[FIDELITY FEDERAL BANCORP LOGO]
2003 Annual Report
Contents
Page
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Financial Highlights 2
Letter to Our Shareholders 3
Market Summary 4
Selected Statistical Information 4
Management's Discussion and Analysis 5
Independent Auditor's Report 31
Consolidated Balance Sheets 32
Consolidated Statements of Income 33
Consolidated Statements of Changes in Stockholders' Equity 35
Consolidated Statements of Cash Flows 36
Notes to Consolidated Financial Statements 38
Corporate Information 68
1
[FIDELITY FEDERAL BANCORP LOGO]
Financial Highlights
(Dollars In Thousands, Except Share and Per Share Data)
December 31, December 31,
2003 2002 Change
- ------------------------------------------------------------------------------------------------------
Per Share
Basic net income (loss) from continuing operations $ 0.02 $ (0.39) 105.13%
Basic net income (loss) from discontinued operations (0.32) 100.00
Basic net income (loss) 0.02 (0.71) 102.82
Diluted net income (loss) from continuing operations 0.02 (0.39) 105.13
Diluted net income (loss) from discontinued operations (0.32) 100.00
Diluted net income (loss) 0.02 (0.71) 102.82
Book value at year end 1.39 1.42 (2.11)
Market price (bid) at year end 1.62 1.47 10.20
For the Year
Net interest income $ 2,823 $ 3,012 (6.27)%
Provision for loan losses 13 (360) (103.61)
Non-interest income 3,878 3,507 10.58
Non-interest expense 6,694 9,927 (32.57)
Net income (loss) from continuing operations 214 (2,407) (108.89)
Net income (loss) from discontinued operations -- (1,988) (100.00)
Net income (loss) 214 (4,395) (104.87)
At Year End
Total assets $ 175,390 $ 132,290 32.58%
Loans (net) 100,437 73,087 37.42
Total deposits 120,680 106,791 13.01
Total stockholders' equity 13,367 9,588 39.41
Averages
Total assets $ 149,577 $ 159,625 (6.29)%
Total earning assets 131,080 138,033 (5.04)
Total loans 82,553 94,821 (12.94)
Total deposits 111,888 119,085 (6.04)
Total stockholders' equity 12,668 11,936 6.13
Profitability Ratios
Return on average assets 0.14% (2.75)%
Return on average stockholders' equity 1.69 (36.82)
Net interest margin 2.15 2.18
Loan Quality Ratios
Net charge offs to average loans 0.14% 0.99%
Allowance for loan losses to loans at end of period 0.73 1.13
Valuation allowance for letters of
credit to total letters of credit 1.05 1.50
Savings Bank Capital Ratios
Tangible capital to adjusted total assets 6.87% 8.52%
Risk-based capital ratios
Tier I capital 9.16 9.95
Total risk-based capital 13.62 12.53
Other Data
Average common and common equivalent shares outstanding 8,932,084 6,183,269
Number of full-time equivalent employees at year end 62 73
Number of banking offices 5 5
2
Letter to Our Shareholders
In 2003, our primary focus was to increase the overall value of the organization
through community banking activities. The Company's growth in 2003, we believe,
can be attributed to adherence to old-fashioned community banking values, where
service to our customers and to our community is of paramount concern.
The year 2003 was one of many accomplishments for the Company. These included:
o The Company recorded net income in 2003 following a $4.4 million loss
in 2002. We believe that the continued expansion of our earning assets,
along with stabilization of non-interest income and expense, will
position the Bank for improved earnings in future years.
o Total assets increased 33% to approximately $175 million, due in part
to increases in the Bank's consumer and commercial lending portfolios.
o Total loans increased to approximately $101 million at year's end, a
37% increase over last year.
o Non-interest income increased by approximately 11%, and non-interest
expense decreased by approximately 33% in 2003.
o Net losses on loans declined to 0.14% of total loans in 2003, the
lowest level in many years.
o Additional progress was made in our asset quality. Total classified
assets decreased by 70% to $1.8 million at December 31, 2003 compared
to $6.0 million at December 31, 2002. Total non-performing assets
declined by 43% to $1.7 million.
o The Company further increased its balance sheet and equity base by
successfully raising $4.1 million in additional equity capital in 2003,
and using these funds to reduce overall unsecured debt levels. This has
had the impact of supporting growth, reducing the burden of servicing
debt, and increasing net income.
o Free Internet banking, including free bill payment, was introduced in
2003 and has provided additional convenience for our customers.
While proud of these accomplishments, we realize the importance of maintaining
our momentum and focus during 2004 and beyond. We must continue to strive to
better position the Company for improved earnings in future years, recognizing
that value is built over the long-term, not by meeting quarterly targets. We
believe that after 2003 we are better positioned to achieve our goals by
maintaining our commitment to exceed customer expectations and serve our
community.
Jack Cunningham Donald R. Neel
Chairman of the Board President and CEO
MARKET SUMMARY
MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Fidelity's common stock is traded on the NASDAQ System under the symbol FFED.
The following table sets forth, for the periods indicated, the high and low bid
prices per share as reported by NASDAQ. The bid prices represent prices between
dealers, do not include retail mark-up, mark-down, or commissions and may not
represent actual transactions.
2003 2002
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Common Stock Bid Prices Common Stock Bid Prices
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Year Ended December 31 High Low High Low
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First quarter $1.75 $1.21 $3.15 $2.30
Second quarter 1.53 1.12 2.95 2.15
Third quarter 1.75 1.25 2.50 1.75
Fourth quarter 1.88 1.50 2.15 1.30
We did not pay any cash dividends on our common stock in 2003 or 2002.
Fidelity's dividend policy is to pay cash or distribute stock dividends when the
Board of Directors deems it to be appropriate, taking into account Fidelity's
financial condition and results of operations, economic and market conditions,
industry standards, and other factors, including regulatory capital requirements
of its savings bank subsidiary. We do not anticipate paying cash dividends in
the foreseeable future. As of February 25, 2004, shares were held of record by
approximately 429 shareholders.
