ANNUAL REPORT
TO SHAREHOLDERS
TABLE OF CONTENTS
Page
Letter to Shareholders ................................................... 1
Selected Consolidated Financial Data ..................................... 2
Management's Discussion and Analysis ..................................... 3
Report of Independent Auditors ........................................... 18
Consolidated Balance Sheets .............................................. 19
Consolidated Statements of Income ........................................ 20
Consolidated Statements of Shareholders' Equity .......................... 21
Consolidated Statements of Cash Flows .................................... 23
Notes to Consolidated Financial Statements ............................... 25
Directors and Executive Officers ......................................... 56
Shareholder Information .................................................. 57
DESCRIPTION OF BUSINESS
MFB Corp. is an Indiana unitary savings and loan holding company organized in
1993, and parent company of its wholly owned savings bank subsidiary, MFB
Financial (the "Bank"). MFB Corp. and the Bank (collectively referred to as the
"Company") conduct business from their corporate office located in Mishawaka,
Indiana and its eleven branch locations in St. Joseph and Elkhart Counties of
Indiana. The Bank offers a variety of lending, deposit, trust and other
financial services to its retail and business customers. The Bank's wholly-owned
subsidiary, Mishawaka Financial Services, Inc., offers general property,
casualty, life and health insurance to customers in the Bank's market area. The
Bank's wholly-owned subsidiaries, MFB Investments I, Inc., MFB Investments II,
Inc. and MFB Investments, LP are Nevada corporations and a Nevada limited
partnership that manage a portion of the Bank's investment portfolio.
MESSAGE TO OUR SHAREHOLDERS
On behalf of the Board of Directors, our management team and all the
employees of MFB Corp. and its subsidiary, MFB Financial, it is my pleasure to
provide you with our Annual Report for the fiscal year ended September 30, 2004.
Without question the past year was an eventful one for our organization. In
October, 2003 we acquired our new headquarters facility. After remodeling the
building to meet our needs, we completed our move this past summer. This
facility now houses all administrative and support staff as well as our business
banking and wealth management personnel. This consolidation into a single
location from two separate ones has improved efficiency for the bank and morale
for our employees. Although overhead expenses of the building have negatively
affected earnings in the short term, we expect to generate considerable lease
income from the 60% of the building that we do not occupy. In fact, at the
present time we are completing negotiations with two quality tenants that not
only will generate revenue but enhance the image of the building as a premier
professional property in this area.
In August, 2004 we completed the acquisition of certain assets and
assumption of certain liabilities of Sobieski Bank located in South Bend,
Indiana. This was the first such acquisition ever undertaken by our 115 year old
institution. MFB Financial acquired $7.3 million in cash, $35.9 million in
investments, $53.7 million in net loans and $9.4 million in other assets from
Sobieski. The liabilities assumed included $69.3 million in deposits, $35.7
million in FHLB advances and $884,000 in other liabilities. This strategic
transaction has allowed MFB to have an immediate and substantial presence in a
portion of St. Joseph County where we were previously underrepresented. The
acquisition improves our growth potential in this market and we are very pleased
with the relationships we are building with our new clients in the western part
of the county.
In addition to the three branch locations acquired in the Sobieski
purchase, we also constructed and opened our new MFB Erskine branch on the south
side of South Bend in early 2004. The Bank now operates eleven offices across
our two county market area.
Primarily as a result of the acquisition, total assets grew $112.6 million
from $428.6 million at the end of last year to $541.2 million at the end of this
fiscal year. Additionally, loans increased $81.7 million and deposits increased
$65.8 million this year. While considerable balance sheet growth occurred this
past year, we retained our focus on the continued improvement in asset quality.
The result was a decrease in nonperforming assets from 1.43% of total loans one
year ago to 1.07% at year end.
The Company generated net income of $1.8 million ($1.30 diluted earnings
per common share) for the year. We experienced strong growth in net interest
income and noninterest income. This revenue growth was offset by increased
noninterest expense driven significantly by the expansion mentioned above. Book
value per common share outstanding was $27.02 at year-end, up from $26.60 last
year and the Company increased the annualized dividend rate again this year to
$0.47 per share, the eighth consecutive annual increase. The market value of the
Company's shares was $31.54 per share at September 30, 2004.
We look forward to the year ahead with optimism and the knowledge that
continued attention to the core principles of high asset quality and steadfast
cost control will allow MFB to remain "Michiana's Finest Bank".
Charles J. Viater
President and Chief Executive Officer
1
MFB CORP. AND SUBSIDIARY
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of MFB Corp. and its
subsidiary is qualified in its entirety by, and should be read in conjunction
with the consolidated financial statements, including notes thereto, included
elsewhere in this Annual Report.
At September 30,
----------------------------------------------------------------------
(In Thousands)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Summary of Financial Condition:
Total assets $ 541,222 $ 428,624 $ 421,200 $ 413,084 $ 396,003
Loans receivable 399,925 318,155 316,391 311,613 317,178
Allowance for loan losses 6,074 5,198 5,143 4,632 1,672
Loans held for sale, net 1,034 6,626 6,404 3,074 6,495
Cash and cash equivalents 28,595 40,357 27,582 34,223 14,544
Securities available for sale, including FHLB stock 74,820 46,499 59,892 54,167 47,930
Goodwill and other intangible assets 5,056 - - - -
Deposits 357,893 292,106 264,377 245,179 239,394
Securities sold under agreements to repurchase - - - 11,022 9,143
FHLB advances 133,443 98,790 119,215 119,685 112,152
Shareholders' equity 35,906 34,251 33,952 34,380 32,514
Years Ended September 30,
----------------------------------------------------------------------
(In Thousands)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Summary of Operating Results:
Interest income $ 22,792 $ 23,326 $ 26,188 $ 30,316 $ 28,666
Interest expense 11,089 12,244 13,829 17,972 16,473
----------- ----------- ----------- ----------- -----------
Net interest income 11,703 11,082 12,359 12,344 12,193
Provision for loan losses 800 1,110 3,369 3,096 1,106
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 10,903 9,972 8,990 9,248 11,087
Noninterest income
Service charges on deposit accounts 3,030 1,624 1,049 903 666
Trust fee income 495 464 298 213 146
Insurance commissions 208 187 158 140 149
Net realized gains from sales of loans 1,032 3,395 1,578 1,046 525
Loan servicing fees, net of amortization 52 (603) (84) 32 82
Mortgage servicing right recovery (impairment) 217 (576) - - -
Net gain (loss) on securities available for sale (109) 40 (934) (52) (41)
Other 755 450 104 314 137
----------- ----------- ----------- ----------- -----------
Total noninterest income 5,680 4,981 2,169 2,596 1,664
Noninterest expense
Salaries and employee benefits 7,021 6,803 5,922 4,944 4,668
Occupancy and equipment expense 2,743 1,558 1,483 1,370 1,148
Professional and consulting fees 1,226 364 297 311 198
Data processing expense 632 596 669 517 443
Other expense 2,936 2,561 2,121 1,841 1,786
----------- ----------- ----------- ----------- -----------
Total noninterest expense 14,558 11,882 10,492 8,983 8,243
----------- ----------- ----------- ----------- -----------
Income before income taxes 2,025 3,071 667 2,861 4,508
Income tax expense 235 671 18 951 1,693
----------- ----------- ----------- ----------- -----------
Net income $ 1,790 $ 2,400 $ 649 $ 1,910 $ 2,815
=========== =========== =========== =========== ===========
Supplemental Data:
Basic earnings per common share $ 1.36 $ 1.87 $ 0.49 $ 1.42 $ 2.04
Diluted earnings per common share 1.30 1.80 0.47 1.38 2.00
Dividends declared per common share .470 .435 .415 .395 .375
Book value per common share 27.02 26.60 25.53 25.72 23.93
Return on assets 0.40% 0.56% 0.16% 0.47% 0.75%
Return on equity 5.05 7.14 1.84 5.75 8.88
Interest rate spread 2.53 2.41 2.73 2.73 2.93
Net yield on average interest-earning assets 2.81 2.73 3.08 3.15 3.38
Dividend pay-out ratio 34.56 23.26 84.69 27.82 18.38
Equity-to-assets 6.63 7.99 8.06 8.32 8.21
Non-performing assets to total loans 1.07 1.43 1.88 .89 .02
Allowance for loan losses to total loans 1.52 1.63 1.63 1.49 .53
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2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The principal business of the Bank has historically consisted of attracting
deposits from the general public and the business community and making loans
secured by various types of collateral, including real estate and general
business assets. The Bank is significantly affected by prevailing economic
conditions as well as government policies and regulations concerning, among
other things, monetary and fiscal affairs, housing and financial institutions.
Deposit flows are influenced by a number of factors, including interest rates
paid on competing investments, account maturities, fee structures, and level of
personal income and savings. Lending activities are influenced by the demand for
funds, the number and quality of lenders, and regional economic cycles. Sources
of funds for lending activities of the Bank include deposits, borrowings,
payments on loans, sale of loans and income provided from operations. The
Company's earnings are primarily dependent upon the Bank's net interest income,
the difference between interest income and interest expense.
Interest income is a function of the balances of loans and investments
outstanding during a given period and the yield earned on such loans and
investments. Interest expense is a function of the amount of deposits and
borrowings outstanding during the same period and interest rates paid on such
deposits and borrowings. The Company's earnings are also affected by the Bank's
provisions for loan losses, service charges, fee income, gains from sales of
loans, mortgage loan servicing fees, income from subsidiary activities,
operating expenses and income taxes.
The August, 2004 acquisition of certain assets and liabilities of Sobieski Bank,
as mentioned throughout the "Management Discussion and Analysis of Financial
Condition and Results of Operations," has significantly impacted the balance
sheet growth of the Company as compared to last year. It is expected that the
acquisition will significantly increase revenues in 2005, particularly related
to net interest income, service charges on deposit accounts and mortgage related
noninterest income. Noninterest expenses are expected to also increase
significantly, particularly related to salaries and employee benefits, occupancy
and equipment and other expense. Although management expects this acquisition to
be accretive to earnings next year, no assurance can be given that this will
occur.
CRITICAL ACCOUNTING POLICIES
Certain of the Company's accounting policies are important to the portrayal of
the Company's financial condition, since they require management to make
difficult, complex or subjective judgments, some of which may relate to matters
that are inherently uncertain. Estimates associated with these policies are
susceptible to material changes as a result of changes in facts and
circumstances. Facts and circumstances that could affect these judgments
include, but are not limited to; changes in interest rates, in the performance
of the economy or in the financial condition of borrowers. Management believes
that its critical accounting policies include determining the allowance for loan
losses, determining the fair value of securities available for sale and the
valuation of mortgage servicing rights.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision for
loan losses and decreased by charge-offs, less recoveries. Management estimates
the allowance for loan losses balance required by evaluating current economic
conditions, changes in character and size of the loan portfolio,
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delinquencies and adequacy of loan collateral securing loan delinquencies,
historical and estimated charge offs and other pertinent information derived
from a review of the loan portfolio. Allocations of the allowance for loan
losses may be made for specific loans, but the entire allowance for loan losses
is available for any loan that, in management's judgment, should be charged-off.
Loan losses are charged against the allowance for loan losses when management
believes the loan balance is uncollectible.
A loan is impaired when the full payment of principal and interest is not
expected to be paid in accordance with the original terms of the loan.
Impairment is evaluated in total for small-balance loans of similar nature such
as residential mortgage and consumer loans, and on an individual loan basis for
commercial loans. If a loan is impaired, a portion of the allowance for loan
losses is allocated so that the loan is reported on a net basis at the present
value of estimated future cash flows using the loan's existing rate or at the
fair value of collateral if repayment is expected solely from the collateral.
Fair Value of Securities Available for Sale: Securities available for sale are
carried at fair value, with unrealized holding gains and losses reported
separately in accumulated other comprehensive income (loss), net of tax. The
Company obtains market values from a third party on a monthly basis in order to
adjust the securities to fair value. As a result of changes in the fair market
value of the Company's available for sale securities portfolio, other
comprehensive (loss), net of tax, totaled $(326,000), $(272,000) and $(239,000)
for 2004, 2003, and 2002, respectively. Additionally, securities available for
sale are required to be written down to fair value when a decline in fair value
is not temporary; therefore, future changes in the fair value of securities
could have a significant impact on the Company's operating results. In
determining whether a market value decline is other than temporary, management
considers the reason for the decline, the extent of the decline and the duration
of the decline. As of September 30, 2004, unrealized losses on equity securities
(primarily floating rate government sponsored entity preferred stocks) totaled
approximately $875,000. These losses have not been recognized into net income
because the securities are of high credit quality (rated AA or higher),
management has the intent and ability to hold the investments for the
foreseeable future, and the decline in fair value is largely due to the
historically low market interest rates at the time the Company's floating rate
preferred stocks repriced. The fair value is expected to recover as the
securities approach their repricing dates and market rates rise. Should our
consideration of these factors change, the Company may be required to record
unrealized losses on some or all of these investments in the income statement.
Further, future changes in generally accepted accounting principles could
require us to record unrealized losses on some or all of these investments in
the income statement.
Mortgage Servicing Rights: Servicing rights represent both purchased rights and
the allocated value of servicing rights retained on loans sold. Servicing rights
are expensed in proportion to, and over the period of, estimated net servicing
revenues. Impairment is evaluated based on the fair value of the rights,
determined using prices for similar assets with similar characteristics or
discounted cash flows using market based assumptions. Any impairment of a
grouping is reported as a valuation allowance. Changes in interest rates and the
level of refinance activity can have volatile effects on the carrying value of
servicing rights. The Company obtains an outside appraisal on a quarterly basis
from a national firm who specializes in mortgage servicing valuation. This
valuation is used to evaluate the Company's mortgage servicing rights asset for
impairment. As September 30, 2004, mortgage servicing rights had a carrying
value of $2.09 million.
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COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 2004 AND 2003
RESULTS OF OPERATIONS
Consolidated net income for the Company for the year ended September 30, 2004
was $1.8 million or $1.30 diluted net income per common share compared to $2.4
million or $1.80 diluted net income per common share for the same period in
2003. The decrease in net income was primarily attributable to an increase in
noninterest expense partially offset by an increase in net interest income,
decreased provision for loan losses over last year and an increase in
noninterest income.
Net interest income totaled $11.7 million for the year ended September 30, 2004
compared to $11.1 million for the same period one year ago. Interest income
decreased $534,000 and interest expense decreased $1.1 million during the year
ended September 30, 2004 compared to the same period in 2003. Although record
low interest rates began to increase during the later half of the fiscal year,
the Company experienced overall decreases in yield earned on interest bearing
assets and rates paid on interest bearing liabilities as compared to the prior
year due to downward repricing of these instruments. The yield on
interest-earning assets decreased 28 basis points from 5.75% in 2003 to 5.47% in
2004. The average interest rate paid on interest-bearing liabilities decreased
40 basis points from 3.34% to 2.94% during the same period, and as a result, the
interest rate spread increased 12 basis points from 2.41% to 2.53% in 2004.
