce acceptable rates of return for the Bank and also serve the community by providing funds for home purchases, business purposes, and consumer needs. The overall loan portfolio grew $15,478,000 (4.3%) in 2005.
As a full service lender, the Bank offers a variety of home mortgage loan products. The Bank makes and subsequently sells fixed rate long-term mortgages, which conform to secondary market standards. This practice allows the Bank to meet the housing credit needs of its service area, while at the same time maintaining loan to deposit ratios and interest sensitivity and liquidity positions within Bank policy. The Bank retains servicing on sold mortgages, thereby furthering the customer relationship and adding to servicing income. During 2005, the Bank sold $4,297,000 in residential mortgages as compared to $3,799,000 in 2004.
The Bank has also been able to service customers with loan needs which do not conform to secondary market requirements by offering variable rate products which are retained in the mortgage portfolio. While not meeting secondary market requirements, these nonconforming mortgages do meet Bank loan guidelines. During 2005, the Bank made approximately $5,809,000 in variable rate mortgage loans which are retained in the mortgage portfolio.
The following table reflects the composition of the commercial and consumer loans in the Consolidated Financial Statements. Included in the residential first mortgage totals below are the “real estate mortgage” loans listed in the Consolidated Financial Statements and other loans to customers who pledge their homes as collateral for their borrowings. A portion of the loans listed in residential first mortgages represent commercial loans where the borrower has pledged his/her residence as collateral. In the majority of the loans to commercial customers, the Bank is relying on the borrower’s cash flow to service the loans. Commercial real estate loans at December 31, 2005 include $173,650,000 in loans secured by commercial and retail property, with the remaining $3,767,000 secured by multi-family units. The most significant loan growth was in construction and land development and commercial secured by real estate which increased $26,410,000 (11.8%) compared to the prior year. Loans secured by first mortgages on residential properties and consumer loans experienced a decrease of $11,386,000 (14.2%) due to weak demand from retail consumers as a result of increasing interest rates and a weak economy. This decrease was only partially offset by an increase in home equity lines of $3,733,000 (23.3%) which was the result of a promotional interest-only rate product. At December 31, 2005, the Bank had $4.2 million of home equity interest-only loans, $3.4 million of which have a promotional rate of 3.99% until February 1, 2006. These interest-only loans represent 11.6% of total consumer loans and 1.1% of total loans.
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The following table shows the balance and percentage composition of loans as of December 31:
| (dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | �� | |||||||||||||||||||||||||||||||||||
| Balances | Percent | Balances | Percent | Balances | Percent | Balances | Percent | Balances | Percent | |||||||||||||||||||||||||||||||
| Secured by real estate: | ||||||||||||||||||||||||||||||||||||||||
| Residential first mortgage | $ | 46,391 | 12.4 | % | $ | 53,059 | 14.8 | % | $ | 46,845 | 13.5 | % | $ | 37,202 | 11.3 | % | $ | 27,456 | 9.6 | % | ||||||||||||||||||||
| Residential home equity/other junior liens | 19,750 | 5.3 | % | 16,017 | 4.5 | % | 13,999 | 4.0 | % | 11,184 | 3.4 | % | 8,066 | 2.8 | % | |||||||||||||||||||||||||
| Construction, land development and farmland | 72,572 | 19.4 | % | 59,873 | 16.7 | % | 54,554 | 15.7 | % | 49,516 | 15.1 | % | 42,221 | 14.7 | % | |||||||||||||||||||||||||
| Commercial | 177,417 | 47.5 | % | 163,706 | 45.7 | % | 165,464 | 47.5 | % | 153,720 | 46.9 | % | 118,191 | 41.2 | % | |||||||||||||||||||||||||
| Consumer | 22,247 | 6.0 | % | 26,965 | 7.5 | % | 25,842 | 7.4 | % | 25,261 | 7.7 | % | 22,719 | 7.9 | % | |||||||||||||||||||||||||
| Commercial | 29,230 | 7.8 | % | 31,772 | 8.9 | % | 33,947 | 9.8 | % | 43,276 | 13.2 | % | 59,602 | 20.8 | % | |||||||||||||||||||||||||
| Other | 6,104 | 1.6 | % | 6,991 | 1.9 | % | 7,366 | 2.1 | % | 7,801 | 2.4 | % | 8,870 | 3.0 | % | |||||||||||||||||||||||||
| Total gross loans | 373,711 | 100.0 | % | 358,383 | 100.0 | % | 348,017 | 100.0 | % | 327,960 | 100.0 | % | 287,125 | 100.0 | % | |||||||||||||||||||||||||
| Net unearned fees | (856 | ) | (1,006 | ) | (931 | ) | (843 | ) | (845 | ) | ||||||||||||||||||||||||||||||
| Total Loans | $ | 372,855 | $ | 357,377 | $ | 347,086 | $ | 327,117 | $ | 286,280 | ||||||||||||||||||||||||||||||
The loan portfolio is periodically reviewed and the results of these reviews are reported to the Bank’s Board of Directors. The purpose of these reviews is to verify proper loan documentation, to provide for the early identification of potential problem loans, and to assist the Bank in evaluating the adequacy of the allowance for loan losses.
The following table shows the amount of commercial, financial, and agricultural loans outstanding as of December 31, 2005, which based on remaining scheduled repayments of principal, mature in the periods indicated:
| Maturing | ||||||||||||||||
| (dollars in thousands) | ||||||||||||||||
| After one | ||||||||||||||||
| Within One | but within | After five | ||||||||||||||
| Year | five years | years | Total | |||||||||||||
| Real estate construction and land development | $ | 45,707 | $ | 26,297 | $ | — | $ | 72,004 | ||||||||
| Real estate other (secured by commercial and multi-family) | 38,749 | 127,150 | 11,518 | 177,417 | ||||||||||||
| Commerical (secured by business assets or unsecured) | 14,318 | 14,256 | 656 | 29,230 | ||||||||||||
| Other (loans to farmers, political subdivisions, and overdrafts) | 1,727 | 2,797 | 1,580 | 6,104 | ||||||||||||
| Totals | $ | 100,501 | $ | 170,500 | $ | 13,754 | $ | 284,755 | ||||||||
Below is a schedule of amounts due after one year which are classified according to their sensitivity to changes in interest rates:
| Interest Sensitivity | ||||||||
| (dollars in thousands) | ||||||||
| Fixed Rate | Variable Rate | |||||||
| Due after one but within five years | $ | 110,638 | $ | 59,862 | ||||
| Due after five years | 11,184 | 2,570 | ||||||
The Bank’s loan personnel have endeavored to make high quality loans using well established policies and procedures and a thorough loan review process. Loans to a borrower with aggregate indebtedness in excess of $1,500,000 are approved by a committee of the Board or the entire Board. The Bank has hired an independent contractor to review the quality of the loan portfolio on a regular basis.
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Nonperforming loans consist of loans accounted for on a nonaccrual basis and loans contractually past due 90 days or more as to interest or principal payments (but not included in nonaccrual loans). The aggregate amount of non-performing loans and other nonperforming assets, as of December 31, is presented in the table below:
| (dollars in thousands) | ||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
Nonperforming Loans and Assets: | ||||||||||||||||||||
| Nonaccrual loans | $ | 5,234 | $ | 1,146 | $ | 4,293 | $ | 3,288 | $ | 2,636 | ||||||||||
| Loans past due 90 days and still accruing | 391 | 288 | — | 809 | 361 | |||||||||||||||
| Total nonperforming loans | 5,625 | 1,434 | 4,293 | 4,097 | 2,997 | |||||||||||||||
| Other real estate | 680 | 735 | 65 | 738 | — | |||||||||||||||
| Total nonperforming assets | $ | 6,305 | $ | 2,169 | $ | 4,358 | $ | 4,835 | $ | 2,997 | ||||||||||
| Nonperforming loans as a percent of total loans | 1.51 | % | 0.40 | % | 1.24 | % | 1.25 | % | 1.04 | % | ||||||||||
| Allowance for loan losses as a percent of nonperforming loans | 124 | % | 425 | % | 127 | % | 141 | % | 189 | % | ||||||||||
There were no other interest bearing assets, at December 31, 2005, that would be required to be disclosed under Item III(C) of Guide 3 of the Securities Act Industry Guide, if such assets were loans.
The loan portfolio has no significant concentrations in any one industry. There were no foreign loans outstanding at December 31, 2005.
Nonperforming assets are comprised of loans for which the accrual of interest has been discontinued, accruing loans 90 days or more past due in payments, loans which have been renegotiated to less than market rates, and other real estate which has been acquired primarily through foreclosure and is awaiting disposition. Loans are generally placed on a nonaccrual basis when principal or interest is past due 90 days or more and when, in the opinion of management, full collection of principal and interest is unlikely. Nonperforming assets increased in 2005 due principally to (i) the default on two loans totaling $2,300,000, both secured by real estate, which are in the process of bankruptcy and/or foreclosure, and (ii) higher loan delinquencies caused in part by the weakened local economy causing cash flow problems for our borrowers and further aggravated by increasing interest rates which affect our residential home developers and builders. During the first quarter of 2006, the Bank classified $2,500,000 of commercial loans as nonaccrual which increase the level of nonperforming loans. Management believes these loans were adequately reserved for as of December 31, 2005. Nonperforming loans are reviewed regularly for collectability and any uncollectible balances are promptly charged off.
Impaired loans, as defined by Statement of Financial Accounting Standards (SFAS) No. 114,Accounting by Creditors for Impairment of Loan,totaled approximately $10,100,000 at December 31, 2005, and included non-accrual and past due 90 days other than homogenous residential and consumer loans, and $6,000,000 of commercial loans separately identified as impaired. Impaired loans totaled $5,900,000 at December 31, 2004, and $9,600,000 at December 31, 2003. A loan is considered impaired when it is probable that all or part of amounts due according to the contractual terms of the loan agreement will not be collected on a timely basis. Impaired loans increased in 2005 in part due to lower appraised values on classified loans.
During 2005, the Bank charged off loans totaling $2,254,000 and recovered $262,000 for a net charge off amount of $1,992,000. The Bank had net charge offs totaling $748,000 in 2004 and $1,106,000 in 2003. Charge offs increased in 2005 due to increased bankruptcies in both commercial and consumer customers as well as lower appraised values of real estate as a result of the local economic conditions. Due partially, to the increased level of charge offs the provision in 2005 was higher than that recorded in 2004 as the allowance is impacted by the level of charge offs.
The allowance for loan losses totaled $6,991,000 at year end which was 1.88% of total loans, compared to $6,093,000 (1.70%) in 2004, and $5,434,000 (1.57%) in 2003. The adequacy of the allowance for loan losses is determined by management’s assessment of the composition of the loan portfolio, an evaluation of specific credits, and an analysis of the following environmental factors: delinquency trends, delinquency levels, loss trends, concentrations of credit, economic trends, loan growth, and management changes. Management continues to refine its techniques in this analysis. Economic factors considered in arriving at the loan loss reserve adequacy as of December 31, 2005, included low levels of consumer
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confidence, a rising interest rate environment, increased bankruptcies and the unemployment rate. When all environmental factors were considered, management determined that the $2,890,000 provision and resulting $6,991,000 allowance were appropriate. Although management evaluates the adequacy of the allowance for loan losses based on information known at a given time, as facts and circumstances change, the provision and resulting allowance may also change. Additional discussion regarding the provision for loan losses can be found under “Provision for Loan Losses” in this Item 7.
The following table sets forth loan balances and summarizes the changes in the allowance for loan losses and reserve for unfunded credit commitments, which is the Corporation’s critical accounting policy, for each of the years ended December 31:
| (dollars in thousands) | ||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
Loans: | ||||||||||||||||||||
| Average daily balance of loans for the year | $ | 366,877 | $ | 340,859 | $ | 340,384 | $ | 311,060 | $ | 270,776 | ||||||||||
| Amount of loans outstanding at end of year | 372,855 | 357,377 | 347,086 | 327,117 | 286,280 | |||||||||||||||
Components: | ||||||||||||||||||||
Allowance for loan losses | ||||||||||||||||||||
| Balance, beginning of year | $ | 6,093 | $ | 5,434 | $ | 5,794 | $ | 5,668 | $ | 5,193 | ||||||||||
| Loans charged off: | ||||||||||||||||||||
| Real estate mortgage | 26 | — | — | — | — | |||||||||||||||
| Commercial | 1,436 | 379 | 1,014 | 598 | 322 | |||||||||||||||
| Consumer | 792 | 543 | 269 | 169 | 195 | |||||||||||||||
| Total charge offs | 2,254 | 922 | 1,283 | 767 | 517 | |||||||||||||||
| Recoveries to loans previously charged off: | ||||||||||||||||||||
| Real estate mortgage | — | — | — | — | — | |||||||||||||||
| Commercial | 120 | 70 | 112 | 177 | 47 | |||||||||||||||
| Consumer | 142 | 104 | 65 | 91 | 45 | |||||||||||||||
| Total recoveries | 262 | 174 | 177 | 268 | 92 | |||||||||||||||
| Net loans charged off | 1,992 | 748 | 1,106 | 499 | 425 | |||||||||||||||
| Additions to allowance charged to operations | 2,890 | 1,407 | 746 | 625 | 900 | |||||||||||||||
| Balance, end of year | 6,991 | 6,093 | 5,434 | 5,794 | 5,668 | |||||||||||||||
Reserve for unfunded credit commitments | ||||||||||||||||||||
| Balance, beginning of year | 307 | 524 | — | — | — | |||||||||||||||
| Additions (reductions) to reserve charged to operations | 147 | (217 | ) | 524 | — | — | ||||||||||||||
| Balance, end of year | 454 | 307 | 524 | — | — | |||||||||||||||
Total allowance for loan losses and reserve for unfunded credit commitments | $ | 7,445 | $ | 6,400 | $ | 5,958 | $ | 5,794 | $ | 5,668 | ||||||||||
Ratios: | ||||||||||||||||||||
| Net loans charged off to average loans outstanding | 0.54 | % | 0.22 | % | 0.32 | % | 0.16 | % | 0.16 | % | ||||||||||
| Allowance for loan losses to outstanding | 1.88 | % | 1.70 | % | 1.57 | % | 1.77 | % | 1.97 | % | ||||||||||
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The following table presents the portion of the allowance for loan losses applicable to each loan category and the percent of loans in each category to total loans, as of December 31:
| (dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||||||||||||||||||||||
| Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||||
| Commercial | $ | 5,864 | 81.9 | % | $ | 4,877 | 80.3 | % | $ | 5,027 | 80.1 | % | $ | 5,166 | 80.2 | % | $ | 2,244 | 79.1 | % | ||||||||||||||||||||
| Consumer | 850 | 9.7 | % | 825 | 10.1 | % | 101 | 10.1 | % | 406 | 10.3 | % | 160 | 11.3 | % | |||||||||||||||||||||||||
| Real estate | 277 | 8.4 | % | 391 | 9.6 | % | 306 | 9.8 | % | 222 | 9.5 | % | 26 | 9.6 | % | |||||||||||||||||||||||||
| Unallocated | — | — | — | — | 3,238 | |||||||||||||||||||||||||||||||||||
| Total | $ | 6,991 | 100.0 | % | $ | 6,093 | 100.0 | % | $ | 5,434 | 100.0 | % | $ | 5,794 | 100.0 | % | $ | 5,668 | 100.0 | % | ||||||||||||||||||||
The following table presents the portion of the reserve for unfunded credit commitments applicable to each loan category and the percent of loans in each category to total loans, as of December 31:
| (dollars in thousands) | ||||||||||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||||||||||
| Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||
| Commercial | $ | 199 | 81.9 | % | $ | 148 | 80.3 | % | $ | 493 | 80.1 | % | ||||||||||||
| Consumer | 255 | 9.7 | % | 158 | 10.1 | % | 29 | 10.1 | % | |||||||||||||||
| Real estate | — | 8.4 | % | 1 | 9.6 | % | 2 | 9.8 | % | |||||||||||||||
| Total | $ | 454 | 100.0 | % | $ | 307 | 100.0 | % | $ | 524 | 100.0 | % | ||||||||||||
Deposits
Deposit balances of $422,086,000 at December 31, 2005 were approximately $22,800,000 higher than the previous year end. Because year end deposit balances can fluctuate, it is more meaningful to analyze changes in average balances. Average deposits increased 4.8% in 2005 compared to 2004. Average demand deposits increased $2.8 million (3.9%) while average NOW, savings and money market deposit account (MMDA) balances decreased $8.4 million (4.6%). Average certificates of deposit increased $24.6 million (17.8%). Management generated deposits in 2005 with various rate specials on selected certificates and by increased use of wholesale funding sources. Average noninterest bearing deposits grew by 7.2% from 2003 to 2004, average NOW, savings, and MMDA balances grew 7.1% from 2003 to 2004, and average certificates of deposit grew 1.9% from 2003 to 2004.