Selected Statistical Information
(Dollars In Thousands, Except Share and Per Share Data)
Six months
ended
Selected Financial Data as of December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
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Total assets $175,390 $132,290 $159,659 $166,466 $171,457
Interest-bearing deposits 1,263 2,369 14,605 14,718 22,911
Investment securities available for sale 52,208 34,912 18,074 21,001 24,305
Loans, net 100,437 73,087 104,432 107,842 96,919
Deposits 120,680 106,791 120,155 126,944 135,016
Borrowings 8,077 10,586 12,317 13,939 14,465
Federal Home Loan Bank advances 31,550 3,000 12,333 9,903 9,039
Stockholders' equity 13,367 9,588 11,895 8,775 5,427
Selected Operations Data for
Year Ended
Interest income $ 6,650 $ 9,034 $ 11,455 $ 12,100 $ 6,019
Interest expense 3,827 6,022 8,501 8,457 4,268
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Net interest income 2,823 3,012 2,954 3,643 1,751
Provision for loan losses 13 (360) 1,349 670 1,345
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Net interest income after provision for
loan losses 2,810 3,372 1,605 2,973 406
Non-interest income 3,878 3,507 3,933 1,816 1,001
Non-interest expense 6,694 9,927 5,698 7,314 5,148
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Income (loss) from continuing operations
before tax (6) (3,048) (160) (2,525) (3,741)
Income tax benefit (220) (641) (384) (1,369) (1,671)
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Income (loss) from continuing operations 214 (2,407) 224 (1,156) (2,070)
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Loss from discontinued operations before - (1,537)
tax
Income tax expense - 451
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Loss from discontinued operations - (1,988)
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Net income (loss) $ 214 $ (4,395) $ 224 $ (1,156) $ (2,070)
=============================================================================
Selected Financial Ratios
Return on average assets 0.14% (2.75)% 0.14% (0.71)% (2.41)%
Return on stockholders' equity 1.69 (36.82) 2.18 (16.14) (51.37)
Net interest margin 2.15 2.18 2.03 2.49 2.24
Net interest spread 2.11 2.23 2.12 2.33 2.00
Tangible equity to assets at year end 6.87 8.52 8.48 8.42 6.78
Allowance for loan losses to loans 0.73 1.13 2.01 1.75 2.04
Allowance for loan losses to 49.33 91.48 55.90 222.27 179.96
non-performing loans
Dividend payout ratio N/A N/A N/A N/A N/A
Per Share Data
Diluted net income (loss) from continuing $ 0.02 $ (0.39) $ 0.04 $ (0.29) $ (0.66)
operations
Diluted net income (loss) from (0.32)
discontinued operations
Diluted net income (loss) 0.02 (0.71) 0.04 (0.29) (0.66)
Basic net income (loss) from continuing 0.02 (0.39) 0.04 (0.29) (0.66)
operations
Basic net income (loss) from discontinued (0.32)
operations
Basic net income (loss) 0.02 (0.71) 0.04 (0.29) (0.66)
Cash dividends declared
Book value at year end 1.39 1.42 1.99 1.90 1.72
Closing market price (bid) at year end 1.62 1.47 2.30 1.31 1.25
Number of average common and common
equivalent shares outstanding 8,932,084 6,183,269 5,146,726 4,057,168 3,147,662
4
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Special Note Regarding Forward-Looking Statements
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
results of operations of Fidelity Federal. The information contained in this
section should be read in conjunction with the consolidated financial statements
and accompanying notes contained in this report.
Portions of this Management's Discussion and Analysis, as well as the notes to
the consolidated financial statements and the Letter To Our Shareholders,
contains or incorporates by reference certain forward-looking statements, within
the meaning of the Private Securities Litigation Reform Act of 1995, about our
financial condition, results of operations and business that are based on our
current and future expectations. You can find many of these statements by
looking for words such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential," or "continue,"
or the negative of such terms and other comparable terminology. Such statements
reflect our current views with respect to future events and are subject to risks
and uncertainties, including those discussed in the Management Discussion and
Analysis, notes to the consolidated financial statements and the Letter to
Shareholders, that could cause actual results to differ materially from those
contemplated in such forward-looking statements. A few uncertainties which could
affect our future performance include, without limitation, the effects of
competition, technological changes and regulatory developments; changes in
fiscal, monetary and tax policies; market, economic conditions, either
nationally or regionally, resulting in, among other things, credit quality
deterioration; and changes in the securities markets. Investors should consider
these risks, uncertainties, and other factors in addition to those mentioned by
us in other filings from time to time when considering any forward-looking
statement.
We believe it is important to communicate our expectations to our investors.
However, you are cautioned that no forward-looking statement is a guarantee of
future performance and you should not place undue reliance on these
forward-looking statements, which speak only as of the date of this annual
report. There may be events in the future that we are not able to predict
accurately or over which we have no control. We do not undertake any obligation
to publicly release any revisions to these forward-looking statements to reflect
events or circumstances after the date of this annual report or to reflect the
occurrence of unanticipated events which may cause actual results to differ from
those expressed or implied by the forward-looking statements contained in this
prospectus.
General
Fidelity Federal Bancorp ("Fidelity"), incorporated in 1993 under the laws of
the State of Indiana, is a registered savings and loan holding company with its
principal office in Evansville, Indiana. Fidelity's savings bank subsidiary,
United Fidelity Bank, fsb ("United"), was organized in 1914, is a
federally-chartered stock savings bank located in Evansville, Indiana, and is
regulated by the Office of Thrift Supervision ("OTS"). Fidelity, through its
savings bank subsidiary, is engaged in the business of obtaining funds in the
form of savings deposits and other borrowings and investing such funds in
consumer, commercial, and mortgage loans, and in investment securities.
Operating Strategy
Fidelity's strategy is to continue to operate as an independent,
community-oriented financial institution dedicated to meeting the financial
needs of consumers and businesses in its market area. Fidelity prides itself in
meeting or exceeding customer expectations. Fidelity emphasizes mortgage and
commercial lending activities, as well as increasing its portfolio of consumer
loans. The strategy also includes continued management of its portfolio of
mortgage-backed securities, and to increase core deposit growth to support
growth in loans and investments.
Performance Overview
The primary source of Fidelity's revenue is net interest income from loans and
deposits, fees generated from loan sales and fees from financial services
provided to customers. Economic factors, such as interest rates, business
spending and consumer confidence, in addition to competition, influences loan
and deposit volume that is generated by Fidelity.
5
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Fidelity's earnings increased $4.6 million over 2002. Net interest income
decreased slightly and provision for loan losses increased, while being offset
by higher noninterest income and a significant decrease in noninterest expense.
Nonrecurring losses in 2002 were incurred from discontinued operations and
valuation allowances established against a deferred tax asset, and a retained
interest in a securitization transaction.
Net income per share was $0.02 compared to a loss of ($0.71) in 2002. Return on
assets and return on equity for 2003 were 0.14% and 1.69%, respectively,
compared to (2.75)% and (36.82)% for 2002, respectively.
Fidelity's balance sheet increased from $132.3 million at December 31, 2002 to
$175.4 million at December 31, 2003. This increase was attributed to growth in
the investment and loan portfolios. This growth was funded primarily by
increases in certificate of deposits and Federal Home Loan Bank advances. A $4.0
million increase in regulatory capital during the second quarter of 2003
supported balance sheet expansion.
During 2003, interest rates declined to record low levels, creating an
unprecedented volume of mortgage loan originations, and contributing to the
increase in non-interest income. However, mortgage loan volume slowed in the
third quarter as interest rates began to rise.
Fidelity increased its consumer loan portfolio by $19.3 million to $39.0 million
at December 31, 2003, primarily through acquisition of loans through its network
of automobile dealers. The capacity to increase the portfolio was created when
the Company completed a $49.5 million automobile securitization transaction near
the end of 2002. Commercial real estate and commercial loans increased by $4.4
million in 2003. The primary collateral sources on these loans have been
income-producing residential properties, and owner-occupied commercial real
estate.
Fidelity's classified assets have continued to decrease over the past three
years. Total classified assets have declined from $7.7 million at December 31,
2001 to $1.8 million at December 31, 2003. Due to a loan payoff subsequent to
year-end, the level of classified assets declined further to $1.3 million.
Comparison of Financial Condition at December 31, 2003 and December 31, 2002
Total assets at December 31, 2003 increased $43.1 million to $175.4 million from
$132.3 million in December 2002, primarily due to the increases in
mortgage-backed securities available for sale of $17.3 million and an increase
in net loans of $27.4 million. Average assets for the year ended December 31,
2003 decreased by $10.0 million from $159.6 million at December 31, 2002 to
$149.6 million at December 31, 2003. The decrease in total average assets is
primarily due to decreases in the consumer loan category resulting from the
$49.5 million loan securitization transaction completed in late 2002. As a
result, average consumer loan outstandings for 2003 decreased $12.0 million from
the prior year. In addition, loan workout activities reduced foreclosed assets
held for sale from an average of $1.8 million in 2002 to $920,000 for December
31, 2003.