The provision for loan losses is determined in conjunction with management's
review and evaluation of current economic conditions, changes in the character
and size of the loan portfolio, loan delinquencies (current status as well as
past trends), adequacy of collateral securing impaired and delinquent loans,
historical and estimated net charge-offs and other pertinent information. Based
on the factors above, the provision for loan losses decreased from $1.1 million
for the year ended September 30, 2003 to $800,000 for the year ended September
30, 2004. Net charge-offs totaled $1.1 million and $526,000 for the years ended
September 30, 2003 and 2004 respectively. The Bank continues to improve its loan
review and risk assessment procedures giving particular consideration to the
risks related to the growing commercial loan portfolio and the risk of loss for
$2.2 million of commercial loans classified as impaired at the end of this year.
Impaired loans declined from $4.0 million last year due to charge offs and
payments on those loans.
Noninterest income increased from $5.0 million for the twelve months ended
September 30, 2003 to $5.7 million for the year ended September 30, 2004.
Service charges on deposit accounts, trust fee income and insurance commissions
reflected strong growth from 2003 to 2004, offset by the decrease in net gains
on loans sold to secondary markets. Loans sold to the secondary market decreased
by 59.3% between 2003 and 2004. In addition to the items above, the increase in
noninterest income was affected by two additional items, mortgage servicing
right impairment and subsequent recoveries and net losses on securities. For the
year ended September 30, 2004, the mortgage servicing rights valuation recovery
was $217,000 compared to the impairment charge of $576,000 last year. The
impairment and recovery on mortgage servicing rights is related to the decline
and subsequent recovery in the market value of servicing rights associated with
MFB Financial's $207 million mortgage loan servicing portfolio. The loss on
securities for the year of $109,000 is the result of a write down of equity
securities held by MFB Corp. based on current estimates of fair value.
Noninterest expense increased from $11.9 million to $14.6 million for the
comparable twelve month periods ending September 30. The significant growth in
occupancy expense is related to the operation of three acquired branches, the
opening of another branch and the expenses related to the acquisition of the new
Corporate offices. Professional and consulting fees increased over the prior
year due to two major projects and expenses related to the acquisition of
certain assets and assumption of certain liabilities of Sobieski Bank.
Management expects professional and consulting expenses related to the
acquisition to decline significantly for the
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5
year ended September 30, 2005. However, consulting related expenses for
implementation of Sarbanes/Oxley Section 404 regulations are expected to
increase significantly. The internal control reporting requirements mandated by
Section 404 are to be implemented by the Company by September 30, 2005. Other
expense increased over last year due to increases in advertising, telephone,
postage, insurance and foreclosure expenses. Other expenses also increased over
last year due to $97,000 of amortization expense on intangible assets recorded
in the acquisition. Amortization expense is expected to be $559,000 next year.
Income tax expense declined from $671,000 last year to $235,000 this year
primarily due to decreased net income before tax. Federal income tax expense
declined from $552,000 to $229,000 and state income tax expense declined from
$119,000 to $6,000. The overall effective income tax expense rate declined from
21.9% last year to $11.6% this year primarily due to maintaining a comparable
level of low income housing income tax credits on a reduced amount of taxable
income.
BALANCE SHEET COMPOSITION
Cash and cash equivalents decreased $11.8 million from $40.4 million as of
September 30, 2003 to $28.6 million as of September 30, 2004. Net cash used in
investing activities of $27.3 million was offset by net cash provided by
operating activities and financing activities amounting to $12.6 million and
$3.0 million, respectively.
As of September 30, 2004, the total securities available for sale portfolio
amounted to $66.0 million, an increase of $26.0 million from $40.0 million at
September 30, 2003. Securities available for sale and FHLB stock of $35.9
million were part of the acquisition of certain assets from Sobieski Bank. The
securities portfolio activity included security purchases of $11.0 million,
security maturities and sales totaling $8.9 million, principal payments on
mortgage-backed and related securities of $9.2 million, and a $700,000 decrease
due to premium amortization and market value declines on securities available
for sale.
As of September 30, 2004, loans receivable were $399.9 million, an increase of
$81.7 million from $318.2 million as of September 30, 2003. Commercial loans
outstanding increased by $30.2 million from $130.4 million at September 30, 2003
to $160.6 million at September 30, 2004. Consumer loan receivables, which
include home equity term loans and lines of credit, increased $9.0 to $39.0
million while residential mortgage loans increased $42.5 million from $157.8
million to $200.3 million at September 30, 2004. As part of the Sobieski
acquisition mentioned above, $40.2 million of mortgage loans, $9.3 million of
commercial loans, and $4.7 million of consumer loans, were acquired.
Diversification of the asset mix in the balance sheet will continue to be a
focus to improve profit margins, control margin volatility and to appeal to a
broader range of customers and potential customers. The Company continues to
build on its reputation as a quality local lender satisfying the market's desire
for local service and local decision making.
During the year ended September 30, 2004, the Company completed secondary market
mortgage loan sales totaling $46.8 million, and the net gains realized on these
loan sales were $1.0 million, including $581,000 related to recording mortgage
loan servicing rights. Loan sales last year were $115.1 million, and the net
gains realized on these loans sales were $3.4 million, including $1.3 million
related to recording mortgage loan servicing rights. The loans sold during the
year ended September 30, 2004 were primarily fixed rate mortgage loans with
maturities of fifteen years or longer. The sale of mortgage loans serves as a
source of additional liquidity and management anticipates that the Company will
continue to deliver fixed rate loans to the secondary market to meet consumer
demand, manage interest rate risk, and diversify the
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asset mix of the Company. Adjustable rate loans often provide rates of return
that are generally superior to other investments that carry similar terms to
repricing. The Company anticipates that these loans will continue to be
originated and retained in the Bank's portfolio. As part of its efforts to
manage interest rate risk, the Company originated and held in its portfolio $4.8
million of fixed rate mortgage loans originated during 2004, with an interest
rate of 6.00%. At September 30, 2004, $1.0 million of loans were classified as
loans held for sale compared to $6.6 million at September 30, 2003. Mortgage
loans serviced for others by the Company grew from $161.6 million last year to
$206.5 million at the end of this year of which, $31.9 million were acquired in
the acquisition.
The Company's allowance for loan losses at September 30, 2004 was $6.1 million
or 1.52% of loans, comparable to the $5.2 million or 1.63% of loans at the end
of last year. Loan loss reserves of $602,000 were acquired as part of the
acquisition. The ratio of nonperforming assets to loans was 1.07% at September
30, 2004 compared to 1.43% at September 30, 2003. Based on the evaluation of
many factors including current economic conditions, changes in the character and
size of the loan portfolio, current and past delinquency trends and historical
and estimated net charge-offs, the Company provided $800,000 to its allowance
for loan losses during the year ended September 30, 2004 compared to $1.1
million for the prior year ended September 30, 2003. Net charge offs deducted
from the allowance for loan losses were $526,000 for the year ended September
30, 2004 compared to $1.1 million last year. In management's opinion, the
Company's allowance for loan losses at September 30, 2004 and loan loss
provision for the year is appropriate in light of an improving loan portfolio
offset by the allowance determined to be necessary for an additional $54.3
million in new loans from the acquisition.
Premises and equipment increased from $6.1 million at September 30, 2003 to
$19.4 million at September 30, 2004 due to the purchase and remodeling of the
Corporate headquarters, opening of an additional branch and the acquisition of
fixed assets related to Sobieski Bank. On October 31, 2003, the Company
completed the $7.3 million purchase of an existing building in Mishawaka,
Indiana to serve as its new corporate headquarters. The Company presently
occupies approximately 35% of that 120,000 square foot building and intends to
lease the remaining space to tenants. Presently, tenants occupy approximately
15,000 square feet under leases that run through February 29, 2005. The location
of the new headquarters building is expected to accelerate the growth,
recognition and efficiency of the organization. Fixed assets of $3.4 million
were added this year as a result of the Sobieski acquisition including three
branch offices.
Goodwill and other intangible assets totaling $5.15 million were recorded at the
acquisition date as a result of the purchase of certain assets and liabilities
of Sobieski Bank. These intangibles represent the difference between the
purchase price and the value of the assets purchased and the value of the
liabilities assumed. At September 30, 2004 the balance of Goodwill was $2.36
million and the balance of the other intangible assets was $2.69 million. The
Company will assess goodwill for impairment at least annually. The other
intangible assets included the identified value of the core deposits acquired
and the value of customer relationships obtained in the acquisition. These two
intangible assets are amortized to expense over a ten year period.
Total deposits increased $65.8 million to $357.9 million as of September 30,
2004 from $292.1 million as of September 30, 2003. Core deposits consisting of
demand, NOW, savings and MMDA accounts increased from $133.8 million to $167.8
million from September 30, 2003 to September 30, 2004. As part of the assumption
of certain liabilities of Sobieski Bank, MFB assumed $47.4 million in
certificates of deposits and $21.8 million of core deposits. Federal
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Home Loan Bank ("FHLB") advances increased from $98.8 million as of September
30, 2003 to $133.4 million as of September 30, 2004. This increase was primarily
due to the assumption of Sobieski Bank's FHLB advances totaling $35.7 million.
Total shareholders' equity increased from $34.3 million as of September 30, 2003
to $35.9 million as of September 30, 2004. The increases to equity resulted from
net income of $1.8 million and $523,000 generated from the exercise of stock
options, offset by cash dividend payments of $617,000, and a $326,000 adjustment
to reflect the decrease in market value of securities available for sale. As
discussed in Note 3 of the "Notes to Consolidated Financial Statements," the
Company has continued to experience a significant decline in the value of two
marketable equity securities due to the low rate environment. The book value of
MFB Corp. common stock, based on the actual number of shares outstanding,
increased from $26.60 at September 30, 2003 to $27.02 at September 30, 2004.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 2003 AND 2002
RESULTS OF OPERATIONS
Consolidated net income for the Company for the year ended September 30, 2003
was $2.4 million or $1.80 diluted net income per common share compared to
$649,000 or $0.47 diluted net income per common share for the same period in
2002. The increase in net income was primarily attributable to a decreased
provision for loan losses over the previous year and an increase in noninterest
income offset by decreased net interest income and an increase in noninterest
expense.
Net interest income totaled $11.1 million for the year ended September 30, 2003
compared to $12.4 million for the same period in 2002. Interest income decreased
$2.9 million and interest expense decreased $1.6 million during the year ended
September 30, 2003 compared to the same period in 2002. Despite increases in the
volume of interest earning assets and interest bearing liabilities from 2002 to
2003, net interest income decreased as a result of the decline in the interest
rates earned on interest earning assets exceeding the decline in interest rates
paid on interest bearing liabilities. The yield on interest-earning assets
decreased 79 basis points from 6.54% in 2002 to 5.75% in 2003. The average
interest rate paid on interest-bearing liabilities decreased 46 basis points
from 3.80% to 3.34% during the same period, and as a result, the interest rate
spread decreased 32 basis points from 2.73% in 2002 to 2.41% in 2003. The rate
paid on interest bearing deposits declined from 2.95% in 2002 to 2.30% in 2003.
However, the rate paid on FHLB borrowings only declined from 5.68% to 5.64%.
The provision for loan losses decreased from $3.4 million for the year ended
September 30, 2002 to $1.1 million for the year ended September 30, 2003. Net
charge-offs totaled $2.9 million and $1.1 million for the years ended September
30, 2002 and 2003 respectively. For the year ended September 30, 2002, the
provision was charged $1.25 million related to a commercial loan to a furniture
manufacturing company. The provision was also charged $770,000 for increases in
loss allocations on certain commercial loans from information obtained from a
required periodic examination completed in August 2002 by the Office of Thrift
Supervision (OTS). For the year ended September 30, 2003, the $1.1 million
provision relates specifically to the factors above and $387,000 in charge offs
on two loans exceeding specific reserves allocated to those loans. Impaired
loans declined from $6.6 million at September 30, 2002 to $4.0 million at
September 30, 2003 due to the loan charge offs above and an $850,000 reduction
in the balance of one specific impaired loan from liquidation of collateral.
Noninterest income increased from $2.2 million for the twelve months ended
September 30, 2002 to $5.0 million for the year ended September 30, 2003.
Service charges on deposit accounts, trust fee income, insurance commissions and
net gains from sale of loans reflected strong
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growth from 2002 to 2003. The decline in the overall interest rate environment
resulted in a significant increase in mortgage loan originations and subsequent
mortgage loan sales to the secondary market. Related to this, the rate decline
also contributed to heavy mortgage refinancings leading to a significant
increase in amortization of mortgage servicing rights which is netted against
loan servicing fees. Other noninterest income increased primarily due to income
earned from the purchase of two bank owned life insurance policies. In addition
to the items above, the increase in noninterest income was affected by two
additional items, mortgage servicing right impairment and net gain (loss) on
securities. During the third quarter ended June 30, 2003, the Company recorded a
$704,000 ($425,000 net of tax) impairment charge due to the decline in value of
its approximate $161.6 million mortgage loan servicing portfolio. The value of
mortgage servicing portfolios in the mortgage banking industry declined
significantly from 2002 due to the record low interest rate environment. Due to
a moderate increase in values, a $465,000 ($280,000 net of tax) impairment
recovery was recorded during the fourth quarter ended September 30, 2003. During
the year ended September 30, 2002, the Company recorded an $895,000 write down
of a $1.0 million WorldCom, Inc. corporate note investment. That note was sold
in October, 2002 for $160,000 netting a gain of $40,000.
Noninterest expense increased from $10.5 million to $11.9 million for the
comparable twelve month periods ending September 30, 2002 and 2003. The
significant growth in salaries and benefits is the result of continued staffing
of several key positions in the organization designed to position the Bank for
growth in the coming years, increases in mortgage commissions due to
significantly higher mortgage origination volume and pension expense related to
the termination of the Company's pension plan. Occupancy expense increased due
to additional furniture and equipment purchases while data processing expense
decreased due to the renegotiation of contracted information system services.
Other expense increased from 2002 to 2003 due to increases in advertising,
telephone, postage, business development, consulting and foreclosure expenses.
ASSET/LIABILITY MANAGEMENT
The Company is subject to interest rate risk to the extent that its
interest-bearing liabilities, primarily deposits and Federal Home Loan Bank
(FHLB) advances, reprice more rapidly or at different rates than its
interest-earning assets.
A key element of the Company's asset/liability plan is to protect net earnings
by managing the maturity or repricing mismatch between its interest-earning
assets and rate-sensitive liabilities. Historically, the Company has sought to
reduce exposure to its earnings through the use of adjustable rate loans and
through the sale of fixed rate loans in the secondary market, and by extending
funding maturities through the use of FHLB advances.
As part of its efforts to monitor and manage interest rate risk, the Company
uses the Net Portfolio Value ("NPV") methodology adopted by the Office of Thrift
Supervision (OTS) as part of its capital regulations. In essence, this approach
calculates the difference between the present value of expected cash flows from
assets and the present value of expected cash flows from liabilities, as well as
cash flows from off-balance-sheet contracts. The difference is the NPV which was
8.72% as of September 30, 2004, down slightly from 9.05% at September 30, 2003.
