Dear Stockholder:
Some things never change. During 2003 and 2004 we saw interest rates at the same
levels we had in the early years of your bank in the 1960's. Obviously during
this period, rates fluctuated greatly from record highs to the recent forty-year
low. Now, with the economy getting more robust, the rates we are paying on
deposits and earning on loans are gradually increasing. A positive trend in the
economic outlook is very favorable not only for the country as a whole but for
your organization as well.
The overview on page four of the attached Management Disclosure and Analysis
states that 2004 was a significant year for your corporation. Briefly told,
deposit growth was a healthy 6.2% with an excellent loan growth of 14.4%. Loan
growth was achieved with no compromise in the credit quality of the banking
subsidiary's loan portfolio. The Corporation also posted solid profits with
total capital increasing 7.2% after a cash dividend for the year of 3.6%.
Additionally, we would like to point out that the third and again the fourth
quarters of 2004 were particularly strong in profitability. We ask that you take
the time to read and review the Management Discussion and Analysis, as it will
show in great detail the financial activities of your corporation during the
past year.
As for the future, we have several new opportunities on the horizon. Planned are
three new full service, seven- day-a-week supermarket offices in Pick'n Saves
and we are constantly searching for new market locations. We are also
implementing a new advertising and promotional campaign and will be installing
state of the art computer hardware, software and systems for more efficient
customer service.
In closing, I have to say things do change. One thing that remains constant is
that we live in a strong and free country with opportunities to continue to
build your organization. In addition, not changing will be the dedication of
your Board of Directors, management and entire staff of 400-plus employees who
will continue their efforts to insure your investment remains solid and growing.
Very truly yours,
Henry Karbiner, Jr.
Chairman & President
HKJ/vk
Directors and Officers of the Corporation
Directors
Frank J. Bauer President of Frank Bauer Construction Company, Inc.
William N. Beres Chief Financial Officer of Wisvest Corporation
Sanford Fedderly Retired Registered Pharmacist
Scott D. Gerardin Senior Vice President and General Counsel of Tri City
National Bank
William Gravitter President of Hy-View Mobile Home Court, Inc.
Henry Karbiner, Jr. Chairman of the Board, President and Chief Executive
Officer of the Corporation and Chairman of the Board and
Chief Executive Officer of Tri City National Bank
Christ Krantz Vice President of K.R.K., Inc.(corporation owning Ramada
-Airport Motel, Milwaukee) and partner in Veterans Linen
Supply Company and President of Krantz Realty
Robert W. Orth Executive Vice President of Tri City National Bank, and
Senior Vice President of the Corporation
Ronald K. Puetz President and Chief Operating Officer of Tri City
National Bank and Executive Vice President of the
Corporation and Vice President and Treasurer of NDC, LLC
Agatha T. Ulrich Chairman and Director of NDC,LLC, President and Director
of the David A. and Agatha T. Ulrich Foundation, Inc.
David A. Ulrich, Jr. Independent Investor,Retired Vice President and Director
of Mega Marts,Inc., Retired Vice President and Director
of NDC, LLC and Director of the David A. and Agatha T
. Ulrich Foundation, Inc.
William J. Werry Retired Unit President of Tri City National Bank
Scott A. Wilson Senior Vice President and Secretary of the Corporation,
and Executive Vice President and Secretary of Tri City
National Bank
2
Officers
Henry Karbiner, Jr. Chairman of the Board, President and Chief Executive
Officer
Ronald K. Puetz Executive Vice President
Robert W. Orth Senior Vice President
Scott A. Wilson Senior Vice President and Secretary
Thomas W. Vierthaler Vice President and Comptroller
George E. Mikolajczak Vice President - Human Resources
Gary J. Hafemann Assistant Vice President and Auditor
3
Tri City Bankshares Corporation
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion provides additional analysis of the financial
statements and should be read in conjunction with the financial statements. This
discussion focuses on significant factors which affected Tri City Bankshares
Corporation's (the "Corporation") financial performance in 2004 with comparisons
to 2003 and to 2002 where applicable. As of December 31, 2004, the operations of
Tri City National Bank (the "banking subsidiary") contributed substantially all
of the Corporation's revenue and expense for the year. Included in the
operations of the banking subsidiary are the activities of its wholly-owned
subsidiaries, Tri City Capital Corporation, Inc. and Title Service of Southeast
Wisconsin, Inc.
OVERVIEW
The year ended December 31, 2004 was a significant year for the Corporation and
its banking subsidiary in terms of the continued effort to build its loan
portfolio. The year 2004 also saw modest mortgage loan production after the
record activity which peaked early in 2003 and ended by the middle of that year.
Management's simple strategy was to replace revenue generated by secondary
market lending with portfolio lending. The improving economy in 2004 contributed
to loan growth. Earnings were also driven by continued strong margin
performance. Expense controls and the Corporation's historically sound credit
quality both contributed to the strong consolidated earnings as well.
FORWARD-LOOKING STATEMENTS
This report contains statements that may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995, such
as statements other than historical facts contained or incorporated by reference
in this report. These statements speak of Corporation's plans, goals, beliefs or
expectations, refer to estimates or use similar terms. Future filings by the
Corporation with the Securities and Exchange Commission, and statements other
than historical facts contained in written material, press releases and oral
statements issued by, or on behalf of the Corporation, may also constitute
forward-looking statements.
Forward-looking statements are subject to significant risks and uncertainties.
The Corporation's actual results may differ materially from the results
discussed in such forward-looking statements. Factors that might cause actual
results to differ from the results discussed in forward-looking statements
include, but are not limited to the factors set forth in Exhibit 99.1 of the
Corporation's Annual Report on Form 10-K for the year ended December 31, 2004,
which exhibit is incorporated herein by reference.
All forward-looking statements contained in this report or which may be
contained in future statements made for or on behalf of the Corporation are
based upon information available at the time the statement is made and the
Corporation assumes no obligation to update any forward-looking statement.
CRITICAL ACCOUNTING POLICIES
A number of accounting policies require us to use management's judgment. Three
of the more significant policies are:
o Establishing the amount of the provision and allowance for loan
losses. We evaluate our loan portfolio at least quarterly to determine
the adequacy of the allowance for loan losses. Included in the review
are five components: (1) An historic review of losses and allowance
coverage based on peak and average loss volume; (2) A review of
portfolio trends in volume and composition with attention to possible
concentrations; (3) A review of delinquency trends and loan
performance compared to our peer group; (4) A review of local and
national economic conditions; and (5) A quality analysis review of
non-performing loans identifying charge-offs, potential loss after
collateral liquidation and credit weaknesses requiring above-normal
supervision. If we misjudge the adequacy of the allowance and
experience additional losses, a charge to earnings may result.
4
o Establishing the value of mortgage servicing rights. Mortgage
servicing rights ("MSRs") are established on loans (primarily mortgage
loans) that we originate and sell, but continue to service as we
collect the payments and tax escrows. Generally accepted accounting
principles require that we recognize, as income, the estimated fair
market value of the asset when originated, even though management does
not intend to sell these rights. The estimated value of MSRs is the
present value of future net cash flows from the servicing relationship
using current market assumptions for factors such as prepayments and
servicing costs. As the loans are repaid and the servicing revenue is
earned, MSR's are amortized. Net servicing revenues and newly
originated MSR's generally exceed this amortization expense. However,
if actual prepayment experience is greater than anticipated and new
loan volume declines, net servicing revenues may be less than expected
and a charge to earnings may result.
o Determining the amount of current and deferred income taxes. The
determination of current and deferred income taxes is based on complex
analyses of many factors including interpretation of federal and state
income tax laws, the difference between tax and financial reporting of
temporary differences and current accounting standards. The federal
and state taxing authorities who make assessments based on their
determination of tax laws periodically review the Corporation's
interpretation of federal and state tax laws. This assessment may
result in an adjustment to amounts previously provided for.
PERFORMANCE SUMMARY
The Corporation recorded net income of $8.4 million for the year ended December
31, 2004, a decrease of $329,000 or 3.8% from the $8.7 million earned in 2003.
Basic earnings per share for 2004 were $1.01, a 5.6% decrease from 2003 basic
earnings per share of $1.07. Return on average assets and return on average
equity for 2004 were 1.26% and 9.49%, respectively, compared to 1.41% and
10.56%, respectively, for 2003. Cash dividends of $0.70 per share paid in 2004
increased by 9.4% over 2003. Key factors behind these results were:
o Taxable equivalent net interest income was $30.2 million for 2004,
$232,000 or 0.77% higher than 2003. Taxable equivalent interest income
increased $41,000 while interest expense decreased $191,000. The
relatively small increase in taxable equivalent net interest income
was attributable to large volume variances (with balance sheet growth
and differences in the mix of taxable and tax exempt earning assets
adding $3.0 million to taxable equivalent net rate interest income),
offset entirely by equally large unfavorable rate variances (as the
impact of changes in the interest rate environment reduced taxable
equivalent net interest income by $3.0 million). The decrease of
$191,000 in interest paid on deposits was entirely attributable to a
shift in the mix of deposits (out of time deposits) and a lower rate
environment. Average earning assets increased $35.2 million to $608.7
million while interest bearing liabilities increased $27.8 million to
$415.8 million.
o Net interest income and net interest margin were impacted in 2004 by
the sustained low interest rate environment, competitive pricing
pressures, higher earning asset balances, and total deposit growth.
The average Federal funds rate of 1.43% in 2004 was 27 basis points
("bp") higher than the average rate in 2003.
o The net interest margin for 2004 was 4.91%, compared to 5.15% in 2003.
The 24 bp decrease in net interest margin is attributable to the net
of a 21 bp decrease in interest rate spread (the net of a 34 bp
decrease in the yield on earning assets, substantially offset by a 13
bp lower cost of interest-bearing liabilities), and a 3 bp lower
contribution from net free funds.
o Total loans were $471.2 million at December 31, 2004, an increase of
$59.0 million from December 31, 2003, entirely due to commercial and
residential real estate loan growth. These loan balances grew $60.5
million (16.9%) and represented 88.8% of total loans at December 31,
2004, compared to 86.8% at year end 2003. Total deposits were $590.4
million at December 31, 2004, an increase of $34.4 million or 6.2%
from year end 2003, with growth centered primarily in short term and
transaction deposit accounts.
5
o Asset quality remains strong in the banking subsidiary. Net charge
offs were $82,000, a decrease of $168,000 from 2003, with the majority
of the decrease attributable to fewer charge offs in the consumer loan
portfolio. Net charge offs were 0.02% of average loans compared to
0.06% in 2003. The provision for loan losses increased to $435,000
compared to $420,000 in 2003. The ratio of allowance for loan losses
to loans was 1.20% and 1.28% at December 31, 2004 and 2003,
respectively. Nonperforming loans were $2.0 million, representing
0.42% of total loans at year end 2004, compared to $1.5 million or
0.35% of total loans at year end 2003.
o Non-interest income was $6.4 million for 2004, $1.2 million or 16.2%
lower than 2003, the decrease attributable to declining mortgage
banking activity. Mortgage banking revenue decreased $1.6 million
(76.6%) to $0.5 million, from the record income of $2.1 recorded in
2003 during the boom in residential refinancing.
o Non-interest expense was $23 million, down $486,000 or 2.1% from 2003.
Personnel expense decreased $440,000 or 3.2%, primarily due to the
reduction in profit sharing bonuses paid to officers. The reduction
was the result of the banking subsidiary's lower earnings compared to
2003.
o Income tax expense increased to $3.7 million, up $180,000 from 2003.
The increase was primarily attributable to a shift in the investment
strategy of the Corporation and its subsidiaries from tax advantaged
municipal investments to taxable government securities and a
settlement with the Wisconsin Department of Revenue concerning the
Corporation's Nevada subsidiary. Beginning in 2004, certain assets
held in the Nevada subsidiary are limited as to eligibility for
favorable tax treatment.
INCOME STATEMENT ANALYSIS
Table 1 provides average balances of earning assets and interest-bearing
liabilities, the interest income and expense resulting from each, and the
calculated interest rates earned and paid. The table further shows net interest
income, interest rate spread, and the net interest margin on a taxable
equivalent basis for the years ended December 31, 2004, 2003 and 2002.
6
TABLE 1
AVERAGE BALANCES AND INTEREST RATES
(interest rates on a taxable equivalent basis)
(Dollars in Thousands)
2004 2003 2002
---- ---- ----
Yield Yield Yield
Average or Average or Average or
Balance Interest Cost Balance Interest Cost Balance Interest Cost
ASSETS (000's)
Interest Earning Assets:
Loans $444,938 $28,379 6.38% $396,427 $27,363 6.90% $388,566 $29,923 7.70%
Taxable Investment Securities 96,732 3,259 3.37% 72,877 2,895 3.97% 74,230 3,595 4.84%
Non Taxable Investment
securities 65,561 3,388 5.17% 86,433 4,565 5.28% 75,146 4,682 6.23%
Federal Funds Sold 1,423 23 1.59% 17,735 185 1.04% 14,388 245 1.70%
-------- ------- -------- ------- -------- -------
Total Interest Earning Assets 608,654 35,049 5.76% 573,472 35,008 6.10% 552,330 38,445 6.96%
------- ------- -------
Noninterest-Earning Assets:
Other Assets 55,894 46,815 47,784
-------- -------- --------
TOTAL ASSETS $664,548 $620,287 $600,114
======== ======== ========
LIABILITIES AND EQUITY (000's)
Interest-Bearing Liabilities:
Transaction Accounts $122,311 $ 1,409 1.15% $ 95,935 $ 1,087 1.13% $ 71,571 $ 1,077 1.51%
Money Market 48,695 367 0.75% 47,560 351 0.74% 58,303 699 1.20%
Savings Deposits 141,962 766 0.54% 136,114 780 0.57% 122,097 1,226 1.00%
Other Time Deposits 89,716 2,166 2.41% 105,741 2,838 2.68% 128,114 4,759 3.71%
Short-Term Borrowings 13,104 184 1.40% 2,625 27 1.03% 6,099 79 1.29%
-------- ------- -------- ------- -------- -------
Total Interest-Bearing
Liabilities 415,788 4,892 1.18% 387,975 5,083 1.31% 386,184 7,840 2.03%
------- ------- -------
Noninterest Bearing Liabilities:
Demand Deposits 157,400 146,385 135,254
Other 3,016 3,404 2,713
Stockholders' Equity 88,344 82,523 75,963
-------- -------- --------
Total Liabilities and
Stockholders' Equity $664,548 $620,287 $600,114
======== ======== ========
Net interest earnings and
interest rate spread $30,157 4.58% $29,925 4.79% $30,605 4.93%
======= ===== ======= ===== ======= =====
Net interest margin (FTE) 4.91% 5.15% 5.46%
===== ===== =====
NET INTEREST INCOME
Net interest income is the Corporation's primary source of income. Net interest
income is the difference between interest income on earning assets, such as
loans and securities, and the interest expense on interest-bearing deposits and
other borrowings, such as the Federal funds purchased through a correspondent
bank, used to fund such assets. Net interest income is affected by increasing or
decreasing interest rates as well as the mix and volume of both the earning
assets and funding deposits. Additionally, the composition and characteristics
of such assets and deposits contribute to the sensitivity of the balance sheet
to changes in interest rates. Examples of these characteristics include loans
with floating rates tied to an index, such as the Tri City National Bank
reference rate, and the contractual maturities of loans. Similarly, on the
deposit side, the ratio of time deposits to deposits with no stated investment
term impacts balance sheet sensitivity.
7
A measure of the interest rate spread and net interest margin will explain
changes in net interest income. Interest rate spread is the difference between
the yield on earning assets and the rate paid for interest-bearing liabilities
that fund those assets. The net interest margin is expressed as the percentage
of net interest income to average earning assets. The net interest margin
exceeds the interest rate spread because non-interest-bearing sources of funds,
principally demand deposits and stockholders' equity, also support earning
assets. To compare tax-exempt asset yields to taxable yields, the yield on
tax-exempt loans and securities is computed on a taxable equivalent basis. Net
interest income, interest rate spread, and net interest margin are discussed on
a taxable equivalent basis.