6
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Loans
The following table shows the composition of Fidelity's loan portfolio:
December December December December December
2003 2002 2001 2000 1999
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(Dollars In Thousands)
Real estate mortgage loans
First mortgage loans
Conventional $ 41,754 $ 36,157 $ 43,929 $ 47,809 $ 48,845
Construction 2,042 1,909 513 1,274 1,867
Commercial 9,144 5,645 6,114 6,873 8,576
Multi-family loans 213 3,083 3,856 4,350 3,629
First mortgage real estate loans
Purchased 778 627 745 1,753 1,899
Home equity loans 5,067 4,586 4,577 5,274 5,567
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58,998 52,007 59,734 67,333 70,383
Commercial and industrial 3,138 2,210 1,848 2,305 4,154
Consumer loans 39,038 19,707 44,988 40,125 24,403
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Total loans 101,174 73,924 106,570 109,763 98,940
Allowance for loan losses (737) (837) (2,138) (1,921) (2,021)
-------------------------------------------------------------------------------------
Net loans $ 100,437 $ 73,087 $104,432 $107,842 $ 96,919
=====================================================================================
Total assets $175,390 $132,290 $159,659 $166,466 $171,457
=====================================================================================
Total loans to total assets 57.7% 55.9% 66.7% 65.9% 57.7%
Fidelity sold most of its fixed-rate conventional mortgage loans, recorded the
gain or loss at the time of sale and used the proceeds to fund future
originations. During 2003, Fidelity generated $45.7 million in fixed-rate and
adjustable-rate 1-4 family loans. Total conventional real estate mortgages
increased by $5.6 million in 2003.
Total commercial real estate loans outstanding have increased by approximately
$3.5 million in 2003 and total commercial and industrial loans have increased by
approximately $900,000. Continued growth is expected in these two loan
categories in 2004.
Multi-family loans decreased from $3.1 million at December 31, 2002 to $213,000
at December 31, 2003. During the second quarter of 2003, two classified
multifamily loans totaling $2.6 million were sold at the contract balance. This
transaction involved a related party and is discussed in the "Related Party"
footnote.
Consumer loans increased by $19.3 million to $39.0 million at December 31, 2003.
The portfolio is primarily composed of prime automobile loans generated through
a network of automobile dealers in Indiana, Kentucky, Illinois and Missouri. In
connection with United's strategic plan, United may increase its consumer loan
portfolio to 28% of total assets. At December 31, 2003, United's consumer loans
to total assets was 22.3%.
Fidelity has no loans to foreign governments, foreign enterprises, foreign
operations of domestic companies or highly leveraged transactions, nor any
concentration to borrowers engaged in the same or similar industries that exceed
ten percent of total loans.
Loan Maturities
The following table sets forth the remaining maturities for commercial loans as
of December 31, 2003:
Within One One to Five
Year Years After Five Years Total
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(In Thousands)
Predetermined interest rates $ 409 $434 $ 843
Floating interest rates 968 190 $1,137 2,295
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$1,377 $624 $1,137 $3,138
========================================================================
7
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Non-Performing Loans
Fidelity discontinues the accrual of interest income on loans when, in the
opinion of management, there is reasonable doubt as to the timely collectibility
of interest or principal. When a loan reaches a ninety day or more past due
status, the asset is generally repossessed or sold, if applicable, or the
foreclosure process is initiated and the loan is re-classified to other real
estate owned to be sold. A loan could be placed in a nonaccrual status sooner
than ninety days if management knows the customer has abandoned the collateral
and has no intention of repaying the loan.
Typically, when a loan reaches non-accrual status, the accrued interest is
reversed from income, unless strong evidence exists that the value of the
collateral would support the collection of interest in a foreclosure situation.
Nonaccrual loans are returned to an accrual status when, in the opinion of
management, the financial position of the borrower indicates that there is no
longer any reasonable doubt as to the timely payment of principal and interest.
Income received on nonaccrual and restructured loans was $43,000 for the year
ended December 31, 2003, $23,000 for the year ended December 31, 2002 and
$22,000 for the year ended December 31, 2001. Additional interest income of
approximately $19,000, $63,000 and $237,000 for the years ended December 31,
2003, 2002 and 2001, respectively, would have been recorded had income on
nonaccruing and restructured loans been considered collectible and accounted for
on an accrual basis.
The following table provides information on Fidelity's non-performing loans.
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
--------------------------------------------------------------------------------
(Dollars In Thousands)
Non-accrual loans
Real estate mortgage $ 788 $ 356 $ 130 $ 253
Home equity 127
Consumer 233 131 116
Multi-family $ 148 229
Commercial 267 388 3,291 472
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Total non-accrual loans 1,415 875 3,537 620 482
Restructured
Consumer 39 190 115 75
Commercial 53 119 118
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Total restructured loans 39 243 234 193
90 days or more past due and accruing
Consumer 54 23 10 135
Commercial 233 22 313
Mortgage 1
--------------------------------------------------------------------------------
Total 90 days or more past due and accruing 287 1 45 10 448
--------------------------------------------------------------------------------
Total non-performing loans $1,702 $915 $3,825 $ 864 $1,123
================================================================================
Ratio of non-performing loans to total loans 1.68% 1.24% 3.59% 0.79% 1.14%
================================================================================
The increase in non-performing loans in 2003 is primarily due to one residential
real estate loan totaling $451,000 on which accrual of interest income was
ceased during the first quarter of 2003. The property was in the foreclosure
process at year end. The proceeds of the sale completed subsequent to year-end
were sufficient to repay principal, accrued interest, and other expenses.
Approximately $233,000 of the $267,000 in commercial non-accrual loans is
associated with one property that represents a small portion of a participated
loan. Management believes that reserves for this loan are adequate.
Analysis of Allowance for Loan Losses and Letter of Credit Valuation Allowance
Fidelity establishes its provision for loan losses and letter of credit
valuation provision and evaluates the adequacy of the allowance for loan losses
and its letter of credit valuation reserve based on management's evaluation of
the performance of its loan and letter of credit portfolios. All of United's
letters of credit are backed by similar collateral; which are low income housing
apartment complexes. All letters of credit secure municipal bond issuances that
fund the affordable housing projects and pay low floater interest rates. The
risks associated with these credits are similar to any other apartment complex
that secures financing through a more traditional commercial loan. The remaining
risk is the properties are all low-income housing properties and must comply
with the appropriate governmental regulations. Compliance is monitored by United
to ensure that all regulatory issues are met to avoid a situation in which the
letters of credit could be called upon.
8
Management's Discussion and Analysis
of Results of Operations and Financial Condition
This evaluation, which includes a review of all loans and letters of credit for
which full collectibility may not be reasonably assured, considers among other
matters, the present value of expected cash flows, the estimated fair value of
the underlying collateral, economic conditions, historical loss experience, the
composition of the portfolios and other factors that warrant recognition in
providing for an adequate loan loss allowance and letters of credit valuation
allowance. This evaluation is performed on a quarterly basis and is designed to
ensure that all relevant matters affecting collectibility will consistently be
identified in a detailed review and that the outcome of the review will be
considered in a disciplined manner by management in determining the necessary
allowances and related provisions. The amounts actually reported in each period
will vary with the outcome of this detailed review.