The following table sets forth average deposit balances and the weighted average rates paid thereon for the years ended December 31:
| (dollars in thousands) | ||||||||||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||
| Balance | Rate | Balance | Rate | Balance | Rate | |||||||||||||||||||
| Non-interest bearing demand | $ | 73,243 | 0.00 | % | $ | 70,477 | 0.00 | % | $ | 65,719 | 0.00 | % | ||||||||||||
| NOW, savings & MMDA | 176,347 | 0.79 | % | 184,792 | 0.64 | % | 172,611 | 0.85 | % | |||||||||||||||
| Time deposits | 163,066 | 3.30 | % | 138,463 | 2.92 | % | 135,842 | 3.16 | % | |||||||||||||||
| Total | $ | 412,656 | 2.00 | % | $ | 393,732 | 1.33 | % | $ | 374,172 | 1.54 | % | ||||||||||||
See Note 9, “Time Certificates of Deposits” in Notes to Consolidated Financial Statements for the maturities of negotiated rate time deposits of $100,000 or more outstanding at December 31, 2005.
The decline in NOW, savings, and MMDA was primarily in MMDAs which decreased 9.8% on average from 2004 to 2005. This decline is attributable to consumers’ and business’ preference for time certificates in this higher rate environment. Average personal MMDAs decreased 16.8% while business accounts decreased 14.2% on average, and public MMDAs remain unchanged compared to the prior year. Average personal MMDA accounts increased 7.0%, business accounts decreased 7.8% and public accounts increased 18.9% from 2003 to 2004.
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The majority of the Bank’s deposits are from core customer sources, representing long term relationships with local personal, business, and public customers. In some financial institutions, the presence of interest bearing certificates greater than $100,000 indicates reliance upon purchased funds. However, large certificates in the Bank’s portfolio consist primarily of core deposits of local customers. The Bank does issue brokered certificates of deposit in the market to meet liquidity needs with alternative funding sources and had an average balance of brokered certificates in 2005 of $23.9 million compared to $11.9 million in 2004. As of December 31, 2005, $26.6 million of these brokered certificates were over $100,000 as compared to $4.8 million as of December 31, 2004.
Capital
The Corporation’s capital at year end totaled $49,446,000, a $3,730,000 (8.2%) increase compared to capital of $45,716,000 at December 31, 2004 and $41,235,000 at December 31, 2003, an increase of 10.9%. Included in capital at December 31, 2005 is a $607,000 net of tax unrealized loss on investment securities available for sale.
Banking regulators have established various ratios of capital to assets to assess a financial institution’s soundness. Tier 1 capital is equal to shareholders’ equity adjusted for unrealized gains or losses accumulated in other comprehensive income while Tier 2 capital also includes a portion of the allowance for loan losses. The regulatory agencies have set capital standards for “well capitalized” institutions. The leverage ratio, which divides Tier 1 capital by three months average assets, must be 5% for a well capitalized institution. The Bank’s leverage ratio was 10.58% at year end 2005. Tier 1 risk-based capital, which includes some off balance sheet items in assets and weights assets by risk, must be 6% for a well capitalized institution. The Bank’s was 12.63% at year end 2005. Total risk-based capital, which includes Tier 1 and Tier 2 capital, must be 10% for a well capitalized institution. The Bank’s total risk based capital ratio was 13.89% at year end 2005. The Bank’s strong capital ratios put it in the best classification on which the FDIC bases its assessment charge.
The following table lists various Bank capital ratios at December 31:
| 2005 | 2004 | 2003 | ||||||||||
| Average equity to average asset ratio | 10.18 | % | 9.71 | % | 9.32 | % | ||||||
| Tier 1 leverage ratio | 10.58 | % | 9.65 | % | 8.95 | % | ||||||
| Tier 1 risk-based capital | 12.63 | % | 11.54 | % | 10.47 | % | ||||||
| Total risk-based capital | 13.89 | % | 12.80 | % | 11.73 | % | ||||||
The Corporation’s ability to pay dividends is subject to various regulatory and state law requirements. Management believes, however, that earnings will continue to generate adequate capital to continue the payment of dividends. In 2005, the Corporation paid dividends totaling $2,548,000, or 39.2% of earnings. Book value of the stock was $15.51 at year end.
Liquidity and Funds Management
Liquidity is monitored by the Bank’s Asset/Liability Management Committee (ALCO) which meets at least monthly. The Board of Directors has approved a liquidity policy which requires the Bank, while it is well capitalized as defined by the Federal Financial Institutions Examination Council (FFIEC), to maintain a current ratio of no less than 1:1 (core basic surplus liquidity equal to 0). Additional requirements of the policy are that when credit available from the Federal Home Loan Bank of Indianapolis (FHLBI) is added to core basic surplus liquidity, the Bank must have liquidity totaling 5% of assets; and when brokered CDs and Federal Funds (Fed Funds) lines are added, the Bank must have liquidity totaling 8% of assets. Should the Bank’s capital ratios fall below the “well capitalized” level, additional liquidity totaling 5% of assets will be required. As of December 31, 2005, the Bank had excess liquidity of at least 4.6% of assets under any of the above standards.
Deposits are the principal source of funds for the Bank. Management monitors rates at other financial institutions in the area to ascertain that its rates are competitive in the market. Management also attempts to offer a wide variety of products to meet the needs of its customers.
It is the intention of the Bank’s management to handle unexpected liquidity needs through its Fed Funds position with a correspondent bank and by FHLBI borrowings. The Bank has a $37,700,000 line of credit available at the FHLBI and the Bank has pledged certain commercial and consumer loans secured by residential real estate as collateral for this borrowing. At December 31, 2005, the Bank had $1,785,000 in borrowings against the line. The Bank also has a blanket repurchase agreement in place where it can borrow from a broker, pledging Treasury and Agency securities as collateral.
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In the event the Bank must borrow for an extended period, management may look to “available for sale” securities in the investment portfolio for liquidity.
Throughout the past year, Fed Funds Sold balances averaged approximately $9,880,000. Periodically, the Bank borrowed money through the Fed Funds market and through short term advances from the FHLBI. Fed Funds Purchased balances averaged $537,000 and short term FHLBI advances averaged $2,074,000 for 2005.
Contractual Obligations and Commitments
The following table lists significant fixed and determinable contractual obligations to third parties as of December 31, 2005:
| Within | One to | Three to | Over | |||||||||||||||||
| (in thousands) | One Year | Three Years | Five Years | Five Years | Total | |||||||||||||||
Deposits without a stated maturity(1) | $ | 246,020 | $ | — | $ | — | $ | — | $ | 246,020 | ||||||||||
Consumer and brokered certificates of deposits(2) | 131,147 | 38,400 | 12,474 | 28 | 182,049 | |||||||||||||||
Long term advances(2) (3) | 412 | 832 | 836 | — | 2,080 | |||||||||||||||
Operating leases(4) | 47 | 35 | — | — | 82 | |||||||||||||||
Purchase obligations(5) | 237 | 4 | — | — | 241 | |||||||||||||||
| (1) | Excludes interest. | |
| (2) | Includes interest on both fixed and variable rate obligations. The interest rate for variable rate obligations is based upon interest rates in effect at December 31, 2005. Future changes in market interest rates could materially affect the contractual amounts to be paid for variable rate obligations. | |
| (3) | See Note 10, “Other Borrowings,” in Notes to Consolidated Financial Statements. | |
| (4) | See Note 14, “Leases,” in Notes to Consolidated Financial Statements. | |
| (5) | Purchase obligations amounts relate to certain contractual payments for services provided for information technology, data processing and training consultants. |
The following table lists significant commitments by maturity date as of December 31, 2005:
| One to | ||||||||||||||||||||
| Within | Three | Three to | Over | |||||||||||||||||
| (in thousands) | One Year | Years | Five Years | Five Years | Total | |||||||||||||||
| Commericial loans | $ | 31,003 | $ | 9,472 | $ | 923 | $ | — | $ | 41,398 | ||||||||||
| Commercial construction loans | 6,679 | 7 | 2,686 | — | 9,372 | |||||||||||||||
| Consumer loans | 9,708 | 2,553 | 3,997 | — | 16,258 | |||||||||||||||
| Standby letters of credit | 2,789 | 411 | — | — | 3,200 | |||||||||||||||
Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.
Quantitative and Qualitative Disclosures about Market Risk
In addition to monitoring liquidity, ALCO reviews other areas of the Bank’s performance. This committee discusses the current economic outlook and its potential impact on the Bank and current interest rate forecasts. Actual results are compared to budget in terms of growth and income. A yield and cost analysis is done to monitor interest margin. Various ratios are discussed including capital ratios and liquidity. Also, the quality of the loan portfolio is reviewed in light of the current allowance, and the Bank’s exposure to market risk is reviewed.
Interest rate risk is the potential for economic losses due to future rate changes and can be reflected as a loss of future net interest income and/or a loss of current market values. ALCO’s objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Tools used by management include the standard GAP report which reflects the repricing schedule for various asset and liability categories and an interest rate shock simulation report. The Bank has no market risk sensitive instruments held for trading purposes. However, the Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers including commitments to extend credit and letters of credit. A commitment or letter of credit is not recorded as an asset until the instrument is exercised (see Note 19, “Financial Instruments with Off-Balance-Sheet Risk” in Notes to Consolidated Financial Statements).
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The table below shows the scheduled maturity and repricing of the Bank’s interest sensitive assets and liabilities as of December 31, 2005:
| (dollars in thousands) | ||||||||||||||||||||
| 0-3 | 4-12 | 1-5 | 5+ | |||||||||||||||||
| Months | Months | Years | Years | Total | ||||||||||||||||
Assets: | ||||||||||||||||||||
| Loans | $ | 174,416 | $ | 53,282 | $ | 133,719 | $ | 4,447 | $ | 365,864 | ||||||||||
| Securities | 2,056 | 12,931 | 41,174 | 6,212 | 62,373 | |||||||||||||||
| Certificates of deposit | 1,571 | 3,828 | 1,767 | — | 7,166 | |||||||||||||||
| Short term investments | 4,820 | — | — | — | 4,820 | |||||||||||||||
| Total assets | $ | 182,863 | $ | 70,041 | $ | 176,660 | $ | 10,659 | $ | 440,223 | ||||||||||
Liabilities: | ||||||||||||||||||||
| NOW, savings, & MMDA | $ | 87,919 | $ | — | $ | — | $ | 86,686 | $ | 174,605 | ||||||||||
| Time deposits | 48,955 | 78,290 | 48,663 | 157 | 176,065 | |||||||||||||||
| FHLBI advances | 304 | — | 1,481 | — | 1,785 | |||||||||||||||
| Total liabilities | $ | 137,178 | $ | 78,290 | $ | 50,144 | $ | 86,843 | $ | 352,455 | ||||||||||
| Rate sensitivity GAP: | ||||||||||||||||||||
| GAP for period | $ | 45,685 | $ | (8,249 | ) | $ | 126,516 | $ | (76,184 | ) | ||||||||||
| Cumulative GAP | 45,685 | 37,436 | 163,952 | 87,768 | ||||||||||||||||
The preceding table sets forth the time periods in which earning assets and interest bearing liabilities will mature or may re-price in accordance with their contractual terms. The entire balance of NOW, savings, and MMDA are not categorized as 0-3 months, although they are variable rate products. Some of these balances are core deposits and are not considered rate sensitive. Allocations are made to time periods based on the Bank’s historical experience and management’s analysis of industry trends.
In the GAP table above, the short term (one year and less) cumulative interest rate sensitivity is 17% asset sensitive at year end, compared to 42% asset sensitive the previous year. Asset sensitivity indicates that the asset base exceeds the funding base, indicating that the Bank will benefit from rising rates in the short term. The rate sensitivity in 2005 was impacted by higher short term liability balances only partially offset by higher short term assets.
Because of the Bank’s asset sensitive position, if market interest rates decrease, this positive GAP position indicates that the interest margin would be negatively affected. However, GAP analysis is limited and may not provide an accurate indication of the impact of general interest rate movements on the net interest margin since repricing of various categories of assets and liabilities is subject to the Bank’s needs, competitive pressures, and the needs of the Bank’s customers. In addition, various assets and liabilities indicated as repricing within the same period may in fact reprice at different times within the period and at different rate indices. Additionally, simulation modeling, which measures the impact of upward and downward movements of interest rates on interest margin, indicates that a 200 basis point decrease in interest rates would reduce net interest income by approximately 7% in the first year, while a 200 basis point increase in interest rates would increase net interest income by approximately 1% in the first year.
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The following table shows the fair market value for interest earning assets and interest bearing liabilities as of December 31, 2005 (on a taxable equivalent basis):
| (dollars in thousands) | ||||||||||||
| Carrying Value | Average Interest Rate | Estimated Fair Value | ||||||||||
Assets: | ||||||||||||
| Loans, net | $ | 365,864 | 7.19 | % | $ | 364,595 | ||||||
| Securities | 62,373 | 4.46 | % | 62,711 | ||||||||
| Certificates of deposit | 7,166 | 3.07 | % | 7,129 | ||||||||
| Short term investments | 4,820 | 3.12 | % | 4,811 | ||||||||
Liabilities: | ||||||||||||
| NOW, savings, & MMDA | $ | 174,605 | 0.79 | % | $ | 174,605 | ||||||
| Time deposits | 176,065 | 3.30 | % | 174,853 | ||||||||
| FHLBI advances | 1,785 | 7.56 | % | 1,877 | ||||||||
Estimated fair value for securities are based on quoted market prices. For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are generally based on carrying values. The fair value of other loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and remaining maturities. Because they have a one day maturity, the carrying value is used as fair value for short term investments. The fair value of deposits with no stated maturity, such as NOW, savings, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit and FHLBI borrowings are estimated using rates currently offered for products with similar remaining maturities.
RESULTS OF OPERATIONS
Net income was $6,500,000 in 2005, a $200,000 (3.4%) increase compared to net income of $6,300,000 in 2004, an increase of 6.8% from 2003 net income of $5,900,000.
The ratio of net income to average shareholders’ equity and to average total assets, for the years ended December 31 follow:
| 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
| Net income as a percent of: | ||||||||||||||||||||
| Average common equity | 13.63 | % | 14.51 | % | 14.90 | % | 17.97 | % | 16.80 | % | ||||||||||
| Average total assets | 1.39 | % | 1.41 | % | 1.39 | % | 1.58 | % | 1.46 | % | ||||||||||
Net Interest Income
Net interest income is the difference between interest earned on loans, securities and other earning assets and interest paid on deposits and borrowed funds. In the following tables, the interest earned on investments and loans is expressed on a fully taxable equivalent (FTE) basis. Tax exempt interest is increased to an amount comparable to interest subject to federal income taxes in order to properly evaluate the effective yields earned on earning assets. The tax equivalent adjustment is based on a federal income tax rate of 34%. The following Yield Analysis shows that the Bank’s interest margin increased 36 basis points in 2005 as a result of an increase of 61 basis points in yield on earning assets, offset by an increase of 35 basis points in the interest cost on deposits and borrowings. In 2004, the interest margin decreased 10 basis points as a result of a decrease of 32 basis points in yield on earning assets, partially offset by a decrease of 26 basis points in the interest cost on deposits and borrowings.