Taxable equivalent net interest income was $30.2 million for 2004, an increase
of $232,000 or 0.8% from 2003. The increase in taxable equivalent net interest
income was a function of growth in the commercial loan portfolio resulting in a
higher level of earning assets partially offset by unfavorable interest rate
changes with maturing loans repricing at lower rates and new business also
yielding a lower rate than in prior years. The taxable equivalent net interest
margin for 2004 was 4.91% compared to 5.15% for 2003. The 24 basis point
compression is attributable to a decrease in the interest rate spread (with a 34
bp decrease on the yields on earning assets partially offset by a 13 bp decrease
in cost of deposits and borrowed funds.) Although the margin compression is
significant, it should be viewed in the context of peer performance where the
Corporation's net interest margin continues to rank in the top quartile of over
1,000 similarly sized banks as ranked by the Federal Financial Institutions
Examination Council in its peer analysis, the Uniform Bank Performance Report.
Interest rates through the first half of 2004 were stable but began to increase
in July as the Federal Reserve made the first of five 25 bp increases to the
discount rate.
For 2004 the yield on earning assets fell 34 bp to 5.76%. This overall decrease
reflects the decline in loan yields of 52 bp, down from 6.90% to 6.38% as well
as a 60 bp decline in the yields earned on investment securities from 3.97% to
3.37%. The decrease in loan yields was the result of a continued low rate
environment for much of 2004 and competitive pricing as the economy
strengthened. The decrease in yields earned on securities is the result of many
callable issues being reinvested at lower rates.
Interest paid on interest-bearing liabilities also decreased in 2004, but not to
the extent that it did in 2003. Funding yields on interest-bearing liabilities
decreased 13 bp to 1.18%. This decrease was most significant in time deposits
(27bp) with changes of 3 bp or less in transaction accounts, money market,
savings and time deposits. The relatively minor change was the result of a
stable rate environment through most of the year. Since the Corporation does not
utilize long-term borrowings or brokered deposits, this 13 bp rate change to
core deposit yields and the shift of core deposits out of time deposits entirely
accounted for the $0.2 million reduction in interest expense.
8
TABLE 2
INTEREST INCOME AND EXPENSE VOLUME AND RATE CHANGE
(Dollars in Thousands)
The following table sets forth, for the periods indicated, a summary of the
changes in interest earned (on a fully taxable equivalent basis) and interest
paid resulting from changes in volume and changes in rates:
2004 Compared to 2003 2003 Compared to 2002
Increase (Decrease) Due to Increase (Decrease) Due to
Volume Rate(1) Net Volume Rate(1) Net
Interest earned on:
Loans $ 3,348 $(2,332) $ 1,016 $ 605 $(3,165) $(2,560)
Taxable investment
securities 948 (584) 364 (65) (635) (700)
Nontaxable investment
securities (1,102) (75) (1,177) 736 (853) (117)
Federal funds sold (170) 8 (162) 57 (117) (60)
------- ------- ------- ------ ------- -------
Total interest-earning
assets $ 3,024 $(2,983) $ 41 $1,333 $(4,770) $(3,437)
======= ======= ======= ====== ======= =======
Interest paid on:
Transaction accounts 297 25 322 367 (357) 10
Money market 8 8 16 (129) (219) (348)
Savings deposits 34 (48) (14) 141 (587) (446)
Other time deposits (429) (242) (671) (830) (1,091) (1,921)
Short-term borrowings 109 47 156 (45) (7) (52)
------- ------- ------- ------ ------- -------
Total interest-bearing
liabilities $ 19 $ (210) $ (191) $ (496) $(2,261) $(2,757)
======= ======= ======= ====== ======= =======
Increase (decrease) in
net interest income $ 232 $ (680)
======= =======
(1) The change in interest due to both rate and volume has been allocated
to rate changes.
Table 2 shows the year to year rate and volume comparisons for interest income
and expense. Volume changes increased taxable equivalent net interest income
$3.0 million. Rate changes decreased the income category just under $3.0 million
resulting in a small net increase of $41,000 in taxable net interest income. The
volume review shows growth in loans increased interest income $3.3 million while
the composition (volume) change of securities from non-taxable to taxable
resulted in a net decrease in interest income of $154,000 (the shift to taxable
government securities increased interest income $948,000 while the shift out of
municipal securities decreased taxable equivalent interest income $1.1 million.)
This shift was the result of a flattened yield curve and limited spread
opportunities in municipal investments. The decrease in interest income due to
rate changes was concentrated in loans (a $2.3 million decrease) with repriced
securities accounting for the remainder of the $3.0 million decease.
Table 2 also shows the change in interest expense on interest bearing deposits.
Composition mix (volume changes) of various categories of interest-bearing
liabilities had no effect (decrease in time deposit volume of $0.43 million was
offset by the increase in transaction account volume of $0.3 million and short
term borrowings of $0.1 million.) The decrease due to rate paid is entirely
attributable to decreased rates on time deposits $0.2 million.
The net result of both volume and rate changes shown in Table 2 for interest
earned on loans is an increase of $1.0 million. Increased income due to loan
volume, showing the Corporation's commitment to loan growth, contributed $3.3
million while unfavorable rate changes decreased interest income $2.3 million.
The net result of both volume and rate changes for interest earned on taxable
investment securities is an increase of $364,000. Interest income in this
category increased $0.9 million as a significant volume of funds previously
deployed in municipal securities were moved to government securities. Taxable
securities interest income decreased $0.6 million due to rate changes.
9
The net result of both volume and rate changes for tax equivalent interest
earned on tax exempt securities is a decrease of $1.2 million. Substantially all
the change was due to volume as numerous callable municipal securities were
reinvested in government securities resulting in a decrease of $1.1 million. In
addition the Corporation had significant excess funds invested on a day-to-day
basis in the Federal funds market in 2003. With considerable loan growth in 2004
those funds were invested in loans resulting in a decrease in interest income of
$162,000 in Fed funds sold.
The net result of both volume and rate changes shown in Table 2 for interest
paid on transaction accounts was an increase of $0.3 million which was almost
entirely due to volume. The Corporation's largest deposit account growth
occurred in its Investor Checking account. The net result of both volume and
rate changes for interest paid on time deposits was a decrease of $0.7 million.
Volume accounted for $0.4 million of the decrease as many depositors opted out
of traditional Certificates of Deposit in view of the low rates available. The
remainder of the decrease ($242,000) was due to lower rates on certificates
which did renew. Short term borrowing interest expense increased $156,000 as the
bank's loan volume increases outpaced deposit growth.
TABLE 3
SELECTED AVERAGE BALANCES
(Dollars in Thousands)
Dollar Percent
ASSETS 2004 2003 Change Change
---- ---- ------ ------
Loans:
Commercial $279,020 $247,302 $ 31,718 12.8%
Residential real estate 127,058 111,155 15,903 14.3
Consumer 38,860 37,970 890 2.3
-------- -------- --------
Total Loans 444,938 396,427 48,511 12.2
-------- -------- --------
Investment securities:
Taxable 96,732 72,877 23,855 32.7
Tax-exempt 65,561 86,433 (20,872 (24.1)
Short-term investments 1,423 17,735 (16,312 (92.0)
-------- -------- --------
Securities and short-term
investments 163,716 177,045 (13,329) (7.5)
-------- -------- --------
Total earning assets 608,654 573,472 35,182 6.1
Other Assets 55,894 46,815 9,079 19.4
-------- -------- --------
Total Assets $664,548 $620,287 $ 44,261 7.1%
======== ======== ========
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Savings deposits $141,962 $136,114 $ 5,848 4.3%
Transaction account deposits 122,311 95,935 26,376 27.5
Money market deposits 48,695 47,560 1,135 2.4
Time deposits 89,716 105,741 (16,025) (15.2)
-------- -------- --------
Total interest-bearing deposits 402,684 385,350 17,334 4.5
Short-term borrowings 13,104 2,625 10,479 399.1
-------- -------- --------
Total interest-bearing liabilities 415,788 387,975 27,813 7.2
Noninterest-bearing demand deposits 157,400 146,385 11,015 7.5
Accrued expenses and other liabilities 3,016 3,404 (388) (11.4)
Stockholders' equity 88,344 82,523 5,821 7.1
-------- -------- --------
Total liabilities and
stockholders' equity $664,548 $620,287 $ 44,261 7.1%
======== ======== ========
10
As shown in Table 3 average earning assets were $608.7 million in 2004, an
increase of $35.2 million (6.1%) from 2003. The loan portfolio contributed $48.5
million of new earning assets, an increase of 12.2%, driven primarily by
commercial real estate loan growth. Compared to 2003, the banking subsidiary
decreased its average position in federal funds sold by $16.3 million (92%),
deploying those funds instead in higher yielding loans. The balance of the
change in earning assets was a volume mix with a shift of $20.9 million out of
tax exempt municipal securities to government securities. Investments in
government securities increased $23.9 million to $96.7 million as a result of
this shift plus $3 million in growth. As a result, the combined total of
investment securities (taxable and tax-exempt municipal investments) had a net
increase of $3.0 million (1.9%) to $163 million. Average other assets increased
$9.1 million, or 19.4% as a result of the purchase of $10 million of Bank Owned
Life Insurance (BOLI) on 17 of the Corporation's senior executives. The
Corporation is both the owner and beneficiary of the policies and qualifies for
tax advantaged treatment of the dividend paid on the investment yield. Total
average assets increased $44.3 million, or 7.1%.
The increase in average earning assets in 2004 was supported by an increase in
average interest-bearing liabilities of $27.8 million, or 7.2% over 2003. This
growth occurred primarily in transaction accounts which increased $26.4 million,
or 27.5%. A decrease of $16.0 million (15.2%) in the average balance of time
deposits was offset by small growth in money market and savings accounts, $5.8
and $1.1 million respectively and an increase in short term borrowings of $10.5
million. Non-interest bearing demand deposits increased $11.0 million, or 7.5%.
In addition, average stockholders' equity increased $5.8 million, or 7.1%. Total
average liabilities and stockholders' equity also increased $44.3 million, or
7.1%.
PROVISION FOR LOAN LOSSES
The provision for loan losses in 2004 was $435,000. The provision for loan
losses was $420,000 in 2003 and the same in 2002. As of December 31, 2004 the
allowance for loan losses was $5.6 million compared to $5.3 million at December
31, 2003 and $5.1 million at year end 2002. Net charge offs for 2004 were
$82,000 compared to $250,000 for 2003 and $128,000 for 2002. Net charge offs as
a percent of average loans were 0.02%, 0.06% and 0.03% for 2004, 2003 and 2002
respectively. The ratio of the allowance for loan losses to total loans was
1.20%, down from 1.28% at December 31, 2003 and 1.29% at December 31, 2002.
Nonperforming loans at December 31, 2004 were $2.0 million compared to $1.5
million at December 31, 2003 and $2.7 million at December 31, 2002.
11
Table 4 summarizes loan loss allowance balances at the beginning and end of each
year; changes in the allowance for loan losses arising from loans charged off
and recoveries on loans previously charged-off, by loan category; additions to
the allowance which have been charged to expense; and selected performance
ratios.
TABLE 4
SUMMARY OF LOAN LOSS EXPERIENCE
(Dollars in Thousands)
Year Ended December 31, 2004 2003 2002 2001 2000
- ------------------------ ---- ---- ---- ---- ----
Balance of allowance for loan
losses at beginning of period $5,289 $5,119 $4,827 $4,521 $4,340
------ ------ ------ ------ ------
Loans charged-off
Commercial 7 9 27 0 130
Real Estate 22 135 86 38 62
Installment 194 195 115 128 9
------ ------ ------ ------ ------
Total loans charged-off 223 339 228 166 201
------ ------ ------ ------ ------
Recoveries of loans previously
charged-off:
Commercial 1 2 2 11 37
Real Estate 44 35 53 21 0
Installment 96 52 45 20 45
------ ------ ------ ------ ------
Total recoveries 141 89 100 52 82
------ ------ ------ ------ ------
Net loans charged-off 82 250 128 114 119
Additions to allowance charged
to expense 435 420 420 420 300
------ ------ ------ ------ ------
Balance at end of period $5,642 $5,289 $5,119 $4,827 $4,521
====== ====== ====== ====== ======
Ratio of net loans charged-off
(recoveries)during the period
to average loans outstanding 0.02% 0.06% 0.03% 0.03% 0.03%
====== ====== ====== ====== ======
Ratio of allowance at end of
year to total loans 1.20% 1.28% 1.29% 1.29% 1,25%
====== ====== ====== ====== ======
The provision for loan loss is a methodology to assess qualitative and
quantitative factors to determine the adequacy of the allowance for loan losses.
Factors considered are the size of the portfolio, levels of nonperforming loans,
historical losses, risk inherent in certain categories of loans, concentrations
of loans to certain borrowers or certain industry segments, economic trends,
collateral pledged, and other factors which could affect loan losses.
12
NON-INTEREST INCOME
Total non-interest income was $6.45 million for 2004, a decrease of $1.25
million (16.2%). The decrease is primarily the result of lower revenue from loan
related fees and servicing revenue.
TABLE 5
NON-INTEREST INCOME
Year Ended December 31, 2004 2003 2002
- ----------------------- ---- ---- ----
Service charge and fees $ 5,243,924 $ 5,376,370 $ 5,181,123
Loan related fees and
mortgage banking revenue 126,954 1,445,029 1,120,822
Increase in cash surrender
value of life insurance 361,935 - -
Other income 716,832 879,488 917,650
----------- ----------- -----------
Total non-interest income $ 6,449,645 $ 7,700,887 $ 7,219,595
=========== =========== ===========
Loan related fees and mortgage banking revenue is the banking subsidiary's
retail activity in consumer home loan fixed rate financing. The banking
subsidiary originates and closes loans for customers, retains the servicing
(payment collection, escrow collection and disbursement) but sells the
underlying assets to the Federal Home Loan Mortgage Corporation. Loan related
fees and mortgage banking revenue consists of servicing fees, the gain or loss
on the sale of loans and other related fees net of amortization of mortgage
servicing rights. Loan related fees and mortgage banking revenue was $0.1
million in 2004 a decrease of $1.3 million (91%) from the record income of $1.4
million recorded in 2003. As mortgage rates fell to historic lows in 2002 and
again in 2003, new and refinanced mortgage activity hit record highs. Service
charges and fees also decreased $0.1 million (2%) to $5.2 million due to a
decrease in the volume of non-sufficient funds ("NSF") items. The increase in
the cash surrender value of life insurance for 2004 of $0.4 million was the
result of the purchase of $10.0 million of Bank Owned Life Insurance ("BOLI") at
the end of 2003. Other income decreased $0.2 million (19%) to $0.7 million from
$0.9 million in 2003 due to non-recurring items.
NON-INTEREST EXPENSE
Total non-interest expense for 2004 was $23.0 million, a decrease of $0.5
million (2.1%) from 2003.
TABLE 6
NON-INTEREST EXPENSE
Year End December 31, 2004 2003 2002
- --------------------- ---- ---- ----
Salaries and employee benefits $ 13,224,810 $ 13,665,275 $ 13,069,429
Occupancy 2,135,640 2,074,453 1,874,442
Equipment 1,682,825 1,816,971 1,904,588
Supplies 493,393 579,161 574,078
Professional fees 667,969 744,333 736,981
Data processing fees 1,744,428 1,590,322 1,352,830
Advertising public relations 634,139 670,583 615,641
Other expenses 2,374,328 2,302,014 2,414,931
Extraordinary expense - - 4,250,000
------------ ------------ ------------
Total non-interest expense $ 22,957,532 $ 23,443,112 $ 26,792,920
============ ============ ============
Salaries and employee benefits decreased $0.4 million (3.2%) compared to 2003.
This decrease was primarily due to a reduction in the employee year end bonus.
This bonus is approved by the Board of Directors for all exempt employees based
on the banking subsidiary's performance for the period December 1 through
November 30. For the period ending November 30, 2004, the bonus approved was 5%.
13
For the period ending November 30, 2003, the bonus approved was 10%. This
accounted for $0.3 million of the decrease, the remainder being reductions in
staffing of both exempt and non-exempt employees.
Occupancy expenses increased modestly and equipment expenses decreased a similar
amount. Combined overhead for these categories in 2004 was $3.8 million,
slightly below the $3.9 million expense in 2003, a decrease of $73,000 (1.9%).
Supply expenses in 2004 totaled $493,000, a decrease of $86,000 (14.8%) from
2003. Professional fees, primarily to outside legal counsel and external
auditor/accounting firms also decreased $76,000 (10.2%) to $668,000. Data
processing fees for 2004 totaled $1.7 million an increase of $154,000 (9.7%).