Classified Assets and Letters of Credit
December 31, December 31, December 31,
2003 2002 2001
--------------------------------------------------------------
(Dollars In Thousands)
Classified assets $1,757 $6,024 $7,357
Classified letters of credit 350
--------------------------------------------------------------
Total classified assets $1,757 $6,024 $7,707
==============================================================
Classified assets and letters of credit of Fidelity totaled $1.8 million at
December 31, 2003 compared to $6.0 million at December 31, 2002, a decrease of
70.0%. Total classified assets were 12.2% and 55.4% of Fidelity's capital and
reserves at December 31, 2003 and December 31, 2002, respectively, and 12.7% and
27.5% of United's core capital and reserves. In addition to the classified
assets and letters of credit, there are other assets and letters of credit
totaling $6.2 million at December 31, 2003 for which management was closely
monitoring the borrowers' abilities to comply with payment terms.
Impaired loans are those that management believes will not perform in accordance
with the original loan terms. At December 31, 2003 and December 31, 2002,
Fidelity had impaired loans totaling $775,000 and $3.5 million respectively. The
allowances for loan losses on such impaired loans totaled $169,000 and $332,000,
which were included in Fidelity's allowance for loan losses at December 31, 2003
and December 31, 2002 respectively. Using similar guidelines for impaired loans,
impaired letters of credit at December 31, 2003 and December 31, 2002 totaled $0
compared to $350,000 at December 31, 2001. Impaired loans do not include large
groups of homogeneous loans that are collectively evaluated for impairment, such
as residential mortgage and consumer installment loans.
Other Real Estate Owned
Other real estate owned totaled $30,000 at December 31, 2003, compared to $2.1
million at December 31, 2002. United disposed of a commercial real estate
property with a value of $1.9 million during the second quarter of 2003 and two
residential duplex units in the first quarter of 2003.
9
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Allowance for Loan Losses
The following table sets forth loan charge-offs and recoveries by the type of
loan and an analysis of the allowance for loan losses for the years ended
December 31, 2003, 2002, 2001 and 2000, and the six months ended December 31,
1999:
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Allowance for loan losses
at beginning of period $ 837 $ 2,138 $ 1,921 $ 2,021 $ 3,521
----------------------------------------------------------------------------------------
Loan charge offs
Real estate mortgage 2 80
Multi-family 469 606 683 2,631
Commercial 1,158 354 12 11
Consumer 234 327 441 391 235
----------------------------------------------------------------------------------------
Total loan charge offs 236 1,954 1,401 1,166 2,877
----------------------------------------------------------------------------------------
Loan recoveries
Real estate mortgage 7
Multi-family 24 937 200 317 3
Commercial 20 3
Consumer 99 76 62 59 26
----------------------------------------------------------------------------------------
Total loan recoveries 123 1,013 269 396 32
----------------------------------------------------------------------------------------
Net charge offs 113 941 1,132 770 2,845
Provision for loan losses
transferred to held for sale (479) (564)
Provision for loan losses 492 204 1,349 670 1,345
----------------------------------------------------------------------------------------
Total net provision for loan losses 13 (360) 1,349 670 1,345
----------------------------------------------------------------------------------------
Allowance for loan losses
at end of period $ 737 $ 837 $ 2,138 $ 1,921 $ 2,021
========================================================================================
Ratio of net charge offs to
average loans outstanding
during period 0.14% 0.99% 1.02% 0.72% 5.20%
========================================================================================
Ratio of provision for loan
losses to average loans
outstanding during period 0.02% (0.38)% 1.21% 0.63% 2.46%
========================================================================================
Ratio of allowance for loan
losses to total loans
outstanding at year end 0.73% 1.13% 2.01% 1.75% 2.04%
========================================================================================
Average amount of loans
outstanding for the period $ 82,553 $94,821 $111,572 $106,599 $108,455
========================================================================================
Amount of loans outstanding
at end of period $ 101,174 $73,924 $106,570 $109,763 $ 98,940
========================================================================================
During the year ended December 31, 2003 and 2002, net charge-offs consisted
primarily of consumer loans. Consumer loan charge-offs of $234,000 were
recognized in 2003 compared to $327,000 in the prior year. Consumer loan
recoveries of $99,000 were received in 2003 compared to $76,000 in 2002.
Charge-offs of $469,000 and $606,000 were recorded on multifamily loans in 2002
and 2001 compared to zero in 2003. During 2002 a subsidiary of United held
general partnership interest in seventeen partnerships. Under the terms of the
partnership agreement, the general partner was obligated to fund certain cash
flow deficits of the particular partnership, or risk defaulting on loans. A
default could have had a negative impact for the partners, including the
company-owned general partner, such as causing recapture of tax credits. As
such, funds would be loaned to the various partnerships to meet obligations. At
the time the loans were made, they were fully reserved through additional
provisions to the allowance for loan loss, due to the performance of the
partnerships and the assessment of the quality of the credit. The loans were
then charged-off.
Recoveries of $937,000 and $200,000 were received on multifamily loans in 2002
and 2001, respectively, compared to $24,000 in 2003. Due to the poor performance
of certain multifamily loans in prior periods and management's assessment of
allowances necessary to reflect the credit quality of these loans, specific
reserves were created and certain charge-offs recorded. Several of these loans
were refinanced through third parties during the past three years. The
refinancing activities generally created additional cash flow because of reduced
interest rates. As these loans were paid off, the reserves previously
established for these loans were reversed or recorded as recoveries to the
extent that the payments received exceeded the charged down balances.
The provision for loan losses increased from $204,000 in 2002 to $492,000 in
2003 due to the $27.3 million increase in total loans outstanding. In the prior
year, operating deficit guarantees provided by Pedcor resulted in payments being
made to Fidelity in the event that cash flows from properties were negative,
based on a pre-determined computation. These guarantees and contingent
liabilities were terminated upon the sale of the partnerships during the fourth
quarter of 2002.
10
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Fidelity's letter of credit valuation allowance was $291,000 at December 31,
2003 compared to $445,000 at December 31, 2002. The decrease is primarily due to
the reduction in classified letters of credit, primarily due to efforts to
refinance the credits on a non-recourse basis in 2001, 2002 and 2003.
Multi-family letters of credit, an off-balance sheet item, carry the same risk
characteristics as conventional loans and totaled $27.8 million at December 31,
2003 compared to $29.7 million at December 31, 2002 and $30.5 million at
December 31, 2001. The valuation allowance for letters of credit totaled 1.0% of
outstanding letters of credit at December 31, 2003 compared to 1.5% at December
31, 2002. The allowance for loan losses and letters of credit to total loans and
letters of credit at December 31, 2003 and 2002 was 0.80% and 1.24%,
respectively. Management is not currently aware of any additional letters of
credit that are expected to be called or funded. Management considers the
allowance for loan losses and valuation allowance for letters of credit adequate
to meet losses inherent in the loan and letter of credit portfolios at December
31, 2003.
The provision for consumer loans was credited in connection with consumer loans
transferred to held for sale for $479,000 for 2003 compared to a credit of
$564,000 in 2002. The credit during 2003 and 2002 is primarily attributable to
the reduction in allocated reserves previously set aside for consumer loans as a
result of completing consumer loan sales during each year in addition to a
securitization transaction in 2002. Fidelity will generally complete consumer
loan sales during the month the loans are identified for sale, therefore no
consumer loans were identified as held for sale at December 31, 2003.