Management and the Board of Directors review the OTS measurements on a quarterly
basis to determine whether the Company's interest rate exposure is within the
limits established by the Board of Directors in the Company's interest rate risk
policy.
The Company's asset/liability management strategy dictates acceptable limits on
the amounts of change in NPV given certain changes in interest rates. The tables
presented here, as of September 30, 2004 and 2003, are an analysis of the
Company's interest rate risk as measured by
- --------------------------------------------------------------------------------
9
changes in NPV for instantaneous and sustained parallel shifts in the yield
curve, in 100 basis point increments, up 300 basis points and down 100 basis
points (Due to the abnormally low interest rate environment at September 30,
2004 and 2003, data was not available from the OTS for the shift downward in
rates by 200 and 300 basis points).
As illustrated in the September 30, 2004 table below, the Company's interest
rate risk is sensitive to both rising and declining rates. The decline in NPV
with a rate reduction is due to the change in value of fixed rate Federal Home
Loan Bank borrowings that would occur. The decline in NPV with a rate increase
is due to the relative volume of mortgage assets with fixed rate characteristics
in the OTS model over the volume of liabilities with fixed rate characteristics.
September 30, 2004
------------------
(Dollars in Thousands)
Change in NPV as % of Portfolio
Interest Rates Net Portfolio Value Value of Assets
In Basis ------------------------------ ------------------------
Points NPV
(Rate Shock) (1) $ Amount $ Change % Change Ratio Change (1)
- --------------- -------- --------- -------- ----- ----------
+300 $36,125 $(12,586) (26)% 6.80% (192) bp
+200 41,987 (6,725) (14) 7.76 (96) bp
+100 46,357 (2,355) (5) 8.42 (30) bp
0 48,712 - - 8.72 -
(100) 47,138 (1,574) (3) 8.37 (35) bp
(1) Expressed in basis points
Specifically, the September 30, 2004 table indicates that the Company's NPV was
$48.7 million or 8.72% of the market value of portfolio assets. Based upon the
assumptions utilized, an immediate 200 basis point increase in market interest
rates would result in a $6.7 million or 14% decrease in the Company's NPV and
would result in a 96 basis point decrease in the Company's NPV ratio to 7.76%.
Also, an immediate 100 basis point decrease in market interest rates would
result in a $1.6 million or 3% decrease in the Company's NPV, and a 35 basis
point decrease in the Company's NPV ratio to 8.37%.
As illustrated in the September 30, 2003 table below, the Company's interest
rate risk was sensitive to both a significant rise and a decline in rates for
the same reasons as noted above.
September 30, 2003
------------------
(Dollars in Thousands)
Change in NPV as % of Portfolio
Interest Rates Net Portfolio Value Value of Assets
In Basis ------------------------------ ------------------------
Points NPV
(Rate Shock) (1) $ Amount $ Change % Change Ratio Change (1)
- --------------- -------- --------- -------- ----- ----------
+300 $37,705 $(2,940) (7)% 8.74% (31) bp
+200 39,819 (826) (2) 9.09 4 bp
+100 40,966 321 1 9.23 18 bp
0 40,645 9.05
(100) 38,193 (2,452) (6) 8.43 (62) bp
(1) Expressed in basis points
Specifically, the September 30, 2003 table indicates that the Company's NPV was
$40.6 million or 9.05% of the market value of portfolio assets. Based upon the
assumptions utilized, an immediate 200 basis point increase in market interest
rates would result in a $826,000 or 2.0%
- --------------------------------------------------------------------------------
10
decline in the Company's NPV and would result in a 4 basis point increase in the
Company's NPV ratio to 9.09%. Also, an immediate 100 basis point decrease in
market interest rates would result in a $2.5 million or 6.0% decrease in the
Company's NPV, and a 62 basis point decrease in the Company's NPV ratio to
8.43%.
In addition to monitoring selected measures of NPV, management also monitors
effects on net interest income resulting from increases or decreases in rates.
This process is used in conjunction with NPV measures to identify excessive
interest rate risk. In managing its asset/liability mix, the Company, depending
on the relationship between long and short term interest rates, market
conditions and consumer preference, may place somewhat greater emphasis on
maximizing its net interest margin than on strictly matching the interest rate
sensitivity of its assets and liabilities. Management believes that the
increased net income which may result from an acceptable mismatch in the actual
maturity or repricing of its asset and liability portfolios can, during periods
of declining or stable interest rates, provide sufficient returns to justify the
increased exposure to sudden and unexpected increases in interest rates which
may result from such a mismatch. Management believes that the Company's level of
interest rate risk is acceptable under this approach as well.
In evaluating the Company's exposure to interest rate movements, certain
shortcomings inherent in the method of analysis presented in the foregoing
tables must be considered. For example, although certain assets and liabilities
may have similar maturities or repricing periods, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
interest rates. Additionally, certain assets, such as adjustable rate mortgages
(ARM's), have features which restrict changes in interest rates on a short-term
basis and over the life of the asset. Further, in the event of a significant
change in interest rates, prepayment and early withdrawal levels would likely
deviate significantly from those assumed above. Finally, the ability of many
borrowers to service their debt may decrease in the event of an interest rate
increase. The Company considers all of these factors in monitoring its exposure
to interest rate risk.
The Board of Directors and management of the Company believe that certain
factors afford the Company the ability to operate successfully despite its
exposure to interest rate risk. The Company manages its interest rate risk by
originating and retaining adjustable rate loans in its portfolio and by normally
selling currently originated fixed rate one-to-four family real estate loans.
Loans classified as held for sale as of September 30, 2004 totaled $1.0 million.
The Company retains the servicing on loans sold in the secondary market and, at
September 30, 2004, $206.5 million of such loans were being serviced for others.
The Company's investment strategy is to maintain a diversified portfolio of high
quality investments that balances the goals of minimizing interest rate and
credit risks while striving to maximize investment return and provide liquidity
necessary to meet funding needs.
The Company offers a range of maturities on its deposit products at competitive
rates and monitors the maturities on an ongoing basis. The Company's cost of
interest-bearing funds has declined from 3.34% for the year ended September 30,
2003 to 2.94% for the year ended September 30, 2004. The Company has also
experienced an increase in the percentage of low interest cost demand and saving
deposits to total deposits which reduces its sensitivity to an increase in
rates.
- --------------------------------------------------------------------------------
11
AVERAGE BALANCE SHEETS
The following are the average balance sheets for the years ended September 30:
2004 2003 2002
Average Average Average
Outstanding Outstanding Outstanding
Balance Balance Balance
------- ------- -------
(In Thousands)
Assets:
Interest earning assets:
Interest-bearing deposits $ 21,210 $ 30,856 $ 22,797
Mortgage-backed securities (1) 18,741 25,852 26,261
Other securities available for sale (1) 24,235 24,412 30,216
FHLB stock 6,932 6,359 6,308
Loans held for sale (2) 1,287 1,532 353
Loans receivable (3) 343,545 316,223 314,210
------------ ------------ ------------
Total interest-earning assets 415,950 405,234 400,145
Noninterest-earning assets, net
of allowance for loan losses 29,116 21,643 17,675
------------ ------------ ------------
Total assets $ 445,066 $ 426,877 $ 417,820
============ ============ ============
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Savings accounts $ 35,309 $ 28,714 $ 19,249
NOW and money market accounts 79,500 67,389 59,433
Certificates of deposit 156,961 155,740 155,519
Repurchase agreements - - 9,988
Other borrowings 1,078 155 -
FHLB advances 104,801 114,146 119,297
------------ ------------ ------------
Total interest-bearing liabilities 377,649 366,144 363,486
Other liabilities 31,974 27,129 19,020
------------ ------------ ------------
Total liabilities 409,623 393,273 382,506
Shareholders' equity:
Common stock 12,393 13,020 12,944
Retained earnings 32,120 29,901 30,402
Net unrealized gain (loss) on
securities available for sale (812) (419) (196)
Treasury stock (8,258) (8,898) (7,836)
------------- ------------- ------------
Total shareholders' equity 35,443 33,604 35,314
------------ ------------ ------------
Total liabilities and
shareholders' equity $ 445,066 $ 426,877 $ 417,820
============ ============ ============
(1) Average outstanding balances reflect unrealized gain (loss) on securities
available for sale.
(2) Average outstanding balances reflect unrealized loss on loans held for
sale.
(3) Total loans less deferred net loan fees and loans in process.
- --------------------------------------------------------------------------------
12
INTEREST RATE SPREAD
The following table sets forth the average effective interest rate earned by the
Company on its consolidated loan and investment portfolios, the average
effective cost of the Company's consolidated deposits, repurchase agreements and
FHLB borrowings, the interest rate spread of the Company, and the net yield on
average interest-earning assets for the periods presented. Average balances are
based on daily average balances.
Year ended September 30,
2004 2003 2002
---- ---- ----
Average interest rate earned on:
Interest-bearing deposits 0.82% 1.11% 1.88%
Mortgage-backed securities (1) 3.21 2.22 4.39
Other securities available for sale (1) 3.08 4.16 4.67
FHLB stock 4.63 5.32 6.31
Loans held for sale 6.07 6.62 7.24
Loans receivable 6.07 6.62 7.24
Total interest-earning assets 5.47 5.75 6.54
Average interest rate of:
Savings accounts .62 0.95 1.12
NOW and money market accounts .72 0.75 1.18
Certificates of deposit 2.94 3.22 3.85
Repurchase agreements - - 1.54
FHLB advances 5.38 5.64 5.68
Other borrowings 3.52 3.87 -
Total interest-bearing liabilities 2.94 3.34 3.80
Interest rate spread (2) 2.53 2.41 2.73
Net yield on interest-earning assets (3) 2.81 2.73 3.08
- --------------------------------------------------------------------------------
(1) Yield is based on amortized cost without adjustment for unrealized gain
(loss) on securities available for sale.
(2) Interest rate spread is calculated by subtracting the average interest rate
cost from the average interest rate earned for the period indicated.
(3) The net yield on average interest-earning assets is calculated by dividing
net interest income by the average interest-earning assets for the period
indicated.
- --------------------------------------------------------------------------------
13
The following table describes the extent to which changes in interest rates and
changes in volume of interest-related assets and liabilities have affected the
Company's consolidated interest income and expense during the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rate (i.e.,
changes in rate multiplied by old volume) and (2) changes in volume (i.e.,
changes in volume multiplied by old rate). Changes not solely attributable to
rate or volume have been allocated proportionately to the change due to volume
and the change due to rate.
Year ending September 30, 2004
compared to year ended Total Net Due to Due to
September 30, 2003 Change Rate Volume
------ ---- ------
(In Thousands)
Interest-earning assets:
Interest-bearing deposits $ (167) $ (76) $ (91)
Securities 30 212 (182)
Mortgage-backed securities (269) (270) 1
FHLB stock (17) (46) 29
Loans held for sale (23) (8) (15)
Loans receivable (88) (1,820) 1,732
------------- ------------- ------------
Total (534) (2,008) 1,474
Interest-bearing liabilities:
Savings accounts (53) (107) 54
NOW and money market accounts 67 (21) 88
Certificates of deposit (405) (444) 39
Repurchase agreements - - -
Other borrowings 32 (1) 33
FHLB advances (796) (284) (512)
------------- ------------- -------------
Total (1,155) (857) (298)
------------- ------------- -------------
Change in net interest income $ 621 $ (1,151) $ 1,772
============ ============= ============
Year ending September 30, 2003
compared to year ended Total Net Due to Due to
September 30, 2002 Change Rate Volume
------ ---- ------
(In Thousands)
Interest-earning assets:
Interest-bearing deposits $ (88) $ (210) $ 122
Securities (403) (146) (257)
Mortgage-backed securities (569) (559) (10)
FHLB stock (60) (63) 3
Loans held for sale 76 (2) 78
Loans receivable (1,818) (1,962) 144
------------- ------------- ------------
Total (2,862) (2,942) 80
Interest-bearing liabilities:
Savings accounts 57 (36) 93
NOW and money market accounts (192) (277) 85
Certificates of deposit (964) (973) 9
Repurchase agreements (154) - (154)
Other borrowings 6 - 6
FHLB advances (337) (47) (290)
------------- ------------- -------------
Total (1,584) (1,333) (251)
------------- ------------- -------------
Change in net interest income $ (1,278) $ (1,609) $ 331
============= ============= ============
- -----------------------------------------------------------------------------------------------------------
14
LIQUIDITY AND CAPITAL RESOURCES
Liquidity relates primarily to the Company's ability to fund loan demand, meet
deposit customers' withdrawal requirements and provide for operating expenses.
Assets used to satisfy these needs consist of cash, deposits with other
financial institutions, overnight interest-bearing deposits in other financial
institutions and securities available for sale. These assets are commonly
referred to as liquid assets.
Liquid assets were $96.1 million as of September 30, 2004 compared to $81.4
million as of September 30, 2003. The sale of fixed rate loans throughout the
year, along with the growth in deposits and the maturity of securities available
for sale has provided sources of additional liquidity. Management believes the
Company's liquidity level as of September 30, 2004 is sufficient to meet
anticipated liquidity needs.
The cash flow statements provide an indication of the Company's sources and uses
of cash as well as an indication of the ability of the Company to maintain an
adequate level of liquidity. A discussion of the changes in the cash flow
statements for the years ended September 30, 2004, 2003 and 2002 follows.
During the year ended September 30, 2004, net cash and cash equivalents
decreased $11.8 million from $40.4 million at September 30, 2003 to $28.6
million at September 30, 2004.
The Company experienced a net increase in cash from operating activities of
$12.6 million during the year primarily attributable to net income of $1.8
million, adjustments for the provision for loan losses of $800,000, change in
accrued expenses and other liabilities of $2.4 million, change in other assets
of $1.1 million, and proceeds of $46.8 million realized from the sale of
mortgage loans, offset by the origination of $40.7 million of loans held for
sale. The Bank originates, sells and delivers its fixed rate, owner-occupied
residential mortgage loans on either a "Best Efforts" delivery program basis or
with FHLMC mandatory delivery programs. The "Best Efforts" program allows the
Bank to commit loans for delivery to investors at prices that are determined
prior to loan approval. In the event that loans are not closed and therefore not
delivered, the Bank incurs no penalty. The strategy reduces interest rate risk
exposure by minimizing the volume of loans closed and carried in the held for
sale loan portfolio. Under the mandatory delivery programs, loans are committed
to be delivered at predetermined prices and penalties could be assessed if
delivery commitments are not met. Those loans held for sale originated at market
that are not committed for delivery at time of origination are subject to market
conditions at time of sale. Of the $1.0 million of loans held for sale at
September 30, 2004, $800,000 were under the "Best Efforts" program and $200,000
were originated without predetermined scheduled delivery dates.
The $27.3 million decrease in cash used in investing activities for the year
ended September 30, 2004 was primarily related to loan originations exceeding
loan payments by $29.5 million and fixed asset acquisitions and purchases of
$11.2 million, offset by principal payments and maturities of securities
exceeding security purchases by $7.1 million and net cash acquired in the bank
acquisition of $6.9 million.