This increase was primarily the result of a change in telecommunications and
upgrades in the wide area network linking all the subsidiary bank's branch
offices to each other and the host processor. Other expenses increased from $2.3
million in 2003 to $2.4 million in 2004. The increase of $72,000 (3.1%) included
no single large item. Extraordinary expense of $4.25 million expense was
incurred in 2002 to settle two lawsuits.
INCOME TAXES
Income tax expense for 2004 was $3.7 million up $0.2 million from 2003 income
tax expense of $3.5 million. The Corporation's effective tax rate (income tax
expense divided by income before income taxes) was 30.45% in 2004, 28.62% in
2003 and 23.99% in 2002.
The increase in the effective tax rate for 2004 was primarily due to a shift in
the investment strategy of the Corporation and its subsidiaries from tax
advantaged municipal investments to taxable government securities (as
represented by the average balances in Table 3). Additionally, similar to many
financial institutions located in Wisconsin, state tax expense increased as a
result of a settlement between the banking subsidiary and the Wisconsin
Department of Revenue. The settlement resulted in a minimal assessment of tax
and interest for tax years under audit. However, the settlement also limits and
restricts the volume and types of assets eligible for favorable tax treatment at
Tri City Capital Corporation, the banking subsidiary's Nevada subsidiary. These
asset restrictions further limit the current and future tax benefit realized
from the Nevada subsidiary.
The increase in the effective rate for 2003 is due to a reduction in taxable
income in 2002 resulting from litigation settlements.
14
BALANCE SHEET ANALYSIS
LOANS
Total loans were $471.2 million at December 31, 2004, an increase of $59.0
million, or 14.3%, from 2003. Loans originated by the Corporation's banking
subsidiary are loans to small businesses and individuals in the communities
served in the greater Milwaukee market. Although the legal lending limit of the
banking subsidiary equals $14 million, management prefers borrowers with credit
needs in the range of $1 million to $5 million. Most borrowers have credit
relationships totaling less than $1 million.
The following table presents information concerning the composition of the
Bank's loans held for investment at the dates indicated.
TABLE 7
LOAN PORTFOLIO COMPOSITION
(Dollars in Thousands)
Year ended December 31, 2004 2003 2002 2001 2000
----------------------------------------------------------------------------------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Commercial $ 27,404 5.82% $ 27,658 6.71% $ 28,587 7.19% $ 42,095 11.29% $ 38,012 10.51%
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Real estate:
construction 44,502 9.44 38,609 9.37 38,125 9.58 28,263 7.58 19,734 5.45
Real estate-
mortgage:
Single family 189,786 40.27 160,934 39.03 158,723 39.90 145,899 39.13 144,826 40.04
Multi-family 10,092 2.14 8,271 2.01 10,490 2.64 7,791 2.09 10,347 2.86
Commercial
real estate 174,223 36.97 150,270 36.45 133,141 33.47 119,374 32.02 121,313 33.53
-------- ------- -------- ------- -------- ------- -------- ------- --------- -------
Total real
estate 418,603 88.82 358,084 86.86 340,479 85.59 301,327 80.82 296,220 81.88
Installment 25,238 5.36 26,533 6.43 28,718 7.22 29,416 7.89 27,540 7.61
-------- ------- -------- ------- -------- ------- -------- ------- --------- -------
Total loans $471,245 100.00% $412,275 100.00% $397,784 100.00% $372,838 100.00% $361,772 100.00%
======== ======= ======== ======= ======== ======= ======== ======= ======== =======
As Table 7 indicates, commercial loans were $27.4 million at year end 2004,
relatively unchanged (down $254,000, less than 1%) and comprise 5.82% of the
total loan portfolio. Commercial loans are collateralized by general business
assets such as equipment, receivables and inventory and have no real estate
component.
Real estate construction loans increased $5.9 million, or 15.3% to $44.5
million, representing 9.44% of the total loan portfolio at the end of 2004,
compared to $38.6 million or 9.37% of the total loan portfolio at the end of
2003. Loans in this category include loans to individuals for construction of
owner occupied single family residences. However, the category consists
primarily of loans to developers that provide financing for the acquisition or
development of commercial real estate or the acquisition or development of
residential subdivisions. Real estate construction loans are made to developers
who are well known to the Corporation, have prior successful project experience
and are well capitalized. Loans are made to customers in the Corporation's
southeastern Wisconsin market who have experience and knowledge of the local
economy. Real estate construction loans of this type are generally larger in
size and involve greater risks than residential mortgage loans because payments
depend on the success of the project or the successful management of the
property. The Corporation will generally make credit extensions to borrowers
with adequate outside liquidity to support the project in the event the actual
performance is slower than projections.
15
Residential real estate loans (single family and 2-4 family dwellings) totaled
$189.8 million, an increase of $28.9 million, or 17.9%. These single family
mortgage loans comprised 40.27% of the Corporation's total loan portfolio,
compared to 39.03% at year end 2003. These loans to area residents remain the
largest component of the Corporation's portfolio. They represent the lowest risk
with individual loans averaging $75,000 and no single loan exceeding $1 million.
They provide a foundation for the sale of all other retail banking products and
have always been a staple of the portfolio. Loans in this category are generally
made with maturities of 1, 2 or 3 years to provide a repricing opportunity to
the Corporation when rates increase. Amortization periods offered to customers
are 20-25 years depending on equity and loan-to-value ratios. Customers seeking
long term rate locks are directed to the secondary market products offered by
the banking subsidiary where rates can be fixed for 15, 20 or 30 years. These
loans are then sold and as a result do not impact the portfolio.
Multi-family real estate loans increased $1.8 million (22.0%) to $10.1 million,
representing 2.14% of the total loan portfolio at December 31, 2004 compared to
$8.3 million (2.01%) at year end 2003. The loans in this category are secured by
properties with more than four family dwelling units. The Corporation remains
conservative in requiring equity ample to sustain reasonable debt service
coverage in the event of interest rate pressure. Loans in this category
typically have maturities of 3, 4 or 5 years and amortized over 15-20 years.
Non-residential real estate loans (commercial real estate loans) are the second
largest component of the Corporation's loan portfolio. The commercial real
estate loans increased $24 million (15.9%) to $174.2 million at December 31,
2004, compared to $150.3 million at year end 2003. This class of loans makes up
37.0% of the total loan portfolio, almost identical to the 36.5% of the total it
comprised at year end 2003. The Corporation's efforts are focused on owner
occupied, improved property such as office buildings, warehouses, small
manufacturing operations, and retail facilities located in its market areas. The
Corporation's $14 million legal lending limit would permit it to compete for
activity in the middle market segment, but management prefers to seek out small
businesses as it primary target borrower. Loans to such businesses are approved
based on the creditworthiness, the economic feasibility and the cash flow
abilities of the borrower. As displayed in Table 4, the loan loss experience of
the Corporation has been excellent historically.
Total real estate loans increased $60.5 million, or 16.9%, to $418.6 million at
December 31, 2004. Such loans account for 88.8% of the Corporation's total loan
portfolio and, as seen in the preceding discussion, are the driver of the
Corporation's earning assets.
Installment loans declined $1.3 million, or 4.9%, to $25.2 million at year end
2004 compared to $26.5 million at December 31, 2003. These retail loans are
highly competitive with the automobile industry offering ever-increasing
incentive pricing / financing. Additionally the home equity market is highly
competitive. The banking subsidiary offers a standard 80% loan-to-value Home
Equity Line of Credit ("HELOC") product. However, management has not been
inclined to compete with the aggressive 90% and 95% HELOC offerings currently
available. As a result, growth in this area has been flat or negative. Consumer
installment loans, including HELOCs, comprise 5.4% of the total loan portfolio
at year end versus 6.4% at year end 2003.
Overall credit management to ensure credit quality requires sound loan
underwriting and administration, systematic monitoring of existing loans,
effective loan review, early identification of problem loans, an adequate
allowance for loan losses and valid nonaccrual and charge off policies.
The Corporation has continued to improve its credit risk management process. The
fundamental control is a detailed underwriting process which includes weekly
credit review meetings to allow quick approvals and senior lender review.
Additionally, a centralized loan operation facility located in Hales Corners,
Wisconsin serves all branch loan officers and controls documentation,
preparation and exception tracking. Periodic review of borrower's loans and
relationships occur as dictated by the type of credit. Single family amortizing
real estate loans may only be reviewed every three years at note maturity,
whereas a commercial facility is reviewed at least annually.
16
Loan maturity distribution and interest rate sensitivity are displayed in Table
8 below. Since nearly 89% of the loan portfolio is collateralized by real
estate, the table has not been divided by loan classification. As discussed
previously, the table reveals the most significant maturity distribution is
three years or less, with $415 million or 88% repricable in this time frame.
This is the result of the banking subsidiary's use of a three year note as its
primary loan instrument.
TABLE 8
Loan Maturity Distribution and Interest Rate Sensitivity
Repricable within Amount
----------------- -----------------
0 - 90 days $ 112.4 Million
91 - 365 days $ 71.9 Million
-------
1 year $ 84.3 Million
3 years $ 230.4 Million
5 years $ 45.4 Million
Over 5 years $ 11.1 Million
-------
$ 471.2 Million
=======
ALLOWANCE FOR LOAN LOSSES
The loan portfolio is the primary asset subject to credit risk. Credit risk is
controlled and monitored through the use of lending standards, management's
close review and underwriting of potential borrowers, and on-going review of
loan payment performance. Management of credit risk and minimization of loan
losses is a high priority of senior management which uses an ongoing program of
early problem loan identification with timely resolution of problems.
Table 9 summarizes loan loss allowance balances at the beginning and end of each
year, changes in the allowance for loan losses arising from loans charged off
and recoveries on loans previously charged-off, additions to the allowance which
have been charged to expense and selected performance ratios.
17
TABLE 9
SUMMARY OF LOAN LOSS EXPERIENCE
(Dollars in Thousands)
Year ended December 31, 2004 2003 2002 2001 2000
- ----------------------- ---- ---- ---- ---- ----
Balance of allowance for
loan losses at Beginning
of period $ 5,289 $ 5,119 $ 4,827 $ 4,521 $ 4,340
--------- --------- --------- --------- ---------
Total loans charged-off (223) (339) (228) (166) (201)
Total recoveries 141 89 100 52 82
--------- --------- --------- --------- ---------
Net loans charged-off (82) (250) (128) (114) (119)
Additions to allowance
charged to expense 435 420 420 420 300
--------- --------- --------- --------- ---------
Balance of allowance for
loan losses at end of
period $ 5,642 $ 5,289 $ 5,119 $ 4,827 $ 4,521
========= ========= ========= ========= =========
Total Loans $ 471,245 $ 412,275 $ 397,784 $ 372,838 $ 361,771
Total non-performing loans $ 1,963 $ 1,461 $ 2,698 $ 2,639 $ 1,883
Ratio of allowance for loan
losses to total
non-performing loans 2.8 3.6 1.9 1.8 2.4
Ration of net loans charged
-off (recoveries) during
the period to average loans
outstanding 0.02% 0.06% 0.03% 0.03% 0.03%
Ratio of allowance at end of
year to total loans 1.20% 1.28% 1.29% 1.29% 1.25%
The allowance for loan losses represents management's estimate of an amount
adequate to provide for probable credit losses in the loan portfolio. To assess
the adequacy of the allowance for loan losses, senior management uses
significant judgment focusing on changes in the size and the character of the
portfolio, changes in levels of nonperforming loans, risks identified within
specific credits, existing economic conditions, underlying collateral, historic
losses within the portfolio, as well as other factors that could affect probable
credit losses.
At December 31, 2004 the allowance for loan losses was $5.6 million, compared to
$5.3 million at year end 2003 and $5.1 million at year end 2002. As of December
31, 2004, the allowance for loan losses to total loans was 1.20% and covered
287% of nonperforming loans, compared to 1.28% and 362%, respectively, at
December 31, 2003 and 1.29% and 190%, respectively at December 31, 2002. As of
December 31, 2004 total loans have grown to $471.2 million from $412.2 million
as of December 31, 2003 and $397.8 million as of December 31, 2002. Non
performing loans were $2.0 million or .42% of total loans as of December 31,
2004 as compared to $1.45 million or .35% at year end 2003 and $2.7 million or
..68% at year end 2002. Net charge offs were $82,000, $250,000, and $128,000 for
2004, 2003, and 2002 respectively. Loans charged off are subject to continuous
review, and specific efforts are taken to achieve maximum recovery of principal,
accrued interest, and related expenses.
Although growth in total loans from 2003 to 2004 was regarded as significant in
management's opinion, underwriting standards were maintained. Historical levels
of loan losses and non-performing loans are regarded by management as being
favorable to our peers in the industry. Credit administration continues to have
high priority, with management monitoring the Corporation's loan portfolio so as
to identify potential loan situations and to address any weaknesses promptly.
18
Because the portfolio continually changes, the allocation of the allowance for
loan losses is performed for analytical purposes, and does not necessarily
indicate a trend of future losses. The total allowance for loan losses, in
management's opinion is available to absorb potential losses in the portfolio if
needed. Management believes the allowance for loan losses to be adequate as of
December 31, 2004
INVESTMENT SECURITIES PORTFOLIO
The investment securities portfolio is intended to provide the Corporation with
adequate liquidity, flexibility in asset/liability management, a source of
stable income, and is structured to have minimum credit exposure to the
Corporation. It is the practice of the Corporation to hold securities to
maturity.
TABLE 10
INVESTMENT SECURITIES PORTFOLIO
(Dollars in Thousands)
Year ended December 31, 2004 2003 2002
------------------------ ---- ---- ----
Amortized Amortized Amortized
Cost Cost Cost
Investment securities held-to-maturity:
Federal agency securities $ 90,320 $ 85,091 $ 67,810
Obligations of states and political
subdivisions (non-taxable) 58,674 72,984 89,661
Obligations of states and
political subdivisions (taxable) 10,457 12,466 5,151
-------- -------- --------
Total investment securities $159,451 $170,541 $162,622
======== ======== ========
Fair value of investment securities $159,585 $172,874 $166,747
======== ======== ========
Total assets at year end $696,618 $654,783 $632,692
======== ======== ========
Average earning assets $608,654 $573,472 $552,330
======== ======== ========
At December 31, 2004, the total carrying value of investment securities
represented 22.9% of total assets, compared to 26.0% at year end 2003 and 25.7%
at year end 2002. On average, the investment portfolio represented 26.2%, 29.7%
and 29.4% of average earning assets for 2004, 2003 and 2002, respectively.
The shift from municipal securities to U.S. government agency securities is the
result of the Corporation taking advantage of more desirable yields on the U.S.
government agencies as compared to municipal obligations during the year. In
addition to yield, the agencies provide more flexibility and liquidity.
Management maintains overall quality as well as addresses its asset/liability
management concerns by limiting purchases of non U.S. government agency
securities to rated investments of high quality or, on a limited basis, well
known local non-rated issues. Diversity in the portfolio is maintained by
limiting the amount of investment to any single debtor. At December 31, 2004,
the Corporation's securities portfolio did not contain any obligations of any
single issuer that were payable by the same source of revenue or taxing
authority where the aggregate carrying value of such securities exceeded 3.5% of
stockholders' equity.
The following table sets forth the maturities of investment securities at
December 31, 2004, the weighted average yields of such securities (calculated on
the basis of the cost and effective yields weighted for the scheduled maturity
of each security) and the tax-equivalent adjustment used in calculating the
yields.
19
TABLE 11
INVESTMENT SECURITIES PORTFOLIO MATURITY DISTRIBUTION
(Dollars in Thousands)
Maturity
-----------------------------------------------------------
After One After Five
Within One Year Within Five Years Within Ten Years
Year ended December 31, 2004 Amount Yield Amount Yield Amount Yield
- ---------------------------- -------- ----- --------- ----- -------- -----
U.S. government agencies
and corporations $ 7,011 5.20% $ 83,309 3.51% $ 0 0%
Obligations of states and
political subdivisions
(non-taxable) 24,335 4.76 34,339 5.38 0 0
Obligations of states and
political subdivisions
(taxable) 4,868 3.45 5,589 3.52 0 0
-------- -------- --------
$ 36,214 $123,237 $ 0
======== ======== ========
Tax equivalent adjustment
for Calculation of yield $ 360 $ 657 $ 0
Note:The weighted average yields on tax-exempt obligations have been
computed on a fully tax-equivalent basis assuming a tax rate of 34%.