Allocation of Allowance for Loan Losses
The allocation for loan losses and the percentage of loans within each category
to total loans at December 31, 2003, 2002, 2001, 2000 and 1999 are as follows:
Allocation of Amount
-----------------------------------------------------------------------------------------
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Real estate mortgage $ 64 $ 91 $ 80 $ 49 $ 49
Home equity 39 23 23 53 54
Multi-family 2 150 258 514 482
Consumer 363 247 505 628 496
Commercial 269 326 1,272 677 940
-----------------------------------------------------------------------------------------
Total $ 737 $ 837 $2,138 $1,921 $2,021
=========================================================================================
Percentage of Loans to Total Loans
-----------------------------------------------------------------------------------------
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------------
Real estate mortgage 43.0% 52.3% 42.4% 45.2% 45.7%
Home equity 5.0 6.2 4.3 4.8 5.5
Multi-family 0.2 4.2 3.6 3.4 5.9
Consumer 38.7 26.7 42.2 36.6 30.0
Commercial 13.1 10.6 7.5 10.0 12.9
-----------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0% 100.0%
=========================================================================================
Association with Affordable Housing
Fidelity previously held a general partnership in seventeen affordable housing
real estate development projects located throughout Indiana, Illinois and
Kentucky. Management considers the projects and properties to be in good
condition. In December 2002, Fidelity sold its general partnerships investments
in these seventeen partnerships but retained limited partnership interests in
two of the seventeen sold. As a limited partner, Fidelity is not responsible for
the management and operating deficits of the partnerships, it only holds one
letter of credit in connection with these properties.
11
Management's Discussion and Analysis
of Results of Operations and Financial Condition
The following table summarizes Fidelity's reduction in current and contingent
liabilities associated with these projects:
Activities associated with Section 42
-------------------------------------
Conventional General
Bank Partner Additional Equity Letters of
Financing Loans Notes Investments Credit
-----------------------------------------------------------------------------
Balance at December 31, 2000 $2,757 $ 283 $15,613
Disbursements/investments $ 585
Paydowns, payoffs, or loss on investment (14) (105) (10,081)
Charge-offs or funding on
outstanding letters of credit (1) (585) (88) (2,976)
-----------------------------------------------------------------------------
Balance at December 31, 2001 2,742 90 2,556
Disbursements/investments 99 277
Sale of partnership interest 78
Paydowns, payoffs, or loss on investment (176) (64) (315)
Charge-offs or funding on
outstanding letters of credit (99) (277) (37) (35)
-----------------------------------------------------------------------------
Balance at December 31, 2002 2,566 67 2,206
-----------------------------------------------------------------------------
Disbursements/investments
Sale of partnership interest
Paydowns or payoffs/loss on investment (2,566) (22) (1,700)
Charge-offs -
-----------------------------------------------------------------------------
Balance at December 31, 2003 $ 0 $ 0 $ 0 $ 45 $ 506
=============================================================================
Specific reserves included in allowance for loan losses
-------------------------------------------------------
Specific Valuation
Conventional General Allowance Reserves Allowance
Bank Financing Partner Additional for equity for Letters
Loans Notes Investments of Credit
-------------------------------------------------------------------------------
Balance at December 31, 2000 $ 248 $4,754
Provision-year ended December 31, 2001 216 $585 (1,493)
Funding on outstanding letter of credit (2,976)
Reclassification (219)
Charge-offs (585)
-------------------------------------------------------------------------------
Balance at December 31, 2001 245 285
Provision-year ended December 31, 2002 9 277 (61)
Charge-offs (126) (277) (224)
-------------------------------------------------------------------------------
Balance at December 31, 2002 128
Provision - year ended December 31, 2003 (128)
-------------------------------------------------------------------------------
Balance at December 31, 2003 $ 0 $ 0 $ 0 $ 0 $ 0
===============================================================================
Investment Securities
United's investment policy is reviewed annually by its Board of Directors. Any
significant changes to the policy must be approved by the Board. The Board has
an interest rate risk management committee, which is responsible for keeping the
investment policy current.
At December 31, 2003, the investment portfolio represented 29.8% of Fidelity's
assets, compared to 26.4% at December 31, 2002, and is managed in a manner
designed to meet the Board's investment policy objectives. During 2003 and 2002,
due to continued reductions in the loan portfolios, excess liquidity was
reinvested in lower risk investment securities. The primary objectives, in order
of priority, are to further the safety and soundness of Fidelity, to provide for
the liquidity necessary to meet day to day, cyclical, and long-term changes in
the mix of Fidelity's assets and liabilities and to provide for diversification
of risk and management of interest rate and economic risk. Fidelity expects
moderate investment activity in 2004, which would include new purchases to
reinvest investment in maturity and paydowns on the mortgage-back portfolio. At
December 31, 2003, the entire investment portfolio was classified as available
for sale. The net unrealized loss at December 31, 2003, which is included as a
component of stockholders' equity, was $209,000 and was comprised of gross
unrealized gains of $50,000 and gross unrealized losses of $386,000 and tax
expense of $127,000. The change in the unrealized loss from December 31, 2002,
was caused primarily by market interest rate changes during the period. Although
the entire portfolio is classified as available for sale, management has not
identified specific investments for sale in future periods.
12
Management's Discussion and Analysis
of Results of Operations and Financial Condition
The following table sets forth the components of United's available-for-sale
investment portfolio as of December 31, 2003, 2002, and 2001:
December 31, December 31, December 31,
2003 2002 2001
-------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Mortgage-backed securities
Federal Home Loan Mortgage Corporation $ 6,739 $17,148 $ 443
Federal National Mortgage Association 25,203 3,382 625
Government National Mortgage Association 20,266 14,382 17,006
--------------------------------------------------
Total securities available for sale $52,208 $34,912 $18,074
==================================================
In 2003, United's investment securities portfolio increased by $17.3 million to
$52.2 million compared to $34.9 million at December 31, 2002. Prepayment rates
generally can be expected to increase during periods of lower interest rates as
some of the underlying mortgages are refinanced at lower rates. Conversely, the
average lives of these securities generally are extended as interest rates
increase.
Due to available liquidity and borrowing capacity, United's investment portfolio
has increased from $18.1 million at December 31, 2001 to $52.2 million at
December 31, 2003. Management anticipates portfolio growth in 2004 to be more
moderate.
The following table sets forth the contractual maturities of investment and
mortgage-backed securities as of December 31, 2003, and the weighted average
yields of such securities. The contractual maturities of mortgage-backed
securities are not typically indicative of the actual holding period for such
investments, as pre-payments on the underlying mortgage loans will reduce the
average life of the investment, based on prevailing market interest rates.
----------------------------------------------------------------------------------------------
After One But After Five But
Within One Year Within Five Years Within Ten Years Over Ten Years Total
------------------------------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Federal Home Loan Mortgage
Corporation $ 6,739 4.05% $ 6,739 4.05%
Federal National Mortgage
Association $4,621 3.98% 20,582 3.78 25,203 3.82
Government National
Mortgage 20,266 3.15 20,266 3.15
Association
----------- ----------- ----------- ----------- -----------
Total $ 0 $0 $4,621 3.98% $47,587 3.55% $52,208 3.59%
=========== =========== =========== =========== ===========
Percent of total 0.00% 0.00% 8.85% 91.15% 100.00%
=========== =========== =========== =========== ===========
Funding Sources
Deposits
Fidelity attracts both short-term and long-term deposits from the retail market
by offering a wide assortment of accounts with different terms and different
interest rates. These deposit alternatives include checking accounts, regular
savings accounts, money market deposit accounts, fixed rate certificates with
varying maturities, variable interest rate certificates, negotiable rate jumbo
certificates ($99,000 or more), and variable rate IRA certificates.