Financing activities generated net cash of $2.9 million for the year ended
September 30, 2004. The net cash was provided primarily from the proceeds from
the borrowing by MFB Corp from a correspondent bank mentioned below, partially
offset by decreases of $3.3 million in deposit cash flows. In August, 2004 MFB
Corp. contributed $6.5 million of additional capital to the Bank
- --------------------------------------------------------------------------------
15
in conjunction with MFB Financial's purchase of certain assets and liabilities
of Sobieski Bank. The capital contribution was funded by a $6.5 million
borrowing from MFB Corp's correspondent bank (see Note 8 of the Notes to the
Consolidated Financial Statements). The proceeds were used by the Bank to
bolster its capital ratios (see Note 11 of the Notes to the Consolidated
Financial Statements), fund the net cash of $407,000 paid at the acquisition's
closing and fund the various legal, accounting and regulatory expenses
associated with the acquisition totaling approximately $440,000.
NEW ACCOUNTING PRONOUNCEMENTS
EITF Issue 03-1 entitled, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments, contains accounting guidance regarding
other-than-temporary impairment on securities that was to take effect for the
quarter ended September 30, 2004. However, the effective date of portions of
this guidance has been delayed, and more interpretive guidance is to be issued
in the near future. The effect of this new and pending guidance on the Company's
financial statements is not known, but it is possible this guidance could change
management's assessment of other-than-temporary impairment in future periods.
(See discussion in Note 3 of the Notes to Consolidated Financial Statements
related to fair value of securities available for sale.)
On March 31, 2004, the FASB issued the Exposure Draft, Share-based payment,
which is a proposed amendment to SFAS No. 123, "Accounting for Stock-based
Compensation." In this draft, the FASB formally proposed to require companies to
recognize the fair value of stock options and other stock-based compensation to
employees for future reporting periods in the income statement based on their
fair values. The final standard would be effective for public companies for
interim or annual periods beginning after June 15, 2005. The Company is in the
process of evaluating the impact of the exposure draft.
IMPACT OF INFLATION
The audited consolidated financial statements presented herein have been
prepared in accordance with U.S generally accepted accounting principles. These
principles require measurement of financial position and operating results in
terms of historical dollars (except for securities available for sale which are
reported at fair market value and loans held for sale which are reported at the
lower of cost or estimated market value in the aggregate), without considering
changes in the relative purchasing power of money over time due to inflation.
The primary assets and liabilities of the Bank are monetary in nature. As a
result, interest rates have a more significant impact on the Company's
performance than the effects of general levels of inflation. Interest rates can
be affected by inflation. However, they do not necessarily move in the same
direction or with the same magnitude as the indexes that measure inflation.
In periods of rapidly changing interest rates, the liquidity and maturity
structures of the Company's assets and liabilities are critical to the
maintenance of acceptable performance levels. For a discussion of the Company's
continuing efforts to reduce its vulnerability to changes in interest rates, see
"Asset/Liability Management."
The principal effect of inflation, as distinct from levels of interest rates, on
earnings is in the area of noninterest expense. Such expense items as employee
compensation, employee benefits, and occupancy and equipment costs may be
subject to increases as a result of inflation. Although difficult to measure, an
additional effect of inflation is the possible increase in the dollar value of
the collateral securing loans made by the Bank.
- --------------------------------------------------------------------------------
16
FORWARD LOOKING STATEMENTS
When used in this filing and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases, "anticipate,"
"would be," "will allow," "intends to," "will likely result," "are expected to,"
will continue," "is anticipated," "estimated," "project," or similar expressions
are intended to identify, "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements are subject to
risks and uncertainties, including but not limited to changes in economic
conditions in the Company's market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in the Company's
market area, changes in the position of banking regulators on the adequacy of
our allowance for loan losses, changes in the fair value of securities available
for sale, changes in the value of the Company's mortgage servicing rights, and
competition, all or some of which could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and advise
readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investing activities, and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
- --------------------------------------------------------------------------------
17
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
MFB Corp.
Mishawaka, Indiana
We have audited the accompanying consolidated balance sheets of MFB Corp. and
Subsidiary as of September 30, 2004 and 2003 and the related consolidated
statements of income, shareholders' equity and cash flows for the years ended
September 30, 2004, 2003 and 2002. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of MFB Corp. and
Subsidiary as of September 30, 2004 and 2003, and the results of their
operations and their cash flows for the years ended September 30, 2004, 2003 and
2002 in conformity with U.S. generally accepted accounting principles.
Crowe Chizek and Company LLC
South Bend, Indiana
November 17, 2004
- --------------------------------------------------------------------------------
18
MFB CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, 2004 and 2003
- -------------------------------------------------------------------------------------------------------------------
2004 2003
---- ----
ASSETS
Cash and due from financial institutions $ 9,524,380 $ 13,881,081
Interest-bearing deposits in other financial
institutions - short-term 19,070,650 26,475,898
----------------- -----------------
Total cash and cash equivalents 28,595,030 40,356,979
Securities available for sale 66,021,011 40,028,743
Other Investments 12,628,329 10,019,782
Loans held for sale 1,033,800 6,625,540
Mortgage Loans 200,340,015 157,770,998
Commercial Loans 160,604,691 130,359,586
Consumer Loans 38,979,895 30,024,074
----------------- -----------------
Loans receivable 399,924,601 318,154,658
Less: allowance for loan losses (6,074,134) (5,198,137)
------------------ -----------------
Loans receivable, net 393,850,467 312,956,521
----------------- -----------------
Premises and equipment, net 19,384,466 6,089,647
Mortgage servicing rights, net 2,092,135 1,373,201
Cash surrender value of life insurance 5,706,756 5,217,387
Goodwill 2,362,836 -
Other intangible assets 2,692,900 -
Other assets 6,854,706 5,955,850
----------------- -----------------
Total assets $ 541,222,436 $ 428,623,650
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand deposits $ 31,657,521 $ 26,481,555
Savings, NOW and MMDA deposits 136,099,148 107,340,694
Time deposits 190,135,947 158,283,602
----------------- -----------------
Total deposits 357,892,616 292,105,851
----------------- -----------------
Federal Home Loan Bank advances 133,443,392 98,790,251
Loans from correspondent banks 6,500,000 300,000
Accrued expenses and other liabilities 7,480,558 3,176,342
----------------- -----------------
Total liabilities 505,316,566 394,372,444
----------------- -----------------
Shareholders' equity
Common stock, 5,000,000 shares authorized;
shares issued: 1,689,417 - 2004 and 2003, shares outstanding:
1,329,060 - 2004; 1,287,710 - 2003 12,486,314 12,560,058
Retained earnings - substantially restricted 32,194,679 31,022,460
Accumulated other comprehensive (loss),
net of tax of $37,932 in 2004 and ($35,735) in 2003 (791,717) (466,113)
Treasury stock, 360,357 common shares - 2004;
401,707 common shares - 2003, at cost (7,983,406) (8,865,199)
------------------ ------------------
Total shareholders' equity 35,905,870 34,251,206
----------------- -----------------
Total liabilities and shareholders' equity $ 541,222,436 $ 428,623,650
================= =================
- --------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
19
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years ended September 30, 2004, 2003 and 2002
- ------------------------------------------------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Interest income
Loans receivable, including fees $ 20,921,584 $ 21,033,219 $ 22,774,932
Securities 1,696,947 1,959,835 2,985,112
Other interest-earning assets 173,736 332,949 428,318
--------------- --------------- ----------------
Total interest income 22,792,267 23,326,003 26,188,362
Interest expense
Deposits 5,447,584 5,806,124 6,899,988
Securities sold under agreements
to repurchase - - 153,509
FHLB advances and other borrowings 5,641,984 6,438,114 6,775,439
--------------- --------------- ----------------
Total interest expense 11,089,568 12,244,238 13,828,936
--------------- --------------- ----------------
Net interest income 11,702,699 11,081,765 12,359,426
Provision for loan losses 800,000 1,110,000 3,369,431
--------------- --------------- ----------------
Net interest income after provision
for loan losses 10,902,699 9,971,765 8,989,995
Noninterest income
Service charges on deposit accounts 3,030,459 1,623,611 1,048,718
Trust fee income 494,922 463,561 297,727
Insurance commissions 208,036 187,143 158,097
Net realized gains from sales of loans 1,032,362 3,395,381 1,578,045
Loan servicing fees, net of amortization 51,460 (602,609) (83,752)
Mortgage servicing right recovery (impairment) 216,905 (576,376) -
Net gain (loss) on securities available for sale (109,253) 40,000 (933,958)
Other 755,497 450,081 104,414
--------------- --------------- -----------------
Total noninterest income 5,680,388 4,980,792 2,169,291
Noninterest expense
Salaries and employee benefits 7,020,737 6,802,641 5,922,166
Occupancy and equipment expense 2,742,768 1,558,025 1,482,756
Professional and consulting fees 1,226,498 363,828 296,840
Data processing expense 632,329 596,106 669,177
Other expense 2,936,183 2,561,010 2,121,091
--------------- --------------- ----------------
Total noninterest expense 14,558,515 11,881,610 10,492,030
--------------- --------------- ----------------
Income before income taxes 2,024,572 3,070,947 667,256
Income tax expense 234,923 671,163 18,719
--------------- --------------- ----------------
Net income $ 1,789,649 $ 2,399,784 $ 648,537
=============== =============== ================
Basic earnings per common share $ 1.36 $ 1.87 $ 0.49
Diluted earnings per common share 1.30 1.80 0.47
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
20
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended September 30, 2004, 2003 and 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other
Comprehensive Total
Retained Income (Loss), Treasury Shareholders'
Common Stock Earnings Net of Tax Stock Equity
------------ -------- - ---------- ----- ------
Balance at September 30, 2001 $ 13,023,255 $ 29,088,683 $ 45,036 $ (7,776,959) $ 34,380,015
------------ ------------ ------------ ------------ ------------
Purchase of 23,190 shares of treasury stock (506,881) (506,881)
Stock option exercise-issuance of 16,700 shares
of treasury stock (199,642) 366,642 167,000
Tax benefit related to employee stock plan 57,103 57,103
Cash dividends declared - $.415 per share (554,220) (554,220)
Comprehensive income:
Net income for the year end September 30, 2002 648,537 648,537
Other comprehensive income (loss) (239,117) (239,117)
--------------
Total comprehensive income - - - - 409,420
------------- ------------- -------------- ------------- -------------
Balance at September 30, 2002 12,880,716 29,183,000 (194,081) (7,917,198) 33,952,437
------------- ------------- -------------- ------------- -------------
Purchase of 75,339 shares of treasury stock (1,676,634) (1,676,634)
Stock option exercise-issuance of 33,000 shares
of treasury stock (350,508) - - 728,633 378,125
Tax benefit related to employee stock plan 29,850 - - - 29,850
Cash dividends declared - $.435 per share - (560,324) - - (560,324)
Comprehensive income:
Net income for the year end September 30, 2003 - 2,399,784 - - 2,399,784
Other comprehensive income (loss) - - (272,032) - (272,032)
--------------
Total comprehensive income - - - - 2,127,752
------------- ------------- -------------- ------------- -------------
Balance at September 30, 2003 $ 12,560,058 $ 31,022,460 $ (466,113) $ (8,865,199) $ 34,251,206
============= ============= =============== ============== =============
- ---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
21
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended September 30, 2004, 2003 and 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other
Comprehensive Total
Retained Income (Loss) Treasury Shareholders'
Common Stock Earnings Net of Tax Stock Equity
------------ -------- ---------- ----- ------
Balance at September 30, 2003 $ 12,560,058 $ 31,022,460 $ (466,113) $ (8,865,199) $ 34,251,206
Stock option exercise-issuance of 41,350 shares
of treasury stock (359,104) - - 881,793 522,689
Tax benefit related to employee stock plan 285,360 - - - 285,360
Cash dividends declared - $.47 per share - (617,430) - - (617,430)
Comprehensive income:
Net income for the year end September 30, 2004 - 1,789,649 - - 1,789,649
Other comprehensive income (loss) - - (325,604) - (325,604)
--------------
Total comprehensive income - - - - 1,464,045
------------- ------------- -------------- ------------- -------------
Balance at September 30, 2004 $ 12,486,314 $ 32,194,679 $ (791,717) $ (7,983,406) $ 35,905,870
============= ============= =============== ============== =============
- ----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
22
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Cash flows from operating activities
Net income $ 1,789,649 $ 2,399,784 $ 648,537
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization, net of
accretion 1,278,662 1,343,323 1,207,633
Provision for loan losses 800,000 1,110,000 3,369,431
Net (gains) losses on securities available for sale 109,253 (40,000) 933,958
Net realized gains from sales of loans (1,032,362) (3,395,381) (1,578,045)
Amortization of mortgage servicing rights 388,580 996,128 365,993
Accretion of intangible assets
and purchase adjustments (133,391) - -
Origination of loans held for sale (40,741,232) (103,572,557) (76,592,582)
Impairment (recovery) of mortgage
servicing rights (216,905) 576,376 -
Proceeds from sales of loans held for sale 46,784,299 115,074,018 73,926,222
Loss on sales of fixed assets 46,165 - -
Equity in loss of investment in limited
partnership 220,253 165,571 163,495
Appreciation in cash surrender value of
life insurance (230,080) (217,387) -
Net change in:
Accrued interest receivable 87,453 244,558 8,095
Other assets 1,074,707 111,208 (2,021,347)
Accrued expenses and other liabilities 2,392,077 (218,535) 1,022,653
--------------- ---------------- ----------------
Net cash from operating activities 12,617,128 14,577,106 1,454,043
Cash flows from investing activities
Net change in interest-bearing time
deposits in other financial institutions (500,000) (501,160) 1,000,000
Net change in loans receivable (29,469,712) (12,474,759) (7,636,389)
Net cash received in acquisition 6,873,938 - -
Proceeds from:
Sales of securities available for sale - 160,000 5,311,521
Principal payments of mortgage-backed
and related securities 9,212,720 34,371,588 21,451,698
Maturities and calls of securities available
for sale 8,944,482 5,000,000 21,794,846
Sales of fixed assets 318,039 - -
Purchase of:
Securities available for sale (11,049,719) (27,152,202) (56,127,721)
Life Insurance (170,545) (5,000,000) -
Premises and equipment, net (11,180,184) (1,527,053) (516,062)
Stock dividend paid by FHLB (312,300) (163,000) -
--------------- ---------------- ----------------
Net cash used in investing activities $ (27,333,281) $ (7,286,586) $ (14,722,107)
- ---------------------------------------------------------------------------------------------------------------------
Continued
23
MFB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 2004, 2003 and 2002
Cash flows from financing activities
Purchase of treasury stock $ - $ (1,676,634) $ (506,881)
Net change in deposits (3,292,653) 27,728,373 19,198,225
Net change in securities sold under
agreements to repurchase - - (11,021,511)
Proceeds from FHLB borrowings 38,000,000 - -
Repayment of FHLB borrowings (38,929,859) (20,424,864) (469,870)
Proceeds from other borrowings 6,500,000 300,000 -
Repayment of other borrowings (300,000) - -
Proceeds from exercise of stock options 522,689 378,125 167,000
Net change in advances from
borrowers for taxes and insurance 1,071,457 (260,488) (185,696)
Cash dividends paid (617,430) (560,324) (554,220)
--------------- ---------------- ----------------
Net cash from financing activities 2,954,204 5,484,188 6,627,047
--------------- ---------------- ----------------
Net change in cash and cash equivalents (11,761,949) 12,774,708 (6,641,017)
Cash and cash equivalents at beginning of year 40,356,979 27,582,271 34,223,288
--------------- ---------------- ----------------
Cash and cash equivalents at end of year $ 28,595,030 $ 40,356,979 $ 27,582,271
=============== =============== ================
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 10,834,701 $ 11,782,216 $ 13,598,405
Income taxes 670,000 400,000 811,500
Supplemental schedule of noncash investing activities:
Transfer from:
Loans receivable to loans held for sale $ - $ 9,656,411 $ -
Loans receivable to real estate owned $ 1,346,757 $ 1,020,835 $ 348,320
- --------------------------------------------------------------------------------------------------------------------
(Continued)
24
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of MFB Corp., and its wholly-owned subsidiary MFB Financial
(the "Bank"), a federal stock savings bank, and the wholly-owned subsidiaries of
the Bank, Mishawaka Financial Services, Inc., MFB Investments I, Inc., MFB
Investments II, Inc. and MFB Investments, LP (together referred to as "the
Company"). Mishawaka Financial Services, Inc. is engaged in the sale of general
property, casualty, life and health insurance to customers in the Bank's market
area. MFB Investments I, Inc., MFB Investments II, Inc. and MFB Investments, LP
are Nevada corporations and a Nevada limited partnership that manage a portion
of the Bank's investment portfolio. All significant intercompany transactions
and balances are eliminated in consolidation.