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The following table shows the daily average balances for major categories of interest earning assets and interest bearing liabilities, interest earned (on a taxable equivalent basis) or paid, and the effective rate or yield, for the three years ended December 31, 2005, 2004, and 2003.
| Yield Analysis of Consolidated Average Assets and Liabilities | ||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | ||||||||||||||||||||||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||||||||||||||||||||||
| Average | Yield/ | Average | Yield/ | Average | Yield/ | |||||||||||||||||||||||||||||||
| Balance | Interest | Rate | Balance | Interest | Rate | Balance | Interest | Rate | ||||||||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||||||||||||||
| Short term investments | $ | 9,930 | $ | 309.5 | 3.12 | % | $ | 14,587 | $ | 166.0 | 1.14 | % | $ | 9,625 | $ | 103.4 | 1.07 | % | ||||||||||||||||||
| Certificates of deposit | 6,551 | 201.1 | 3.07 | % | 3,817 | 95.8 | 2.51 | % | 3,135 | 109.2 | 3.48 | % | ||||||||||||||||||||||||
| Securities: Taxable | 48,272 | 1,821.4 | 3.77 | % | 46,914 | 1,843.6 | 3.93 | % | 29,550 | 1,205.3 | 4.08 | % | ||||||||||||||||||||||||
| Tax-exempt (1) | 16,029 | 1,048.3 | 6.54 | % | 15,612 | 1,083.4 | 6.94 | % | 15,845 | 1,109.0 | 7.00 | % | ||||||||||||||||||||||||
| Commercial loans (2)(3) | 297,423 | 21,673.2 | 7.29 | % | 270,349 | 17,666.2 | 6.53 | % | 273,913 | 18,168.7 | 6.63 | % | ||||||||||||||||||||||||
| Consumer loans (2)(3) | 36,259 | 2,760.9 | 7.61 | % | 36,061 | 2,703.5 | 7.50 | % | 33,494 | 2,673.0 | 7.98 | % | ||||||||||||||||||||||||
| Mortgage loans (2)(3) | 33,195 | 1,954.6 | 5.89 | % | 34,449 | 1,910.6 | 5.55 | % | 32,977 | 1,964.1 | 5.96 | % | ||||||||||||||||||||||||
| Total earning assets and total interest income | 447,659 | $ | 29,769.0 | 6.65 | % | 421,789 | $ | 25,469.1 | 6.04 | % | 398,539 | $ | 25,332.7 | 6.36 | % | |||||||||||||||||||||
| Cash and due from banks | 11,352 | 12,508 | 13,018 | |||||||||||||||||||||||||||||||||
| All other assets | 16,940 | 18,202 | 18,333 | |||||||||||||||||||||||||||||||||
| Allowance for loan losses | (6,743 | ) | (5,921 | ) | (5,871 | ) | ||||||||||||||||||||||||||||||
| Total assets | $ | 469,208 | $ | 446,578 | $ | 424,019 | ||||||||||||||||||||||||||||||
Liabilities and Shareholders’ Equity | ||||||||||||||||||||||||||||||||||||
Interest bearing deposits: | ||||||||||||||||||||||||||||||||||||
| NOW, savings & MMDA | $ | 176,346 | $ | 1,398.5 | 0.79 | % | $ | 184,792 | $ | 1,175.8 | 0.64 | % | $ | 172,611 | $ | 1,468.5 | 0.85 | % | ||||||||||||||||||
| Time deposits | 163,065 | 5,374.4 | 3.30 | % | 138,463 | 4,041.8 | 2.92 | % | 135,842 | 4,288.9 | 3.16 | % | ||||||||||||||||||||||||
| Short term borrowings | 2,611 | 78.0 | 2.98 | % | 626 | 12.2 | 1.95 | % | 1,300 | 17.7 | 1.37 | % | ||||||||||||||||||||||||
| FHLBI advances | 2,688 | 203.1 | 7.56 | % | 5,080 | 376.1 | 7.40 | % | 5,337 | 391.7 | 7.34 | % | ||||||||||||||||||||||||
| Total interest bearing liabilities and total interest expense | 344,710 | 7,054.0 | 2.05 | % | 328,961 | 5,605.9 | 1.70 | % | 315,090 | 6,166.8 | 1.96 | % | ||||||||||||||||||||||||
| Noninterest bearing deposits | 73,243 | 70,477 | 65,719 | |||||||||||||||||||||||||||||||||
| All other liabilities | 3,507 | 3,784 | 3,671 | |||||||||||||||||||||||||||||||||
| Shareholders’ Equity | 47,748 | 43,356 | 39,539 | |||||||||||||||||||||||||||||||||
| Total liabilities and shareholders’ equity | $ | 469,208 | $ | 446,578 | $ | 424,019 | ||||||||||||||||||||||||||||||
| Interest spread | 4.60 | % | 4.34 | % | 4.40 | % | ||||||||||||||||||||||||||||||
| Net interest income-FTE | $ | 22,715.0 | $ | 19,863.2 | $ | 19,165.9 | ||||||||||||||||||||||||||||||
| Net interest margin | 5.07 | % | 4.71 | % | 4.81 | % | ||||||||||||||||||||||||||||||
| (1) | Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate and exclude the effect of any market value adjustments recorded under Statement of Financial Accounting Standards No. 115. | |
| (2) | For purposes of the computation above, non-accruing loans of $3,359,000 in 2005, $ 2,462,000 in 2004 and $4,751,000 in 2003 are included in the average daily loan balance. | |
| (3) | Interest on loans includes origination fees totaling $644,000 in 2005, $726,000 in 2004 and $720,000 in 2003. |
Tax equivalent interest income in each of the three years includes loan origination fees. A substantial portion of such fees is deferred for recognition in future periods or is considered in determining the gain or loss on the sale of real estate mortgage loans.
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The following table sets forth the effects of volume and rate changes on net interest income on a taxable equivalent basis. The change in interest due to changes in both volume and rate has been allocated to the change due to volume and the change due to rate in proportion to the relationship of the absolute dollar amounts of the change in each:
| (dollars in thousands) | ||||||||||||||||||||||||
| Year ended December 31, 2005 | Year ended December 31, 2004 | |||||||||||||||||||||||
| compared to | compared to | |||||||||||||||||||||||
| Year ended December 31, 2004 | Year ended December 31, 2003 | |||||||||||||||||||||||
| Amount of Increase (Decrease) Due to Change in | ||||||||||||||||||||||||
| Total | Total | |||||||||||||||||||||||
| Amount | Amount | |||||||||||||||||||||||
| Average | of Increase/ | Average | of Increase/ | |||||||||||||||||||||
| Volume | Rate | Decrease | Volume | Rate | Decrease | |||||||||||||||||||
Interest Income: | ||||||||||||||||||||||||
| Short term investments | $ | (53 | ) | $ | 197 | $ | 144 | $ | 53 | $ | 9 | $ | 62 | |||||||||||
| Certificates of deposit | 69 | 36 | 105 | 24 | (37 | ) | (13 | ) | ||||||||||||||||
| Securities: | ||||||||||||||||||||||||
| Taxable | 53 | (75 | ) | (22 | ) | 708 | (70 | ) | 638 | |||||||||||||||
| Tax Exempt | 29 | (64 | ) | (35 | ) | (16 | ) | (9 | ) | (25 | ) | |||||||||||||
| Loans | 1,701 | 2,407 | 4,108 | 32 | (557 | ) | (525 | ) | ||||||||||||||||
| Total interest income | $ | 1,799 | $ | 2,501 | $ | 4,300 | $ | 801 | $ | (664 | ) | $ | 137 | |||||||||||
Interest Expense: | ||||||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||||||
| NOW, savings & MMDA | $ | (54 | ) | $ | 276 | $ | 222 | $ | 104 | $ | (396 | ) | $ | (292 | ) | |||||||||
| Time deposits | 718 | 615 | 1,333 | 83 | (330 | ) | (247 | ) | ||||||||||||||||
| Short term borrowings | 39 | 27 | 66 | (9 | ) | 4 | (5 | ) | ||||||||||||||||
| FHLBI advances | (177 | ) | 4 | (173 | ) | (19 | ) | 3 | (16 | ) | ||||||||||||||
| Total interest expense | $ | 526 | $ | 922 | $ | 1,448 | $ | 159 | $ | (719 | ) | $ | (560 | ) | ||||||||||
Net interest income (FTE) | $ | 1,273 | $ | 1,579 | $ | 2,852 | $ | 642 | $ | 55 | $ | 697 | ||||||||||||
Tax equivalent net interest income increased $2,852,000 in 2005. The increase was primarily the result of a $4,300,000 increase in interest income offset by a $1,448,000 increase in interest expense. The increase in interest income is attributable to an increase in average earning assets of $25,870,000 during the year and an increase of 61 basis points in the interest rate earned on assets. Tax equivalent loan interest income was $4,108,000 higher in 2005 than the previous year. The increase was due to an increase of 65 basis points in the rate of interest earned on loans along with an increase in average balances $26,018,000 in 2005. The increase in rates is due to the prime rate increasing 200 basis points during 2005 offset by continued competitive loan pricing. The increase in loans is due to increased demand primarily in the first and second quarter of 2005. In 2004, tax equivalent loan interest was $525,000 less than 2003 due to a decrease of 16 basis points in the rate of interest earned on loans even with a small increase of $475,000 in the average loan balance.
Income on taxable securities decreased $22,000 in 2005 due to a decline of 16 basis points in yield offset by a $1,358,000 increase in average balances. In 2004, deposit growth exceeded loan growth and there were additional funds available for investment securities with an increase in average taxable investment securities of $17,364,000 and increase of $638,000 interest income compared to 2003. Tax equivalent income on tax-exempt bonds decreased $35,000 in 2005 due to a decline of 40 basis points in yield offset by a $417,000 increase in average balances. The decrease in yields was the result of (i) the maturity and/or calls on bonds that were purchased at slightly higher rates than that of the average portfolio and (ii) the flatness of the yield curve during 2005. Interest income on short term investments increased $144,000 due to an increase in yield of 198 basis points offset by a decrease of $4,657,000 in average balances. The average balance of purchased certificates increased $2,734,000. The interest yield increased 56 basis points primarily the result of the certificates purchased in 2005, which had higher rates than those in 2004. Interest income on purchased certificates increased $105,000 in 2005.
Interest expense increased $1,448,000 in 2005 because interest rates increased 35 basis points and average balances increased approximately $15,749,000. The interest cost for NOW, savings and MMDA accounts increased $223,000
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because the interest rate paid was 15 basis points higher even though average balances decreased $8,445,000. Interest on time deposits increased $1,333,000 as a result in growth in average balances of $24,602,000 and increased interest rates of 38 basis points. Deposits shifted to time deposit in 2005 as rates increased during the year. Fed Funds and short term advances from the FHLBI were used through the third quarter of 2005. The Bank entered into two long term borrowings with the FHLBI in 2000. One of the loans, which had a balance of $1,785,000 at year end, amortizes while the other loan matured in April 2005.
Due to the flatness of the yield curve and competitive pressures on deposit pricing, net interest margin may experience compression in 2006.
In the previous year, net interest income had increased $697,000. The increase in net interest income was the result of a $136,000 increase in interest income and a decrease in interest expense of $561,000. The modest increase in interest income in 2004 was due to higher average earning assets of $23,251,000 partially offset by a decline in yield of 32 basis points. The increase in interest expense was the result of a 26 basis drop in rates paid partially offset by an increase of $13,871,000 in average interest bearing liabilities.
The following table shows the composition of average earning assets and interest paying liabilities for the years ended December 31:
| 2005 | 2004 | 2003 | ||||||||||
| As a percent of average earning assets: | ||||||||||||
| Loans | 81.96 | % | 80.82 | % | 85.41 | % | ||||||
| Securities | 14.36 | % | 14.82 | % | 11.39 | % | ||||||
| Certificates of deposit | 1.46 | % | 0.90 | % | 0.80 | % | ||||||
| Short term investments | 2.22 | % | 3.46 | % | 2.40 | % | ||||||
| Average earning assets | 100.00 | % | 100.00 | % | 100.00 | % | ||||||
| NOW, savings, & MMDA | 39.39 | % | 43.81 | % | 43.31 | % | ||||||
| Time deposits | 36.43 | % | 32.83 | % | 34.08 | % | ||||||
| Short term borrowing | 0.58 | % | 0.15 | % | 0.33 | % | ||||||
| FHLBI advances | 0.60 | % | 1.20 | % | 1.34 | % | ||||||
| Average interest bearing liabilities | 77.00 | % | 77.99 | % | 79.06 | % | ||||||
| Earning asset ratio | 95.41 | % | 94.51 | % | 93.99 | % | ||||||
| Free-funds ratio | 23.00 | % | 22.01 | % | 20.94 | % | ||||||
Provision for Loan Losses
The provision for loan losses increased to $3,037,000 in 2005 compared to $1,190,000 in 2004 and $1,270,000 in 2003. At year end, the ratio of the allowance for loan loss to loans was 1.88%, compared to 1.70% in 2004 and 1.57% in 2003. The increase in 2005 was deemed appropriate in light of the increase in non performing loans discussed above. Based on the levels of nonperforming and impaired loans as well as a weakened local economy, which has been impacted by rising interest rates, management expects the provision in 2006 to remain at a higher level than that experienced before 2005. Additional discussion regarding the provision for loan losses and the related allowance can be found under “Loans” in this Item 7.
Noninterest Income
Noninterest income, which includes service charges on deposit accounts, trust income, loan fees, other operating income, and gain (loss) on sale of assets and security transactions, decreased approximately $290,000 (7.1%) in 2005 compared to 2004 and increased $236,000 (6.1%) in 2004 compared to 2003. The primary reason for the decrease in noninterest income was the $467,000 decrease in other income from 2004. In 2005, the Bank experienced higher than normal losses on consumer loan repossessions, and in 2004 other income includes the recognition of a nonrecurring gain of $299,000 that was deferred in 2003 on the disposition of property held for sale. Also, in 2004, the Bank experienced higher than normal gains on the sale of foreclosed real estate. Service charges and other fee income increased to $3,464,000 (4.4%) in 2005 and to $3,319,000 (5.8%) in 2004. The 2005 increase was due primarily to increased NSF charges and network
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income. The 2004 increase was due primarily to the recovery of a mortgage servicing right impairment recorded in 2003. Trust income increased $37,000 in 2005 and decreased $40,000 in 2004. Trust income in 2005 and 2003 included nonrecurring income of approximately $27,000 and $42,000, respectively. The $63,000 gain recognized on the sale of real estate mortgages loans in 2005 was $6,400 lower than the gains realized in 2004, which were $305,000 lower than the gains recognized in 2003. Low sales volume in 2005 increased approximately $498,000 from 2004 which was down approximately $19,400,000 from 2003 as mortgage rates began to rise in the later part of 2003 and refinancing activity decreased. There were no security sales in 2005 and 2004; there was a small gain of $4,000 in 2003 related to the call of a security.
Noninterest Expense
Noninterest expense totaled $13,700,000, a 2.8% increase over expenses of $13,300,000 in 2004, and a 3.4% increase over expenses of $12,800,000 in 2003. The most significant component of noninterest expense is salaries and employee benefits. In 2005, salaries and employee benefits expense remained unchanged at $7,200,000 from 2004, due to timing of filling open positions in 2005. Management expects costs to increase in 2006 due to new positions, filling of open positions, merit increases, and increased employee benefit costs. In 2004, salaries and employee benefit expense increased 2.7% to $7,200,000 due to salary increases, new positions and increased health care costs. Occupancy expense increased $94,000 (8.4%) in 2005 due to increased facility service costs, property taxes and utility costs. In 2004, occupancy expense increased $157,000 (16.4%) as the result of a new facility and increased utility costs. Equipment expense decreased $33,000 (3.9%) to $831,000 in 2005 due primarily to lower equipment depreciation expense. In 2004, equipment expense decreased $144,000 (14.2%) to $865,000 due to lower software amortization expense and lower equipment maintenance costs. In 2005, professional and service fees increased $58,000 (3.6%) due to increased legal fees primarily due to services related to consumer loan collections. In 2004, professional and service fees increased $399,000 (32.6%) due to increased costs associated with increased accounting fees due to the Sarbanes-Oxley Act, and increased personnel costs related to recruitment and staff development. Printing and supplies expense increased $16,000 (5.3%) in 2005 and $11,000 (3.8%) in 2004 as a result of increased customer mailings for compliance and disclosure purposes. Computer service fees increased $45,000 (15.0%) in 2005 due to an increase in outside computer services. In 2004 computer service fees increased $114,000 (61.7%) as a result of a new consumer loan automated decisioning system. Advertising expense increased $17,000 (7.5%) due to more loan and deposit campaigns on new products. In 2004, advertising expense decreased $83,000 (27.2%) from 2003. Other expenses increased $177,000 (10.9%) in 2005 due to increases in loan and collection costs offset by a decrease in NSF check and other losses. In 2004, other expenses decreased $205,000 (11.2%) primarily due to a $130,000 write down of the Challis road property held for sale in 2003, lower NSF check and other losses of $35,000 in 2004 and lower membership costs in 2004 of $33,000.