Average deposits decreased by $7.2 million for the year ended December 31, 2003.
The primary categories affecting the decrease are as follows:
o Average retail certificate of deposits decreased by $6.4 million, or
7.4% due to the maturity of higher interest-bearing deposits and lower
reinvestment opportunities for the customers.
o Average money market accounts decreased $2.9 million, or 30.2%.
13
Management's Discussion and Analysis
of Results of Operations and Financial Condition
During the current low interest rate environment, customer preferences have
shifted to shorter-term liquid deposit products and other deposit alternatives.
These decreases were partially offset by increases in the following:
o Demand deposits increased $600,000 or 12.1%
o Savings increased $512,000 or 10.3%
o NOW accounts increased $1.1 million or 8.4%.
The following table sets forth the average balances of and the average rate paid
on deposits by deposit category for the years ended December 31, 2003, 2002 and
2001.
December 31, December 31, December 31,
2003 2002 2001
----------------------------------------------------------------------------------
Average Deposits Amount Rate Amount Rate Amount Rate
-------------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Demand $ 5,564 $ 4,964 $ 2,654
NOW accounts 13,792 0.49% 12,720 0.90% 11,009 1.78%
Money market accounts 6,743 0.86 9,664 1.42 13,808 3.59
Savings accounts 5,470 0.62 4,958 0.75 4,497 1.60
Certificates of deposit 80,122 3.39 86,531 4.71 91,706 6.10
Brokered deposits 197 3.55 248 6.05 2,179 6.06
--------------- --------------- ----------------
Totals $111,888 2.58% $119,085 3.68% $125,853 5.16%
=============== =============== ================
The current interest rate environment and local market conditions presented
significant repricing opportunities during 2003 and 2002, resulting in an
overall average yield of 2.58% on the deposit portfolio compared to 3.68% in
2002 and 5.16% in 2001.
Deposits at December 31, 2003 were $120.7 million compared to $106.8 million at
December 31, 2002. This increase is primarily associated with the use of public
certificates of deposit to assist in balance sheet growth in the last half of
2003. Management anticipates a portion of these funds upon maturity will be
replaced with core deposits and brokered deposits in 2004. During the fourth
quarter of 2003, United actively began to utilize brokered deposits to help fund
asset growth in 2003.
The following table summarizes certificates of deposit in amounts of $100,000 or
more by maturity as of the following dates:
December 31, December 31, December 31,
2003 2002 2001
- ---------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Three months or less $ 18,168 $ 5,486 $ 3,661
Three to six months 6,929 4,591 3,877
Six to twelve months 1,565 1,139 1,067
Federal Home Loan Bank advances
Fidelity's investment and loan growth in 2003 was also facilitated by utilizing
FHLB advances. FHLB advances outstanding increased from $3.0 million at December
31, 2002 to $31.6 million at December 31, 2003. To the extent that funding
through deposits and other sources is not sufficient, United will continue to
utilize FHLB advances to fund additional growth.
Borrowings
Fidelity's borrowings consisted primarily of FHLB advances, senior notes, junior
notes and unsecured notes. Of the $39.6 million outstanding at December 31,
2003, $31.6 million were FHLB advances.
14
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Fidelity's borrowings, other than FHLB advances, decreased $2.5 million to $8.1
million at December 31, 2003.
o Notes payable secured by multi-family mortgages totaling $2.4 million
were paid off during the second quarter in connection with a sale of
loans which were funded by these borrowings.
o A $1.5 million note payable bearing interest at 10.50% was paid off
during the second quarter.
o Senior subordinated notes totaling $2.2 million bearing interest at
10.00% were retired in 2003.
o These decrease were offset partially by a new $4.0 million junior
subordinated note.
Fidelity utilized capital raised from a $4.1 million stock option exercise by
Pedcor Financial, LLC and affiliates to reduce long-term debt. Also, in the
fourth quarter, United repaid a $1.5 million note bearing interest at 11.00% to
Fidelity which in turn retired $1.5 million in debt outstanding. In the third
quarter, United secured $4.0 million in floating rate junior subordinated
debentures that qualify for Tier II capital inclusion. The interest rate is tied
to the 3-month LIBOR rate + 2.95% adjusted, quarterly. In the fourth quarter of
2003 a $1.0 million unsecured note payable bearing interest at 9.00% was
executed by Fidelity and a related party, Pedcor Bancorp. This is discussed in
more detail in the "Related Party" footnote. These funds were contributed to
increase United's Tier 1 capital. This note is expected to be repaid within six
months.
Capital Resources
Fidelity's stockholders' equity increased $3.8 million to $13.4 million at
December 31, 2003, compared to $9.6 million at December 31, 2002. The change in
stockholders' equity was accounted for by net income of $214,000, a decrease in
the net unrealized gain on securities available for sale of $588,000, and $4.1
million attributable to the exercise of stock options during the second quarter
of 2003 by Pedcor Holdings and affiliates.
Total capital, as defined for regulatory purposes, for United consists of Tier I
capital plus the allowance for loan losses. Minimum capital levels are 4% for
the leverage ratio, which is, defined as Tier I capital as a percentage of total
assets less goodwill and other identifiable intangible assets; 4% for Tier I to
risk-weighted assets; and 8% for total capital to risk-weighted assets.
Tangible Core Tier 1 Risk-based
(Dollars In Thousands) Capital Capital Capital Capital
- ------------------------- -------------------------------------------------------------
Regulatory capital $11,646 $11,869 $10,292 $15,294
Minimum capital requirement 2,542 6,787 4,492 8,984
-------------------------------------------------------------
Excess capital $9,104 $5,082 $5,800 $6,310
=============================================================
Regulatory capital 6.87% 7.00% 9.16% 13.62%
Required capital requirement 1.50 4.00 4.00 8.00
-------------------------------------------------------------
Excess over minimum 5.37% 3.00% 5.16% 5.62%
=============================================================
Regulatory capital 6.87% 7.00% 9.16% 13.62%
Strategic plan capital requirement N/A 6.25 8.25 11.00
-------------------------------------------------------------
Excess over minimum 6.87% 0.75% 0.91% 2.62%
=============================================================
The capital rating assigned to an entity can also be affected by qualitative
judgments made by regulatory agencies about the risk inherent in the entity's
activities that are not part of the calculated ratios. At December 31, 2003 and
2002, the Bank is categorized as well capitalized and met all capital adequacy
requirements. However, United continues to evaluate and pursue opportunities to
improve its capital ratios. There are no specific targets for capital levels
included in the Supervisory Agreement between United and the OTS, only a
requirement that United include capital minimum within its strategic plan. The
strategic plan established minimum capital targets of 6.25% for core capital,
8.25% for Tier I and 11.0% for risk-based capital. United exceeded these
minimums at December 31, 2003.
15
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Liquidity
The primary sources of funds from operations are principal and interest payments
on loans, deposits from customers, and sales and maturities of investment
securities. Fidelity's entire investment portfolio is classified as "available
for sale" and totaled $52.2 million at December 31, 2003 and could be utilized
to assist in liquidity management. In addition, United is authorized to borrow
money from the Federal Home Loan Bank or draw on a $5 million secured line of
credit with another financial institution. At December 31, 2003, United's gross
borrowing capacity is $65.0 million with approximately $4.7 million available to
draw upon based on current assets pledged. As discussed, in "Borrowings", United
obtained $4.0 million in unsecured floating rate junior subordinated debentures.