Nature of Business and Concentrations of Credit Risk: The primary source of
income for the Company results from granting commercial, consumer and
residential real estate loans in St. Joseph and Elkhart counties and the
surrounding area. The Company operates primarily in the banking industry which
accounts for more than 95% of its revenues, operating income and assets.
Use of Estimates In Preparing Financial Statements: The preparation of
consolidated financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period, as well as the
disclosures provided. Areas involving the use of estimates and assumptions in
the accompanying financial statements include the allowance for loan losses,
fair values of securities and other financial instruments, determination and
carrying value of loans held for sale, determination and carrying value of
impaired loans, the value of mortgage servicing rights, the value of investments
in limited partnerships, the value of stock options, the realization of deferred
tax assets, the purchase accounting valuations for assets and liabilities
acquired and the determination of depreciation of premises and equipment
recognized in the Company's financial statements. Actual results could differ
from those estimates. Estimates associated with the allowance for loan losses,
and the fair values of securities and other financial instruments and mortgage
servicing rights are particularly susceptible to material change in the near
term.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash
equivalents is defined to include the Company's cash on hand, due from financial
institutions and short-term interest-bearing deposits in other financial
institutions. The Company reports net cash flows for customer loan transactions,
deposit transactions, short term borrowings having an original maturity of 90
days or less, advances from borrowers for taxes and insurance, and
interest-bearing time deposits in other financial institutions.
- --------------------------------------------------------------------------------
(Continued)
25
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Securities: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with unrealized holding gains and losses reported separately in accumulated
other comprehensive income loss), net of tax. Securities are written down to
fair value when a decline in fair value is not temporary.
Gains and losses on the sale of securities are determined using the specific
identification method based on amortized cost and are reflected in results of
operations at the time of sale. Interest and dividend income, adjusted by
amortization of purchase premium or discount over the estimated life of the
security using the level yield method, is included in earnings.
Mortgage Banking Activities: Mortgage loans originated and intended for sale in
the secondary market are reported as loans held for sale and are carried at the
lower of cost or estimated market value in the aggregate. Net unrealized losses
are recognized in a valuation allowance by charges to income.
Servicing rights are recognized as assets for purchased rights and for the
allocated value of retained servicing rights on loans sold. Servicing rights are
expensed in proportion to, and over the period of, estimated net servicing
revenues. Impairment is evaluated based on the fair value of the rights,
determined using prices for similar assets with similar characteristics, when
available, or based upon discounted cash flows using market-based assumptions.
Any impairment is reported as a valuation allowance.
Loans Receivable: Loans receivable that management has the intent and ability to
hold for the foreseeable future or until maturity or pay-off are reported at
their outstanding principal balances adjusted for any charge-offs, the allowance
for loan losses, and any deferred fees or costs on originated loans, and
unamortized premiums or discounts on purchased loans. Loan fees and certain
direct loan origination costs are deferred, and the net fee or cost is
recognized as an adjustment to interest income using the interest method.
Because some loans may not be repaid in full, an allowance for loan losses is
recorded. An allowance for loan losses is a valuation allowance for probable
incurred credit losses. The allowance for loan losses is increased by a
provision for loan losses charged to expense and decreased by charge-offs (net
of recoveries). Estimating the risk of loss and the amount of loss on any loan
is necessarily subjective. Accordingly, the allowance is maintained by
management at a level considered adequate to cover losses that are currently
anticipated. Management's periodic evaluation of the adequacy of the allowance
is based on the Company's past loan loss experience, known and inherent risks in
the portfolio, periodic, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral, and current
economic conditions. While management may periodically allocate portions of the
allowance for specific problem loan situations, the whole allowance is available
for any loan charge-offs that occur. Loan losses are charged against the
allowance when management believes the uncollectibility of a loan balance is
confirmed.
- --------------------------------------------------------------------------------
(Continued)
26
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Smaller-balance homogeneous loans are evaluated for impairment in total. Such
loans include residential first mortgage loans secured by one-to-four family
residences, residential construction loans, automobile, manufactured homes, home
equity and second mortgage loans. Commercial loans and mortgage loans secured by
other properties are evaluated individually for impairment. Loans are considered
impaired if full principal or interest payments are not anticipated in
accordance with the contractual loan terms. Impaired loans are carried at the
present value of expected future cash flows discounted at the loan's effective
interest rate, or at the fair value of the collateral if the loan is collateral
dependent. A portion of the allowance for loan losses is allocated to impaired
loans if the value of such loans is deemed to be less than the unpaid balance.
If these allocations cause the allowance for loan losses to require an increase,
such increase is reported as a component of the provision for loan losses.
Interest income on loans is accrued over the term of the loans based upon the
principal outstanding. The accrual of interest on loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent that
cash payments are received until, in management's judgment, the borrower has the
ability to make contractual interest and principal payments, in which case the
loan is returned to accrual status.
Foreclosed Real Estate: Real estate properties acquired through, or in lieu of,
loan foreclosure are initially recorded at the lower of carrying amount or fair
value at the date of acquisition, establishing a new cost basis. Any reduction
to fair value from the carrying amount of the related loan at the time of
acquisition is accounted for as a loan loss and charged against the allowance
for loan losses. Valuations are periodically performed by management and
valuation allowances are adjusted through a charge to income for changes in fair
value or estimated selling costs.
Income Taxes: Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. As changes in tax
laws or rates are enacted, deferred tax assets and liabilities are adjusted
through income tax expense. A valuation allowance, if needed, reduces deferred
tax assets to the amount expected to be realized.
Premises and Equipment: Land is carried at cost. Buildings and improvements and
furniture and equipment are carried at cost, less accumulated depreciation and
amortization computed principally by using the straight-line method over the
estimated useful lives of the assets. Useful life of buildings and improvements
is 39 years and the range for furniture and equipment is 3 years to 15 years.
These assets are reviewed for impairment when events indicate the carrying
amount is significantly less than the fair value.
Employee Stock Ownership Plan (ESOP): The Company accounts for its ESOP under
AICPA Statement of Position (SOP) 93-6. The cost of shares issued to the ESOP,
but not yet allocated to participants, are presented as a reduction of
shareholders' equity. Compensation expense is recorded based on the average
market price of the shares committed to be released for allocation to
participant accounts. The difference between the market price and the cost of
shares
- --------------------------------------------------------------------------------
(Continued)
27
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
committed to be released is recorded as an adjustment to common stock. Dividends
on allocated ESOP shares are recorded as a reduction of retained earnings;
dividends on unearned ESOP shares are reflected as a reduction of debt and
accrued interest.
Financial Instruments with Off-Balance-Sheet Risk: The Company, in the normal
course of business, makes commitments to make loans which are not reflected in
the consolidated financial statements. A summary of these commitments is
disclosed in Note 13.
Goodwill and Other intangible Assets: Goodwill results from business
acquisitions and represents the excess of the purchase price over the fair value
of acquired tangible assets and liabilities and identifiable intangible assets.
Goodwill is assessed at least annually for impairment and any such impairment
will be recognized in the period identified.
Other intangible assets consist of core deposit intangible assets and acquired
customer relationship intangible assets arising from the acquisition of certain
assets and assumption of certain liabilities previously discussed. They are
initially measured at fair value and then are amortized on an accelerated method
over their estimated useful lives.
Investments in Limited Partnerships: Investments in limited partnerships
represent the Company's investments in affordable housing projects for the
primary purpose of available tax benefits. The Company is a limited partner in
these investments and as such, the Company is not involved in the management or
operation of such investments. These investments are accounted for using the
equity method of accounting. Under the equity method of accounting, the Company
records its share of the partnership's earnings or losses in its income
statement and adjusts the carrying amount of the investments on the balance
sheet. These investments are reviewed for impairment when events indicate their
carrying amounts may not be recoverable from future undiscounted cash flows. If
impaired, the investments are reported at discounted amounts.
Cash Surrender Value of Life Insurance: The Company has purchased life insurance
policies on certain key executives. Company owned life insurance is recorded at
its cash surrender value, or the amount that can be realized.
Earnings Per Common Share: Basic earnings per common share is based on the net
income divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per common share shows the dilutive
effective of additional potential common shares issuable under stock option
plans.
Stock-Based Compensation: Compensation expense under stock options is reported
using the intrinsic value method. No stock-based compensation cost is reflected
in net income, as all options granted had an exercise price equal to or greater
than the market price of the underlying common stock at date of grant. The
following table illustrates the effect of net income and earnings per share if
expense was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation.
- --------------------------------------------------------------------------------
(Continued)
28
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Net income as reported $1,789,649 $2,399,784 $ 648,537
Less: Stock-based compensation
expense determined under fair value
based method 223,176 198,346 159,852
---------- ---------- -----------
Proforma net income $1,566,473 $2,201,438 $ 488,685
========== ========== ===========
Basic earnings per share as reported $ 1.36 $ 1.87 $ 0.49
Pro forma basic earnings per share 1.19 1.71 0.37
Diluted earnings per share as reported $ 1.30 $ 1.80 $ 0.47
Pro forma diluted earnings per share 1.14 1.65 0.36
The fair values for the options granted during the year were estimated at the
date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions:
2004 2003 2002
---- ---- ----
Risk-free interest rate 4.11% 3.72% 4.83%
Expected dividend rate 1.44 1.82 2.06
Stock price volatility 24.53 23.23 14.41
Estimated Life 8 yrs 8 yrs 8 yrs
In future years, as additional options are granted, the proforma effect on net
income and earnings per share may increase. Stock options are used to reward
directors and certain executive officers and provide them with an additional
equity interest. Options are issued for ten year periods and have varying
vesting schedules.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income (loss). Other comprehensive income (loss) includes the net
change in net unrealized gains and losses on securities available for sale, net
of reclassification adjustments and tax effects, and is also recognized as a
separate component of shareholders' equity.
Segments: MFB Corp. and its subsidiary, MFB Financial and its subsidiary
Mishawaka Financial Services, Inc. provide a broad range of financial services
to individuals and companies in Mishawaka and the surrounding area. These
services include demand, time and savings deposits; lending; insurance; trust
and other financial services. While the Company's management monitors the
revenue streams of the various Company products and services, operations are
managed and financial performance is evaluated on a Company-wide basis.
Accordingly, all of the Company's banking operations are considered by
management to be aggregated in one reportable operating segment.
Restriction on Cash: Cash on hand or on deposit with correspondent banks of $5.3
million and $3.8 million, respectively, was required to meet regulatory reserve
and clearing requirements at year end 2004 and 2003.
- --------------------------------------------------------------------------------
(Continued)
29
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Reclassifications: Some items in the prior consolidated financial statements
have been reclassified to conform with the current presentation.
- --------------------------------------------------------------------------------
(Continued)
30
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 2 - EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators used in the computation of
the basic earnings per common share and diluted earnings per common share is
presented below:
Year ended September 30,
2004 2003 2002
---- ---- ----
Basic Earnings Per Common Share
Numerator
Net income $ 1,789,649 $ 2,399,784 $ 648,537
============== ============== ===============
Denominator
Weighted average common shares
outstanding for basic earnings per
common share 1,316,115 1,285,661 1,334,260
============== ============== ===============
Basic earnings per common share $ 1.36 $ 1.87 $ 0.49
============== ============== ===============
Diluted Earnings Per Common Share
Numerator
Net income $ 1,789,649 $ 2,399,784 $ 648,537
============== ============== ===============
Denominator
Weighted average common shares
outstanding for basic earnings per
common share 1,316,115 1,285,661 1,334,260
Add: Dilutive effects of assumed
exercises of stock options 59,885 44,808 39,617
-------------- -------------- ---------------
Weighted average common shares
and dilutive potential common
shares outstanding 1,376,000 1,330,469 1,373,877
============== ============== ===============
Diluted earnings per common share $ 1.30 $ 1.80 $ 0.47
============== ============== ===============
Stock options for 5,000, -0-, and 42,500 shares of common stock were not
considered in computing diluted earnings per common share for the years ended
September 30, 2004, 2003 and 2002 because they were antidilutive.