Expected maturities will differ from contractual maturities, as borrowers may
have the right to call or repay obligations with or without call or prepayment
penalties. Management has been shortening the overall maturity of the investment
portfolio in anticipation of rising rates by replacing assets that have matured
or been called prior to maturity. Although this has had a negative impact on
yield, management believes that the Corporation is better positioned to take
advantage of rising rates.
DEPOSITS
Deposits are the Corporation's largest source of funds. The Corporation, through
its banking subsidiary, competes in the metropolitan Milwaukee market with other
financial institutions such as banks, thrifts and credit unions, as well as
non-bank institutions, for retail and commercial deposits. Additionally, it
competes for deposits with investment alternatives such as mutual funds and
brokerage houses. The Corporation continues to market its transaction accounts
(demand deposits including all non-interest bearing checking products, and
interest bearing checking) and has had particular success with Investor
Checking. This product offers tiered rates and daily availability. The extended
low rate environment of the past several years has resulted in a customer
preference for greater flexibility over traditional products such as
certificates of deposit. This has aided deposit growth in general and especially
products such as Investor Checking.
At December 31, 2004 deposits were $560 million, up $28 million or 5.3% over
December 31, 2003. As indicated in Table 12, non-interest bearing deposits
increased to $157 million at December 31, 2004, an increase of $11 million, or
7.5%. This growth was through new customer acquisition in both business and
personal checking accounts. Interest-bearing checking accounts increased to $171
million at December 31, 2004, an increase of $28 million, or 19%. Most growth in
this category occurred in the banking subsidiary's Investor Checking product.
Savings accounts increased to $142 million at December 31, 2004, an increase of
$6 million, or 4%. The mix of deposits changed as customers continued to react
to lower yields being paid on certificates of deposit in 2004 as in 2003. Time
deposits (excluding certificates of $100,000 or more) decreased $17 million, or
22%, to $58 million at year end 2004 compared to to $75 million at year end
2003. Time deposits in amounts of $100,000 and over were relatively unchanged at
$31 million as of December 31, 2004, an increase of $0.7 million, or 2%. Table
13 indicates the maturity distribution of all time deposits in amounts $100,000
and greater.
The banking subsidiary generates core deposits to fund earning assets and has
never relied on brokered deposits for growth. At December 31, 2004 there were no
brokered deposits in the Corporation.
20
TABLE 12
AVERAGE DAILY BALANCE OF DEPOSITS AND AVERAGE RATE PAID ON DEPOSITS
(Dollars in Thousands)
Year ended December 31, 2004 2003 2002
- ---------------------- --------------- --------------- ---------------
Amount Rate Amount Rate Amount Rate
-------- ----- -------- ----- -------- -----
Noninterest-bearing
demand deposits $157,400 $146,385 $135,254
Interest-bearing
transaction deposits 171,007 1.04% 143,495 1.00% 129,873 1.37%
Savings 141,962 0.54 136,114 0.57 122,097 1.00
Time deposits (excluding
time certificates of
deposit of $100,000 or
more) 58,228 2.30 74,949 2.50 87,139 3.72
Time deposits ($100,000
or more) 31,488 2.62 30,792 3.13 40,976 3.70
-------- -------- --------
$560,085 $531,735 $515,339
======== ======== ========
TABLE 13
MATURITY DISTRIBUTION
DEPOSITS IN AMOUNTS OF $100,000 AND OVER
(Dollars in Thousands)
December 31, 2004:
Three months or less $ 5,287
After 3 through 6 months 6,685
After 6 through 12 months 8,464
After 1 year through 2 years 3,331
After 2 years through 3 years 1,722
After 3 years through 4 years 2,073
After 4 years through 6 years 3,926
---------
$ 31,488
=========
OTHER FUNDING SOURCES
The banking subsidiary meets daily funding needs through other short-term
borrowings; principally its Federal funds purchased facility with its
correspondent bank and its Treasury, tax and loan facility with the U.S.
Treasury. Federal funds purchased totaled $9.5 million at year end 2004 as
compared to $9.0 million for year end 2003. Treasury, tax and loan borrowings
totaled $2.7 million and $1.5 million at year end 2004 and 2003, respectively.
The Federal funds purchased facility is a non-collateralized demand borrowing.
The treasury tax and loan notes are demand notes representing secured borrowings
from the U.S. Treasury, collateralized by qualifying securities. The funds are
placed with the subsidiary bank at the discretion of the U.S. Treasury and may
be called at any time. Other short term borrowing at the banking subsidiary
increased $1.7 million. The increase was associated with normal daily flow of
funds into and out of the subsidiary. See also the "Liquidity" section below.
LIQUIDITY
The objective of liquidity management is to ensure that the corporation and its
banking subsidiary has the ability to generate sufficient cash or cash
equivalents in a timely and cost efficient manner so as to meet the commitments
as they fall due. Funds are available from a number of sources, primarily from
core deposits and loan and security repayments and/or maturities. If needed,
additional liquidity can come from the sale of portfolio securities or loans,
lines of credit with major banks and the banking subsidiary's ability to acquire
deposits.
21
It has been management's practice not to sell loans or securities prior to
maturity. The use of its credit facilities has been the principal source of
funding for liquidity when needed. At year end 2004, the banking subsidiary has
a $38 million approved Federal funds purchased facility with its correspondent
bank and has the ability to borrow an additional $57 million under reverse
repurchase agreements. Management has avoided the use of brokered deposits,
however the banking subsidiary has, through its normal day-to-day activity,
developed deposit relationships with a number of local government entities and
has pledged securities and loans to these depositors to meet their
securitization requirements. The banking subsidiary's free securities available
for the reverse repurchase agreements are in addition to securities pledged to
specific depositors. The banking subsidiary continues to attract deposits
through offering competitive deposit rates while offering a high level of
service through extended hours, seven days per week banking and its thirty two
locations in the Milwaukee metropolitan area.
OFF-BALANCE SHEET ARRANGEMENTS
The Corporation utilizes certain derivative financial instruments to meet the
ongoing credit needs of its customers and in order to manage the market exposure
of its residential loans held for sale and its commitments to extend credit for
residential loans. Derivative financial instruments include commitments to
extend credit. The Corporation does not use interest rate contracts (e.g. swaps)
or other derivatives to manage interest rate risk and has none of these
instruments outstanding. The banking subsidiary does have, through its normal
operations, loan commitments and standby letters of credit outstanding as of
December 31, 2004 in the amount of $81.3 million and $2.9 million respectively.
These are further explained in Note 14 of Notes to Consolidated Financial
Statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk arises from exposure to changes in interest rates, exchange rates,
commodity prices, and other relevant market rate or price risk. Market risk in
the form of interest rate risk is measured and managed through the
asset/liability management system. The Corporation uses financial modeling
techniques that measure the sensitivity of future earnings due to changing rate
environments to measure interest rate risk. Policies approved by the Board of
Directors limit exposure of earnings at risk. General interest rate movements
are used to develop sensitivity and monitor exposure at one year. These limits
are based on the Corporation's exposure to a 100 bp and 200 bp immediate and
sustained parallel rate move, either upward or downward.
The Corporation's primary market risk exposure is interest rate risk and, to a
lesser extent, liquidity risk. All of the Corporation's transactions are
denominated in United States dollars, with no specific foreign exchange
exposure.
Interest Rate Risk
Interest Rate Risk ("IRR") is the exposure of a banking organization's financial
condition to adverse movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value. However, excessive
levels of IRR could pose a significant threat to the Corporation's earnings and
capital base. Accordingly, effective risk management that maintains IRR at
prudent levels is essential to the Corporation's safety and soundness.
When assessing IRR, the Corporation seeks to ensure that appropriate policies,
procedures, management information systems and internal controls are in place to
maintain IRR at prudent levels with consistency and continuity. Evaluating the
quantitative level of IRR exposure requires the Corporation to assess the
existing and potential future effects of changes in interest rates on its
consolidated financial condition, including capital adequacy, earnings,
liquidity and, where appropriate, asset quality.
Financial institutions derive their income primarily from the excess of interest
collected over interest paid. The rates of interest an institution earns on its
assets and pays on its liabilities generally are established contractually for a
period of time. Since market interest rates change over time, an institution is
exposed to lower profit margins (or losses) if it cannot adapt to interest rate
changes. For example, assume that an institution's assets carry intermediate or
long-term fixed rates and that those assets are funded with short-term
liabilities. If market interest rates rise by the time the short-term
liabilities must be refinanced, the increase in the institution's interest
expense on its liabilities may not be sufficiently offset if assets continue to
earn at the long-term fixed rates. Accordingly, an institution's profits could
22
decrease on existing assets because the institution will either have lower net
interest income or, possibly, net interest expense. Similar risks exist when
assets are subject to contractual interest rate ceilings, or rate-sensitive
assets are funded by longer-term, fixed-rate liabilities in a decreasing rate
environment.
Financial institutions are also subject to prepayment risk in falling rate
environments. For example, mortgage loans and other financial assets may be
prepaid by a debtor so that the debtor may refund its obligations at new, lower
rates. Prepayments of assets carrying higher rates reduce the Corporation's
interest income and overall asset yields. Certain portions of an institution's
liabilities may be short-term or due on demand, while most of its assets may be
invested in long-term loans or investments. Accordingly, the Corporation seeks
to have in place sources of cash to meet short-term demands. These funds can be
obtained by increasing deposits, borrowing or selling assets. Also, short-term
borrowings provide additional sources of liquidity for the Corporation.
Several ways an institution can manage IRR include: selling existing assets or
repaying certain liabilities; matching repricing periods for new assets and
liabilities by shortening terms of new loans or investments. The Corporation,
through it's banking subsidiary has employed all these strategies in varying
degrees. An institution might also invest in more complex financial instruments
intended to hedge or otherwise change IRR. Interest rate swaps, futures
contracts, options on futures and other such derivative financial instruments
often are used for this purpose. The Corporation has not purchased such
derivative financial instruments in the past and does not presently intend to
purchase such instruments.
TABLE 14
CONTRACTUAL OBLIGATIONS
PAYMENTS DUE BY PERIOD
(In Thousands)
Less Than One to Four to More than
Contractual Obligations Total One Year Three Years Five Years Five Years
- ----------------------- -------- -------- --------- -------- --------
Certificate of Deposit
and Other Time Deposits $ 88,810 $ 60,174 $ 16,579 $ 12,057 $ 0
Short-Term Debt
Obligations 12,234 12,234 0 0 0
Minimum Operating
Lease Obligations 2,325 592 840 655 238
-------- -------- -------- -------- --------
Total $103,369 $ 73,000 $ 17,419 $ 12,712 $ 238
======== ======== ======== ======== ========
In order to measure earnings sensitivity to changing rates, the Corporation uses
two different measurement tools: static gap analysis, and simulation of
earnings. The static gap analysis starts with contractual repricing information
for assets and liabilities. These items are then combined with repricing
estimations for administered rate (interest-bearing demand deposits, savings,
and money market accounts) and non-rate related products (demand deposit
accounts, other assets, and other liabilities) to create a baseline repricing
balance sheet. In addition to the contractual information, residential mortgage
whole loan products are adjusted based on industry estimates of prepayment
speeds that capture the expected prepayment of principal above the contractual
amount.
At the end of 2004, the Corporation's balance sheet was liability sensitive to
interest rate movements for principal amounts maturing in one year. (Asset
sensitive means that assets will reprice faster than liabilities. In a rising
rate environment, an asset sensitive bank will generally benefit. Liability
sensitive means interest bearing deposits will reprice faster than assets. In a
rising rate environment a liability sensitive bank will generally not benefit.)
As indicated in Table 15, the Corporation's earning assets mature primarily in
2005, 2006 and 2007, while funding is dominantly short term, with $340 million
in savings and interest bearing checking accounts that have no stated maturity
and are considered to be floating rate funds. Historically, the Corporation has
relied on core deposit growth in these areas because funding costs for both
23
products are the lowest of the various interest bearing products offered by
financial institutions. Additionally, funding has become more short term as many
depositors moved out of traditional certificate of deposits into money market
and savings accounts. Balances in time deposits have decreased to $88.8 million
at December 31, 2004, a decline of $6.3 million (6.6%) from 2003. Likewise, time
deposits decreased $25 million or 21% during 2003 from December 31, 2002
balances. These decreases were the result of the continued low rate environment.
The effect of this deposit mix movement was partially offset by continued growth
in demand deposits and partially offset by an increase in floating rate loans.
However, the banking subsidiary's traditional vehicle for residential real
estate loans and commercial real estate loans held in its portfolio remains a
note with maturity of one, two, or three years.
Given the Corporation's funding acquisition and deployment strategy, management
reporting and board approved limits target a cumulative ratio of 1.0 for Rate
Sensitive Assets vs. Rate Sensitive Liabilities (RSA/RSL) at one year. The
banking subsidiary RSA/RSL is 0.97 at December 31, 2004 (where a cumulative
ratio of 1.0 is balanced and neither asset nor liability sensitive after one
year). The liability sensitive difference of 0.03 means that $11 million more
interest bearing liabilities will be rate adjusted than earning assets at that
point. The 12 month weighted liability gap is $75.6 million. The ratio and
analysis includes assumptions that closely follow the banking subsidiary's
techniques for managing risk; lagged interest rate adjustments, administered
rate products, rate adjustment of cash flow from amortization and prepayment of
loans through reinvestment, and the reinvestment of maturing assets and
liabilities.
Along with the static gap analysis, determining the sensitivity of short-term
future earnings to a hypothetical plus or minus 100 bp and 200 bp parallel rate
shock can be accomplished through the use of simulation modeling. In addition to
the assumptions used to create the static gap, simulation of earnings includes
the modeling of the balance sheet as an ongoing entity. The model projects net
interest income based on a hypothetical change in interest rates. The resulting
net interest income for the next 12-month period is compared to the net interest
income amount calculated using flat rates. This difference represents the
Corporation's earnings sensitivity to a plus or minus 100 and 200 bp parallel
rate shock.
These results are based solely on the modeled changes in market rates, and do
not reflect the earnings sensitivity that may arise from other factors such as
the shape of the yield curve and changes in spread between key market rates.
These actions also do not include any action management may take to mitigate
potential income variances. Actual results will differ from simulated results
due to the timing, magnitude and frequency of interest rate changes as well as
changes in market conditions and management strategies.
24
The following tables summarize interest rate sensitive assets and liabilities by
year of maturity as of December 31, 2004 and 2003:
TABLE 15
TRI CITY BANKSHARES CORPORATION
QUANTITATIVE DISCLOSURES OF MARKET RISK
(Dollars in Thousands)
Principal Amount Maturing in Fair Value
-------------------------------------------------------------------------------------
December 31, 2004 2005 2006 2007 2008 2009 Thereafter Total 12/31/03
-------- -------- -------- -------- -------- -------- -------- --------
Rate-sensitive assets:
Fixed interest rate loans $128,397 $105,875 $113,962 $ 23,666 $ 7,256 $ 9,532 $388,688 $386,192
Average interest rate 5.95% 5.83% 5.79% 5.76% 5.42% 5.16% 5.83%
Variable interest rate
loans $ 52,103 $ 12,573 $ 9,024 $ 2,170 $ 442 $ 6,245 $ 82,557 $ 82,027
Average interest rate 5.73% 5.53% 5.30% 5.29% 5.51% 5.19% 5.60%
Fixed interest rate
securities $ 36,141 $ 30,399 $ 23,770 $ 53,320 $ 15,822 $ 0 $159,452 $159,586
Average interest rate 3.52% 3.13% 3.39% 3.56% 4.08% 0.00% 3.50%
Rate-sensitive liabilities:
Savings and interest-bearing
Checking $340,021 $340,021 $340,021
Average interest rate 0.81% 0.81%
Time deposits $ 60,174 $ 11,818 $ 4,762 $ 5,046 $ 7,011 $ 0 $ 88,810 $ 88,867
Average interest rate 2.37% 2.78% 3.38% 3.20% 4.01% 0.00% 2.65%
Variable interest rate
Borrowings $ 12,234 $ 12,234 $ 12,234
Average interest rate 1.40% 1.40%
December 31, 2003
Principal Amount Maturing in Fair Value
-------------------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total 12/31/03
-------- -------- -------- -------- -------- -------- -------- --------
Rate-sensitive assets:
Fixed interest rate loans $109,018 $ 93,471 $107,613 $ 23,609 $ 13,362 $ 5,227 $352,300 $356,033
Average interest rate 6.19% 6.45% 5.88% 5.55% 5.45% 4.32% 6.07%
Variable interest rate
loans $ 30,879 $ 9,628 $ 9,895 $ 4,179 $ 1,701 $ 3,694 $ 59,976 $ 60,610
Average interest rate 4.34% 4.38% 4.37% 6.17% 4.81% 5.02% 4.53%
Fixed interest rate
securitie $ 31,772 $ 31,266 $ 60,134 $ 29,444 $ 17,756 $ 169 $170,541 $172,874
Average interest rate 3.90% 3.67% 2.78% 3.64% 2.83% 4.30% 3.31%
Rate-sensitive liabilities:
Savings and interest-bearing
Checking $312,078 $312,078 $312,078
Average interest rate 0.78% 0.78%
Time deposits $ 63,110 $ 18,739 $ 5,335 $ 2,817 $ 5,131 $ 0 $ 95,132 $ 96,211
Average interest rate 1.59% 4.15% 3.56% 3.71% 3.15% 0.00% 2.35%
Variable interest rate
Borrowings $ 10,548 $ 10,548 $ 10,548
Average interest rate 1.04% 1.04%
25
CAPITAL
The adequacy of the Corporation's capital is regularly reviewed to ensure that
sufficient capital is available for current and future needs and is in
compliance with regulatory guidelines. The assessment of overall capital
adequacy depends on a variety of factors, including asset quality, liquidity,
earnings stability, changing competitive forces, economic condition in markets
served, and strength of management.