Federal Income Tax Expense
Fluctuations in income taxes resulted primarily from changes in the level of profitability and in variations in the amount of tax-exempt income. Income tax expense increased $156,000 to $2,884,000 (5.7%) in 2005 and increased $174,000 to $2,728,000 (6.8%) in 2004. Although income tax expense increased, the effective rate remained at approximately 30% in 2005, 2004 and 2003. For further information, see Note 12, “Federal Income Taxes,” in Notes to Consolidated Financial Statements.
Critical Accounting Policies
Our accounting and reporting policies are in accordance with accounting principles generally accepted within the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for the allowance for loan losses is deemed critical since it involves the use of estimates and requires significant management judgments. Application of assumptions different from those that we have used could result in material changes in our financial position or results of operations.
Our methodology for determining the allowance and related provision for loan losses and reserve for unfunded credit commitments is described above in “Financial Condition – Loans”. In particular, this area of accounting requires a significant amount of judgment because a multitude of factors can influence the ultimate collection of a loan or other type of credit. Should the factors noted above and as described in Note 1, “Summary of Significant Accounting Policies,” in Notes to Consolidated Financial Statements, differ from our assumptions (for example, an increase in past due loans, deterioration of the economy), our allowance for loan losses would likely be adversely impacted. It is extremely difficult to precisely measure the amount of losses that may be inherent in our loan portfolio. We attempt to accurately quantify the necessary allowance and related provision for loan losses, but there can be no assurance that our modeling process will successfully identify all of the losses inherent in our loan portfolio. As a result, we could record future provisions for loan losses that may be significantly different from the levels that we have recorded.
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Impact of New Accounting Standards
See Note 27, “Impact of New Accounting Standards,” in Notes to Consolidated Financial Statements for discussion of new accounting standards and their impact.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Included in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 8. Financial Statements and Supplementary Data.
| Index to Consolidated Financial Statements: | Page | |||
| Report of Independent Registered Public Accounting Firm | 27 | |||
| Report of Independent Registered Public Accounting Firm | 28 | |||
| Report of Independent Registered Public Accounting Firm | 29 | |||
| Consolidated Balance Sheets | 30 | |||
| Consolidated Statements of Income | 31 | |||
| Consolidated Statements of Stockholders’ Equity and Comprehensive Income | 32 | |||
| Consolidated Statements of Cash Flows | 33 | |||
| Notes to Consolidated Financial Statements | 34 | |||
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 | BDO Seidman, LLP Accountants and Consultants | 99 Monroe Avenue N.W., Suite 800 Grand Rapids, Michigan 49503-2654 Telephone: (616) 774-7000 Fax: (616) 776-3680 |
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
FNBH Bancorp, Inc.
Howell, MI
FNBH Bancorp, Inc.
Howell, MI
We have audited the accompanying consolidated balance sheets of FNBH Bancorp, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FNBH Bancorp, Inc. and subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FNBH Bancorp, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 22, 2006 expressed an unqualified opinion thereon.
 |
| Grand Rapids, Michigan |
| February 22, 2006 |
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| BDO Seidman, LLP Accountants and Consultants | 99 Monroe Avenue N.W., Suite 800 Grand Rapids, Michigan 49503-2654 Telephone: (616) 774-7000 Fax: (616) 776-3680 |
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
FNBH Bancorp, Inc.
Howell, MI
FNBH Bancorp, Inc.
Howell, MI
We have audited management’s assessment, included in Management’s Annual Report on Internal Control Over Financial Reporting, in Item 9A, that FNBH Bancorp, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FNBH Bancorp, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that FNBH Bancorp, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also in our opinion, FNBH Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (Unites States), the accompanying consolidated balance sheets as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for the years then ended of FNBH Bancorp, Inc. and our report dated February 22, 2006 expressed an unqualified opinion thereon.
|
| Grand Rapids, Michigan |
| February 22, 2006 |
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KPMG LLP
Suite 1200
150 West Jefferson
Detroit, MI48226-4429
Suite 1200
150 West Jefferson
Detroit, MI48226-4429
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
FNBH Bancorp, Inc.:
FNBH Bancorp, Inc.:
We have audited the accompanying consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows of FNBH Bancorp, Inc. and subsidiaries (the Corporation) for the year ended December 31, 2003. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of FNBH Bancorp, Inc. and subsidiaries for the year ended December 31, 2003, in conformity with U.S. generally accepted accounting principles.
 |
| Detroit, Michigan |
| January 16, 2004 |
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FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2005 and 2004
Consolidated Balance Sheets
December 31, 2005 and 2004
| 2005 | 2004 | |||||||
Assets | ||||||||
| Cash and due from banks | $ | 19,281,982 | $ | 12,157,948 | ||||
| Short term investments | 4,819,709 | 5,680,395 | ||||||
| Total cash and cash equivalents | 24,101,691 | 17,838,343 | ||||||
| Certificates of deposit | 7,166,000 | 6,091,000 | ||||||
| Investment securities held to maturity, net (fair value of $16,763,204 at December 31, 2005 and $16,705,640 at December 31, 2004) | 16,425,674 | 16,009,337 | ||||||
| Investment securities available for sale, at fair value | 32,388,356 | 30,775,695 | ||||||
| Mortgage-backed securities available for sale, at fair value | 12,405,476 | 16,432,188 | ||||||
| FHLBI and FRB stock, at cost | 1,153,550 | 1,130,650 | ||||||
| Total investment securities | 62,373,056 | 64,347,870 | ||||||
| Loans: | ||||||||
| Commercial | 305,387,518 | 286,940,773 | ||||||
| Consumer | 36,161,235 | 36,077,528 | ||||||
| Real estate mortgage | 31,306,493 | 34,358,613 | ||||||
| Total loans | 372,855,246 | 357,376,914 | ||||||
| Less allowance for loan losses | (6,991,125 | ) | (6,092,949 | ) | ||||
| Net loans | 365,864,121 | 351,283,965 | ||||||
| Premises and equipment, net | 10,465,856 | 11,086,901 | ||||||
| Land and facilities held for sale, net | — | 95,680 | ||||||
| Other real estate owned, held for sale | 679,733 | 735,000 | ||||||
| Accrued interest and other assets | 6,574,686 | 5,431,302 | ||||||
| Total assets | $ | 477,225,143 | $ | 456,910,061 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Liabilities | ||||||||
| Deposits: | ||||||||
| Demand (non-interest bearing) | $ | 71,415,340 | $ | 71,785,184 | ||||
| NOW | 40,739,655 | 49,206,656 | ||||||
| Savings and money market | 133,865,335 | 147,298,849 | ||||||
| Time deposits | 145,927,984 | 122,981,856 | ||||||
| Brokered certificates of deposit | 30,137,273 | 7,990,365 | ||||||
| Total deposits | 422,085,587 | 399,262,910 | ||||||
| Other borrowings | 1,785,094 | 8,066,836 | ||||||
| Accrued interest, taxes, and other liabilities | 3,908,137 | 3,864,267 | ||||||
| Total liabilities | 427,778,818 | 411,194,013 | ||||||
Stockholders’ Equity | ||||||||
| Common stock, no par value. Authorized 4,200,000 shares; 3,187,374 shares issued and outstanding at December 31, 2005 and 3,179,654 shares issued and outstanding at December 31, 2004 | 6,225,947 | 6,009,181 | ||||||
| Retained earnings | 43,389,917 | 39,430,621 | ||||||
| Deferred directors’ compensation | 575,045 | 455,481 | ||||||
| Unearned long term incentive plan | (137,407 | ) | (151,048 | ) | ||||
| Accumulated other comprehensive loss, net | (607,177 | ) | (28,187 | ) | ||||
| Total stockholders’ equity | 49,446,325 | 45,716,048 | ||||||
| Total liabilities and stockholders’ equity | $ | 477,225,143 | $ | 456,910,061 | ||||
See accompanying notes to consolidated financial statements.
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FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
December 31, 2005, 2004, and 2003
Consolidated Statements of Income
December 31, 2005, 2004, and 2003
| 2005 | 2004 | 2003 | ||||||||||
| Interest and dividend income: | ||||||||||||
| Interest and fees on loans | $ | 26,247,716 | $ | 22,137,252 | $ | 22,666,583 | ||||||
| Interest and dividends on investment securities: | ||||||||||||
| U.S. Treasury and agency securities | 1,711,402 | 1,667,506 | 975,069 | |||||||||
| Obligations of states and political subdivisions | 729,222 | 747,483 | 770,269 | |||||||||
| Corporate bonds | 59,959 | 125,381 | 188,463 | |||||||||
| Other securities | 50,004 | 51,278 | 41,759 | |||||||||
| Interest on short term investments | 315,528 | 166,978 | 104,818 | |||||||||
| Interest on certificates of deposit | 201,076 | 95,832 | 109,201 | |||||||||
| Total interest and dividend income | 29,314,907 | 24,991,710 | 24,856,162 | |||||||||
| Interest expense: | ||||||||||||
| Interest on deposits | 6,772,924 | 5,217,598 | 5,757,465 | |||||||||
| Interest on other borrowings | 281,073 | 388,268 | 409,389 | |||||||||
| Total interest expense | 7,053,997 | 5,605,866 | 6,166,854 | |||||||||
| Net interest income | 22,260,910 | 19,385,844 | 18,689,308 | |||||||||
| Provision for loan losses | 3,037,000 | 1,190,000 | 1,270,000 | |||||||||
| Net interest income after provision for loan losses | 19,223,910 | 18,195,844 | 17,419,308 | |||||||||
| Noninterest income: | ||||||||||||
| Service charges and other fee income | 3,464,122 | 3,318,666 | 3,136,077 | |||||||||
| Trust income | 284,394 | 246,950 | 287,344 | |||||||||
| Gain on sale of loans | 62,512 | 68,881 | 373,516 | |||||||||
| Gain on sale/call of investments | — | — | 3,823 | |||||||||
| Other | 8,612 | 475,560 | 73,376 | |||||||||
| Total noninterest income | 3,819,640 | 4,110,057 | 3,874,136 | |||||||||
| Noninterest expense: | ||||||||||||
| Salaries and employee benefits | 7,230,103 | 7,236,801 | 7,048,376 | |||||||||
| Net occupancy expense | 1,208,830 | 1,115,030 | 957,710 | |||||||||
| Equipment expense | 831,299 | 864,604 | 1,008,275 | |||||||||
| Professional and service fees | 1,680,037 | 1,622,399 | 1,223,346 | |||||||||
| Printing and supplies | 318,091 | 302,032 | 291,103 | |||||||||
| Computer service fees | 344,095 | 299,114 | 184,996 | |||||||||
| Advertising | 238,323 | 221,618 | 304,589 | |||||||||
| Other | 1,801,865 | 1,625,052 | 1,829,715 | |||||||||
| Total noninterest expense | 13,652,643 | 13,286,650 | 12,848,110 | |||||||||
| Income before federal income taxes | 9,390,907 | 9,019,251 | 8,445,334 | |||||||||
| Federal income taxes | 2,883,921 | 2,728,156 | 2,554,437 | |||||||||
| Net income | $ | 6,506,986 | $ | 6,291,095 | $ | 5,890,897 | ||||||
| Per share statistics: | ||||||||||||
| Basic EPS | $ | 2.03 | $ | 1.98 | $ | 1.86 | ||||||
| Diluted EPS | $ | 2.03 | $ | 1.97 | $ | 1.86 | ||||||
| Dividends | $ | 0.80 | $ | 0.72 | $ | 0.68 | ||||||
| Basic average shares outstanding | 3,200,146 | 3,185,025 | 3,162,836 | |||||||||
| Diluted average shares outstanding | 3,200,518 | 3,186,142 | 3,162,836 | |||||||||
See accompanying notes to consolidated financial statements.
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FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
December 31, 2005, 2004, and 2003
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
December 31, 2005, 2004, and 2003
| Accumulated | ||||||||||||||||||||||||
| Deferred | Unearned | Other | ||||||||||||||||||||||
| Common | Retained | Directors’ | Long Term | Comprehensive | ||||||||||||||||||||
| Stock | Earnings | Compensation | Incentive Plan | Income (Loss) | Total | |||||||||||||||||||
| Balances at December 31,2002 | $ | 5,465,089 | $ | 31,685,849 | $ | — | $ | (247,282 | ) | $ | 675,958 | $ | 37,579,614 | |||||||||||
| Issued 4,482 shares for long term incentive plan | 110,137 | �� | (110,137 | ) | — | |||||||||||||||||||
| Amortization of long term incentive plan | 134,767 | 134,767 | ||||||||||||||||||||||
| Issued 4,055 shares for employee stock purchase plan | 88,722 | 88,722 | ||||||||||||||||||||||
| Issued 907 shares for current directors’ fees | 21,954 | 21,954 | ||||||||||||||||||||||
| Issued 1,689 shares for directors’ variable fee plan | 39,996 | 39,996 | ||||||||||||||||||||||
| Comprehensive income: | ||||||||||||||||||||||||
| Net income | 5,890,897 | 5,890,897 | ||||||||||||||||||||||
| Change in unrealized gain (loss) on investment securities available for sale, net of tax effect | (369,422 | ) | (369,422 | ) | ||||||||||||||||||||
| Total comprehensive income | 5,521,475 | |||||||||||||||||||||||
| Cash dividends ($0.68 per share) | (2,151,047 | ) | (2,151,047 | ) | ||||||||||||||||||||
| Balances at December 31, 2003 | 5,725,898 | 35,425,699 | — | (222,652 | ) | 306,536 | 41,235,481 | |||||||||||||||||
| Issued 4,261 shares for long term incentive plan | 115,985 | (115,985 | ) | — | ||||||||||||||||||||
| Amortization of long term incentive plan | 184,530 | 184,530 | ||||||||||||||||||||||
| 146 shares from long term incentive plan forfeited | (3,059 | ) | 3,059 | — | ||||||||||||||||||||
| Issued 4,352 shares for employee stock purchase plan | 109,521 | 109,521 | ||||||||||||||||||||||
| Issued 794 shares for current directors’ fees | 22,791 | 22,791 | ||||||||||||||||||||||
| Issued 1,179 shares for directors’ variable fee plan | 32,092 | 32,092 | ||||||||||||||||||||||
| Issued 283 shares for deferred directors’ fees | 5,953 | 5,953 | ||||||||||||||||||||||
| Directors’ deferred compensation (590 stock units) | 18,270 | 18,270 | ||||||||||||||||||||||
| Reclassification of directors’ deferred compensation (19,321 stock units) | 437,211 | 437,211 | ||||||||||||||||||||||
| Comprehensive income: | ||||||||||||||||||||||||
| Net income | 6,291,095 | 6,291,095 | ||||||||||||||||||||||
| Change in unrealized gain (loss) on investment securities available for sale, net of tax effect | (334,723 | ) | (334,723 | ) | ||||||||||||||||||||
| Total comprehensive income | 5,956,372 | |||||||||||||||||||||||
| Cash dividends ($0.72 per share) | (2,286,173 | ) | (2,286,173 | ) | ||||||||||||||||||||
| Balances at December 31, 2004 | 6,009,181 | 39,430,621 | 455,481 | (151,048 | ) | (28,187 | ) | 45,716,048 | ||||||||||||||||
| Issued 2,325 shares for long term incentive plan | 70,239 | (70,239 | ) | — | ||||||||||||||||||||
| Amortization of long term incentive plan | 83,880 | 83,880 | ||||||||||||||||||||||
| Issued 3,687 shares for employee stock purchase plan | 95,975 | 95,975 | ||||||||||||||||||||||
| Issued 722 shares for current directors’ fees | 20,765 | 20,765 | ||||||||||||||||||||||
| Issued 986 shares for directors’ variable fee plan | 29,787 | 29,787 | ||||||||||||||||||||||
| Directors’ deferred compensation (4,105 stock units) | 119,564 | 119,564 | ||||||||||||||||||||||
| Comprehensive income: | ||||||||||||||||||||||||
| Net income | 6,506,986 | 6,506,986 | ||||||||||||||||||||||
| Change in unrealized loss on investment securities available for sale, net of tax effect | (578,990 | ) | (578,990 | ) | ||||||||||||||||||||
| Total comprehensive income | 5,927,996 | |||||||||||||||||||||||
| Cash dividends ($0.80 per share) | (2,547,690 | ) | (2,547,690 | ) | ||||||||||||||||||||
| Balances at December 31, 2005 | $ | 6,225,947 | $ | 43,389,917 | $ | 575,045 | $ | (137,407 | ) | $ | (607,177 | ) | $ | 49,446,325 | ||||||||||
See accompanying notes to consolidated financial statements.