- --------------------------------------------------------------------------------
(Continued)
31
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 3 - SECURITIES
The amortized cost and fair value of securities available for sale are as
follows:
-------------------------September 30, 2004--------------------------
------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Debt securities
U.S. Government
and federal agencies $ 9,303,466 $ 54,182 $ (6,017) $ 9,351,631
Municipal bonds 343,334 13,176 - 356,510
Mortgage-backed 45,266,242 232,176 (93,096) 45,405,322
Corporate notes 7,733,879 131,603 (210,809) 7,654,673
---------------- ------------ -------------- ---------------
62,646,921 431,137 (309,922) 62,768,136
Marketable equity securities 4,127,875 - (875,000) 3,252,875
---------------- ------------ -------------- ---------------
$ 66,774,796 $ 431,137 $ (1,184,922) $ 66,021,011
================ ============ ============== ===============
-------------------------September 30, 2003--------------------------
------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Debt securities
U.S. Government
and federal agencies $ 9,368,820 $ 194,081 $ - $ 9,562,901
Municipal bonds 346,124 22,772 - 368,896
Mortgage-backed 16,807,629 67,861 (106,398) 16,769,092
Corporate notes 9,770,890 196,087 (480,548) 9,486,429
---------------- ------------ -------------- ---------------
36,293,463 480,801 (586,946) 36,187,318
Marketable equity securities 4,237,128 - (395,703) 3,841,425
---------------- ------------ -------------- ---------------
$ 40,530,591 $ 480,801 $ (982,649) $ 40,028,743
================ ============ ============== ===============
- -----------------------------------------------------------------------------------------------------------------
(Continued)
32
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 3 - SECURITIES (Continued)
Securities with unrealized losses at year-end 2004, aggregated by investment
category and length of time that individual securities have been in a continuous
unrealized loss position, are as follows:
Less than 12 Months 12 Months or More Total
------------------- ----------------- -----
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
----- ---- ----- ---- ----- ----
Debt securities
U.S. Government and $ 2,852,257 $ (6,017) $ - $ - $ 2,852,257 $ (6,017)
federal agencies
Mortgage-backed 12,964,402 (52,988) 3,873,878 (40,108) 16,838,280 (93,096)
Corporate notes 984,855 (15,145) 4,768,560 (195,664) 5,753,415 (210,809)
----------- --------- ------------ ------------ ------------- -----------
16,801,514 (74,150) 8,642,438 (235,772) 25,443,952 (309,922)
Marketable equity securities - - 3,125,000 (875,000) 3,125,000 (875,000)
----------- --------- ------------ ------------ ------------- -----------
Total $16,801,514 $ (74,150) $ 11,767,438 $ (1,110,772) $ 28,568,952 $(1,184,922)
=========== ========= ============ ============ ============= ===========
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the Company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Of the total gross unrealized losses of $1,185,000, $875,000 relates to the
reduced value of floating rate preferred stocks of government sponsored
agencies. This decline in value is primarily attributable to the current level
of interest rates, and the timing of scheduled coupon adjustments, which occur
every one to two years. Such adjustments resulted in coupons being set at a
level lower than today's market. Credit issues are not considered to be a
significant factor relative to the current unrealized losses. As the level of
interest rates rise, and coupons are adjusted, the value of the preferred stock
issues is expected to increase. Based on current interest rate forecasts and the
resulting estimates of recovery obtained by the Company from outside experts,
management currently expects recovery of the unrealized losses.
Related to the unrealized losses for debt securities classified as corporate
notes, $167,000 of unrealized losses is attributable to a trust preferred bond
issued by a regional banking organization. This unrealized loss is primarily
attributable to the low interest rate environment, and the variable interest
rate structure of the bond. Such interest rate adjustments resulted in coupons
being set at a level lower than today's market. As interest rates rise and the
bonds coupon rate increases, management anticipates recovery of the unrealized
losses. Management has the ability to hold this bond to maturity, at which time
the face value of the bond would be realized. Credit issues are not considered
to be a significant factor relative to the current unrealized losses.
The amortized cost and fair value of debt securities by contractual maturity are
shown below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
- --------------------------------------------------------------------------------
(Continued)
33
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
September 30, 2004
------------------
Amortized Fair
Cost Value
---- -----
Due in one year or less $ 4,439,269 $ 4,525,933
Due after one year through
five years 11,723,023 11,646,690
Due after five years through
ten years 224,654 224,561
Due after ten years 993,733 965,630
---------------- ---------------
17,380,679 17,362,814
Mortgage-backed securities 45,266,242 45,405,322
---------------- ---------------
$ 62,646,921 $ 62,768,136
================ ===============
Proceeds from sales of securities available for sale were $-0- during the year
ended September 30, 2004. A $109,253 write down on a corporate stock held by MFB
Corp. was recorded based on current estimates of fair value for the year ended
September 30, 2004.
Proceeds from sales and liquidation of securities available for sale were
$160,000 during the year ended September 30, 2003. Gross gains of $40,000 and
gross losses of $-0- were realized on these sales.
Proceeds from sales of securities available for sale were $5,311,521 during the
year ended September 30, 2002. Gross gains of $130,287 and gross losses of
$168,766 were realized on these sales. The company recorded an $895,479 write
down on a $1.0 million WorldCom, Inc. corporate note investment during its
fiscal third quarter, 2002. The sale of this investment accounted for the
$160,000 in proceeds and $40,000 gain for the year ended September 30, 2003.
- --------------------------------------------------------------------------------
(Continued)
34
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 4 - LOANS RECEIVABLE
Loans receivable, at September 30 are summarized as follows:
2004 2003
---- ----
Residential mortgage loans:
Secured by one-to-four family residences $ 176,816,762 $ 129,472,398
Construction loans 20,259,466 22,066,066
Other 3,898,833 6,727,880
----------------- -----------------
200,975,061 158,266,344
Less:
Net deferred loan origination fees (496,427) (557,611)
Undisbursed portion of construction and
other mortgage loans (138,619) 62,265
------------------ -----------------
Total residential mortgage loans 200,340,015 157,770,998
Commercial
Commercial real estate 99,198,554 80,913,758
Commercial 61,752,718 49,709,400
----------------- -----------------
160,951,272 130,623,158
Less: net deferred loan origination fees (346,581) (263,572)
----------------- -----------------
Total commercial loans 160,604,691 130,359,586
Consumer loans:
Home equity and second mortgage 32,006,458 24,534,708
Other 6,973,437 5,489,366
----------------- -----------------
Total consumer loans 38,979,895 30,024,074
Total Loans Receivable $ 399,924,601 $ 318,154,658
================= =================
Activity in the allowance for loan losses is summarized as follows for the years
ended September 30:
2004 2003 2002
---- ---- ----
Balance at beginning of year $ 5,198,137 $ 5,143,005 $ 4,631,981
Provision for loan losses 800,000 1,110,000 3,369,431
Acquired allowance for loan losses 602,467 - -
Charge-offs (543,734) (1,388,152) (2,872,683)
Recoveries 17,264 333,284 14,276
-------------- ----------------- -----------------
Balance at end of year $ 6,074,134 $ 5,198,137 $ 5,143,005
============== ================= =================
- --------------------------------------------------------------------------------
(Continued)
35
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 4 - LOANS RECEIVABLE (Continued)
Impaired loans were as follows:
2004 2003
---- ----
Year-end loans with no allocated allowance
for loan losses $ - $ -
Year-end loans with allocated allowance
for loan losses 2,217,000 4,027,000
--------------- ----------------
Total $ 2,217,000 $ 4,027,000
=============== ================
Amount of the allowance for loan
losses allocated $ 995,000 $ 1,370,000
Average of impaired loans during the year 2,506,000 5,233,000
Interest income recognized during impairment 82,000 82,000
Cash-basis interest income recognized during
impairment 73,000 66,000
The average balance of impaired loans in 2002 was $8,070,000 and there was
$227,000 interest income and $226,000 cash-basis interest income recognized
during impairment.
Nonperforming loans were as follows at year end.
2004 2003
---- ----
Loans past due over 90 days still on accrual status $ - $ -
Non-accrual loans 2,719,000 3,845,000
--------------- ----------------
Total nonperforming loans $ 2,719,000 $ 3,845,000
=============== ================
A total of $1.4 million and $3.6 million of the impaired loans were non-accrual
loans as of September 30, 2004 and 2003.
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The Company is subject to certain recourse
obligations on the loans serviced for Telebank. The unpaid principal balances of
mortgage loans serviced for others at September 30, 2004 and 2003 are summarized
as follows:
2004 2003
---- ----
Mortgage loan portfolios serviced for:
Federal Home Loan Mortgage Corporation $ 197,860,783 $ 150,542,108
Fannie Mae Corporation 2,303,866 4,532,304
Merchants Bank 1,290,447 1,637,562
Telebank 956,407 1,009,175
Hanover Capital Mortgage Holdings, Inc. 495,090 775,670
LaSalle Bank, FSB 867,408 1,088,242
Citizens Bank 691,911 861,611
Federal Home Loan Bank of Indianapolis 1,090,545 1,118,750
Bank Mutual 975,002 -
--------------- ----------------
$ 206,531,459 $ 161,565,422
=============== ================
- ---------------------------------------------------------------------------------------------------------------------
(Continued)
36
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 4 - LOANS RECEIVABLE, (Continued)
Custodial escrow balances maintained in connection with the foregoing serviced
loans were $3,202,322 and $1,247,181 at September 30, 2004 and 2003.
Activity for capitalized mortgage servicing rights and the related valuation
allowance was as follows:
2004 2003 2002
---- ---- ----
Servicing rights, net of valuation allowance:
Balance at beginning of year $ 1,373,201 $ 1,616,588 $ 1,068,801
Additions 581,035 1,329,117 913,780
Change in Valuation allowance 216,905 (576,376) -
Acquired from Sobieski 309,574 - -
Amortized to expense (388,580) (996,128) (365,993)
-------------- ------------- -------------
Balance at end of year $ 2,092,135 $ 1,373,201 $ 1,616,588
============== ============= =============
Valuation allowance:
Balance at beginning of year $ (576,376) $ -
Impairment charge (414,736) (1,155,894)
Impairment recovery 631,641 579,518
-------------- --------------
Balance at end of year $ (359,471) $ (576,376)
============== ==============
Certain directors and executive officers of the Company and its subsidiary,
including associates of such persons, are loan customers. A summary of the
related party loan activity, for loans aggregating $60,000 or more to any one
related party, is as follows:
2004 2003
---- ----
Balance at beginning of year $ 2,333,898 $ 2,058,788
New loans 215,335 1,058,916
Repayments (601,218) (783,806)
----------------- ---------------
Balance at end of year $ 1,948,015 $ 2,333,898
================ ===============
- --------------------------------------------------------------------------------
(Continued)
37
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 5 - PREMISES AND EQUIPMENT, NET
Premises and equipment at September 30 are summarized as follows:
2004 2003
---- ----
Land $ 4,492,767 $ 1,851,042
Buildings and improvements 13,187,855 4,606,342
Furniture and equipment 6,319,254 3,707,259
------------- ------------
Total cost 23,999,876 10,164,643
Accumulated depreciation and amortization (4,615,410) (4,074,996)
-------------- ------------
$ 19,384,466 $ 6,089,647
============= ============
Depreciation and amortization of premises and equipment included in occupancy
and equipment expense was approximately $945,000, $557,000 and $562,000 for the
years ended September 30, 2004, 2003 and 2002, respectively. The Company
purchased a new corporate headquarters building on October 31, 2003 at a cost of
$7.3 million including land cost of $1.75 million. Building improvements on the
new Corporate headquarters totaled $743,000 in 2004. Premises and equipment
added in the Sobieski acquisition totaled $3.4 million.
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
Goodwill
The change in balance for goodwill during the year ended September 30, 2004 is
as follows:
2004
Beginning of year $ -
Acquired goodwill 2,362,836
-------------
End of Year $ 2,362,836
=============
Acquired Intangible Assets
Acquired intangible assets were as follows as of year end:
2004
Gross Carrying Accumulated
Amount Amortization
Amortized intangible assets:
Core deposit intangibles $ 1,610,000 $ 48,800
Other customer relationship intangibles 1,180,000 48,300
-------------------- ------------------
Total $ 2,790,000 $ 97,100
==================== ==================
- ----------------------------------------------------------------------------------------------
(Continued)
38
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Aggregate amortization expense was $97,100 for 2004.
Estimated amortization expenses for each of the next five years ending September
30:
2005 $ 559,200
2006 435,100
2007 385,500
2008 335,800
2009 286,300
NOTE 7 - DEPOSITS
At September 30, 2004, the scheduled maturities of certificates of deposit for
the years ending September 30, are as follows:
2005 $109,463,008
2006 22,748,111
2007 45,886,909
2008 8,535,751
2009 2,448,897
Thereafter 1,053,271
------------
$190,135,947
============
The aggregate amount of short-term jumbo certificates of deposit in
denominations of $100,000 or more was approximately $42,736,000 and $38,795,000
at September 30, 2004 and 2003.
NOTE 8 - BORROWINGS
At September 30, 2004, advances from the Federal Home Loan Bank of Indianapolis
with fixed and variable rates ranging from 3.60% to 7.31% are required to be
repaid in the year ending September 30 as follows:
2005 $ 11,200,000
2006 10,500,000
2007 9,000,000
2008 53,000,000
2009 17,160,392
Thereafter 32,583,000
------------
$133,443,392
============
At September 30, 2004, $8,799,400 of FHLB stock, $168,762,000 of eligible
mortgage loan collateral, $55,449,000 of other real estate related collateral,
and $21,263,000 of other securities are pledged to the FHLB to secure advances
outstanding. The Company's additional borrowing capacity with the FHLB is $17.7
million at September 30, 2004.
- --------------------------------------------------------------------------------
(Continued)
39
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
In addition, $112 million of the advances outstanding at September 30, 2004
contained put options with put dates ranging from October 2004 to January 2005,
whereby the advance can be called by the FHLB prior to maturity.
In the quarter ended September 30, 2004, the Company borrowed $6.5 million from
a correspondent bank. This variable rate line of credit, tied to the one year
LIBOR rate plus 175 basis points (presently at 4.33% as of September 30, 2004),
matures on August 31, 2005, at which time it may be converted to a term loan to
be amortized over a five year period.
The borrowing is collateralized by MFB Financial stock and requires the Bank to
remain "well-capitalized" as defined by regulatory capital adequacy guidelines.
NOTE 9 - EMPLOYEE BENEFITS
Employee Pension Plan: On April 1, 2003, the Bank terminated its qualified
noncontributory multiple-employer defined benefit pension plan covering
substantially all of its employees. The plan was administered by the trustees of
the Financial Institutions Retirement Fund. At termination, the Company made a
contribution of $148,000 to the Fund as part of the termination agreement to
cover the deficit between the vested benefits and the value of the Company's
calculated portion of the total plan assets. Pension plan expense for the years
ended September 30, 2003 and 2002 was approximately $148,000 and $5,300,
respectively.
401(k) Plan: The Company maintains a retirement savings 401(k) plan which covers
all full time employees who are 21 years or older and have completed one year of
service. Participants may defer up to 15% of compensation, and the Company
increased its match to 125% (90% for the years ending September 30, 2003 and
2002) of elective deferrals on 6% of the participants' compensation effective
October 1, 2003. Expense for the 401(k) plan for the years ended September 30,
2004, 2003 and 2002 was approximately $315,000, $193,000 and $150,000,
respectively.
Employee Stock Ownership Plan (ESOP): The Company maintains an ESOP for eligible
employees. Employees with at least one year of employment and who have attained
age twenty-one are eligible to participate. Benefits generally become 100%
vested after five years of credited service. A participant who terminates
employment for reasons other than death, normal retirement (or early
retirement), or disability prior to the completion of five years of credited
service does not receive any benefits under the ESOP. Forfeitures are
reallocated among the remaining participating employees, in the same proportion
as contributions. Benefits are payable in the form of stock except for
fractional shares which are paid in cash upon termination of employment. The
Company's contributions to the ESOP are not fixed, so benefits payable under the
ESOP cannot be estimated. ESOP participants receive distributions from their
ESOP accounts only upon termination of service.