United also obtained a $10 million repurchase agreement line of credit with
another financial institution in January 2004. Fidelity believes that the above
actions in addition to a $2.5 million debt offering that Fidelity anticipates
completing in the first quarter of 2004, will assist it in meeting its future
liquidity needs. In the second quarter of 2003, Pedcor exercised $4.1 million of
its option to purchase additional Fidelity stock. As discussed in the
"Borrowings" section of the management discussion and analysis. These funds were
utilized to reduce debt at Fidelity during 2003.
Fidelity is not subject to any regulatory restrictions on the payment of
dividends to its stockholders. However, United is restricted from paying any
dividends to Fidelity without prior approval of the OTS under the terms of the
Supervisory Agreement.
Fidelity has a $500,000 line of credit and can draw on this line until the
expiration in September 2004. Fidelity anticipates repaying balances on the line
prior to the line's expiration in September 2004. At December 31, 2003, $275,000
was outstanding on the line of credit. Fidelity's liquidity position may be
further improved by the potential issuance of additional stock, additional debt
or equity financing, or dividends from United to Fidelity.
Supervisory Agreement
Management has expended significant time and effort ensuring that United
continues to operate in compliance with the Supervisory Agreement. The
supervisory agreement, as amended on November 18, 2003, currently requires
United Fidelity Bank to:
o Refrain from paying dividends without OTS approval;
o continue to comply with its strategic plan, including its capital
targets, as discussed in the capital resources section of the
management discussion and analysis, consistent with United's business
plan as approved by the OTS;
o refrain from engaging in any transaction with or distribution of funds
to Fidelity or its subsidiaries or selling any assets to an affiliate
without OTS approval; and
o not engage in new activities not included in its strategic plan without
OTS approval.
United Fidelity Bank believes that it currently is in compliance with all
provisions of the supervisory agreement.
Contractual Obligations and Commitments
The company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to originate loans, standby letters of
credit and unadvanced loans and lines of credit.
The instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized in the balance sheets. The contract amounts of these
instruments reflect the extent of involvement the company has in the particular
classes of financial instruments.
16
Management's Discussion and Analysis
of Results of Operations and Financial Condition
The following table summarizes the contractual obligations and commitments at
December 31, 2003.
Payments Due by Period
Less than 1 - 3 3 - 5 After 5
Total 1 Year Years Years Years
- ---------------------------------------------------- --------- ------------- ----------- --------- ------------
(Dollars In Thousands)
Contractual Cash Obligations:
FHLB advances $31,550 $13,050 $17,500 $1,000
Junior subordinated notes 5,002 $5,002
Senior subordinated notes 1,800 1,800
Other borrowings 1,275 1,275
--------- ------------- ----------- --------- ------------
Total contractual obligations $39,627 $14,325 $ 19,300 $1,000 $5,002
========= ============= =========== ========= ============
Payments Due by Period
Other commitments: Less than 1 - 3 3 - 5 After 5
Total 1 Year Years Years Years
--------- ------------- ----------- --------- ------------
Unadvanced loans and lines $12,839 $6,792 $6,047
Standby letters of credit 27,774 27,774 - -
Commitments to originate loans 6,150 6,150 - - -
Commitments to sell loans 343 343 - - -
Commitments to purchase securities 8,500 8,500
--------- ------------- ----------- --------- ------------
Total commitments $55,606 $49,559 $0 $0 $6,047
========= ============= =========== ========= ============
For additional information regarding Contractual Obligations and Commitments,
see note, "Commitments and Contingent Liabilities", to the consolidated
financial statements.
Effect of Inflation and Changing Prices
Fidelity's Consolidated Financial Statements and related financial data
presented have been prepared in accordance with accounting principles generally
accepted in the United States of America, which require the measurement of
financial position and operating results in terms of historical dollars, without
considering the change in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of
Fidelity's operations and in increased loan amounts and in increased interest
rates (which must include a real rate of return and an additional amount to
reflect expected inflation over the term of the loan). Unlike most industrial
companies, virtually all of the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates generally have a
more significant impact on a financial institution's performance than do general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
Off-Balance Sheet Arrangements
In the normal course of business, to meet the financing needs of its customers,
Fidelity is a party to financial instruments with off-balance sheet risk. These
financial instruments include commitments to extend credit and standby letters
of credit. Fidelity's exposure to credit loss in the event of nonperformance by
the other party to these financial instruments is represented by the contractual
amount of the instruments. Fidelity uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. Fidelity generally requires collateral or other security to support
the financial instruments with credit risk. The amount of collateral or other
security is determined based on management's credit evaluation of the
counterparty. Fidelity evaluates each customer's creditworthiness on a
case-by-case basis.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Letters of
credit are conditional commitments issued by Fidelity to guarantee the
performance of a customer to a third party. Letters of credit and other
commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the letters of credit and
commitments are expected to expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements. For
further information about these arrangements, see Commitments and Contingent
Liabilities of the Notes to Consolidated Financial Statements included elsewhere
in this report.
17
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Application of Critical Accounting Policies
Fidelity's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America and reporting
practices followed within the banking industry. The application of these
principles requires management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and accompanying
notes. These estimates, assumptions, and judgments are based on information
available as of the date of the financial statements; as this information
changes, the financial statements could reflect different estimates,
assumptions, and judgments.
Reserve for Credit Losses: Fidelity maintains a reserve to absorb probable loan
losses inherent in the portfolio. The reserve for credit losses is maintained at
a level Fidelity considers to be adequate to absorb probable loan losses
inherent in the portfolio and is based on ongoing quarterly assessments and
evaluations of the collectibility and historical loss experience of loans.
Credit losses are charged and recoveries are credited to the reserve. Provisions
for credit losses are based on Fidelity's review of the historical credit loss
experience and such factors that, in management's judgment, deserve
consideration under existing economic conditions in estimating probable credit
losses. In determining the appropriate level of reserves, Fidelity estimates
losses using a range derived from "base" and "conservative" estimates.
Fidelity's methodology for assessing the appropriate reserve level consists of
several key elements, as discussed below. Fidelity's strategy for credit risk
management includes a combination of conservative exposure limits significantly
below legal lending limits, and conservative underwriting, documentation and
collection standards. The strategy also emphasizes diversification on a
geographic, industry and customer level, regular credit examinations and
quarterly management reviews of large credit exposures and loans experiencing
deterioration of credit quality.
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to Fidelity. Included in the review of individual
loans are those that are impaired as provided in SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan." Any reserves for impaired loans are
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or fair value of the underlying collateral.
Fidelity evaluates the collectibility of both principal and interest when
assessing the need for a loss accrual. Historical loss rates are applied to
other commercial loans not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans,
are not individually risk graded. Rather, standard credit scoring systems and
delinquency monitoring are used to assess credit risks. Reserves are established
for each pool of loans based on the expected net charge-offs for one year. Loss
rates are based on the average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgment, reflect the impact of any
current conditions on loss recognition. Factors that management consider in the
analysis include the effects of the national and local economies, trends in the
nature and volume of loans (delinquencies, charge-offs and nonaccrual loans),
changes in mix, credit score migration comparisons, asset quality trends, risk
management and loan administration, changes in the internal lending policies and
credit standards, collection practices and examination results from bank
regulatory agencies and Fidelity's external credit examiners.
An unallocated reserve is maintained to recognize the imprecision in estimating
and measuring loss when evaluating reserves for individual loans or pools of
loans. Reserves on individual loans and historical loss rates are reviewed
quarterly and adjusted as necessary based on changing borrower and/or collateral
conditions and actual collection and charge-off experience.