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FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
December 31, 2005, 2004, and 2003
Consolidated Statements of Cash Flows
December 31, 2005, 2004, and 2003
| 2005 | 2004 | 2003 | ||||||||||
| Cash flows from operating activities: | ||||||||||||
| Net income | $ | 6,506,986 | $ | 6,291,095 | $ | 5,890,897 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Provision for loan losses | 3,037,000 | 1,190,000 | 1,270,000 | |||||||||
| Depreciation and amortization | 984,021 | 1,014,720 | 992,986 | |||||||||
| Deferred income tax expense (benefit) | (503,802 | ) | 159,167 | (118,597 | ) | |||||||
| Net amortization (accretion) on investment securities | 15,183 | (16,031 | ) | 126,508 | ||||||||
| Earned portion of long term incentive plan | 83,880 | 184,530 | 134,767 | |||||||||
| Shares issued for current directors’ compensation | 50,552 | 54,883 | 61,950 | |||||||||
| Shares earned for deferred directors’ compensation | 119,564 | 24,223 | — | |||||||||
| Gain on sale/call of investments | — | — | (3,823 | ) | ||||||||
| Gain on sale of loans | (62,512 | ) | (68,881 | ) | (373,516 | ) | ||||||
| Proceeds from sale of loans | 6,102,540 | 11,285,139 | 23,486,120 | |||||||||
| Gain on the sale of other real estate owned, held for sale | (20,507 | ) | (98,850 | ) | (22,710 | ) | ||||||
| (Gain) loss on sale of land and facilities held for sale | 2,595 | (42,716 | ) | — | ||||||||
| Origination of loans held for sale | (5,788,325 | ) | (10,541,000 | ) | (22,524,120 | ) | ||||||
| Loss on disposal of equipment | 19,990 | — | 8,958 | |||||||||
| (Increase) decrease in accrued interest income and other assets | (338,394 | ) | (135,314 | ) | 48,167 | |||||||
| Increase (decrease) in accrued interest, taxes, and other liabilities | (103,130 | ) | (29,240 | ) | 906,988 | |||||||
| Net cash provided by operating activities | 10,105,641 | 9,271,725 | 9,884,575 | |||||||||
| Cash flows from investing activities: | ||||||||||||
| Purchases of available for sale securities | (5,119,280 | ) | (36,556,566 | ) | (22,783,210 | ) | ||||||
| Purchases of held to maturity securities | (2,091,712 | ) | (4,776,698 | ) | (234,270 | ) | ||||||
| Purchases/stock dividend FHLBI stock | (22,900 | ) | (47,900 | ) | (38,500 | ) | ||||||
| Proceeds from maturities and calls of available for sale securities | 3,000,000 | 24,500,000 | 3,500,000 | |||||||||
| Proceeds from mortgage-backed securities paydowns-available for sale | 3,647,345 | 3,660,069 | 5,977,649 | |||||||||
| Proceeds from maturities and calls of held to maturity securities | 1,666,000 | 3,820,125 | 2,046,100 | |||||||||
| Proceeds from mortgage-backed securities paydowns-held to maturity | — | — | 26,028 | |||||||||
| Purchases of certificates of deposit | (10,600,000 | ) | (5,993,000 | ) | (1,187,000 | ) | ||||||
| Maturity of certificates of deposit | 9,525,000 | 1,455,000 | 3,514,000 | |||||||||
| Purchase of loans | — | (6,279,807 | ) | (3,000,000 | ) | |||||||
| Net increase in loans | (18,690,040 | ) | (6,996,938 | ) | (18,662,903 | ) | ||||||
| Proceeds from sale of other real estate owned, held for sale | 1,043,955 | 990,652 | 760,916 | |||||||||
| Proceeds from sale of land and facilities held for sale | 93,085 | 1,503,016 | — | |||||||||
| Capital expenditures | (382,966 | ) | (346,912 | ) | (2,655,515 | ) | ||||||
| Net cash used in investing activities | (17,931,513 | ) | (25,068,959 | ) | (32,736,705 | ) | ||||||
| Cash flows from financing activities: | ||||||||||||
| Net increase in deposits | 22,822,677 | 189,609 | 25,001,090 | |||||||||
| Payments on FHLBI note | (3,281,742 | ) | (260,872 | ) | (241,547 | ) | ||||||
| Proceeds from issuance of short term debt | 11,000,000 | 3,000,000 | — | |||||||||
| Repayment of short term debt | (14,000,000 | ) | — | — | ||||||||
| Dividends paid | (2,547,690 | ) | (2,286,173 | ) | (2,151,047 | ) | ||||||
| Shares issued for employee stock purchase plan | 95,975 | 109,521 | 88,722 | |||||||||
| Net cash provided by financing activities | 14,089,220 | 752,085 | 22,697,218 | |||||||||
| Net increase (decrease) in cash and cash equivalents | 6,263,348 | (15,045,149 | ) | (154,912 | ) | |||||||
| Cash and cash equivalents at beginning of year | 17,838,343 | 32,883,492 | 33,038,404 | |||||||||
| Cash and cash equivalents at end of year | $ | 24,101,691 | $ | 17,838,343 | $ | 32,883,492 | ||||||
| Supplemental disclosures: | ||||||||||||
| Interest paid | $ | 6,813,756 | $ | 5,642,097 | $ | 6,168,253 | ||||||
| Federal income taxes paid | 3,546,682 | 2,609,881 | 2,460,000 | |||||||||
| Loans transferred to other real estate | 968,181 | 1,561,802 | 95,000 | |||||||||
| Properties transferred to land and facilities held for sale | — | 155,690 | — | |||||||||
| Loans charged off | 2,253,717 | 922,078 | 1,282,563 | |||||||||
See accompanying notes to consolidated financial statements.
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Notes to Consolidated Financial Statements
| (1) | Summary of Significant Accounting Policies |
Principles of Consolidation
The consolidated financial statements include the accounts of FNBH Bancorp, Inc. and its wholly owned subsidiaries, First National Bank in Howell (including its wholly owned subsidiary FNBH Mortgage Company, LLC) and H.B. Realty Co. All significant intercompany balances and transactions have been eliminated.
First National Bank in Howell (Bank) is a full-service bank offering a wide range of commercial and personal banking services. These services include checking accounts, savings accounts, certificates of deposit, commercial loans, real estate loans, installment loans, collections, traveler’s checks, night depository, safe deposit box, U.S. Savings Bonds, and trust services. The Bank serves primarily five communities – Howell, Brighton, Green Oak Township, Hartland, and Fowlerville – all of which are located in Livingston County, Michigan. The Bank is not dependent upon any single industry or business for its banking opportunities.
H.B. Realty Co. was established on November 26, 1997 to purchase land for a future branch site of the Bank and to hold title to other Bank real estate when it is considered prudent to do so.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The accounting and reporting policies of FNBH Bancorp, Inc. and subsidiaries (Corporation) conform to accounting principles generally accepted in the United States of America and to general practice within the banking industry. The following is a description of the more significant of these policies.
| (a) | Brokered Certificates of Deposit | |
| Brokered certificates of deposit are purchased periodically from other financial institutions in denominations of less than $100,000. These investments are fully insured by the FDIC. Brokered CD’s are not marketable, and there is a penalty for early withdrawal. | ||
| (b) | Investment and Mortgage-Backed Securities | |
| The Bank classifies debt and equity investments and mortgage–backed securities as follows: | ||
| Investment securities held to maturity are those securities which management has the ability and positive intent to hold to maturity. Investment securities held to maturity are stated at cost, adjusted for amortization of premium and accretion of discount. | ||
| Investment securities that we may not hold until maturity are accounted for as securities available for sale and are stated at fair value, with unrealized gains and losses, net of income taxes, reported as a separate component of other comprehensive income until realized. | ||
| Trading account securities are carried at fair value. Realized and unrealized gains or losses on trading securities are included in noninterest income. The Bank holds no securities under the trading classification. | ||
| Gains or losses on the sale of securities are computed based on the adjusted cost of the specific security. | ||
| Management reviews all securities for impairment and records other-than-temporary impairments, if any, as a component of noninterest income. | ||
| (c) | Loans | |
| Loans are stated at their principal amount outstanding, net of an allowance for loan losses and unearned discount. Interest on loans is accrued daily based on the outstanding principal balance. Loan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of the |
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| yield. Net unamortized deferred loan fees amounted to $856,000 and $1,006,000 at December 31, 2005 and 2004, respectively. | ||
| The Bank originates real estate mortgage loans for sale to the secondary market and sells the loans with servicing retained. Mortgage loans held for sale are carried at the lower of cost or market, determined on a net aggregate basis. Market is determined on the basis of delivery prices in the secondary mortgage market. When loans are sold, gains and losses are recognized based on the specific identification method. | ||
| The total cost of mortgage loans originated and sold is allocated between the loan servicing right and the mortgage loan, based on their relative fair values at the date of origination. The capitalized cost of loan servicing rights is amortized in proportion to, and over the period of, estimated net future servicing revenue. The Bank enters into interest rate lock commitments to originate loans at a rate determined prior to funding. Interest rate lock commitments on residential mortgage loans that are intended to be sold are considered to be derivatives. Fair value is based on fees currently charged to enter into similar agreements. At December 31, 2005 and 2004, the fair value of interest rate lock commitments was insignificant. | ||
| Mortgage servicing rights, which are included in other assets, are periodically evaluated for impairment. For purposes of measuring impairment, mortgage servicing rights are stratified based on predominant risk characteristics of the underlying serviced loans. These risk characteristics include loan type, term, year originated, and note rate. Impairment represents the excess of cost of an individual mortgage servicing right’s stratum over its fair value and is recognized through a valuation allowance. | ||
| Fair values for individual strata are based on quoted market prices for comparable transactions, if available, or estimated fair value. Estimates of fair value include assumptions about prepayment, default and interest rates, and other factors which are subject to change over time. Changes in these underlying assumptions could cause the fair value of mortgage servicing rights, and the related valuation allowance, to change significantly in the future. | ||
| (d) | Allowance for Loan Losses and Credit Commitments | |
| The allowance for loan losses is based on management’s periodic evaluation of the loan portfolio and reflects an amount that, in management’s opinion, is adequate to absorb probable losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior loan loss experience, nonperforming loan levels, the composition of the loan portfolio, and management’s evaluation of the collectibility of specific loans, which includes analysis of the value of the underlying collateral. Although the Bank evaluates the adequacy of the allowance for loan losses based on information known to management at a given time, various regulatory agencies, as part of their normal examination process, may require future additions to the allowance for loan losses. | ||
| The Bank also maintains a reserve for losses on unfunded credit commitments and letters of credit to provide for the risk of loss inherent in these arrangements. The reserve is computed using the same methodology as that used to determine the allowance for loan losses. This reserve is reported as a liability on the balance sheet within accrued interest, taxes, and other liabilities, while the corresponding provision for these losses is recorded as a component of the provision for loan losses. | ||
| (e) | Nonperforming Assets | |
| The Bank charges off all or part of loans when amounts are deemed to be uncollectible, although collection efforts may continue and future recoveries may occur. | ||
| Nonperforming assets are comprised of loans for which the accrual of interest has been discontinued, loans for which the terms have been renegotiated to less than market rates due to a serious weakening of the borrower’s financial condition, loans 90 days past due and still accruing, and other real estate, which has been acquired primarily through foreclosure and is awaiting disposition. | ||
| Loans are generally placed on a nonaccrual status when principal or interest is past due 90 days or more and when, in the opinion of management, full collection of principal and interest is unlikely. At the time a loan is placed on nonaccrual status, interest previously accrued but not yet collected is charged against current income. Income on such loans is then recognized only to the extent that cash is received and where future collection of principal is probable. |
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| The Bank considers a loan to be impaired when it is probable that it will be unable to collect all or part of amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is accrued based on the principal amounts outstanding. The accrual of interest is generally discontinued when an impaired loan becomes 90 days past due. | ||
| (f) | Real Estate | |
| Other real estate owned at the time of foreclosure is recorded at the lower of the Bank’s cost of acquisition or the asset’s fair market value, net of disposal cost. Any write-downs at date of acquisition are charged to the allowance for loan losses. Expenses incurred in maintaining assets and subsequent write-downs to reflect declines in value are charged to other noninterest expense. | ||
| Real estate held for sale is recorded at the lower of carrying amount or estimated fair value less estimated disposal costs. Subsequent declines in estimated fair value and/or disposal costs are recorded as a component of noninterest expense. | ||
| (g) | Premises and Equipment | |
| Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization, computed on the straight-line method, are charged to operations over the estimated useful lives of the assets. Estimated useful lives range up to 40 years for buildings, up to 7 years for furniture and equipment and up to 15 years for land improvements. Leasehold improvements are generally depreciated over the shorter of the respective lease term or estimated useful life. | ||
| Premises and equipment are evaluated periodically for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. Impairment exists when the expected undiscounted future cash flows of a long-lived asset are less than its carrying value. In that event, the Bank recognizes a loss for the difference between the carrying amount and the estimated fair value of the asset based on a quoted market price, if applicable, or a discounted cash flow analysis. Impairment losses are recorded in other noninterest expense on the income statement. | ||
| (h) | Advertising Costs | |
| Advertising costs are generally expensed as incurred. | ||
| (i) | Federal Income Taxes | |
| Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. | ||
| (j) | Stock-Based Compensation | |
| At December 31, 2005 and 2004, the Corporation has two stock-based compensation plans, which are described more fully in notes 16 and 17. | ||
| (k) | Statements of Cash Flows | |
| For purposes of reporting cash flows, cash equivalents include amounts due from banks, federal funds sold and other short term investments with original maturities of 90 days or less. | ||
| (l) | Comprehensive Income | |
| SFAS No. 130,Reporting Comprehensive Income,established standards for the reporting and display of comprehensive income and its components (such as changes in unrealized gains and losses on securities available for sale) in a financial statement that is displayed with the same prominence as other financial statements. The Corporation reports comprehensive income within the statement of stockholders’ equity and comprehensive income. Comprehensive income includes net income and any changes in equity from nonowner sources that are not recorded in the income statement. |
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| (m) | Earnings Per Share | |
| Basic earnings per common share is calculated by dividing net income by the average number of common shares and deferred director fee stock units outstanding during the year. Diluted earnings per common share is calculated by dividing net income by the average number of common shares and deferred director fee stock units outstanding during the year, plus the effect of common stock equivalents (for example, restricted share rights) that are dilutive. | ||
| (n) | Reclassification | |
| Certain reclassifications of 2004 and 2003 information have been made to conform to the current year presentation. | ||
| (2) | Certificates of Deposit | |
| At December 31, 2005 the scheduled maturities of certificates of deposit were: |
| Maturing in 2006 | $ | 5,399,000 | ||
| Maturing in 2007 | 1,571,000 | |||
| Maturing in 2008 | 196,000 | |||
| Total | $ | 7,166,000 | ||
| (3) | Investment and Mortgage-Backed Securities | |
| A summary of the amortized cost and approximate fair value of investment and mortgage-backed securities at December 31, 2005 and 2004 follows: |
| December 31, 2005 | December 31, 2004 | |||||||||||||||||||||||||||||||
| Unrealized | Unrealized | Unrealized | Unrealized | |||||||||||||||||||||||||||||
| Amortized | gross | gross | Fair | Amortized | gross | gross | Fair | |||||||||||||||||||||||||