TABLE 16
CAPITAL
(Dollars in Thousands)
Year ended December 31, 2004 2003 2002
- ----------------------- ---- ---- ----
Total stockholders' equity $ 92,549 $ 86,284 $ 79,838
Tier 1 capital 92,549 86,284 79,838
Total capital 98,190 91,573 84,957
Book value per common share $ 11.00 $ 10.49 $ 9.90
Cash dividends per common share 0.70 0.64 0.57
Dividend reinvestment price at end of period 19.40 19.20 16.30
Low reinvestment price for the period 19.40 17.00 14.92
High reinvestment price for the period 19.40 19.20 16.30
Total equity/assets 13.29% 13.18% 12.62%
Tier 1 leverage ratio 13.61 13.52 12.89
Tier 1 risk-based capital ratio 18.77 19.81 19.08
Total risk-based capital ratio 19.91 21.02 20.30
Shares outstanding (period end) 8,414 8,224 8,063
Basic shares outstanding (average) 8,337 8,158 7,992
Diluted shares outstanding (average) 8,337 8,158 7,992
Total stockholders' equity at December 31, 2004 increased $6.2 million to $92.5
million, or $11.00 per share compared with $10.49 per share at the end of 2003.
Stockholders' equity is also described in Note 15, "Stockholders' Equity," of
the notes to consolidated financial statements.
The increase in stockholders' equity for 2004 was primarily composed of the
retention of earnings, and stockholder participation in the Corporation's
dividend reinvestment program, with offsetting decreases to stockholders' equity
from the payment of cash dividends. Stockholders' equity to assets at December
31, 2004 was 13.29%, compared to 13.18% at the end of 2003.
Cash dividends paid in 2004 were $0.70 per share compared with $0.64 per share
in 2003, an increase of 9.38%. Cash dividends paid in 2003 of $0.64 per share
compared with $0.57 per share in 2002, an increase of 12.2%.
As of December 31, 2004 and 2003, the Corporation's Tier 1 leverage ratios were
13.61% and 13.52% respectively, Tier 1 risk-based capital ratios were 18.77% and
19.81% respectively, and total risk-based capital (Tier 1 and Tier 2) ratios
were 19.91% and 21.02%, respectively. All of the ratios are in excess of
regulatory minimum and well capitalized requirements. It is management's intent
to exceed of the minimum requisite capital levels. Capital ratios are included
in Note 16, "Regulatory Matters," of the notes to consolidated financial
statements.
26
Earnings continue to be stable and provide sufficient capital retention for
anticipated growth. Although the Corporation pays a significant portion of its
earnings to its shareholders in the form of dividends a large percentage of
those dividends are returned to the Corporation through shareholder
participation in the Corporation's dividend reinvestment program. The dividend
reinvestment price is determined by management with Board of Directors approval,
taking into consideration a number of the factors discussed above, and how they
compare to market value and the Corporation's peer group of banks.
Management believes that the Corporation has a strong capital position and is
positioned to take advantage of opportunities for profitable geographic and
product expansion, and to provide depositor and investor confidence. Management
actively reviews capital strategies for the Corporation and each of its
subsidiaries in light of perceived business risks, future growth opportunities,
industry standards, and regulatory requirements.
RESULTS OF OPERATIONS
2003 COMPARED TO 2002
Net income for the Corporation increased $1.9 million (27.2%) during 2003. This
change was primarily due to the negative effect of a one-time after tax charge
to net income of approximately $2.5 million in the first two quarters of 2002.
The charge was the result of a mediated lawsuit brought against the banking
subsidiary by Centrex Credit Corporation during the first Quarter of 2002. In
addition, during the second quarter of 2002, the banking subsidiary negotiated a
settlement of a lawsuit initiated against it by Creve Coeur Mortgage Associates,
Inc.
Interest income and fees on loans decreased $2.6 million (8.6%) in 2003. The
decrease was associated with the decline in balances in the loan portfolio
during the first half of 2003 and the continued downward pressure on rates on
the remainder of the portfolio. In an effort to compete in the marketplace
during this period of declining interest rates, management considered it
appropriate to meet competition on repricing the banking subsidiary's one-, two-
and three-year term loans in an effort to preserve as much of the portfolio as
possible. Interest income from the portfolio growth during the fourth quarter of
2003 was not sufficient to offset loss of interest income from portfolio
shrinkage experienced during the first half of the year.
Management's lending strategy continues to maximize the banking subsidiary's net
interest margin (NIM). The banking subsidiary's year to date net interest income
as a percentage of average earning assets was 5.01% for 2003. Although
compression of the margin continues, this net margin ranked in the upper
quartile of the banking subsidiary's peer group as reported in the most recent
Uniform Bank Performance Report prepared by the Federal Financial Institutions
Examination Council at the time. Investment securities interest income decreased
$775,900 (11.6%) during 2003. As a result of low interest rates, a high level of
early (called) maturing securities, and modest commercial loan demand,
management chose to expand the investment portfolio in an effort to bridge a
portion of the low interest cycle. During the third and fourth quarters of 2003,
management made a concerted effort to invest excess liquidity in securities that
provided liquidity as well as safety. During 2003 the average investment
portfolio balance of $158.2 million earned a tax equivalent yield of 4.67%
compared to 5.53% for 2002.
Non-interest income increased $481,300 (6.7%) in 2003. This increase is
attributed to residential mortgage financing and refinancing activity beginning
in the last two quarters of 2002 through the first two quarters of 2003. The
protracted period of strong demand provided the opportunity to market rates that
ultimately allowed for sale above par in the secondary market. The resulting
gain on sale of these residential mortgages increased $655,000 compared to this
same category of non-interest income during 2002. However, since a significant
part of the activity was refinancing, income derived from the capitalization of
the subsidiary's mortgage servicing rights actually declined $331,000 from the
record totals realized in 2002.
Interest expense on short-term borrowings decreased $51,500 (65.4%) in 2003. As
discussed earlier, the banking subsidiary was in a federal funds sold position
for nearly the entire year in 2003.
Interest expense on deposit accounts decreased $2.7 million (34.8%) in 2003.
Although deposit balances continued to increase, growth during 2003 was managed
at a modest level due to weak loan demand. The decrease in interest expense was
27
the result of the continued low rate environment and shift of time deposits to
more liquid and lower-yielding savings instruments.
Non-interest expenses decreased $3.3 million (12.5%) during 2003 primarily due
to the $4.25 million charges in 2002 associated with the settlements of
lawsuits.
Tri City Bankshares Corporation
Selected Financial Data
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
Total interest income $33,896,224 $33,456,289 $36,851,725 $38,917,085 $38,564,214
Total interest expense 4,892,165 5,083,972 7,839,428 12,608,919 13,640,563
Net interest income 29,004,059 28,372,317 29,012,297 26,308,166 24,923,651
Provision for loan losses 435,000 420,000 420,000 420,000 300,000
Net interest income after
provision for loan losses 28,569,059 27,952,317 28,592,297 25,888,166 24,623,651
Income before income
taxes 12,061,172 12,210,092 9,018,972 10,352,054 10,769,069
Provision for income tax 3,673,000 3,493,000 2,164,000 2,730,000 2,889,000
Net income 8,388,172 8,717,092 6,854,972 7,622,054 7,880,069
Basic earnings per share 1.01 1.07 .86 .97 1.03
Cash dividends declared
per share .70 .64 .57 .51 .47
Average daily balances:
(amounts in thousands)
Total assets $ 664,548 $ 620,287 $ 600,114 $ 569,906 $ 546,183
Total net loans 439,475 391,959 389,362 366,316 339,243
Held to maturity
investment securities 161,971 158,567 148,579 121,311 136,523
Total deposits 560,084 531,735 515,339 476,164 440,620
Total stockholders' equity 88,344 82,523 75,963 71,077 65,427
28
Tri City Bankshares Corporation
Market for Corporation's Common Stock
And Related Stockholder Matters
The Corporation's stock is traded on the over-the-counter market under the
trading symbol "TRCY." Trading in the Corporation's stock is limited and
sporadic and the Corporation believes that no established trading market for the
Corporation's stock exists. For purposes of the Corporation's Automatic Dividend
Reinvestment Plan, the Board of Directors is required to establish the "Fair
Market Value" of the Corporation's stock on a quarterly basis based on factors
set forth in the Dividend Reinvestment Plan. The following sets forth the Fair
Market Value established under the Dividend Reinvestment Plan over the past two
years:
Price range: 2004 2003
---- ----
First quarter $ 19.40 $ 17.00
Second quarter 19.40 17.50
Third quarter 19.40 19.20
Fourth quarter 19.40 19.20
As of December 31, 2004, the number of holders of record of the Corporation's
common stock was 738.
The Corporation declared four quarterly cash dividends in 2004 in the amount of
$0.175 per share. These dividends were declared on January 7, April 14, July 14
and October 13, payable on January 21, April 23, July 23 and October 22,
respectively. Quarterly dividends of $0.160 per share were paid each of the four
quarters of 2003.
The Corporation is not party to any loan agreement, indenture or other agreement
which restricts its ability to pay dividends; however, the Wisconsin Business
Corporation Law authorizes directors to declare and pay cash dividends only out
of the Corporation's unreserved and unrestricted earned surplus. See Note 15 of
Notes to Consolidated Financial Statements for restrictions imposed by
regulatory agencies upon the subsidiary bank's ability to transfer funds to the
parent corporation.
29
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Tri City Bankshares Corporation
We have audited the accompanying consolidated balance sheets of Tri City
Bankshares Corporation (the "Corporation") as of December 31, 2004 and 2003, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the two years in the period ended December 31, 2004. 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 audits. The consolidated financial statements
of Tri City Bankshares Corporation for the year ended December 31, 2002 were
audited by other auditors whose report dated February 7, 2003, except for the
first paragraph of Note 15 as to which date is February 28, 2003, expressed an
unqualified opinion on those statements.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States of America). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated 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 consolidated financial position of Tri
City Bankshares Corporation as of December 31, 2004 and 2003, and the
consolidated results of its operations and its cash flows for each of the two
years in the period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.
s/ VIRCHOW, KRAUSE & COMPANY, LLP
Milwaukee, Wisconsin
February 9, 2005
30
Report of Independent Registered Public Accounting Firm
Board of Directors
Tri City Bankshares Corporation
We have audited the accompanying consolidated statements of income,
stockholders' equity and cash flows for the year ended December 31, 2002. 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 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 estimated 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 consolidated results of operations and
cash flows of Tri City Bankshares Corporation for the year ended December 31,
2002, in conformity with U.S. generally accepted accounting principles.