The ESOP shares as of September 30 were as follows:
2004 2003 2002
---- ---- ----
Allocated shares 152,750 152,750 147,500
Shares withdrawn from the plan by participants (29,984) (24,274) (16,198)
-------------- ------------- ---------------
Total ESOP shares held in the plan 122,766 128,476 131,302
============== ============= ===============
- --------------------------------------------------------------------------------
(Continued)
40
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Stock Option Plans: The Board of Directors of the Company has adopted the MFB
Corp. Stock Option Plans (the "Option Plans"). The number of options authorized
under the Plans totals 450,000 shares of common stock. Officers, employees and
outside directors of the Company and its subsidiary are eligible to participate
in the Option Plans. The option exercise price must be no less than 85% of the
fair market value of common stock on the date of the grant, and the option term
cannot exceed ten years and one day from the date of the grant. As of September
30, 2004, all options granted have an exercise price of at least 100% of the
market value of the common stock on the date of grant and no compensation
expense was recognized for stock options for the years ended September 30, 2004,
2003 and 2002. As of September 30, 2004, 68,000 options remain available for
future grants.
Activity in the Option Plans is summarized as follows:
Weighted Weighted
Number of Average Average
Outstanding Exercise Exercise Fair Value
Options Price Price of Grants
------- ----- ----- ---------
Balance at September 30, 2001 188,650 $10.00 - 26.75 $16.68
Granted 16,500 18.75 - 20.55 19.73 $ 4.45
Forfeited (2,500) 17.25 - 20.55 17.91
Exercised (16,700) 10.00 10.00
--------
Balance at September 30, 2002 185,950 10.00 - 26.75 17.53
Granted 59,000 21.30 21.30 5.82
Forfeited (500) 21.30 21.30
Exercised (33,000) 10.00 - 21.30 11.46
--------
Balance at September 30, 2003 211,450 10.00 - 26.75 19.71
Granted 26,500 30.35 - 34.01 31.90 9.96
Forfeited - - -
Exercised (41,350) 10.00 - 26.75 13.30
--------
Balance at September 30, 2004 196,600 15.00 - 34.01 22.69
========
Options exercisable at September 30, based on vesting schedules established
at date of grant, are as follows:
Weighted
Number Average
of Options Exercise Price
---------- --------------
2002 156,264 $ 16.91
2003 139,994 18.68
2004 123,494 22.04
- --------------------------------------------------------------------------------
(Continued)
41
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
At September 30, 2004 options outstanding were as follows:
Outstanding Exercisable
----------- -----------
Weighted Average Weighted
Remaining Average
Range of Contractual Exercise Exercise
Exercise Prices Number Life in years Price Number Price
--------------- ------ ------------- ----- ------ -----
$15.00 - $18.75 39,500 2.55 $ 15.89 35,200 $ 15.54
$20.55 - $26.75 130,600 5.83 22.90 78,794 23.94
$30.35 - $34.01 26,500 9.39 31.90 9,500 30.35
----------------------------------------------------------------------------------
Outstanding at
year end
196,600 5.65 years $ 22.69 123,494 $ 22.04
==================================================================================
NOTE 10 - INCOME TAXES
The Company files consolidated income tax returns. Income tax expense for
the years ended September 30 are summarized as follows:
2004 2003 2002
---- ---- ----
Federal: Current $ 402,246 $ 731,145 $ 367,179
Deferred (173,499) (178,801) (418,795)
--------------- --------------- --------------
228,747 552,344 (51,616)
State: Current - 166,354 73,222
Deferred 6,176 (47,535) (2,887)
-------------- --------------- --------------
6,176 118,819 70,335
-------------- -------------- --------------
Total income tax expense $ 234,923 $ 671,163 $ 18,719
============== ============== ==============
Total income tax expense differed from the amounts computed by applying the
federal income tax rate of 34% in all periods presented to income before income
taxes as a result of the following for the years ended September 30:
2004 2003 2002
---- ---- ----
Income taxes at statutory rate $ 688,354 $ 1,044,122 $ 226,867
Tax effect of:
State tax, net of federal income tax effect 4,076 78,421 46,421
Low income housing credits (398,208) (348,257) (214,072)
Bank owned life insurance income (78,227) (73,912) -
Other items, net 18,928 (29,211) (40,497)
-------------- --------------- --------------
Total income tax expense $ 234,923 $ 671,163 $ 18,719
============== ============== ==============
- --------------------------------------------------------------------------------
(Continued)
42
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
The components of the net deferred tax asset (liability) recorded in the
consolidated balance sheets as of September 30 are as follows:
2004 2003
---- ----
Deferred tax assets
Bad debt deduction $ 2,405,965 $ 2,111,061
Low income housing credit carry-forward 513,556 241,388
Net deferred loan fees 319,344 325,271
Depreciation 22,586 -
Net unrealized depreciation on securities available for sale - 35,735
Other 64,107 118,627
-------------- --------------
3,325,558 2,832,082
Deferred tax liabilities
Accretion (75,554) (70,745)
Depreciation - (27,964)
FHLB stock dividend (220,477) (96,775)
Mortgage servicing rights (808,493) (543,924)
Net Unrealized appreciation on securities available for sale (37,932) -
--------------- --------------
(1,142,456) (739,408)
--------------- --------------
Net deferred tax asset (liability) $ 2,183,102 $ 2,092,674
============== ==============
Federal income tax laws provided savings banks with additional bad debt
deductions through the tax year ended September 30, 1987, totaling $4,596,000
for the Bank. Accounting standards do not require a deferred tax liability to be
recorded on this amount, which liability would otherwise total $1,563,000 at
September 30, 2004 and 2003. If the Bank were liquidated or otherwise ceases to
be a bank or if tax laws change, the $1,563,000 would be recorded as expense.
Tax legislation passed in August 1996 requires the Bank to deduct a provision
for bad debts for tax purposes based on actual loss experience and recapture the
excess bad debt reserve accumulated in tax years after September 30, 1987. The
related amount of deferred tax liability which must be recaptured is
approximately $446,000 and is payable over a six year period beginning with the
tax year ending September 30, 1999. The deferred tax liability was fully
recaptured as of September 30, 2004.
NOTE 11 - REGULATORY MATTERS
The Bank is subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
regulators about components, risk weightings, and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition. If
- --------------------------------------------------------------------------------
(Continued)
43
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
only adequately capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is asset
growth and expansion, and plans for capital restoration are required.
The Bank's actual capital and required capital amounts and ratios are presented
below:
Minimum
Requirement
Minimum To Be Well
Requirement Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
As of September 30, 2004
Total capital (to risk
weighted assets) $ 36,870 10.04% $ 29,368 8.00% $ 36,710 10.00%
Tier 1 (core) capital
(to risk weighted assets) 33,562 8.88 14,684 4.00 22,026 6.00
Tier 1 (core) capital (to
adjusted total assets) 33,562 6.29 21,334 4.00 26,668 5.00
As of September 30, 2003
Total capital (to risk
weighted assets) $ 36,346 12.41% $ 23,435 8.00% $ 29,294 10.00%
Tier 1 (core) capital
(to risk weighted assets) 33,268 11.36 11,718 4.00 17,576 6.00
Tier 1 (core) capital (to
adjusted total assets) 33,268 7.77 17,116 4.00 21,395 5.00
Regulations limit the dividends that may be paid by the Bank without prior
approval of the Office of Thrift Supervision. In addition, the Bank is subject
to dividend limitations by the OTS in conjunction with the approval of the
acquisition of certain assets and liabilities of Sobieski Bank. Under the terms
of the agreement, the Bank must remain "well-capitalized" for one year after the
acquisition date. Accordingly, at October 1, 2004, $160,000 of the Bank's
retained earnings was potentially available for distribution to the Company,
without obtaining prior regulatory approval.
- --------------------------------------------------------------------------------
(Continued)
44
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 12 - OTHER NON-INTEREST INCOME AND EXPENSE
Other noninterest income and expense amounts are summarized as follows for the
years ended September 30:
2004 2003 2002
---- ---- ----
Other noninterest income
Other service charges and fees $ 159,913 $ 226,925 $ 125,735
ATM foreign surcharges 57,010 47,047 54,349
Visa interchange income 81,966 63,856 44,946
Partnership equity loss (217,510) (165,570) (163,495)
Bank owned life insurance 230,079 217,387 -
Rental Income 244,642 - -
Rental Income - Other Real Estate 102,465 - -
Other 96,932 60,436 42,879
-------------- -------------- --------------
$ 755,497 $ 450,081 $ 104,414
============== ============== ==============
Other noninterest expense
Printing, postage and supplies 437,609 376,421 338,588
Advertising and Business development 409,906 357,381 202,016
Telephone 239,479 211,560 164,066
Insurance 190,960 135,606 125,736
Directors fees 167,537 157,788 141,917
Other 1,490,692 1,322,254 1,148,768
-------------- -------------- --------------
$ 2,936,183 $ 2,561,010 $ 2,121,091
============== ============== ==============
NOTE 13 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONTINGENCIES
Various outstanding commitments and contingent liabilities are not reflected in
the financial statements. Commitments to make loans at September 30 are as
follows:
------------------2 0 0 4---------------- ------------------2 0 0 3----------------
------- -------
Fixed Variable Fixed Variable
Rate Loans Rate Loans Total Rate Loans Rate Loans Total
---------- ---------- ----- ---------- ---------- -----
Mortgage loans $ 752,500 $ 606,700 $ 1,359,200 $ 9,885,230 $ 2,211,760 $ 12,096,990
Commercial loans 3,166,010 - 3,166,010 2,795,409 105,398 2,900,807
Unused equity lines of credit 13,937,273 22,364,940 36,302,213 10,186,616 20,598,890 30,785,506
Unused commercial lines
and letters of credit - 61,856,887 61,856,887 13,875 60,825,163 60,839,038
Unused construction loan
lines of credit 3,178,347 - 3,178,347 4,675,825 5,638,811 10,314,636
------------ ------------- ------------ ------------ ------------ ------------
$ 21,034,130 $ 84,828,527 $105,862,657 $27,556,955 $89,380,022 $116,936,977
============ ============= ============ =========== =========== ============
- --------------------------------------------------------------------------------------------------------------------
(Continued)
45
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
Fixed rate mortgage loan commitments at September 30, 2004 are at an average
rate of 6.23% with terms primarily ranging from 15 to 30 years. Commercial loan
fixed rate commitments are primarily for five year terms with an average rate of
6.62%. The average rate on variable rate mortgage loan commitments is 5.83% and
are tied to the one year treasury bill rate. Rates on variable commercial loan
commitments are tied to the national prime rate.
Since commitments to make loans and to fund unused lines of credit and loans in
process may expire without being used, the amounts do not necessarily represent
future cash commitments. In addition, commitments are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. The maximum exposure to credit loss in the event of nonperformance by
the other party is the contractual amount of these instruments. The same credit
policy is used to make such commitments as is used for loans receivable.
Under employment agreements with certain executive officers, certain events
leading to separation from the Company could result in cash payments totaling
$1.54 million as of September 30, 2004.
The Company and the Bank are subject to certain claims and legal actions arising
in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material adverse effect on the consolidated financial
position or results of operation of the Company.
NOTE 14 - SHAREHOLDER RIGHTS PLAN
The Company has adopted a Shareholder Rights Plan and declared a dividend
distribution at the rate of one Right for each share of common stock held of
record as of the close of business on October 21, 1996, and for each share of
common stock issued thereafter up to the Distribution Date (defined below).
Each Right entitles holders of common stock to buy one share of common stock of
the Company at an exercise price of $46. The Right would be exercisable, and
would detach from the common stock (the "Distribution Date") only if a person or
group (i) were to acquire 12% or more of the outstanding shares of common stock
of the Company; (ii) were to announce a tender or exchange offer that, if
consummated, would result in a person or group beneficially owning 30% or more
of the outstanding shares of common stock of the Company; or (iii) were declared
by the Board to be an Adverse Person (as defined in the Plan) if such person or
group beneficially owns 10% or more of the outstanding shares of common stock in
the Company. In the event of any occurrence triggering the Distribution Date,
each Right may be exercised by the holder (other than such an acquiring person
or group) to purchase shares of common stock of the Company (or, in certain
circumstances, common stock of the acquiring person) at a 50% discount to market
price. The Company is entitled to redeem the Rights at $.01 per Right at any
time. The Rights will expire at the close of business on October 1, 2006.
- --------------------------------------------------------------------------------
(Continued)
46
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 15 - BUSINESS COMBINATION
On August 6, 2004, the Company acquired certain assets and assumed certain
liabilities of Sobieski Bank, a savings and loan association with three
locations in South Bend, Indiana. As a result of this acquisition, the Company
expects to further solidify its market share in the St. Joseph and Elkhart
counties, expand its customer base to enhance deposit fee income, provide an
opportunity to market additional products and services to new customers, and
reduce operating costs through economies of scale.
The transaction resulted in a premium of $407,000 over the fair value of net
assets acquired. As part of the transaction, $2.4 million in goodwill, $1.2
million in customer relationship intangibles and $1.6 million in core deposit
intangibles were acquired. The intangible assets will be amortized over ten
years, using an accelerated method. Goodwill will not be amortized but instead
evaluated periodically for impairment. Goodwill and intangible assets will be
deducted for tax purposes over 15 years using the straight line method.
The following table summarizes the estimated fair value of assets acquired and
liabilities assumed at the date of acquisition.
Cash $ 7,281,000
Securities, including FHLB stock 35,922,000
Net Loans 53,674,000
Premises and equipment 3,445,000
Goodwill 2,363,000
Core deposit intangible 1,610,000
Customer relationship intangible 1,180,000
Other assets 812,000
----------------
Total assets acquired 106,287,000
================
Certificates of deposits (47,442,000)
Other deposits (21,815,000)
----------------
Total Deposits (69,257,000)
FHLB advances (35,739,000)
Other liabilities (884,000)
----------------
Total liabilities assumed (105,880,000)
----------------
Net assets acquired $ 407,000
================
- --------------------------------------------------------------------------------
(Continued)
47
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
The following table presents pro forma information for the years ended September
30, 2004 and 2003 as if the acquisition had occurred at October 1, 2003 and
2002. The pro forma information includes adjustments for interest income and
loans and securities acquired, amortization of intangibles arising from the
transaction, depreciation expense on property acquired, interest expense on
deposits acquired, and the related income tax effects. The effects of certain
transactions related to various fraudulent and otherwise unauthorized loan
matters impacting Sobieski Bank's historical financial results were not included
in the pro forma information below. However, other factors negatively impacting
the historical financial results of Sobieski Bank have not been excluded from
the pro forma information presented below. Therefore, pro forma financial
information is not necessarily indicative of the results of operations as they
would have been had the acquisition been effected on the assumed dates.
2004 2003
Net interest income $ 14,694,000 $ 14,073,000
Net income 1,328,000 1,938,000
Basic earnings per share $ 1.01 $ 1.51
Diluted earnings per share .97 1.46
- --------------------------------------------------------------------------------
(Continued)
48
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 16 - PARENT COMPANY FINANCIAL STATEMENTS
Presented below are the condensed financial statements for the parent company,
MFB Corp.