| cost | gains | losses | value | cost | gains | losses | value | |||||||||||||||||||||||||
| Held to maturity: | ||||||||||||||||||||||||||||||||
| Obligations of state and political subdivisions | $ | 16,425,674 | $ | 365,562 | $ | (28,032 | ) | $ | 16,763,204 | $ | 16,009,337 | $ | 696,303 | $ | — | $ | 16,705,640 | |||||||||||||||
| Total held to maturity | 16,425,674 | 365,562 | (28,032 | ) | 16,763,204 | 16,009,337 | 696,303 | — | 16,705,640 | |||||||||||||||||||||||
| Available for sale: | ||||||||||||||||||||||||||||||||
| U.S. Treasury and agency securities | 32,095,107 | 6,068 | (717,398 | ) | 31,383,777 | 29,975,734 | 61,903 | (299,522 | ) | 29,738,115 | ||||||||||||||||||||||
| Corporate bonds | 1,000,062 | 4,517 | — | 1,004,579 | 1,001,104 | 36,476 | — | 1,037,580 | ||||||||||||||||||||||||
| Mortgage-backed securities | 12,618,628 | 35,073 | (248,225 | ) | 12,405,476 | 16,270,832 | 194,770 | (33,414 | ) | 16,432,188 | ||||||||||||||||||||||
| Total available for sale | 45,713,797 | 45,658 | (965,623 | ) | 44,793,832 | 47,247,670 | 293,149 | (332,936 | ) | 47,207,883 | ||||||||||||||||||||||
| Total securities | $ | 62,139,471 | $ | 411,220 | $ | (993,655 | ) | $ | 61,557,036 | $ | 63,257,007 | $ | 989,452 | $ | (332,936 | ) | $ | 63,913,523 | ||||||||||||||
| There were 24 securities in a continuous loss position for 12 months or more at December 31, 2005, which consisted of six asset backed securities and 18 agency securities. Because the declines in fair value were due to changes in market interest rates, not in estimated cash flows, and the securities are bank qualified municipals, federal agencies, or mortgage-backed securities issued by federal agencies, no other-than-temporary impairment was recorded at December 31, 2005. The Corporation has both the intent and ability to hold these securities for the time necessary to recover the amortized cost. |
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| The following is a summary of the unrealized losses and fair value of securities available for sale portfolio at December 31, 2005 and 2004, by length of time that individual securities in each category have been in a continuous loss position: |
| December 31, 2005 | ||||||||||||||||||||||||
| Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
| Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
| gross | Fair | gross | Fair | gross | Fair | |||||||||||||||||||
| losses | value | losses | value | losses | value | |||||||||||||||||||
| Available for sale: | ||||||||||||||||||||||||
| U.S. Treasury and agency securities | $ | (188,952 | ) | $ | 10,414,796 | $ | (528,446 | ) | $ | 18,962,912 | $ | (717,398 | ) | $ | 29,377,708 | |||||||||
| Mortgage-backed securities | (89,078 | ) | 7,146,899 | (159,147 | ) | 4,380,673 | (248,225 | ) | 11,527,572 | |||||||||||||||
| Total available for sale | $ | (278,030 | ) | $ | 17,561,695 | $ | (687,593 | ) | $ | 23,343,585 | $ | (965,623 | ) | $ | 40,905,280 | |||||||||
| December 31, 2004 | ||||||||||||||||||||||||
| Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
| Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
| gross | Fair | gross | Fair | gross | Fair | |||||||||||||||||||
| losses | value | losses | value | losses | value | |||||||||||||||||||
| Available for sale: | ||||||||||||||||||||||||
| U.S. Treasury and agency securities | $ | (212,126 | ) | $ | 21,264,600 | $ | (87,396 | ) | $ | 2,912,605 | $ | (299,522 | ) | $ | 24,177,205 | |||||||||
| Mortgage-backed securities | (24,430 | ) | 4,771,822 | (8,984 | ) | 1,064,810 | (33,414 | ) | 5,836,632 | |||||||||||||||
| Total available for sale | $ | (236,556 | ) | $ | 26,036,422 | $ | (96,380 | ) | $ | 3,977,415 | $ | (332,936 | ) | $ | 30,013,837 | |||||||||
The amortized cost and approximate fair value of investment and mortgage-backed securities at December 31, 2005 and 2004, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| December 31, 2005 | December 31, 2004 | |||||||||||||||
| Amortized | Approximate | Amortized | Approximate | |||||||||||||
| cost | fair value | cost | fair value | |||||||||||||
Held to maturity: | ||||||||||||||||
| Due in one year or less | $ | 2,384,602 | $ | 2,402,255 | $ | 1,279,805 | $ | 1,308,479 | ||||||||
| Due after one year through five years | 7,307,216 | 7,495,656 | 8,926,155 | 9,398,971 | ||||||||||||
| Due after five years through ten years | 1,881,449 | 1,871,800 | 1,953,582 | 2,029,413 | ||||||||||||
| Due after ten years | 4,852,407 | 4,993,493 | 3,849,795 | 3,968,777 | ||||||||||||
| $ | 16,425,674 | $ | 16,763,204 | $ | 16,009,337 | $ | 16,705,640 | |||||||||
Available for sale: | ||||||||||||||||
| Due in one year or less | $ | 8,238,228 | $ | 8,186,734 | $ | 3,005,150 | $ | 2,986,680 | ||||||||
| Due after one year through five years | 24,856,941 | 24,201,622 | 26,992,032 | 26,810,797 | ||||||||||||
| Due after five years through ten years | — | — | 979,656 | 978,218 | ||||||||||||
| 33,095,169 | 32,388,356 | 30,976,838 | 30,775,695 | |||||||||||||
| Mortgage-backed securities | 12,618,628 | 12,405,476 | 16,270,832 | 16,432,188 | ||||||||||||
| $ | 45,713,797 | $ | 44,793,832 | $ | 47,247,670 | $ | 47,207,883 | |||||||||
| Proceeds from sales/calls of available for sale securities totaled approximately $0, $8,000,000, and $3,500,000 during 2005, 2004, and 2003, respectively; gross realized gains of $4,587 and gross realized losses of $764 were recorded as a result of sales of available-for-sale securities during 2003 (none in 2005 and 2004). |
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| The amortized cost and approximate fair value of investment securities of states (including all their political subdivisions) that individually exceeded 10% of stockholders’ equity at December 31, 2005 and 2004 are as follows: |
| 2005 | 2004 | |||||||||||||||
| Amortized | Approximate | Amortized | Approximate | |||||||||||||
| cost | fair value | cost | fair value | |||||||||||||
| State of Michigan | $ | 11,673,789 | $ | 11,877,846 | $ | 10,545,620 | $ | 10,971,396 | ||||||||
| Investment securities, with an amortized cost of approximately $1,792,000 at December 31, 2005 and $1,865,000 at December 31, 2004, were pledged to secure public deposits and for other purposes as required or permitted by law. | ||
| The Bank owns stock in both the Federal Home Loan Bank of Indianapolis (FHLBI) and the Federal Reserve Bank (FRB), both of which are recorded at cost. The Bank is required to hold stock in the FHLBI equal to 5% of the institution’s borrowing capacity with the FHLBI. The Bank’s investment in FHLBI stock amounted to $1,109,300 and $1,086,400 as of December 31, 2005 and 2004, respectively. The Bank’s investment in FRB stock, which totaled $44,250 at December 31, 2005 and 2004, respectively, is a requirement for the Bank’s membership in the Federal Reserve System. These investments can only be resold to, or redeemed, by the issuer. |
| (4) | Loans | |
| Loans on nonaccrual status amounted to $5,234,000, $1,146,000 and $4,293,000, at December 31, 2005, 2004, and 2003, respectively. If these loans had continued to accrue interest in accordance with their original terms, approximately $270,000, $98,000, and $320,000 of interest income would have been recognized in 2005, 2004, and 2003 respectively. The Bank had no troubled-debt restructured loans at December 31, 2005 and 2004. | ||
| Details of past-due and nonperforming loans follow: |
| 90 days past due | ||||||||||||||||||||||||
| and still accruing interest | Nonaccrual | |||||||||||||||||||||||
| 2005 | 2004 | 2003 | 2005 | 2004 | 2003 | |||||||||||||||||||
| Commercial and mortgage loans secured by real estate | $ | 384,842 | $ | 285,771 | $ | — | $ | 4,124,339 | $ | 243,374 | $ | 4,253,075 | ||||||||||||
| Consumer loans | 5,756 | 2,541 | — | 91,599 | 92,285 | 24,882 | ||||||||||||||||||
| Commercial and other loans | — | — | — | 1,018,133 | 810,175 | 14,932 | ||||||||||||||||||
| Total | $ | 390,598 | $ | 288,312 | $ | — | $ | 5,234,071 | $ | 1,145,834 | $ | 4,292,889 | ||||||||||||
| Impaired loans totaled $10.1 million, $5.9 million, and $9.6 million at December 31, 2005, 2004, and 2003, respectively. Specific reserves relating to these loans were $2.1 million, $1.7 million, and $1.6 million at December 31, 2005, 2004, and 2003, respectively. | ||
| Cash received and recognized as income on impaired loans approximated $655,000, $428,000, and $308,000 for the years ended December 31, 2005, 2004, and 2003, respectively. Average impaired loans for the years ended December 31, 2005, 2004, and 2003 were approximately $8.3 million, $7.4 million, and $9.6 million, respectively. | ||
| Loans serviced for others including commercial participations sold, were approximately $48.9 million, $52.6 million, and $59.4 million at December 31, 2005, 2004, and 2003, respectively. | ||
| The Bank capitalized $22,000 $21,000, and $140,000, in mortgage servicing rights and incurred approximately $82,000, $94,000, and $94,000, in related amortization expense during 2005, 2004, and 2003, respectively. At December 31, 2005 and 2004, these mortgage servicing rights had a gross book value of $248,000 and $308,000, respectively, and fair value of approximately $404,000 and $355,000, respectively. The weighted average amortization period for mortgage servicing rights capitalized in 2005 is approximately 5 years. Mortgage loans with mortgage servicing rights capitalized totaled approximately $38.2 million at December 31, 2005, $38.9 million at December 31, 2004, and $43.2 million at December 31, 2003. The valuation allowance for capitalized mortgage servicing rights was $61,000 at December 31, 2005, and $103,000 at December 31, 2004. |
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| Estimated aggregate amortization expense relating to the Bank’s mortgage servicing rights as of December 31, 2005 is as follows: | ||
| Year: | ||||
| 2006 | $ | 67,000 | ||
| 2007 | 53,000 | |||
| 2008 | 43,000 | |||
| 2009 | 31,000 | |||
| 2010 | 22,000 | |||
| 2011 and thereafter | 32,000 | |||
| Total | $ | 248,000 | ||
| Included in real estate loans at December 31, 2005 and 2004 were approximately $172,000 and $274,000, respectively, of fixed-rate mortgage loans held for sale. The Bank enters into forward commitments to sell these loans into the secondary market prior to origination. Additionally, the Bank had 45-day forward commitments to sell mortgages as of December 31, 2005, which had not yet been funded. These commitments approximated $166,000. | ||
| (5) | Allowance for Loan Losses and Reserve for Unfunded Credit Commitments | |
| The following represents a summary of the activity in the allowance for loan losses and the reserve for unfunded credit commitments for the years ended December 31, 2005, 2004, and 2003: |
| 2005 | 2004 | 2003 | ||||||||||
| Components: | ||||||||||||
Allowance for loan losses | ||||||||||||
| Balance, beginning of year | $ | 6,092,949 | $ | 5,434,375 | $ | 5,794,399 | ||||||
| Loans charged off: | ||||||||||||
| Real estate mortgage | 25,771 | — | — | |||||||||
| Commercial | 1,436,463 | 378,914 | 1,013,792 | |||||||||
| Consumer | 791,483 | 543,164 | 268,771 | |||||||||
| Total charge offs | 2,253,717 | 922,078 | 1,282,563 | |||||||||
| Recoveries to loans previously charged off: | ||||||||||||
| Real estate mortgage | — | — | — | |||||||||
| Commercial | 120,012 | 69,515 | 111,652 | |||||||||
| Consumer | 141,881 | 104,137 | 64,887 | |||||||||
| Total recoveries | 261,893 | 173,652 | 176,539 | |||||||||
| Net loans charged off | 1,991,824 | 748,426 | 1,106,024 | |||||||||
| Additions to allowance charged to operations | 2,890,000 | 1,407,000 | 746,000 | |||||||||
| Balance, end of year | 6,991,125 | 6,092,949 | 5,434,375 | |||||||||
Reserve for unfunded credit commitments | ||||||||||||
| Balance, beginning of year | 307,000 | 524,000 | — | |||||||||
| Additions (reductions) to reserve charged to operations | 147,000 | (217,000 | ) | 524,000 | ||||||||
| Balance, end of year | 454,000 | 307,000 | 524,000 | |||||||||
Total allowance for loan losses and reserve for unfunded credit commitments | $ | 7,445,125 | $ | 6,399,949 | $ | 5,958,375 | ||||||
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| (6) | Premises and Equipment | |
| A summary of premises and equipment, and related accumulated depreciation and amortization, at December 31, 2005 and 2004 follows: |
| 2005 | 2004 | |||||||
| Land and land improvements | $ | 2,921,480 | $ | 2,897,502 | ||||
| Premises | 10,035,233 | 10,055,978 | ||||||
| Furniture and equipment | 5,397,742 | 6,550,056 | ||||||
| 18,354,455 | 19,503,536 | |||||||
| Less accumulated depreciation and amortization | (7,888,599 | ) | (8,416,635 | ) | ||||
| Premises and equipment, net | $ | 10,465,856 | $ | 11,086,901 | ||||
| (7) | Land and Facilities Held for Sale | |
| During the first quarter of 2004, the Bank transferred two pieces of property originally acquired for future expansion, and previously recorded as premises and equipment, to land and facilities held for sale. One of the properties was sold in the fourth quarter of 2004 and a gain of approximately $43,000 was recognized as a component of noninterest income. The remaining property was sold in the second quarter of 2005 and a loss of approximately $2,600 was recognized as a component of noninterest income. | ||
| (8) | Other Real Estate Owned | |
| At December 31, 2005, the Bank owned three foreclosed properties with a lower of cost or market value of $679,733. As of December 31, 2004, the Bank owned four foreclosed properties with a lower of cost or market value of $735,000. Costs to maintain the properties are included as a component of noninterest expense. A gain or loss will be recognized upon the sale of the properties, which will be included as a component of noninterest income or expense. | ||
| (9) | Time Certificates of Deposit | |
| At December 31, 2005, the scheduled maturities of time deposits including brokered certificates of deposit including brokered certificates of deposit with a remaining term of more than one year were: |
| Year of maturity: | ||||
| 2007 | $ | 32,072,321 | ||
| 2008 | 4,570,963 | |||
| 2009 | 7,780,142 | |||
| 2010 | 4,296,153 | |||
| 2011 and thereafter | 22,517 | |||
| Total | $ | 48,742,096 | ||
| Included in time deposits are certificates of deposit and brokered certificates of deposit in amounts of $100,000 or more. These certificates and their remaining maturities at December 31, 2005 and 2004 are as follows: |
| 2005 | 2004 | |||||||
| Three months or less | $ | 29,599,143 | $ | 18,229,224 | ||||
| Three through six months | 16,225,630 | 6,204,213 | ||||||
| Six through twelve months | 24,527,040 | 4,769,590 | ||||||
| Over twelve months | 20,803,079 | 25,146,559 | ||||||
| Total | $ | 91,154,892 | $ | 54,349,586 | ||||
| Interest expense attributable to the above deposits amounted to approximately $2,810,000, $1,472,000, and $1,472,000 in 2005, 2004, and 2003, respectively. |
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| (10) | Other Borrowings | |
| The Bank has a borrowing capacity of approximately $37,700,000 with the FHLBI and had an advance outstanding balance of approximately $1,785,000 and $8,067,000 at December 31, 2005 and 2004, respectively. Variable-or fixed-rate advances are available with terms ranging from one day to 10 years. An outstanding advance requires 125% collateral coverage by one-to-four family whole-mortgage loans. A summary of the outstanding advance at December 31, 2005, follows: |
| Weighted | ||||||||
| average | ||||||||
| Maturity | interest rate | Amount | ||||||
| Fixed rate: | ||||||||
| Within one year | 7.29 | % | $ | 304,281 | ||||
| Two years | 7.29 | % | 328,623 | |||||
| Three years | 7.29 | % | 354,913 | |||||
| Four years | 7.29 | % | 383,307 | |||||
| Five years | 7.29 | % | 413,970 | |||||
| Total long term advance | $ | 1,785,094 | ||||||
| (11) | Deferred Gain on the Sale of Real Estate | |
| In December 2003, the Bank sold a piece of real estate previously classified as facilities held for sale on the balance sheet and provided financing to the buyer. In accordance with SFAS No. 66,Accounting for Sales of Real Estate,the Bank deferred the gain of $299,000 on the sale under the installment method. In the first quarter of 2004, the Bank sold the loan associated with this transaction with no recourse and accordingly recognized the deferred gain as a component of noninterest income. | ||
| (12) | Federal Income Taxes | |
| Federal income tax expense (benefit) consists of: |
| 2005 | 2004 | 2003 | ||||||||||
| Current | $ | 3,387,723 | $ | 2,568,989 | $ | 2,673,034 | ||||||
| Deferred | (503,802 | ) | 159,167 | (118,597 | ) | |||||||
| Total federal income tax | $ | 2,883,921 | $ | 2,728,156 | $ | 2,554,437 | ||||||
Federal income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 34% to pretax income as a result of the following:
| 2005 | 2004 | 2003 | ||||||||||
| Computed “expected” tax expense | $ | 3,192,908 | $ | 3,066,545 | $ | 2,871,414 | ||||||
| Increase (reduction) in tax resulting from: | ||||||||||||
| Tax-exempt interest and dividends, net | (325,188 | ) | (331,745 | ) | (336,850 | ) | ||||||
| Other, net | 16,201 | (6,644 | ) | 19,873 | ||||||||
| Total federal income tax | $ | 2,883,921 | $ | 2,728,156 | $ | 2,554,437 | ||||||
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| The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2005 and 2004 are presented below: |
| 2005 | 2004 | |||||||
| Deferred tax assets: | ||||||||
| Allowance for loan losses | $ | 2,377,695 | $ | 2,022,336 | ||||
| Unrealized loss on securities available for sale | 312,788 | 11,600 | ||||||
| Deferred directors’ fees | 195,533 | 154,864 | ||||||