/s/Ernst & Young LLP
Milwaukee, Wisconsin
February 7, 2003 except for
Note 15 as to which date
is February 28, 2003
31
TRI CITY BANKSHARES CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
- --------------------------------------------------------------------------------
ASSETS
2004 2003
-------------- -------------
Cash and due from banks $ 35,425,012 $ 40,849,479
Held to maturity securities, fair value of $159,585,976 and
$172,873,927 as of 2004 and 2003, respectively 159,451,575 170,541,123
Loans, less allowance for loan losses of $5,641,593 and
$5,289,467 as of 2004 and 2003, respectively 465,603,614 406,985,461
Premises and equipment, net 20,541,600 21,892,460
Cash surrender value of life insurance 10,361,935 10,000,000
Mortgage servicing rights 957,565 998,514
Accrued interest receivable and other assets 4,276,731 3,516,178
-------------- -------------
TOTAL ASSETS $ 696,618,032 $ 654,783,215
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Demand $ 161,574,101 $ 148,813,893
Savings and NOW 340,020,788 312,078,384
Other time 88,810,037 95,131,632
-------------- -------------
Total Deposits 590,404,926 556,023,909
Federal funds purchased and securities sold under
repurchase agreements 9,485,945 9,013,622
Other borrowings 2,748,441 1,534,292
Accrued interest payable and other liabilities 1,430,182 1,927,548
-------------- -------------
Total Liabilities 604,069,494 568,499,371
-------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Cumulative preferred stock, $1 par value, 200,000 shares
authorized, no shares issued -- --
Common stock, $1 par value,
15,000,000 shares authorized, 8,413,621 and
8,223,557 shares issued and outstanding as of 2004 and 2003,
respectively 8,413,621 8,223,557
Additional paid-in capital 17,507,720 14,010,617
Retained earnings 66,627,197 64,049,670
-------------- -------------
Total Stockholders' Equity 92,548,538 86,283,844
-------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 696,618,032 $ 654,783,215
============== =============
See accompanying notes to consolidated financial statements
32
TRI CITY BANKSHARES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
2004 2003 2002
------------ ------------ ------------
INTEREST INCOME
Interest and fees on loans $ 28,379,143 $ 27,363,387 $ 29,922,942
Interest on investment securities
Taxable 3,239,110 2,876,095 3,575,161
Tax exempt 2,236,084 3,012,969 3,089,815
Interest on federal funds sold 22,561 184,512 244,481
Other 19,326 19,326 19,326
------------ ------------ ------------
Total Interest Income 33,896,224 33,456,289 36,851,725
------------ ------------ ------------
INTEREST EXPENSE
Interest on deposits 4,708,419 5,056,656 7,760,564
Interest on federal funds purchased and securities sold under
repurchase agreements 171,605 6,597 37,799
Interest on other borrowings 12,141 20,719 41,065
------------ ------------ ------------
Total Interest Expense 4,892,165 5,083,972 7,839,428
------------ ------------ ------------
Net interest income before provision for loan losses 29,004,059 28,372,317 29,012,297
Provision for loan losses 435,000 420,000 420,000
------------ ------------ ------------
Net interest income after provision for loan losses 28,569,059 27,952,317 28,592,297
------------ ------------ ------------
NONINTEREST INCOME
Service charges and fees 5,243,924 5,376,370 5,181,123
Loan related fees and mortgage banking revenue 126,954 1,445,029 1,120,822
Increase in cash surrender value of life insurance 361,935 -- --
Other income 716,832 879,488 917,650
------------ ------------ ------------
Total Noninterest Income 6,449,645 7,700,887 7,219,595
------------ ------------ ------------
NONINTEREST EXPENSES
Salaries and employee benefits 13,224,810 13,665,275 13,069,429
Net occupancy costs 2,135,640 2,074,453 1,874,442
Furniture and equipment expenses 1,682,825 1,816,971 1,904,588
Computer services 1,744,428 1,590,322 1,352,830
Advertising and promotional 634,139 670,583 615,641
Regulatory agency assessments 233,092 227,578 224,766
Office supplies 493,393 579,161 574,078
Litigation settlements -- -- 4,250,000
Other expenses 2,809,205 2,818,769 2,927,146
------------ ------------ ------------
Total Noninterest Expenses 22,957,532 23,443,112 26,792,920
------------ ------------ ------------
Income before income taxes 12,061,172 12,210,092 9,018,972
Less: Applicable income taxes 3,673,000 3,493,000 2,164,000
------------ ------------ ------------
NET INCOME $ 8,388,172 $ 8,717,092 $ 6,854,972
============ ============ ============
Basic earnings per share $ 1.01 $ 1.07 $ 0.86
============ ============ ============
Weighted average shares outstanding 8,336,889 8,157,628 7,991,745
============ ============ ============
See accompanying notes to consolidated financial statements
33
TRI CITY BANKSHARES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Additional Retained
Common Stock Paid-In Capital Earnings Total
-----------------------------------------------------------
BALANCES - December 31, 2001 $ 7,889,502 $ 8,736,812 $ 58,239,135 $ 74,865,449
Net income -- -- 6,854,972 6,854,972
Cash dividends - $0.57 per share -- -- (4,561,720) (4,561,720)
Common stock issued under dividend reinvestment plan
- 173,085 shares 173,085 2,507,001 -- 2,680,086
Common stock fractional shares redeemed (51) (470) -- (521)
------------ ------------ ------------ -------------
BALANCES - December 31, 2002 8,062,536 11,243,343 60,532,387 79,838,266
Net income -- -- 8,717,092 8,717,092
Cash dividends - $0.64 per share -- -- (5,199,809) (5,199,809)
Common stock issued under dividend reinvestment plan
- 161,042 shares 161,042 2,767,634 -- 2,928,676
Common stock fractional shares redeemed (21) (360) -- (381)
------------ ------------ ------------ ------------
BALANCES - December 31, 2003 8,223,557 14,010,617 64,049,670 86,283,844
Net income -- -- 8,388,172 8,388,172
Cash dividends - $0.70 per share -- -- (5,810,645) (5,810,645)
Common stock issued under dividend reinvestment plan
- 172,076 shares 172,076 3,166,173 -- 3,338,249
Common stock issued under Employee
Stock plan - 18,000 shares 18,000 331,200 -- 349,200
Common stock fractional shares redeemed (12) (270) -- (282)
------------ ------------ ------------ ------------
BALANCES - December 31, 2004 $ 8,413,621 $ 17,507,720 $ 66,627,197 $ 92,548,538
============ ============ ============ ============
See accompanying notes to consolidated financial statements
34
TRI CITY BANKSHARES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
2004 2003 2002
--------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 8,388,172 $ 8,717,092 $ 6,854,972
Adjustments to reconcile net income to
net cash flows provided by operating
activities
Depreciation 2,140,330 2,125,009 2,057,661
Amortization of premiums and
accretion of discounts on
investment securities- net 5,561 (116,395) (119,494)
Gain on sale of loans (499,121) (2,131,615) (1,400,663)
Provision for loan losses 435,000 420,000 420,000
Provision (benefit) for deferred income taxes (368,000) (146,000) 371,000
Proceeds from sales of loans held for sale 42,084,600 116,220,685 100,494,561
Originations of loans held for sale (41,585,479) (114,089,070) (99,093,898)
Increase in cash surrender value of life insurance (361,935) -- --
Net change in
Accrued interest receivable and other assets (694,604) 538,099 (186,887)
Accrued interest payable and other liabilities (154,366) (241,664) (365,206)
------------ ------------ ------------
Net Cash Flows Provided by Operating Activities 9,390,158 11,296,141 9,032,046
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in held to maturity securities
Maturities, prepayments and calls 111,534,275 83,209,270 85,298,684
Purchases (100,450,288) (91,011,783) (104,047,576)
Net increase in loans (59,053,153) (14,740,467) (25,074,182)
Purchase of life insurance -- (10,000,000) --
Purchases of premises and equipment - net (789,470) (1,828,671) (1,490,723)
------------ ------------ -------------
Net Cash Flows Used in Investing Activities (48,758,636) (34,371,651) (45,313,797)
------------ ------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 34,381,017 12,839,659 21,914,941
Net change in federal funds purchased
and securities sold under repurchase
agreements 472,323 7,513,622 (1,750,000)
Net change in other borrowings 1,214,149 (4,465,708) 4,570,744
Dividends paid (5,810,645) (5,199,809) (4,561,720)
Common stock issued - net 3,687,167 2,928,295 2,679,565
------------ ------------ ------------
Net Cash Flows Provided by Financing Activities 33,944,011 13,616,059 22,853,530
------------ ------------ ------------
Net Change in Cash and Cash Equivalents (5,424,467) (9,459,451) (13,428,221)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 40,849,479 50,308,930 63,737,151
------------ ------------ ------------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 35,425,012 $ 40,849,479 $ 50,308,930
============ ============ ============
SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid for interest $ 4,894,222 $ 5,342,182 $ 8,226,238
Cash paid for income taxes 3,690,000 3,360,000 1,434,000
See accompanying notes to consolidated financial statements
35
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - Summary of Significant Accounting Policies
- --------------------------------------------------------------------------------
Consolidation
The consolidated financial statements of Tri City Bankshares Corporation (the
"Corporation") include the accounts of its wholly owned subsidiary, Tri City
National Bank (the "Bank"). Tri City National Bank includes the accounts of its
wholly owned subsidiaries, Tri City Capital Corporation, a Nevada investment
subsidiary, and Title Service of Southeast Wisconsin, Inc., a title company
subsidiary. The consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America and conform to general practices within the banking industry. All
significant intercompany accounts and transactions have been eliminated in the
consolidated financial statements.
Nature of Banking Activities
The consolidated income of the Corporation is principally from the income of its
wholly owned subsidiary. The Bank grants commercial, residential and consumer
loans and accepts deposits primarily in the metropolitan Milwaukee, Wisconsin
area. The Corporation and the Bank are subject to competition from other
financial institutions and nonfinancial institutions providing financial
products. Additionally, the Corporation and the Bank are subject to the
regulations of certain regulatory agencies and undergo periodic examination by
those regulatory agencies.
Use of Estimates
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination
of the allowance for loan losses, the valuation allowance for deferred income
tax assets and mortgage servicing rights.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash and
balances due from banks and federal funds sold, all of which mature within
ninety days. The Bank maintains amounts due from banks which, at times, may
exceed federally insured limits. The Bank has not experienced any losses in such
accounts.
Held to Maturity Securities
Securities classified as held to maturity are those securities the Bank has both
the intent and ability to hold to maturity regardless of changes in market
conditions, liquidity needs or changes in general economic conditions. Interest
and dividends are included in interest income from the related securities as
earned. These securities are carried at cost, adjusted for amortization of
premium and accretion of discount, computed by the effective interest method
over their contractual lives. The sale of a security within three months of its
maturity date or after collection of at least 85 percent of the principal
outstanding at the time the security was acquired is considered a maturity for
purposes of classification and disclosure. Realized gains and losses are
computed on a specific identification basis and declines in value determined to
be other than temporary are included in gains (losses) on sale of securities.
36
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - Summary of Significant Accounting Policies (cont.)
- --------------------------------------------------------------------------------
Loans
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or payoff are reported at the amount of unpaid
principal, reduced by an allowance for loan losses and any deferred fees or
costs in originating loans. Interest income is accrued and credited to income on
a daily basis based on the unpaid principal balance. Loan origination fees, net
of certain direct loan origination costs, are deferred and recognized as an
adjustment of the loan yield using an effective interest method. The accrual of
interest income on impaired loans is discontinued when, in the opinion of
management, there is reasonable doubt as to the borrower's ability to meet
payment of interest or principal when they become due. Management may elect to
continue the accrual of interest when the estimated fair value of collateral is
sufficient to cover the principal balance and accrued interest. When interest
accrual is discontinued, all unpaid accrued interest is reversed. Cash
collections on impaired loans are credited to the loan receivable balance and no
interest income is recognized on those loans until the principal balance is
current. Loans are returned to accrual status when the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated market value in the aggregate. Net unrealized
losses are recognized through a valuation allowance by charges to income. All
sales are made without recourse. The Bank also services loans that have been
sold with servicing retained by the Bank. Such loans are not included in the
accompanying consolidated balance sheets. There were no loans held for sale at
December 31, 2004 or 2003.
Allowance for Loan Losses
The allowance for loan losses is composed of specific and general valuation
allowances. The Bank establishes specific valuation allowances on loans
considered impaired. A loan is considered impaired (and a specific valuation
allowance established for an amount equal to the impairment) when the carrying
amount of the loan exceeds the present value of the expected future cash flows,
discounted at the loan's original effective interest rate, or the fair value of
the underlying collateral. General valuation allowances are based on an
evaluation of the various risk components that are inherent in the credit
portfolio. The risk components that are evaluated include past loan loss
experience; the level of nonperforming and classified assets; current economic
conditions; volume, growth and composition of the loan portfolio; adverse
situations that may affect the borrower's ability to repay; the estimated value
of any underlying collateral; peer group comparisons; regulatory guidance; and
other relevant factors.
The allowance is increased by provisions charged to earnings and reduced by
charge-offs, net of recoveries. Management may transfer reserves between
specific and general valuation allowances as considered necessary. The adequacy
of the allowance for loan losses is reviewed and approved by the Bank's Board of
Directors. The allowance reflects management's best estimate of the probable and
estimable losses on loans, and is based on a risk model developed and
implemented by management and approved by the Bank's Board of Directors.
In addition, various regulatory agencies periodically review the allowance for
loan losses. These agencies may require additions to the allowance for loan
losses based on their judgments of collectibility based on information available
to them at the time of their examination.
37
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - Summary of Significant Accounting Policies (cont.)
- --------------------------------------------------------------------------------
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Corporation, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Corporation does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
Mortgage Servicing Rights
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through the sale of financial assets. Capitalized mortgage
servicing rights are amortized into noninterest income in proportion to, and
over the period of, the estimated future net servicing income of the underlying
financial assets. Servicing assets are evaluated for impairment based upon the
fair value of the rights as compared to amortized cost. Impairment is determined
by stratifying rights by predominant characteristics, such as interest rates and
terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based on discounted cash flows using market
based assumptions such as prepayment speeds, interest rates, and other factors
which are subject to change over time. Impairment is recognized through a
valuation allowance to the extent that fair value is less than the capitalized
amount.
Premises and Equipment
Depreciable assets are stated at cost less accumulated depreciation. Provisions
for depreciation are computed on straight-line methods over the estimated useful
lives of the assets, which range from 3 to 10 years for furniture and equipment
and 15 to 40 years for buildings and leasehold improvements. Repairs and
maintenance costs are expensed as incurred.
Employee Benefit Plan
The Bank has established a defined contribution 401(k) profit-sharing plan for
qualified employees. The Bank's policy is to fund contributions as accrued.
Other Real Estate Owned
Other real estate owned, acquired through partial or total satisfaction of loans
is carried at the lower of cost or fair value less cost to sell. At the date of
acquisition, losses are charged to the allowance for loan losses. Revenue and
expenses from operations and changes in the valuation allowance are included in
other expenses.
Off-Balance Sheet Financial Instruments
In the ordinary course of business the Bank has entered into off-balance-sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit and standby letters of credit. Such financial instruments are
recorded in the financial statements when they are funded or related fees are
incurred or received.
38
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - Summary of Significant Accounting Policies (cont.)
- --------------------------------------------------------------------------------
Derivative Financial Instruments
The Corporation utilizes derivative financial instruments to meet the ongoing
credit needs of its customers and in order to manage the market exposure of its
residential loans held for sale and its commitments to extend credit for
residential loans. Derivative financial instruments include commitments to
extend credit. The Corporation does not use interest rate contracts (e.g. swaps,
caps, floors) or other derivatives to manage interest rate risk and has none of
these instruments outstanding.
Advertising Costs
All advertising costs incurred by the Corporation are expensed in the period in
which they are incurred.
Income Taxes
The Corporation files a consolidated federal income tax return and individual
state income tax returns. Income tax expense is recorded based on the liability
method. Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes. The differences relate principally to the allowance
for loan losses, mortgage servicing rights, deferred loan fees, and premises and
equipment. Valuation allowances are established when necessary to reduce
deferred income tax assets to the amount expected to be realized.
Earnings Per Share
Basic earnings per share are computed based upon the weighted average number of
common shares outstanding during each year. The Corporation had no potentially
dilutive securities outstanding during each of the three years in the period
ended December 31, 2004.
Interim Financial Data
The interim financial data (see Note 21) is unaudited; however, in management's
opinion, the interim data includes all adjustments, consisting only of normal,
recurring adjustments necessary for a fair presentation of results for the
interim periods.
Segment Reporting
The Corporation has determined that it has one reportable segment - community
banking. The Corporation offers a range of financial products and services to
external customers, including: accepting deposits, originating residential,
consumer and commercial loans and, to a much lesser extent, leasing space in
branch facilities to third parties. Revenues for each of these products and
services are disclosed in the consolidated statements of income.
39
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - Summary of Significant Accounting Policies (cont.)
- --------------------------------------------------------------------------------
Fair Value of Financial Instruments
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Value of Financial Instruments", requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, 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,
could not be realized in immediate settlement of the instrument. SFAS No. 107
excludes certain financial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Corporation.
The following methods and assumptions were used by the Corporation in estimating
the fair value of its financial instruments:
CARRYING AMOUNTS APPROXIMATE FAIR VALUES FOR THE FOLLOWING INSTRUMENTS
Cash and due from banks Non marketable equity securities
Mortgage servicing rights - using current market assumptions
for prepayments, servicing cost and other factors
Accrued interest receivable
Variable rate loans that reprice frequently where no
significant change in credit risk has occurred
Cash surrender value of life insurance Demand deposits
Variable rate money market accounts Variable rate certificates
of deposit Accrued interest payable
Federal funds purchased and securities sold under repurchase agreements
Short term borrowings
QUOTED MARKET PRICES
Where available, or if not available, based on quoted market prices of
comparable instruments for the following instrument:
Held to maturity securities
DISCOUNTED CASH FLOWS
Using interest rates currently being offered on instruments with similar
terms and with similar credit quality:
All loans except variable rate loans described above
Fixed rate certificates of deposit
QUOTED FEES CURRENTLY BEING CHARGED FOR SIMILAR INSTRUMENTS
Taking into account the remaining terms of the agreements and the
counterparties' credit standing:
Off-balance-sheet instruments
-----------------------------
Letters of credit
Lending commitments
Since the majority of the Corporation's off-balance-sheet instruments consist of
nonfee-producing, variable rate commitments, the Corporation had determined
these do not have a distinguishable fair value.
40
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - Summary of Significant Accounting Policies (cont.)
- --------------------------------------------------------------------------------
Recent Accounting Pronouncement
On December 15, 2004, the Financial Accounting Standards Board ("FASB") issued
Statement No. 123R, "Share-Based Payment" ("SFAS 123R"), which requires
compensation costs related to share-based payment transactions to be recognized
in the financial statements. With limited exceptions, the amount of the
compensation cost will be measured based on the grant-date fair value of the
equity or liability instruments issued. In addition, liability awards will be
re-measured each reporting period. Compensation cost will be recognized over the
period that an employee provides service in exchange for the award. SFAS 123R
replaces FASB Statement no. 123, "Accounting for Stock Issued to Employees" SFAS
123R is effective for all interim or annual periods beginning after June 15,
2005. Early adoption is encouraged and retroactive application of the provisions
of SFAS 123R to the beginning of the fiscal year that includes the effective
date is permitted, but not required. The Corporation has not adopted this
pronouncement and is currently evaluating the impact that the adoption of SFAS
123R will have on its consolidated financial statements.
Reclassifications
Certain 2003 and 2002 amounts have been reclassified to conform with the 2004
presentation. The reclassifications have no effect on previously reported net
income, basic earnings per share, and stockholders' equity.
- --------------------------------------------------------------------------------
NOTE 2 - Cash and Due From Banks
- --------------------------------------------------------------------------------
The Bank is required to maintain vault cash and reserve balances with Federal
Reserve Banks based upon a percentage of deposits. These requirements
approximated $9,092,000 and $7,815,000 at December 31, 2004 and 2003,
respectively.