CONDENSED BALANCE SHEETS
September 30, 2004 and 2003
2004 2003
---- ----
ASSETS
Cash and cash equivalents $ 885,981 $ 416,295
Securities available for sale 1,126,925 1,200,915
Investment in Bank subsidiary 40,789,446 33,200,296
Other assets 113,264 225,295
--------------- ----------------
Total assets $ 42,915,616 $ 35,042,801
=============== ================
LIABILITIES
Loan payable to Bank subsidiary $ 450,000 $ 450,000
Loans from correspondent bank 6,500,000 300,000
Accrued expenses and other liabilities 59,746 41,595
--------------- ----------------
Total liabilities 7,009,746 791,595
SHAREHOLDERS' EQUITY 35,905,870 34,251,206
--------------- ----------------
Total liabilities and shareholders' equity $ 42,915,616 $ 35,042,801
=============== ================
CONDENSED STATEMENTS OF INCOME
Years ended September 30, 2004, 2003 and 2002
2004 2003 2002
---- ---- ----
INCOME
Dividends from Bank subsidiary - cash $ 630,000 $ 2,070,000 $ 1,055,000
Interest income 39,081 42,666 61,740
-------------- -------------- ---------------
Total 669,081 2,112,666 1,116,740
EXPENSES
Interest expense 56,758 36,141 36,901
Other expenses 291,541 186,183 153,178
-------------- -------------- ---------------
Total 348,299 222,324 190,079
Income before income taxes and
equity in undistributed (excess distributed)
net income of Bank subsidiary 320,782 1,890,342 926,661
Income tax benefit 40,186 69,884 50,835
-------------- -------------- ---------------
Income before equity in undistributed
(excess distributed) net income
of Bank subsidiary 360,968 1,960,226 977,496
Equity in undistributed (excess distributed)
net income of Bank subsidiary 1,428,681 439,558 (328,959)
-------------- -------------- ---------------
Net income $ 1,789,649 $ 2,399,784 $ 648,537
============== ============== ===============
- --------------------------------------------------------------------------------
(Continued)
49
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 16 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended September 30, 2004, 2003 and 2002
2004 2003 2002
---- ---- ----
Cash flows from operating activities
Net income $ 1,789,649 $ 2,399,784 $ 648,537
Adjustments to reconcile net income to
net cash from operating activities
Equity in (undistributed) excess distributed
net income of Bank subsidiary (1,428,681) (439,558) 328,959
Investment impairment valuation 109,253 - -
Net change in other assets 376,055 (155,278) 29,967
Net change in accrued expenses and
other liabilities 18,151 (403) (7,545)
--------------- -------------- ---------------
Net cash from operating activities 864,427 1,804,545 999,918
Cash flows from investing activities
Investment in banking subsidiary (6,500,000) - -
---------------- -------------- --------------
Net cash from investing activities (6,500,000) - -
Cash flows from financing activities
Purchase of MFB Corp. common stock - (1,676,634) (506,881)
Proceeds from exercise of stock options 522,689 378,125 167,000
Proceeds from other borrowings 6,500,000 - -
Repayment of other borrowings (300,000) - -
Cash dividends paid (617,430) (560,324) (554,220)
---------------- -------------- --------------
Net cash from financing activities 6,105,259 (1,858,833) (894,101)
--------------- -------------- --------------
Net change in cash and cash equivalents 469,686 (54,288) 105,817
Cash and cash equivalents at beginning
of year 416,295 470,583 364,766
--------------- -------------- --------------
Cash and cash equivalents at end of year $ 885,981 $ 416,295 $ 470,583
=============== ============== ==============
- --------------------------------------------------------------------------------
(Continued)
50
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 17 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table shows the estimated fair values and the related carrying
amounts of the Company's financial instruments at September 30, 2004 and 2003.
Items which are not financial instruments are not included.
2 0 0 4 2 0 0 3
------- -------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Assets
- ------
Cash and cash equivalents $ 28,595,030 $ 28,595,000 $ 40,356,979 $ 40,357,000
Other investments 12,628,329 12,628,000 10,019,782 10,020,000
Securities available for sale 66,021,011 66,021,000 40,028,743 40,029,000
Loans held for sale 1,033,800 1,034,000 6,625,540 6,626,000
Loans receivable, net of
allowance for loan losses 393,850,467 401,428,443 312,956,521 324,510,000
Liabilities
- -----------
Noninterest bearing demand
deposits (31,657,521) (31,658,000) (26,481,555) (26,482,000)
Savings, NOW and MMDA
deposits (136,099,148) (136,099,000) (107,340,694) (107,341,000)
Other time deposits (190,135,947) (191,771,000) (158,283,602) (163,299,000)
FHLB advances (133,443,392) (141,889,000) (98,790,251) (110,451,000)
Loans from correspondent
banks (6,500,000) (6,500,000) (300,000) (300,000)
For purposes of the above disclosures of estimated fair value, the following
assumptions were used as of September 30, 2004 and 2003. The estimated fair
value for cash and cash equivalents and interest-bearing time deposits in other
financial institutions are considered to approximate cost. The estimated fair
value for securities available for sale is based upon quoted market values for
the individual securities or for equivalent securities. The estimated fair value
for loans held for sale, net, is based on the price offered in the secondary
market on September 30, 2004 and 2003 for loans having similar interest rates
and maturities. The estimated fair value for loans receivable is based upon
estimates of the difference in interest rates the Company would charge the
borrowers for similar such loans with similar maturities made at September 30,
2004 and 2003, applied for an estimated time period until the loan is assumed to
reprice or be paid. In addition, when computing the estimated fair value for
loans receivable, the allowance for loan losses was subtracted from the
calculated fair value for consideration of credit issues. The estimated fair
value for other investments, noninterest bearing demand deposits and savings,
NOW and MMDA deposits is based upon their carrying value. The estimated fair
value for other time deposits as well as loans from correspondent banks and FHLB
advances is based upon estimates of the rate the Company would pay on such
deposits or borrowings at September 30, 2004 and 2003, applied for the time
period until maturity. The estimated fair value of other financial instruments
and off-balance-sheet loan commitments approximate cost
- --------------------------------------------------------------------------------
(Continued)
51
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 17 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
and are not considered significant to this presentation.
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that were the Company to have
disposed of such items at September 30, 2004 and 2003, the estimated fair values
would necessarily have been achieved at that date, since market values may
differ depending on various circumstances. The estimated fair values at
September 30, 2004 and 2003 should not necessarily be considered to apply at
subsequent dates.
In addition, other assets and liabilities of the Company that are not defined as
financial instruments are not included in the above disclosures, such as
property and equipment. Also, nonfinancial instruments typically not recognized
in financial statements nevertheless may have value but are not included in the
above disclosures. Excluded, among other items, are the estimated earning power
of core deposit accounts, the trained work force, customer goodwill and similar
items.
- --------------------------------------------------------------------------------
(Continued)
52
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 18 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows:
2004 2003 2002
---- ---- ----
Net change in net unrealized gains and losses
on securities available for sale
Unrealized gains (losses) arising during
the year $ (361,190) $ (324,551) $ (1,199,295)
Reclassification adjustment for (gains) losses
included in net income 109,253 (40,000) 933,958
-------------- --------------- ---------------
Net change in net unrealized gains
and losses on securities available
for sale (251,937) (364,551) (265,337)
Tax expense (benefit) 73,667 (92,519) (26,220)
-------------- -------------- ----------------
Total other comprehensive income (loss) $ (325,604) $ (272,032) $ (239,117)
=============== ============== ================
- --------------------------------------------------------------------------------
(Continued)
53
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
--------------Year Ended September 30, 2004--------------
-----------------------------
1st 2nd 3rd 4th*
(In thousands, except per share data) Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 5,527 $ 5,446 $ 5,505 $ 6,314
Interest expense 2,719 2,699 2,697 2,974
----------- ----------- ----------- -----------
Net interest income 2,808 2,747 2,808 3,340
Provision for loan losses 300 200 150 150
----------- ----------- ----------- -----------
Net interest income after provision for loan
losses 2,508 2,547 2,658 3,190
Non-interest income 1,474 1,195 1,760 1,251
Non-interest expense 3,255 3,399 3,573 4,331
----------- ----------- ----------- -----------
Income before income taxes 727 343 845 110
Income tax expense 108 (10) 238 (101)
----------- ------------ ----------- ------------
Net income $ 619 $ 353 $ 607 $ 211
=========== =========== =========== ===========
Basic earnings per common share $ .48 $ .27 $ .46 $ .16
=========== =========== =========== ===========
Diluted earnings per common share $ .45 $ .26 $ .44 $ .15
=========== =========== =========== ===========
* The increase in non-interest expense in the fourth quarter of fiscal year 2004
is primarily related to expense incurred in connection with the acquisition
previously mentioned and the additional costs incurred to operate the related
new branch locations. The increases in interest income, interest expense and net
interest income during the fourth quarter are primarily related to the assets
and liabilities acquired.
- --------------------------------------------------------------------------------
(Continued)
54
MFB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004, 2003 and 2002
- --------------------------------------------------------------------------------
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (Continued)
--------------Year Ended September 30, 2003--------------
-----------------------------
1st 2nd 3rd* 4th
(In thousands, except per share data) Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 6,173 $ 5,691 $ 5,732 $ 5,730
Interest expense 3,258 3,113 3,065 2,808
----------- ----------- ----------- -----------
Net interest income 2,915 2,578 2,667 2,922
Provision for loan losses 450 450 110 100
----------- ----------- ----------- -----------
Net interest income after provision for loan
losses 2,465 2,128 2,557 2,822
Non-interest income 1,307 1,418 386* 1,870
Non-interest expense 2,703 2,985 3,095 3,099
----------- ----------- ----------- -----------
Income before income taxes 1,069 561 (152) 1,593
Income tax expense 308 91 (213) 485
----------- ----------- ------------ -----------
Net income $ 761 $ 470 $ 61 $ 1,108
=========== =========== =========== ===========
Basic earnings per common share $ .58 $ .37 $ .05 $ .87
=========== =========== =========== ===========
Diluted earnings per common share $ .56 $ .36 $ .05 $ .83
=========== =========== =========== ===========
* The significant decline in net income for the third quarter of fiscal year
2003 is primarily due to a $704,000 mortgage servicing rights impairment charge.
- --------------------------------------------------------------------------------
(Continued)
55
MFB CORP. AND SUBSIDIARY
DIRECTORS AND OFFICERS
September 30, 2004
- --------------------------------------------------------------------------------
MFB CORP. AND MFB FINANCIAL DIRECTORS
M. Gilbert Eberhart (age 70) has served as Secretary of MFB Financial since 1987
and of MFB Corp. since inception. He is a dentist based in Mishawaka.
Thomas F. Hums (age 71) served as President and Chief Executive Officer of MFB
Financial from 1972 until September 1995. He also served as President and Chief
Executive Officer of Mishawaka Financial Services, Inc. from 1975 until
September 1995. He also served as President and Chief Executive Officer of MFB
Corp. from inception until September 1995. He is the current Chairman of MFB
Corp. and MFB Financial.
Jonathan E. Kintner (age 61) is an optometrist based in Mishawaka.
Christine A. Lauber (age 59) is a Certified Public Accountant in private
practice in South Bend, Indiana.
Michael J. Marien (age 56) is a Sales Representative with Signode Corporation, a
division of ITW.
Charles J. Viater (age 50) has served as President and Chief Executive Officer
of MFB Corp., MFB Financial and Mishawaka Financial Services, Inc. since
September 1995. He previously served as Executive Vice President for Amity
Federal Savings Bank and Chief Financial Officer of Amity Bancshares, Inc.
beginning in December 1990.
Reginald H. Wagle (age 62) has served as Vice President of Memorial Health
Foundation since 1992. Until 1992, he was a free-lance political consultant and
until 1991, he also served as District Director for the Office of United States
Representative John P. Hiler, Third Congressional District of Indiana.
Robert C. Beutter (age 69) has served as Mayor of Mishawaka, Indiana for twenty
years and is currently in private law practice in Mishawaka, Indiana.
MFB FINANCIAL EXECUTIVE OFFICERS
Charles J. Viater Thomas J. Flournoy
President and Executive Vice President and
Chief Executive Officer* Chief Financial Officer
Donald R. Kyle James P. Coleman, III
Executive Vice President and Executive Vice President and
Chief Operating Officer Director of Wealth Management
M. Gilbert Eberhart
Secretary*
* Holds same position with MFB Corp.
- --------------------------------------------------------------------------------
(Continued)
56
MFB CORP. AND SUBSIDIARY
SHAREHOLDER INFORMATION
September 30, 2004
- --------------------------------------------------------------------------------
Market Information
The common stock of MFB Corp. is traded on the National Association of
Securities Dealers Automated Quotation System, National Market System, under the
symbol "MFBC." As of September 30, 2004, there were approximately 470
shareholders of record. The following table sets forth market price (based on
daily closing prices) and dividend information for the Company's common stock
for the periods indicated.
Dividend
Fiscal Quarters Ended High Trade Low Trade Declared
- --------------------- ---------- --------- --------
December 31, 2002 23.44 20.59 .105
March 31, 2003 22.97 21.10 .11
June 30, 2003 26.65 22.39 .11
September 30, 2003 32.00 25.18 .11
December 31, 2003 33.09 30.00 .11
March 31, 2004 35.00 29.96 .12
June 30, 2004 35.00 30.52 .12
September 30, 2004 31.54 27.60 .12
Transfer Agent and Registrar
Registrar and Transfer Co.
10 Commerce Drive
Cranford, NJ 07016
Special Counsel
Barnes & Thornburg
1313 Merchants Company Building
11 South Meridian Street
Indianapolis, In. 46204
Independent Auditors
Crowe Chizek and Company LLC
330 East Jefferson Blvd.
South Bend, IN 46624
- --------------------------------------------------------------------------------
(Continued)
57
Shareholder and General Inquiries
The Company is required to file an Annual Report on Form 10-K for its fiscal
year ended September 30, 2004 with the Securities and Exchange Commission.
Copies of this annual report may be obtained without charge upon written request
to:
Charles J. Viater
President and Chief Executive Officer
MFB Corp.
4100 Edison Lakes Parkway (Suite 300)
Mishawaka, IN 46545
Office Locations
- ----------------
Corporate Headquarters Main Office Branch Office
4100 Edison Lakes Parkway 121 S Church St. 25990 County Road 6
Mishawaka, IN 46545 Mishawaka, IN 46544 Elkhart, IN 46514
Branch Office Branch Office
2427 Mishawaka Ave. 23132 US 33
South Bend, IN 46615 Elkhart, IN 46517
Branch Office Branch Office
100 E. Wayne St. 402 W. Cleveland Rd.
Suite 150 Mishawaka, IN 46545
South Bend, IN 46601
Branch Office Branch Office
2930 W. Cleveland Rd. 411 W McKinley Ave
South Bend, IN 46628 Mishawaka, IN 46545
Branch Office Branch Office
740 S. Walnut 23761 Western Ave.
South Bend, IN 46619 South Bend, IN 46619
Branch Office
742 E. Ireland Rd.
South Bend, IN 46614
- --------------------------------------------------------------------------------
(Continued)
58