| Other | 290,218 | 235,914 | ||||||
| Total gross deferred tax assets | 3,176,234 | 2,424,714 | ||||||
| Deferred tax liabilities: | ||||||||
| Deferred loan fees | 153,100 | 158,016 | ||||||
| Other | 203,414 | 251,968 | ||||||
| Total gross deferred tax liabilities | 356,514 | 409,984 | ||||||
| Net deferred tax asset | $ | 2,819,720 | $ | 2,014,730 | ||||
| The deferred tax assets are subject to certain asset realization tests. Management believes no valuation allowance is required at December 31, 2005, due to the combination of potential recovery of tax previously paid and the reversal of certain deductible temporary differences. | ||
| (13) | Related Party Transactions | |
| Certain directors and executive officers, including their immediate families and companies in which they are principal owners, were loan customers of the Bank during 2005 and 2004. Deposits to such individuals and their related interests totaled approximately $1.0 million at December 31, 2005 and $.9 million at December 31, 2004. Such loans were made in the ordinary course of business, in accordance with the Bank’s normal lending policies, including the interest rate charged and collateralization, and do not represent more than a normal credit risk. | ||
| Loans to related parties are summarized below for the periods indicated: |
| 2005 | 2004 | |||||||
| Balance at beginning of year | $ | 5,179,300 | $ | 4,226,100 | ||||
| New loans and related parties | 2,167,800 | 1,500,000 | ||||||
| Loan repayments | (1,271,700 | ) | (546,800 | ) | ||||
| Balance at end of year | $ | 6,075,400 | $ | 5,179,300 | ||||
| (14) | Leases | |
| The Bank has a noncancelable operating lease that provides for renewal options. | ||
| Future minimum lease payments under the noncancelable lease as of December 31, 2005 are as follows: |
| Year ending December 31: | ||||
| 2006 | $ | 46,660 | ||
| 2007 | 34,995 | |||
| Total lease payments | $ | 81,655 | ||
| Rental expense charged to operations in 2005, 2004, and 2003 amounted to approximately $59,000, $60,000, and $60,000 respectively, including amounts paid under short term, cancelable leases. |
| (15) | Retirement Plan | |
| The Bank sponsors a defined contribution money purchase thrift plan covering all employees 21 years of age or older who have completed one year of service as defined in the plan agreement. Contributions are equal to 5% of total employee earnings plus 50% of employee contributions (limited to 10% of their earnings) or the maximum |
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| amount permitted by the Internal Revenue Code. The plan expense of the Bank for 2005, 2004, and 2003 was approximately $370,000, $376,000, and $344,000, respectively. | ||
| (16) | Long Term Incentive Plan | |
| The Corporation maintains a Long Term Incentive Plan under which stock options and restricted stock may be granted to employees. To date, no stock options have been granted under the plan. Restricted stock awards have been made to key employees, providing for the immediate award of the Corporation’s stock, subject to a five-year vesting period. The awards are recorded at fair market value on the grant date and are amortized into salary expense over the vesting period. Compensation costs related to restricted stock awards included in salary expense in 2005, 2004, and 2003, amounted to $84,000, $185,000, and $135,000, respectively. |
| (17) | Directors’ Stock Fee Plan | |
| Each director of the Corporation who is not an officer or employee of any subsidiary of the Corporation is eligible to participate in the Compensation Plan for Nonemployee Directors. The plan fees consist of both a fixed and variable component. The fixed component equals the per-meeting fee paid for attendance at board meetings of both the Bank and the Corporation and any committees of their respective boards. The variable component of the plan is equal to the total fixed fees paid to a specific director for services performed during the preceding calendar year, multiplied by bonus amounts, (expressed as the percentage of base compensation payable to officers of the Bank for the preceding calendar year under the Bank’s Incentive Bonus Plan). Expenses related to both fixed and variable fees are recorded as noninterest expense in the year incurred regardless of payment method. Compensation costs related to both fixed and variable stock directors’ fees included in noninterest expense in 2005, 2004, and 2003 amounted to $120,000, $103,000, and $84,000, respectively. | ||
| Fixed directors’ fees may be paid in cash, to a current stock purchase account, to a deferred cash investment account, or to a deferred stock account according to each eligible director’s payment election. Current stock is issued quarterly based on the average fair market value of the stock for the preceding quarter. When deferred stock is elected, payments are credited to a deferred stock account for each participating director, and stock units are computed quarterly based on the average fair market value of the stock for the preceding quarter. When dividends are declared, they are computed based on the stock units available in each director’s deferred account, are reinvested in stock units and charged to expense. The units are converted to shares and issued to participating directors upon retirement. As of December 31, 2005, there were approximately 19,700 shares earned and available for distribution in the fixed-fee deferred stock accounts. | ||
| Variable directors’ fees may be paid to a current stock purchase account or to a deferred stock account. Current stock is issued based on the average fair market value of the stock for the preceding quarter. Deferred stock units are computed for directors electing to use a deferred stock account, and dividends are reinvested throughout the year as declared. As of December 31, 2005, there were approximately 4,400 shares earned and available for distribution in the variable-fee deferred stock accounts. In September 2004, the Corporation reclassified Deferred Directors’ Compensation related to fixed and variable fees associated with deferred stock accounts from a liability to a component of equity. Prior periods were not reclassified as the impact of this change was determined not to be significant. | ||
| (18) | Employees’ Stock Purchase Plan | |
| The Employees’ Stock Purchase Plan allows eligible employees to purchase shares of common stock, no par value, of FNBH Bancorp, Inc. at a price less than market price under Section 423 of the Internal Revenue Code of 1986 as amended. Eligible employees must have been continuously employed for one year, must work at least 20 hours per week, and must work at least five months in a calendar year. Since the adoption of the plan, the purchase price for each share of stock was 85% of fair market value of a share of stock on the purchase date. Effective April 1, 2005, the purchase price for each share of stock is 95% of fair market value of a share of stock on the purchase date. |
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| (19) | Financial Instruments with Off-Balance-Sheet Risk | |
| The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are loan commitments to extend credit and letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. | ||
| The Bank’s exposure to credit loss in the event of the nonperformance by the other party to the financial instruments for loan commitments to extend credit and letters of credit is represented by the contractual amounts of these instruments. The Bank uses the same credit policies in making credit commitments as it does for on-balance-sheet loans. | ||
| Financial instruments whose contract amounts represent credit risk at December 31, 2005 and 2004 are as follows: |
| 2005 | 2004 | |||||||
| Consumer | $ | 16,258,000 | $ | 12,625,000 | ||||
| Commercial construction | 9,372,000 | 14,200,000 | ||||||
| Commercial | 41,398,000 | 51,027,000 | ||||||
| Total credit commitments | $ | 67,028,000 | $ | 77,852,000 | ||||
| Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; residential real estate; and income-producing commercial properties. Market risk may arise if interest rates move adversely subsequent to the extension of commitments. | ||
| As of December 31, 2005 and 2004, the Bank had outstanding irrevocable standby letters of credit, which carry a maximum potential commitment of approximately $3,200,000 and $3,236,000, respectively. These letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The majority of these letters of credit are short term guarantees of one year or less, although some have maturities which extend as long as two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank primarily holds real estate as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held on those commitments at December 31, 2005 and 2004, where there is collateral, is in excess of the committed amount. A letter of credit is not recorded on the balance sheet until a customer fails to perform. | ||
| (20) | Capital | |
| The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct, material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation’s and the Bank’s capital classification are also subject to qualitative judgments by regulators with regard to components, risk weightings, and other factors. | ||
| Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined). |
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| The most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category. | ||
| The Corporation’s and the Bank’s actual capital amounts and ratios are also presented in the following table as of December 31, 2005 and 2004: |
| Minimum for | To be well capitalized | |||||||||||||||||||||||
| capital adequacy | under prompt corrective | |||||||||||||||||||||||
| Actual | purposes | action provision | ||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| As of December 31, 2005 | ||||||||||||||||||||||||
| Total Capital (to risk weighted assets) | ||||||||||||||||||||||||
| Bank | $ | 54,723,000 | 13.89 | % | $ | 31,520,000 | ³8 | % | $ | 39,400,000 | ³10 | % | ||||||||||||
| FNBH Bancorp | 55,009,000 | 13.96 | % | 31,521,000 | ³8 | % | N/A | N/A | ||||||||||||||||
| Tier 1 Capital (to risk weighted assets) | ||||||||||||||||||||||||
| Bank | 49,767,000 | 12.63 | % | 15,760,000 | ³4 | % | 23,640,000 | ³6 | % | |||||||||||||||
| FNBH Bancorp | 50,053,000 | 12.70 | % | 15,760,000 | ³4 | % | N/A | N/A | ||||||||||||||||
| Tier 1 Capital (to average assets) | ||||||||||||||||||||||||
| Bank | 49,767,000 | 10.58 | % | 18,810,000 | ³4 | % | 23,512,000 | ³5 | % | |||||||||||||||
| FNBH Bancorp | 50,053,000 | 10.64 | % | 18,810,000 | ³4 | % | N/A | N/A | ||||||||||||||||
| As of December 31, 2004 | ||||||||||||||||||||||||
| Total Capital (to risk weighted assets) | ||||||||||||||||||||||||
| Bank | $ | 47,813,000 | 12.80 | % | $ | 29,893,000 | ³8 | % | $ | 37,367,000 | ³10 | % | ||||||||||||
| FNBH Bancorp | 48,423,000 | 12.96 | % | 29,902,000 | ³8 | % | N/A | N/A | ||||||||||||||||
| Tier 1 Capital (to risk weighted assets) | ||||||||||||||||||||||||
| Bank | 43,121,000 | 11.54 | % | 14,947,000 | ³4 | % | 22,420,000 | ³6 | % | |||||||||||||||
| FNBH Bancorp | 43,729,000 | 11.70 | % | 14,951,000 | ³4 | % | N/A | N/A | ||||||||||||||||
| Tier 1 Capital (to average assets) | ||||||||||||||||||||||||
| Bank | 43,121,000 | 9.65 | % | 17,870,000 | ³4 | % | 22,338,000 | ³5 | % | |||||||||||||||
| FNBH Bancorp | 43,729,000 | 9.78 | % | 17,877,000 | ³4 | % | N/A | N/A | ||||||||||||||||
| (21) | Net Income per Common Share | |
| Basic net income per common share is computed by dividing net income applicable to common stock by the weighted average number of shares of common stock and deferred director fee stock units outstanding during the period. Diluted net income per common share is computed by dividing net income applicable to common stock by the weighted average number of shares and deferred director fee stock units outstanding and potential common stock outstanding, such as shares of unvested restricted stock outstanding during the period, of which there were 372 shares as of December 31, 2005, and 1,117 shares as of December 31, 2004, calculated under the treasury stock method. | ||
| The following table presents basic and diluted net income per share: |
| 2005 | 2004 | 2003 | ||||||||||
| Weighted average basic shares outstanding | 3,200,146 | 3,185,025 | 3,162,836 | |||||||||
| Effect of dilutive restricted stock | 372 | 1,117 | — | |||||||||
| Weighted average diluted shares outstanding | 3,200,518 | 3,186,142 | 3,162,836 | |||||||||
| Net income | $ | 6,506,986 | $ | 6,291,095 | $ | 5,890,897 | ||||||
| Basic net income per share | $ | 2.03 | $ | 1.98 | $ | 1.86 | ||||||
| Diluted net income per share | $ | 2.03 | $ | 1.97 | $ | 1.86 | ||||||
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| (22) | Contingent Liabilities | |
| The Corporation is subject to various claims and legal proceedings arising out of the normal course of business, none of which, in the opinion of management, based on the advice of legal counsel, is expected to have a material effect on the Corporation’s financial position or results of operations. | ||
| (23) | Fair Value of Financial Instruments | |
| SFAS No. 107,Disclosures About Fair Value of Financial Instruments,requires disclosure of fair-value information about financial instruments for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair-value estimates cannot be substantiated by comparison to independent markets and, in many cases, cannot be realized in immediate settlement of the instrument. | ||
| Fair-value methods and assumptions for the Corporation’s financial instruments are as follows: | ||
| Cash and cash equivalents– The carrying amounts reported in the consolidated balance sheet for cash and short term investments reasonably approximate those assets’ fair values. | ||
| Certificates of deposit– The carrying amounts reported in the consolidated balance sheet for certificates of deposit reasonably approximate those assets’ fair values. | ||
| Investment and mortgage-backed securities– Fair values for investment and mortgage-backed securities are based on quoted market prices. | ||
| FHLBI and FRB stock– The carrying amounts reported in the consolidated balance sheet for FHLBI and FRB stock reasonably approximate those assets’ fair values. | ||
| Loans– For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are generally based on carrying values. The fair value of fixed-rate loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. | ||
| Accrued interest income– The carrying amount of accrued interest income is a reasonable estimate of fair value. | ||
| Deposit liabilities– The fair value of deposits with no stated maturity, such as demand deposit, NOW, savings, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is estimated using rates currently offered for wholesale funds with similar remaining maturities. | ||
| Other borrowings– The fair value of other borrowings is estimated based on quoted market prices. | ||
| Accrued interest payable– The carrying amount of accrued interest payable is a reasonable estimate of fair value. | ||
| Off-balance-sheet instruments– The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of commitments to extend credit, including letters of credit, is estimated to approximate their aggregate book balance and is not considered material and therefore not included in the following table. |
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| The estimated fair values of the Corporation’s financial instruments are as follows: |
| 2005 | 2004 | |||||||||||||||
| Carrying | Fair | Carrying | Fair | |||||||||||||
| value | value | value | value | |||||||||||||
| Financial assets: | ||||||||||||||||
| Cash and cash equivalents | $ | 24,102,000 | $ | 24,102,000 | $ | 17,838,000 | $ | 17,838,000 | ||||||||
| Certificates of deposit | 7,166,000 | 7,129,000 | 6,091,000 | 6,081,000 | ||||||||||||
| Investment and mortgage-backed securities | 61,220,000 | 61,557,000 | 63,217,000 | 63,914,000 | ||||||||||||
| FHLBI and FRB stock | 1,154,000 | 1,154,000 | 1,131,000 | 1,131,000 | ||||||||||||
| Loans, net | 365,864,000 | 364,595,000 | 351,284,000 | 355,584,000 | ||||||||||||
| Accrued interest income | 2,453,000 | 2,453,000 | 2,080,000 | 2,080,000 | ||||||||||||
| Financial liabilities: | ||||||||||||||||
| Deposits: | ||||||||||||||||
| Demand | $ | 71,415,000 | $ | 71,415,000 | $ | 71,785,000 | $ | 71,785,000 | ||||||||
| NOW | 40,740,000 | 40,740,000 | 49,207,000 | 49,207,000 | ||||||||||||
| Savings and money market accounts | 133,865,000 | 133,865,000 | 147,299,000 | 147,299,000 | ||||||||||||
| Time deposits | 145,928,000 | 144,868,000 | 122,982,000 | 122,973,000 | ||||||||||||
| Brokered certificates | 30,137,000 | 29,985,000 | 7,990,000 | 7,976,000 | ||||||||||||
| Other borrowings | 1,785,000 | 1,877,000 | 8,067,000 | 8,298,000 | ||||||||||||
| Accrued interest expense | 813,000 | 813,000 | 573,000 | 573,000 | ||||||||||||
| Limitations | ||
| Fair-value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discounts that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair-value estimates are based on judgments regarding future loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. | ||
| (24) | Dividend Restrictions | |
| On a parent company-only basis, the Corporation’s only source of funds is dividends paid by the Bank. The ability of the Bank to pay dividends is subject to limitations under various laws and regulations and to prudent and sound banking principles. The Bank may declare a dividend without the approval of the Office of the Comptroller of the Currency (OCC) unless the total dividends in a calendar year exceeds the total of its net profits for the year combined with its retained profits of the two preceding years. Under these provisions, approximately $13.3 million was available for dividends on December 31, 2005, without the approval of the OCC. |