41
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 3 - Held to Maturity Securities
- --------------------------------------------------------------------------------
Amortized costs and fair values of held to maturity securities as of December
31, 2004 and 2003 are summarized as follows:
2004
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
------------ ------------ ------------ ------------
Obligations of other U.S.
government agencies and corporations $ 90,319,686 $ 254,084 $ 559,029 $ 90,014,741
Obligations of states and political
subdivisions 69,131,889 584,454 145,108 69,571,235
------------ ------------ ------------ ------------
Totals $159,451,575 $ 838,538 $ 704,137 $159,585,976
============ ============ ============ ============
2003
-----------------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
------------ ------------ ------------ ------------
Obligations of other U.S.
government agencies and corporations $ 85,090,838 $ 854,144 $ 93,213 $ 85,851,769
Obligations of states and political
subdivisions 85,450,285 1,679,984 108,111 87,022,158
------------ ------------ ------------ ------------
Totals $170,541,123 $ 2,534,128 $ 201,324 $172,873,927
============ ============ ============ ============
42
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 3 - Held to Maturity Securities (cont.)
- --------------------------------------------------------------------------------
The following table presents the portion of the Bank's held to maturity
securities portfolio which has gross unrealized losses, reflecting the length of
time that individual securities have been in a continuous unrealized loss
position at December 31, 2004.
Continuous unrealized Continuous unrealized
losses existing for less than losses existing for greater
12 Months than 12 months Total
---------------------------------------------------------------------------------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
------------- ------------- ------------- ------------ ------------- -------------
Obligations of other U.S.
government agencies
and corporations $ 42,493,137 $ 487,482 $ 7,198,125 $ 71,547 $ 50,411,262 $ 559,029
Obligations of states and
political subdivisions 14,107,594 42,094 7,932,034 103,014 22,039,627 145,108
------------- ------------- ------------- ------------ ------------- -------------
Totals $ 56,600,731 $ 529,576 $ 15,130,159 $ 174,561 $ 72,450,889 $ 704,137
============= ============= ============= ============ ============= =============
Management does not believe any individual unrealized loss as of December 31,
2004 represents other than temporary impairment. The Bank held fourteen
investment securities at December 31, 2004 that had unrealized losses existing
for greater than 12 months. The securities consisted of twelve municipal
securities and two mortgage-backed securities. Management believes the temporary
impairment in fair value was caused by market fluctuations. Since securities are
held to maturity, management does not believe that the Bank will experience any
losses on these investments.
The amortized cost and fair value of held to maturity securities at December 31,
2004, by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers or issuers may have the right to
call or prepay obligations with or without call or prepayment penalties.
2004
-------------------------------
Amortized Cost Fair Value
-------------- --------------
Due in one year or less $ 36,214,710 $ 36,350,484
Due after one year through 5 years 123,236,865 123,235,491
-------------- --------------
Totals $ 159,451,575 $ 159,585,975
============== ==============
Held to maturity securities with an amortized cost of $34,558,073 and
$37,594,588 at December 31, 2004 and 2003, respectively, were pledged as
collateral on public deposits and for other purposes as required or permitted by
law.
43
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 4 - Loans
- --------------------------------------------------------------------------------
Major classification of loans are as follows at December 31:
2004 2003
---------------- ----------------
Commercial $ 27,403,425 $ 27,657,550
Real estate
Construction 44,501,970 38,609,564
Commercial 184,315,630 158,541,079
Residential 189,785,916 160,933,661
Installment and consumer 25,238,266 26,533,074
---------------- ----------------
471,245,207 412,274,928
Less: Allowance for loan losses (5,641,593) (5,289,467)
---------------- ----------------
Net Loans $ 465,603,614 $ 406,985,461
================ ================
Nonaccrual loans totaled approximately $275,000 and $181,000 at December 31,
2004 and 2003, respectively. Loans, greater than 90 days past due and accruing
interest, totaled approximately $1,688,000 and $1,280,000 at December 31, 2004
and 2003, respectively.
Certain directors and executive officers of the Corporation, and their related
interests, had loans outstanding in the aggregate amounts of $7,692,830 and
$7,181,503 at December 31, 2004 and 2003, respectively. During 2004 and 2003,
$1,886,142 and $6,336,395 of new loans were made and repayments totaled
$1,374,822 and $1,667,207, respectively. These loans were made on substantially
the same terms, including interest rates and collateral, as those prevailing at
the same time for comparable transactions with other persons and did not involve
more than normal risks of collectibility or present other unfavorable features.
- --------------------------------------------------------------------------------
NOTE 5 - Allowance for Loan Losses
- --------------------------------------------------------------------------------
The allowance for loan losses reflected in the accompanying consolidated
financial statements represents the allowance available to absorb probable loan
losses inherent in the portfolio. An analysis of changes in the allowance is
presented in the following tabulation as of December 31:
2004 2003 2002
----------- ----------- -----------
Balance at Beginning of Year $ 5,289,467 $ 5,118,705 $ 4,827,300
Charge-offs (223,269) (338,382) (228,663)
Recoveries 140,395 89,144 100,068
Provision charged to operations 435,000 420,000 420,000
----------- ----------- -----------
Balance at End of Year $ 5,641,593 $ 5,289,467 $ 5,118,705
=========== =========== ===========
- --------------------------------------------------------------------------------
NOTE 6 - Mortgage Servicing Rights
- --------------------------------------------------------------------------------
The unpaid principal balance of mortgage loans serviced for others, which are
not included in the accompanying consolidated balance sheets, was $189,519,101,
$187,390,773 and $155,717,847 at December 31, 2004, 2003 and 2002, respectively.
For these sold loans, the Bank has recorded originated capitalized mortgage
servicing rights, as shown below.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were $875,703, $837,877and
$1,450,553 at December 31, 2004, 2003 and 2002, respectively.
44
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 6 - Mortgage Servicing Rights (cont.)
- --------------------------------------------------------------------------------
The following is an analysis of the mortgage servicing rights activity for the
years ended December 31:
Unamortized cost of mortgage
servicing rights 2004 2003 2002
---------- ---------- ----------
Balance at beginning of year $ 998,514 $ 789,903 $ 250,000
Additions of mortgage servicing rights 331,218 895,197 819,744
Amortization (372,167) (686,586) (279,841)
---------- ---------- ----------
Balance at End of Year $ 957,565 $ 998,514 $ 789,903
========== ========== ==========
A valuation allowance for the impairment of mortgage servicing rights was not
necessary at December 31, 2004, 2003 or 2002.
The projections of amortization expense shown below for mortgage servicing
rights are based on existing asset balances and the existing interest rate
environment at December 31, 2004. Future amortization may be significantly
different depending upon changes in the mortgage servicing portfolio, mortgage
interest rates and market conditions.
Estimated future amortization by year is as follows:
2005 $ 155,358
2006 155,358
2007 155,358
2008 155,357
2009 155,357
Thereafter 180,777
----------
$ 957,565
==========
- --------------------------------------------------------------------------------
NOTE 7 - Premises and Equipment
- --------------------------------------------------------------------------------
Premises and equipment are stated at cost less accumulated depreciation at
December 31 and are summarized as follows:
2004 2003
------------ ------------
Land $ 5,501,217 $ 5,496,069
Buildings and leasehold improvements 25,394,527 25,028,836
Furniture and equipment 10,855,369 10,533,867
------------ ------------
Total - at cost 41,751,113 41,058,772
Less: Accumulated depreciation (21,209,513) (19,166,312)
------------ ------------
Net Premises and Equipment $ 20,541,600 $ 21,892,460
============ ============
Depreciation expense amounted to $2,140,330, $2,125,009, and $2,057,661 in 2004,
2003 and 2002, respectively.
45
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 8 - Deposits
- --------------------------------------------------------------------------------
The aggregate amount of time deposits, each with a minimum denomination of
$100,000, was $31,489,000 and $30,793,000 at December 31, 2004 and 2003,
respectively.
Scheduled maturities of time deposits was as follows:
2004
-----------
Due within one year $60,174,038
After one year but within two years 11,817,789
After two years but within three years 4,761,625
After three years but within four years 5,045,905
After four years but within five years 7,010,680
-----------
Totals $88,810,037
===========
Interest expense on deposits was as follows:
2004 2003 2002
---------- ---------- ----------
Interest-bearing checking accounts $1,409,405 $1,087,130 $1,076,785
Money market accounts 366,668 351,284 699,042
Savings accounts 766,295 779,834 1,226,144
Time deposit accounts 2,166,051 2,838,408 4,758,593
---------- ---------- ----------
Totals $4,708,419 $5,056,656 $7,760,564
========== ========== ==========
- --------------------------------------------------------------------------------
NOTE 9 - Federal Funds Purchased and Securities Sold Under Repurchase Agreements
- --------------------------------------------------------------------------------
The Bank has the ability to borrow (purchase) federal funds of up to $38,000,000
under a revolving line-of-credit agreement with lenders. Such borrowings bear
interest at the lender bank's announced daily federal funds rate and mature
daily. There were $9,485,945 and $9,013,622 federal funds purchased outstanding
at December 31, 2004 and 2003, respectively.
The Bank may also borrow through securities sold under repurchase agreements
(reverse repurchase agreements). Reverse repurchase agreements, which are
classified as secured borrowings, generally mature within one to four days from
the transaction date. They are reflected at the amount of cash received in
connection with the transaction. The Bank had no reverse repurchase agreements
at December 31, 2004 and 2003, respectively. The Bank pledged U.S. government
agencies and municipal obligations whose carrying values were $27,561,184 and
$28,558,326 at December 31, 2004 and 2003, respectively, as collateral. The Bank
may be required to provide additional collateral based on the fair value of the
underlying securities.
In addition, at December 31, 2004, the Bank could also borrow up to $57,062,188
under existing reverse repurchase agreements with another bank. There were no
reverse repurchase agreements outstanding at December 31, 2004 or 2003 under
this agreement.
- --------------------------------------------------------------------------------
NOTE 10 - Other Borrowings
- --------------------------------------------------------------------------------
Other borrowings consist of treasury, tax and loan accounts due to the Federal
Reserve Bank under a $6,000,000 line of credit. Treasury, tax and loan account
balances were $2,748,441 and $1,534,292 at December 31, 2004 and 2003,
respectively. Such accounts generally are repaid within one to 120 days from the
transaction date and are collateralized by a pledge of investment securities
with a carrying value of $6,996,889 and $9,036,262 at December 31, 2004 and
2003, respectively.
46
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 11 - Income Taxes
- --------------------------------------------------------------------------------
The provision for income taxes included in the accompanying consolidated
financial statements consists of the following components for the year ending
December 31:
2004 2003 2002
Current Taxes ----------- ----------- -----------
Federal $ 3,253,000 $ 3,048,000 $ 1,646,000
State 788,000 591,000 147,000
----------- ----------- -----------
Total Current Provision 4,041,000 3,639,000 1,793,000
----------- ----------- -----------
Deferred Income Taxes (Benefit)
Federal (268,000) (108,000) 319,000
State (100,000) (38,000) 52,000
----------- ----------- -----------
Total Deferred Provision (368,000) (146,000) 371,000
----------- ----------- -----------
Total Provision for Income Taxes $ 3,673,000 $ 3,493,000 $ 2,164,000
=========== =========== ===========
The net deferred income tax assets in the accompanying consolidated balance
sheets include the following amounts of deferred income tax assets and
liabilities at December 31:
2004 2003
----------- -----------
Deferred Income Tax Assets
Allowance for loan losses $ 2,220,000 $ 2,081,000
Excess servicing gains 7,000 10,000
Reserve for health plan 195,000 249,000
Other 52,000 25,000
Deferred Income Tax Liabilities
Depreciation (384,000) (715,000)
Safe harbor lease (55,000) (95,000)
Deferred loan fees (375,000) (281,000)
Mortgage servicing rights (377,000) (393,000)
Valuation allowance (84,000) (50,000)
----------- -----------
Net Deferred Income Tax Assets $ 1,199,000 $ 831,000
=========== ===========
47
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 11 - Income Taxes (cont.)
- --------------------------------------------------------------------------------
A reconciliation of statutory federal income taxes based upon income before
taxes to the provision for federal and state income taxes is as follows:
2004 2003 2002
------------------------------------------------------------------------------
% of Pretax % of Pretax % of Pretax
Amount Income Amount Income Amount Income
------------------------------------------------------------------------------
Reconciliation of statutory to
effective rates
Federal income taxes at
statutory rate $ 4,100,798 34.00% $ 4,151,431 34.00% $ 3,066,450 34.00%
Adjustments for
Tax exempt interest on
municipal obligations (726,229) (6.02) (1,021,279) (8.36) (1,050,537) (11.65)
Increase in taxes
resulting from state
income taxes, net of
federal tax benefit 454,080 3.76 352,440 2.89 131,340 1.46
Increase in cash
surrender value of
life insurance (123,058) (1.02) -- -- -- --
Other - net (32,591) (0.27) 10,408 0.09 16,747 0.18
----------- ----- ----------- ----- ----------- -----
Income Tax Provision $ 3,673,000 30.45% $ 3,493,000 28.62% $ 2,164,000 23.99%
=========== ===== =========== ===== =========== =====
Like many financial institutions located in Wisconsin, the Bank transferred
investment securities to a Nevada investment subsidiary, which holds and manages
those assets. The investment subsidiary has not filed returns with or paid
income or franchise taxes to the State of Wisconsin. The Wisconsin Department of
Revenue (the "Department") recently implemented a program to audit Wisconsin
financial institutions which incorporated investment subsidiaries in low-tax
jurisdictions. The Department has generally indicated that it will assess income
or franchise taxes on the income of the Nevada investment subsidiaries of
Wisconsin banks. The Department completed such an audit at the Bank. On August
10, 2004, the Bank entered into a confidential settlement with the Department
with respect to its Nevada investment subsidiary; no other issues were raised by
the audits. The settlement resulted in an immaterial payment of taxes and
interest for the years under audit. The settlement limits the current and future
tax benefit realized from the Bank's Nevada investment subsidiary; however the
impact on the Corporation's operating results will be nominal.
A federal income tax audit of the Corporation has resulted in proposed
adjustments for the years ended December 31, 1999 - 2002 totaling $431,000 plus
interest of $82,000 through May 21, 2004. The Corporation does not agree with
the proposed adjustment and has filed a protest with the Internal Revenue
Service appeals office. Management believes the Corporation has adequately
provided for this item in its tax provision.
48
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 12 - Employee Benefit Plans
- --------------------------------------------------------------------------------
The Bank has a contributory defined-contribution 401(k) retirement plan. This
plan covers substantially all employees who have attained the age of 21 and
completed one year of service. Participants may contribute a portion of their
compensation (up to IRS limits) to the plan. The Bank may make regular and
matching contributions to the plan each year. In 2004, 2003 and 2002, the Bank
provided a dollar-for-dollar match of employee contributions up to 5% of their
compensation. Participants direct the investment of their contributions into one
or more investment options. The Bank recorded contributions expense of $339,949,
$322,482, and $303,513 in 2004, 2003 and 2002, respectively.
In December 2003, the Corporation adopted a Stock Purchase Plan to aid the
Corporation in obtaining and retaining key management personnel by providing
them with an opportunity to acquire an ownership interest in the Corporation by
purchasing the Company's common stock. Eligibility to participate in the plan is
restricted to directors, officers at a position of vice president or above, and
certain officers with ten or more years of continous service. Participants may
subscribe to purchase shares annually during January of each year, subject to
limitations as defined in the plan, at a price per share equivalent to the most
recently established fair market value determined under the Corporation's
Automatic Dividend Reinvestment Plan. The maximum number of shares available to
be issued under the plan is 125,000 shares. Common shares subscribed and issued
under the plan were 18,000 in 2004. At December 31, 2004, there were 107,000
shares available for purchase under the plan.
The Bank purchased paid-up life insurance as owner and beneficiary on certain
officers and executives to provide the Bank with funds in the event of the death
of such individuals and to help recover the cost of employee benefits. Included
in the consolidated financial statements is $10,361,935 and $10,000,000 of
related cash surrender value as of December 31, 2004 and 2003 respectively.
49
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 13 - Operating Leases
- --------------------------------------------------------------------------------
The Corporation leases various banking facilities under operating lease
agreements from various companies. Three of these facilities are leased from
companies held by a director and major shareholder of the Corporation. All of
the agreements include renewal options and one agreement requires the Bank to
pay insurance, real estate taxes and maintenance costs associated with the
lease. Rental amounts are subject to annual escalation based upon increases in
the Consumer Price Index. Aggregate rental expense under the leases amounted to
$591,632, $628,739, and $560,656 in 2004, 2003 and 2002, respectively.