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| (25) | Condensed Financial Information – Parent Company Only | |
| The condensed balance sheets at December 31, 2005 and 2004, and the condensed statements of income and cash flows for the years ended December 31, 2005, 2004, and 2003, of FNBH Bancorp, Inc. follow: |
Condensed Balance Sheets
| 2005 | 2004 | |||||||
| Assets: | ||||||||
| Cash | $ | 52,955 | $ | 148,585 | ||||
| Investment in subsidiaries: | ||||||||
| First National Bank in Howell | 48,354,429 | 44,302,826 | ||||||
| H.B. Realty Co. | 1,000 | 200,530 | ||||||
| FNBH Mortgage Company, LLC | 805,000 | 805,000 | ||||||
| Other assets | 235,962 | 259,107 | ||||||
| Total assets | $ | 49,449,346 | $ | 45,716,048 | ||||
| Liabilities and Stockholders’ Equity: | ||||||||
| Other liabilities | $ | 3,021 | $ | — | ||||
| Stockholders’ equity | 49,446,325 | 45,716,048 | ||||||
| Total liabilities and stockholders’ equity | $ | 49,449,346 | $ | 45,716,048 | ||||
Condensed Statements of Income
| Year ended December 31 | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
| Operating income: | ||||||||||||
| Dividends from subsidiaries | $ | 1,975,313 | $ | 1,680,000 | $ | 2,014,688 | ||||||
| Total operating income | 1,975,313 | 1,680,000 | 2,014,688 | |||||||||
| Operating expenses: | ||||||||||||
| Administrative and other expenses | 88,014 | 97,032 | 46,602 | |||||||||
| Total operating expenses | 88,014 | 97,032 | 46,602 | |||||||||
| Income before equity in undistributed net income of subsidiaries | 1,887,299 | 1,582,968 | 1,968,086 | |||||||||
| Equity in undistributed net income of subsidiaries | 4,619,687 | 4,708,127 | 3,922,811 | |||||||||
| Net income | $ | 6,506,986 | $ | 6,291,095 | $ | 5,890,897 | ||||||
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Condensed Statements of Cash Flows
| Year ended December 31 | ||||||||||||
| 2005 | 2004 | 2003 | ||||||||||
| Cash flows from operating activities: | ||||||||||||
| Net income | $ | 6,506,986 | $ | 6,291,095 | $ | 5,890,897 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Decrease (increase) in other assets | 23,145 | (1,256 | ) | 8,305 | ||||||||
| Increase (decrease) in other liabilities | 3,021 | (24,700 | ) | 3,500 | ||||||||
| Change in long term incentive plan and deferred compensation | 253,996 | 263,635 | 24,630 | |||||||||
| Equity in undistributed net income of subsidiaries | (4,619,687 | ) | (4,708,127 | ) | (3,922,811 | ) | ||||||
| (4,339,525 | ) | (4,470,448 | ) | (3,886,376 | ) | |||||||
| Net cash provided by operating activities | 2,167,461 | 1,820,647 | 2,004,521 | |||||||||
| Cash flows from investing activities: | ||||||||||||
| Investments in and advancements to subsidiary, net | 188,624 | (10,000 | ) | (70,000 | ) | |||||||
| Net cash provided by (used in) investing activities | 188,624 | (10,000 | ) | (70,000 | ) | |||||||
| Cash flows from financing activities: | ||||||||||||
| Dividends paid | (2,547,690 | ) | (2,286,173 | ) | (2,151,047 | ) | ||||||
| Common stock issued | 95,975 | 109,521 | 260,809 | |||||||||
| Transfer from subsidiary for directors’ deferred compensation | — | 437,211 | — | |||||||||
| Net cash used in financing activities | (2,451,715 | ) | (1,739,441 | ) | (1,890,238 | ) | ||||||
| Net increase (decrease) in cash | (95,630 | ) | 71,206 | 44,283 | ||||||||
| Cash at beginning of year | 148,585 | 77,379 | 33,096 | |||||||||
| Cash at end of year | $ | 52,955 | $ | 148,585 | $ | 77,379 | ||||||
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| (26) | Quarterly Financial Data — Unaudited |
The following table presents summarized quarterly data for each of the two years ended December 31:
| Quarters ended in 2005 | ||||||||||||||||
| March 31 | June 30 | September 30 | December 31 | |||||||||||||
| Selected operations data: | ||||||||||||||||
| Interest and dividend income | $ | 6,763,696 | $ | 7,211,160 | $ | 7,600,435 | $ | 7,739,616 | ||||||||
| Net interest income | 5,287,037 | 5,526,081 | 5,693,856 | 5,753,936 | ||||||||||||
| Provision for loan losses | 366,000 | 1,178,000 | 500,000 | 993,000 | ||||||||||||
| Income before federal income taxes | 2,396,046 | 1,625,570 | 2,810,160 | 2,559,131 | ||||||||||||
| Net income | 1,660,950 | 1,158,670 | 1,924,460 | 1,762,906 | ||||||||||||
| Basic net income per share | 0.52 | 0.36 | 0.60 | 0.55 | ||||||||||||
| Diluted net income per share | 0.52 | 0.36 | 0.60 | 0.55 | ||||||||||||
| Cash dividends per share | 0.19 | 0.19 | 0.21 | 0.21 | ||||||||||||
| Quarters ended in 2004 | ||||||||||||||||
| March 31 | June 30 | September 30 | December 31 | |||||||||||||
| Selected operations data: | ||||||||||||||||
| Interest and dividend income | $ | 6,109,186 | $ | 5,984,536 | $ | 6,256,913 | $ | 6,641,075 | ||||||||
| Net interest income | 4,677,850 | 4,625,586 | 4,902,904 | 5,179,504 | ||||||||||||
| Provision for loan losses | 495,000 | 200,000 | 300,000 | 195,000 | ||||||||||||
| Income before federal income taxes | 2,081,310 | 1,863,320 | 2,370,692 | 2,703,929 | ||||||||||||
| Net income | 1,455,804 | 1,315,270 | 1,647,092 | 1,872,929 | ||||||||||||
| Basic net income per share | 0.46 | 0.41 | 0.52 | 0.59 | ||||||||||||
| Diluted net income per share | 0.46 | 0.41 | 0.52 | 0.58 | ||||||||||||
| Cash dividends per share | 0.17 | 0.17 | 0.19 | 0.19 | ||||||||||||
| (27) | Impact of New Accounting Standards |
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R),Share-Based Payment. This Statement is a revision of SFAS No. 123,Accounting for Stock-Based Compensation,and supersedes APB opinion No. 25,Accounting for Stock Issued to Employees,and its related implementation guidance. The Statement originally effective July 1, 2005, now delayed until January 1, 2006, is required to be adopted using a “modified prospective” method. Under the modified prospective method, the Statement applies to new awards and to awards modified, repurchased or cancelled after the effective date. Additionally, compensation cost for the unvested portion of awards as of the effective date is required to be recognized as the awards vest after the effective date. This Statement focuses on the accounting for transactions that involve employee services compensated for in share-based payments and requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. The Statement also establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees.
The Corporation currently has two plans affected by the issuance of this Statement. The Long Term Incentive Plan allows for the granting of stock options to certain employees; however, the Corporation has not, to date, issued any options under this plan. Consequently, the Statement will have no impact on the Corporation’s results of operations or financial condition until such time as options are granted. The second plan affected is the Employee Stock Purchase Plan (ESPP).The Statement allows for ESPP shares to be issued at 95% of fair market value as of the grant date with no compensation expense recognized. Effective April 1, 2005, the Corporation’s plan allows for the purchase of shares at 95% of fair market value as of the grant date, thus no compensation expense will be recognized upon the effectiveness of SFAS 123(R). One result of implementing this standard will be the reclassification within equity of the balance in unearned long term incentive plan to common stock. Other than this reclassification, the Corporation does not expect the implementation of this Statement to have an impact on its results of operations or financial position.
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In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1,The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.This FSP provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. The guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. Management applied the guidance in this FSP in 2005.
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
1.Evaluation of Disclosure Controls and Procedures. With the participation of management, the Corporation’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Corporation’s disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of December 31, 2005, have concluded that, as of such date, the Corporation’s disclosure controls and procedures were effective.
2.Management’s Annual Report on Internal Control Over Financial Reporting. The Corporation’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), for the Corporation. The Corporation’s internal control system was designed to provide reasonable assurance to the Corporation regarding the preparation and fair presentation of published financial statements. The Corporation’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Based on this assessment and those criteria, the Corporation’s management concluded that, as of December 31, 2005, the Corporation’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been detected.
3.Attestation Report of the Registered Independent Public Accounting Firm. BDO Seidman, LLP, an independent registered public accounting firm that audited the consolidated financial statements of the Corporation for the year ended December 31, 2005, has issued an attestation report on management’s assessment of the effectiveness of the Corporation’s internal control over financial reporting. The report is set forth on page 27.
4.Change in Internal Control Over Financial Reporting. During the fourth quarter ended December 31, 2005, there were no changes in the Corporation’s Internal Control Over Financial Reporting that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Item 9B. Other Information.
None
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PART III
Item 10. Directors and Executive Officers of the Registrant.
Directors
The information with respect to Directors and Nominees of the Registrant, set forth under the caption “Election of Directors” on pages I and II of the Corporation’s definitive proxy statement, as filed with the Commission relating to the April 12, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.
The information with respect to Directors and Nominees of the Registrant, set forth under the caption “Election of Directors” on pages I and II of the Corporation’s definitive proxy statement, as filed with the Commission relating to the April 12, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.
Executive Officers
The information called for by this item is contained in Part I of this Form 10-K Report.
The information called for by this item is contained in Part I of this Form 10-K Report.
We have adopted a Code of Ethics for our chief executive officer and senior financial officers. A copy of our Code of Ethics is available upon request by writing to the Corporation’s Chief Financial Officer at 101 East Grand River, Howell, Michigan 48843 and is available on our website atwww.fnbsite.com.
Item 11. Executive Compensation.
The information set forth under the caption “Summary Compensation Table” on pages VIII and IX of the Corporation’s definitive proxy statement, as filed with the Commission relating to the April 12, 2006 Annual Meeting of Shareholders, is incorporated herein by reference. Information under the caption “Committee Report on Executive Compensation” on page VI and VII and “Shareholder Return Performance Graph” on page XI of the definitive proxy statement is not incorporated by reference herein and is not deemed to be filed with the Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information set forth under the caption “Ownership of Common Stock” on page X of the Corporation’s definitive proxy statement, as filed with the Commission relating to the April 12, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.
The following information is provided under Item 201(d):
| Number of securities remaining | ||||||
| Number of securities to be | Weighted - average | available for future issuance | ||||
| issued upon exercise of | exercise price of | under equity compensation | ||||
| outstanding options, | outstanding options, | plans (excluding securities | ||||
| Plan Category | warrants, and rights | warrants, and rights | reflected in column (a)) | |||
| (a) | (b) | (c) | ||||
| Equity compensation plans approved by security holders | 0 | 0 | 273,522(1) |
(1) Includes 164,168 shares available under the Long Term Incentive Plan, 71,716 shares available under the Compensation Plan for Nonemployee Directors and 37,638 shares included under the Employee Stock Purchase Plan.
Item 13. Certain Relationships and Related Transactions.
The information set forth under the caption “Certain Transactions with Management” on page IX of the Corporation’s definitive proxy statement, as filed with the Commission relating to the April 12, 2006, Annual Meeting of Shareholders, is incorporated herein by reference.
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Item 14. Principal Accountant Fees and Services.
The information set forth under the caption “Audit Matters and Our Relationship with Our Independent Auditors” on pages V and VI of the Corporation’s definitive proxy statement, as filed with the Commission relating to the April 12, 2006, Annual Meeting of Shareholders, is incorporated herein by reference. Information under the caption “Report of Our Audit Committee” in our definitive proxy statement is not incorporated by reference herein and is also not deemed to be filed with the Securities and Exchange Commission.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
| (a) | Documents files as part of this report on Form 10-K. | |
| 1. | Financial Statements | |
| The financial statements are set forth under Item 8 of this report of 10-K. | ||
| 2. | Financial Statement Schedule | |
| Not applicable. | ||
| 3. | Exhibits (Numbered in accordance with Item 601 of Regulation S-K) | |
| The Exhibit Index is located on the final page of this report on Form 10-K. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, dated March 6, 2006.
FNBH BANCORP, INC.
| /s/ Herbert W. Bursch | Herbert W. Bursch, President & Chief Executive Officer | |
| (Principal Executive Officer) | ||
| /s/ Janice B. Trouba | Janice B. Trouba, Chief Financial Officer | |
| (Principal Financial and Accounting Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each director of the Registrant, who’s signature appears below, hereby appoints Herbert W. Bursch and Janice B. Trouba, and each of them severally, as his or her attorney-in-fact, to sign in his or her name and on his or her behalf, as a director of the Registrant, and to file with the Commission any and all Amendments to this Report on Form 10-K.
| Signature | Date | |||
| W. Rickard Scofield, Chairman of the Board | /s/ W. Rickard Scofield | 3/6/2006 | ||
| Donald K. Burkel, Vice Chairman of the Board | /s/ Donald K. Burkel | 3/6/2006 | ||
| Athena Bacalis, Director | /s/ Athena Bacalis | 3/6/2006 | ||
| Gary R. Boss, Director | /s/ Gary R. Boss | 3/6/2006 | ||
| Herbert W. Bursch, Director | /s/ Herbert W. Bursch | 3/6/2006 | ||
| Barbara Draper, Director | /s/ Barbara Draper | 3/6/2006 | ||
| Richard F. Hopper, Director | /s/ Richard F. Hopper | 3/6/2006 | ||
| Dona Scott Laskey, Director | /s/ Dona Scott Laskey | 3/6/2006 | ||
| James R. McAuliffe, Director | /s/ James R. McAuliffe | 3/6/2006 | ||
| Randolph E. Rudisill, Director | /s/ Randolph E. Rudisill | 3/6/2006 | ||
| R. Michael Yost, Director | /s/ R. Michael Yost | 3/6/2006 | ||
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EXHIBIT INDEX
The following exhibits are filed herewith, indexed according to the applicable assigned number:
Exhibit
Number
Number
| (10) | FNBH Bancorp, Inc. Employees’ Stock Purchase Plan as Amended January 20, 2005 | |
| (21) | Subsidiaries of the Registrant | |
| (23.1) | Consent of BDO Seidman, LLP | |
| (23.2) | Consent of KPMG, LLP | |
| (24) | Power of Attorney (included in signature section) | |
| (31.1) | Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| (31.2) | Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| (32.1) | Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). | |
| (32.2) | Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (18 U.S.C. 1350). |
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The following exhibits, indexed according to the applicable assigned number, were previously filed by the Registrant and are incorporated by reference in this Form 10-K Annual Report.
| Exhibit | ||||
| Number | Original Filing Form and Date | |||
| (3.1) | Restated Articles of Incorporation of the Registrant | Exhibit 3.1 of Form 10, effective June 30, 1995 (“Form 10”) | ||
| (3.2) | Amendment to the Corporation’s Articles of Incorporation to Increase Authorized Shares | Appendix I of Proxy Statement dated March 17, 1998 | ||
| (3.3) | Bylaws of the Registrant | Exhibit 3.2 of Form 10 | ||
| (4) | Form of Registrant’s Stock Certificate | Exhibit 4 of Form 10 | ||
| Material Contracts: | ||||
| (10.1) | Howell Branch Lease Agreement | Exhibit 10.2 to Form 10 | ||
| (10.2) | Corporation’s Long Term Incentive Plan* | Appendix II of Proxy Statement dated March 17, 1998 | ||
| (10.3) | FNBH Bancorp Inc. Employees’ Stock Purchase Plan | Exhibit 4 to Registration Statement on Form S-8 (Reg. No. 333-46244) | ||
| (10.4) | Amended and Restated Compensation Plan for Nonemployee Directors* | Appendix II of Proxy Statement dated March 15, 2002 |
| * | Represents a compensation plan |
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