At December 31, 2004, the future minimum lease payments for each of the five
succeeding years and in the aggregate are as follows:
2005 $ 591,632
2006 458,881
2007 380,828
2008 327,690
2009 327,690
Thereafter 238,643
-----------
$ 2,325,364
===========
- --------------------------------------------------------------------------------
NOTE 14 - Commitments and Contingencies
- --------------------------------------------------------------------------------
The Corporation and Bank are party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, financial guarantees and standby letters of credit. They involve,
to varying degrees, elements of credit and interest rate risk in excess of
amounts recognized on the consolidated balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments. The Bank uses the same credit policies in making commitments and
issuing letters of credit as they do for on-balance-sheet instruments.
50
- --------------------------------------------------------------------------------
NOTE 14 - Commitments and Contingencies (cont.)
- --------------------------------------------------------------------------------
A summary of the contract or notional amount of the Bank's exposure to
off-balance-sheet risk as of December 31, 2004 and 2003 is as follows:
Financial instruments whose contract amounts represent credit risk:
2004 2003
----------- -----------
Commitments to extend credit $81,332,217 $68,098,668
Standby letters of credit $ 2,869,735 $ 1,661,053
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Standby letters of credit are conditional
commitments issued to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank evaluates each customer's credit worthiness 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 and equipment, and income-producing commercial properties.
- --------------------------------------------------------------------------------
NOTE 15 - Stockholders' Equity
- --------------------------------------------------------------------------------
Common Stock
The Board of Directors, on February 12, 2003, approved an amendment, effective
February 28, 2003, to the Corporation's articles of incorporation, which
increased the number of authorized shares of $1 par value common stock from
5,000,000 shares to 15,000,000 shares in connection with a three for one common
stock split, completed on March 3, 2003. All share and per share information
included in the consolidated financial statements has been restated to give
effect to the stock split.
Cumulative Preferred Stock
The Corporation's articles of incorporation authorize the issuance of up to
200,000 shares of $1 par value cumulative preferred stock. The Board of
Directors is authorized to divide the stock into series and fix and determine
the relative rights and preferences of each series. No shares have been issued.
Retained Earnings
The principal source of income and funds of the Corporation are dividends from
the Bank. Dividends declared by the Bank that exceed the retained net income for
the most current year plus retained net income for the preceding two years must
be approved by federal regulatory agencies. Under this formula, dividends of
approximately $17,134,000 may be paid without prior regulatory approval.
Maintenance of adequate capital at the Bank effectively restricts potential
dividends to an amount less than $17,134,000.
Under Federal Reserve regulations, the Bank is limited as to the amount it may
lend to its affiliates, including the Corporation. Such loans are required to be
collateralized by investments defined in the regulations. In addition, the
maximum amount available for transfer from the Bank to the Corporation in the
form of loans is limited to 10% of the Bank's stockholders' equity in the case
of any one affiliate or 20% in the case of all affiliates.
51
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 16 - Regulatory Capital Requirements
- --------------------------------------------------------------------------------
The Corporation (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal and state 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 and the
Bank'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
their assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk-weightings, and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
requires the Corporation and the Bank to maintain minimum amounts and ratios
(set forth in the table that follows) 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). Management believes that as of December
31, 2004 and 2003 the Corporation and the Bank met all capital adequacy
requirements to which they are subject.
As of December 31, 2004, the most recent notification from the regulatory
agencies categorized the subsidiary Bank as well-capitalized under the
regulatory framework for prompt corrective action. To be categorized as
well-capitalized, an institution must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the following table.
There are no conditions or events since these notifications that management
believes have changed the institution's category.
Listed below is a comparison of the Corporation's and the Bank's actual capital
amounts with the minimum requirements for well capitalized and adequately
capitalized banks, as defined by the federal regulatory agencies' Prompt
Corrective Action Rules, as of December 31, 2004 and 2003.
To Be Well Capitalized
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 2004
Total capital (to risk weighted
assets)
Tri City Bankshares Corporation $98,190,000 19.9% $39,445,000 8.0% N/A N/A
Tri City National Bank $93,179,000 18.9% $39,414,000 8.0% $49,267,000 10.0%
Tier 1 capital (to risk weighted
assets)
Tri City Bankshares Corporation $92,549,000 18.8% $19,723,000 4.0% N/A N/A
Tri City National Bank $87,537,000 17.8% $19,707,000 4.0% $29,560,000 6.0%
Tier 1 capital (to average assets)
Tri City Bankshares Corporation $92,549,000 13.6% $27,209,000 4.0% N/A N/A
Tri City National Bank $87,537,000 12.9% $27,196,000 4.0% $33,995,000 5.0%
As of December 31, 2003
Total capital (to risk weighted
assets)
Tri City Bankshares Corporation $91,573,000 21.0% $34,851,000 8.0% N/A N/A
Tri City National Bank $86,972,000 20.0% $34,824,000 8.0% $43,530,000 10.0%
Tier 1 capital (to risk weighted
assets)
Tri City Bankshares Corporation $86,284,000 19.8% $17,426,000 4.0% N/A N/A
Tri City National Bank $81,682,000 18.8% $17,412,000 4.0% $26,118,000 6.0%
Tier 1 capital (to average assets)
Tri City Bankshares Corporation $86,284,000 13.5% $25,529,000 4.0% N/A N/A
Tri City National Bank $81,682,000 12.8% $25,517,000 4.0% $31,896,000 5.0%
52
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 16 - Regulatory Capital Requirements (cont.)
- --------------------------------------------------------------------------------
Differences between the Corporation's and the Bank's equity under accounting
principles generally accepted in the United States of America and capital as
defined by regulatory agencies is due to the allowance for loan losses.
- --------------------------------------------------------------------------------
NOTE 17 - Concentration of Credit Risk
- --------------------------------------------------------------------------------
Practically all of the Bank's loans, commitments, and commercial and standby
letters of credit have been granted to customers in the subsidiary Bank's market
area. Although the Bank has a diversified loan portfolio, the ability of their
debtors to honor their contracts is dependent on the economic conditions of the
counties surrounding the Bank. The concentration of credit by type of loan is
set forth in Note 4.
- --------------------------------------------------------------------------------
NOTE 18 - Fair Value of Financial Instruments
- --------------------------------------------------------------------------------
The estimated fair values of financial instruments at December 31, 2004 and 2003
are as follows:
2004 2003
--------------------------- ---------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------------------------------------------------
FINANCIAL ASSETS
Cash and due from banks $ 34,425,012 $ 35,425,012 $ 40,849,479 $ 40,849,479
============ ============ ============ ============
Held to maturity securities $159,451,575 $159,585,976 $170,541,123 $172,873,927
============ ============ ============ ============
Non marketable equity securities $ 322,100 $ 322,100 $ 322,100 $ 322,100
============ ============ ============ ============
Loans, net $465,603,614 $462,577,106 $406,985,461 $411,353,618
============ ============ ============ ============
Cash surrender value of life insurance $ 10,361,935 $ 10,361,935 $ 10,000,000 $ 10,000,000
============ ============ ============ ============
Mortgage servicing rights $ 957,565 $ 957,565 $ 998,514 $ 998,514
============ ============ ============ ============
Accrued interest receivable $ 2,969,647 $ 2,969,647 $ 2,986,496 $ 2,986,496
============ ============ ============ ============
FINANCIAL LIABILITIES
Deposits $590,404,926 $590,462,225 $556,023,909 $557,103,424
============ ============ ============ ============
Federal funds purchased and securities
sold under repurchase agreements $ 9,485,945 $ 9,485,945 $ 9,013,622 $ 9,013,622
============ ============ ============ ============
Other borrowings $ 2,748,411 $ 2,748,411 $ 1,534,292 $ 1,534,292
============ ============ ============ ============
Accrued interest payable $ 265,356 $ 265,356 $ 267,413 $ 267,413
============ ============ ============ ============
The estimated fair value of fee income on letters of credit at December 31, 2004
and 2003 is insignificant. Loan commitments on which the committed interest rate
is less than the current market rate are also insignificant at December 31, 2004
and 2003.
53
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 18 - Fair Value of Financial Instruments (cont.)
- --------------------------------------------------------------------------------
The Bank assumes interest rate risk (the risk that general interest rate levels
will change) as a result of its normal operations. As a result, fair values of
the Bank's financial instruments will change when interest rate levels change
and that change may be either favorable or unfavorable to the Bank. Management
attempts to match maturities of assets and liabilities to the extent believed
necessary to minimize interest rate risk. However, borrowers with fixed rate
obligations are less likely to prepay in a rising rate environment and more
likely to repay in a falling rate environment. Conversely, depositors who are
receiving fixed rates are more likely to withdraw funds before maturity in a
rising rate environment and less likely to do so in a falling rate environment.
Management monitors rates and maturities of assets and liabilities and attempts
to minimize interest rate risk by adjusting terms of new loans and deposits and
by investing in securities with terms that mitigate the Bank's overall interest
rate risk.
- --------------------------------------------------------------------------------
NOTE 19 - Litigation Settlement
- --------------------------------------------------------------------------------
The Bank settled two separate legal actions during the year ended December 31,
2002. Both of these actions were a result of a loan fraud perpetrated by an
individual not associated with the Bank. The individual was convicted and is now
serving his sentence in a federal penitentiary. Two of the Bank's former
employees were also convicted of providing false information used by this person
to obtain the fraudulent loans from the plaintiffs in these actions. In the
first action, Creve Coeur Mortgage Associates, Inc. v. Tri City National Bank, a
settlement was reached on April 17, 2002. As part of the agreement, the
subsidiary Bank paid $2,400,000 to Creve Coeur Mortgage Associates. The second
action, Centex Credit Corporation v. Tri City National Bank, went through
mediation in January 2002, resulting in a settlement agreement dated as of
January 15, 2002. As part of the agreement, the Bank paid Centex $1,850,000.
The Bank's fidelity bond insurer denied initial requests for coverage of the
losses that resulted from these lawsuits. The Bank pursued a lawsuit against the
fidelity bond insurer which resulted in a summary judgment to the insurance
company. The case was appealed to the Wisconsin Court of Appeals on January 29,
2003. The case was fully briefed by both the Bank and the insurance company and
a decision was issued by the Wisconsin Court of Appeals, District I on December
9, 2003. In that decision, the panel of three appellate court judges unanimously
affirmed the trial court on a similar rationale that the appropriate
interpretation of the words in the bond did not cover the losses suffered by the
subsidiary Bank as a result of paying settlements or judgments to third-party
claimants in litigation. The Bank has decided not to petition the Wisconsin
Supreme Court for review of the decision by the Wisconsin Court of Appeals, thus
ending the litigation.
54
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 20 - Tri City Bankshares Corporation (Parent Company Only)
Financial Information
- --------------------------------------------------------------------------------
CONDENSED BALANCE SHEETS
December 31,
---------------------------
2004 2003
ASSETS ------------ ------------
Cash on deposit with subsidiary Bank $ 4,137,564 $ 3,799,710
Premises and equipment, net 1,523,987 1,588,356
Investment in subsidiary Bank 86,178,019 80,266,131
Other assets, net 708,968 629,647
------------ ------------
TOTAL ASSETS $ 92,548,538 $ 86,283,844
============ ============
STOCKHOLDERS' EQUITY
Cumulative preferred stock, $1 par
value, 200,000 shares
authorized, no shares issued $ -- $ --
Common stock, $1 par value,
15,000,000 shares authorized, 8,413,621
and 8,223,557 shares issued and
outstanding as of 2004 and 2003,
respectively 8,413,621 8,223,557
Additional paid-in capital 17,507,720 14,010,617
Retained earnings 66,627,197 64,049,670
------------ ------------
TOTAL STOCKHOLDERS' EQUITY $ 92,548,538 $ 86,283,844
============ ============
CONDENSED STATEMENTS OF INCOME
Years Ended December 31,
---------------------------------------
2004 2003 2002
---------------------------------------
INCOME
Dividends from subsidiary Bank $ 2,576,000 $ 2,352,000 $ 2,100,000
Interest income from subsidiary
Bank 53,994 47,092 68,129
Management fees from subsidiary
Bank 522,662 507,600 507,600
----------- ----------- -----------
Total Income 3,152,656 2,906,692 2,675,729
EXPENSES
Administrative and general
- net 700,371 785,019 704,397
----------- ----------- -----------
Income before income taxes and
equity in undistributed earnings
of subsidiary Bank 2,452,285 2,121,673 1,971,332
Less: Applicable income taxes
(benefit) (24,000) (61,000) (26,000)
----------- ----------- -----------
Income before equity in
undistributed earnings of subsidiary 2,476,285 2,182,673 1,997,332
Equity in undistributed earnings
of subsidiary Bank 5,911,887 6,534,419 4,857,640
----------- ----------- -----------
NET INCOME $ 8,388,172 $ 8,717,092 $ 6,854,972
=========== =========== ===========
55
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 20 - Tri City Bankshares Corporation (Parent Company Only)
Financial Information (cont.)
- --------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31,
---------------------------------------
2004 2003 2002
---------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 8,388,172 $ 8,717,092 $ 6,854,972
Adjustments to reconcile net
income to net cash flows
from operating activities
Depreciation 90,803 99,272 109,429
Equity in undistributed
income of subsidiary Bank (5,911,887) (6,534,419) (4,857,640)
Other (79,322) (56,618) (42,631)
----------- ----------- -----------
Net Cash Flows Provided by
Operating Activities 2,487,766 2,225,327 2,064,130
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of premises and equipment
- net (26,434) (1,573) (51,351)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (5,810,645) (5,199,809) (4,561,720)
Common stock issued - net 3,687,167 2,928,295 2,679,565
----------- ----------- -----------
Net Cash Flows Used in Financing
Activities (2,123,478) (2,271,514) (1,882,155)
----------- ----------- -----------
Net Change in Cash 337,854 (47,760) 130,624
CASH - BEGINNING OF YEAR 3,799,710 3,847,470 3,716,846
----------- ----------- -----------
CASH - END OF YEAR $ 4,137,564 $ 3,799,710 $ 3,847,470
=========== =========== ===========
56
TRI CITY BANKSHARES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 21 - Quarterly Results of Operations (Unaudited)
- --------------------------------------------------------------------------------
The following is a summary of the quarterly results of operations for the years
ended December 31, 2004 and 2003:
(In thousands, except per share data)
Three Months Ended
------------------------------------------
December September June March
2004 31 30 30 31
--------- --------- -------- --------
Interest income $ 8,906 $ 8,731 $ 8,185 $ 8,074
Interest expense (1,292) (1,251) (1,162) (1,187)
------- ------- ------- -------
Net interest income 7,614 7,480 7,023 6,887
Provision for loan losses (120) (105) (105) (105)
Noninterest income 1,602 1,573 1,700 1,575
Noninterest expense (5,528) (5,744) (5,930) (5,755)
------- ------- ------- -------
Income before income taxes 3,568 3,204 2,688 2,602
Income taxes (1,136) (1,032) (805) (700)
------- ------- ------- -------
Net Income $ 2,432 $ 2,172 $ 1,883 $ 1,902
======= ======= ======= =======
Basic earnings per share $ 0.29 $ 0.26 $ 0.23 $ 0.23
2003
Interest income $ 8,128 $ 8,202 $ 8,553 $ 8,573
Interest expense (1,196) (1,201) (1,298) (1,389)
------- ------- ------- -------
Net interest income 6,932 7,001 7,255 7,184
Provision for loan losses (105) (105) (105) (105)
Noninterest income 1,535 2,028 2,165 1,973
Noninterest expense (5,988) (5,917) (5,819) (5,719)
------- ------- ------- -------
Income before income taxes 2,374 3,007 3,496 3,333
Income taxes (632) (853) (1,035) (973)
------- ------- ------- -------
Net Income $ 1,742 $ 2,154 $ 2,461 $ 2,360
======= ======= ======= =======
Basic earnings per share $ 0.21 $ 0.26 $ 0.30 $ 0.29
57
Form 10-K
Shareholders interested in obtaining a copy of the Corporation's Annual Report
to the Securities and Exchange Commission as filed on Form 10-K may do so at no
cost by writing to:
Office of the Secretary
Tri City Bankshares Corporation
6400 South 27th Street
Oak Creek, Wisconsin 53154
58