Fidelity, has not substantively changed any aspect of its overall approach in
the determination of the reserve for loan and lease losses. There have been no
material changes in assumptions or estimation techniques as compared to prior
periods that impacted the determination of the current year reserve for loan
losses.
18
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Based on the procedures discussed above, management is of the opinion that the
reserve of $737,000 was adequate, but not excessive, to absorb estimated credit
losses associated with the loan portfolio at December 31, 2003.
Valuation of Servicing Rights: When Fidelity sells loans through either
securitizations or Freddie Mac, it may retain one or more subordinated tranches,
servicing rights, interest-only strips, credit recourse, other residual
interests, all of which are considered retained interests in the securitized or
sold loans. Gain or loss on sale or securitization of the loans depends in part
on the previous carrying amount of the financial assets sold or securitized,
allocated between the assets sold and the retained interests based on their
relative fair value at the date of sale or securitization. To obtain fair
values, quoted market prices are used if available. If quotes are not available
for retained interests, Fidelity calculates fair value based on the present
value of future expected cash flows using both management's best estimates and
third-party data sources for the key assumptions - credit losses, prepayment
speeds, forward yield curves and discount rates commensurate with the risks
involved. Gain or loss on sale or securitization of loans is reported as a
component of other non-interest income in the Consolidated Statements of Income.
Retained interests from securitized or sold loans, excluding servicing rights,
are carried at fair value. Adjustments to fair value for retained interests are
included in other non-interest expense in the Consolidated Statements of Income
if the fair value has declined below the carrying amount and such decline has
been determined to be other-than-temporary. See "Automobile Loan Securitization"
in the footnotes to the consolidated financial statements for projected adverse
changes in assumptions and the impact on the fair value.
Servicing rights resulting from loan sales are amortized in proportion to and
over the period of estimated net servicing revenues. Servicing rights are
assessed for impairment quarterly, based on fair value, with temporary
impairment recognized through a valuation allowance and permanent impairment
recognized through a write-off of the servicing asset and related valuation
reserve. Key economic assumptions used in measuring any potential impairment of
the servicing rights include the prepayment speed of the underlying loans, the
weighted-average life of the loan, the discount rate and the weighted-average
default rate, as applicable. The primary risk of material changes to the value
of the servicing rights resides in the potential volatility in the economic
assumptions used, particularly the prepayment speed. Fidelity monitors this risk
and adjusts its valuation allowance as necessary to adequately reserve for any
probable impairment in the portfolio. For purposes of measuring impairment, the
mortgage servicing rights are stratified based on financial asset type and
interest rates. Fees received for servicing loans owned by investors are based
on a percentage of the outstanding monthly principal balance of such loans and
are included in non-interest income as loan payments are received. Costs of
servicing loans are charged to expense as incurred. See "Loan Servicing" in the
footnotes to the consolidated financial statements.
Income Taxes: Fidelity accounts for income taxes using the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amount of existing assets and liabilities and their
respective tax bases. Such differences can relate to differences in accounting
for credit losses, depreciation timing differences, unrealized gains and losses
on investment securities, deferred compensation and leases, which are treated as
operating leases for tax purposes and loans for financial statement purposes.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The determination of current and deferred income taxes is based on complex
analyses of many factors including interpretation of Federal and state income
tax laws, the difference between tax and financial reporting basis of assets and
liabilities (temporary differences), estimates of amounts due or owed, the
timing of reversals of temporary differences and current financial accounting
interpretations used in determining the current and deferred income tax
liabilities.
Fidelity has a net deferred tax asset of $6.3 million at December 31, 2003. The
realization of the recorded deferred tax assets ultimately rests upon Fidelity's
ability to generate taxable income to utilize the net operating loss
carryforwards and low income housing tax credits that make up the majority of
the recorded deferred tax asset. To determine that it is more likely than not
that these carryforwards and tax credits will be utilized prior to their
expiration, management utilizes a model that projects the utilization of the
carryforwards and credits based upon the estimated future taxable income of
Fidelity. The most significant assumption used in the model is pre-tax income
estimated by management.
19
Management's Discussion and Analysis
of Results of Operations and Financial Condition
The amount used for pre-tax income for 2004, 2005 and 2006 is estimated based on
the budgeted income in United's most recent strategic plan as approved by the
OTS. Amounts used for pre-tax income for 2007 and into the future assumes 10%
growth in earnings. Fidelity established a $600,000 valuation allowance at
December 31, 2002, due to a level of projected profitability for 2002 that was
less than originally anticipated. Additional details on Fidelity's deferred tax
asset and model assumptions may be found under the heading "Income Tax" in the
notes to the consolidated financial statements and under the heading "Income Tax
Expense (Benefit)" in the Management Discussion and Analysis.
Additional accounting policies followed by Fidelity and United are presented in
Note 1 to the financial statements. These policies, along with the disclosures
presented in the other financial statement notes and in this financial review,
provide information on how significant assets and liabilities are valued in the
financial statements and how those values are determined.
New Accounting Pronouncements
In April 2003, the FASB issues SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain embedded derivatives, and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
Statement amends SFAS No. 133 to reflect the decisions made as part of the
Derivatives Implementation Group (DIG) and in other FASB projects or
deliberations. SFAS No. 149 was effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. Adoption of this Standard did not have a material effect on Fidelity's
Consolidated Financial Statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This Statement
establishes standards for how an entity classifies and measures certain
financial instruments with characteristics of both liabilities and equity. This
Statement requires that an issuer classify a financial instrument that is within
its scope as a liability. Many of those instruments were previously classified
as equity or in some cases presented between the liabilities section and the
equity section of the statement of financial position. This Statement was
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003. Adoption of this Standard did not have a material
effect on Fidelity's Consolidated Financial Statements.
In November 2002, the FASB issued Interpretation No. 45, (FIN 45) "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which elaborates on the disclosures to be
made by a guarantor about its obligations under certain guarantees issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The Interpretation expands on the accounting guidance of
SFAS No. 5, "Accounting for Contingencies," SFAS No. 57, "Related Party
Disclosures," and SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments." It also incorporates without change the provisions of FASB
Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others," which is superseded. The initial recognition and measurement provisions
of this Interpretation apply on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure requirements in this
Interpretation were effective for periods ending after December 15, 2002.
Adoption of this Interpretation did not have a material effect on Fidelity's
Consolidated Financial Statements.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities." This Interpretation clarifies the application of
ARB No. 51, "Consolidated Financial Statements," for certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated support from other parties. This
Interpretation requires variable interest entities (VIE's) to be consolidated by
the primary beneficiary which represents the enterprise that will absorb the
majority of the VIE's expected losses if they occur, receive a majority of the
VIE's residual returns if they occur, or both. Qualifying Special Purpose
Entities (QSPE) are exempt from the consolidation requirements of FIN 46. This
Interpretation was effective for VIE's created after January 31, 2003 and for
VIE's in which an enterprise obtains an interest after that date.
20
Management's Discussion and Analysis
of Results of Operations and Financial Condition
In December 2003, the FASB issued Staff Interpretation No. 46R (FIN 46R),
"Consolidation of Variable Interest Entities - an interpretation of ARB 51
(revised December 2003)," which replaces FIN 46. FIN 46R was primarily issued to
clarify the required accounting for interests in VIE's. Additionally, this
Interpretation exempts certain entities from its requirements and provides for
special effective dates for enterprises that have fully or partially applied FIN
46 as of December 24, 2003. Application of FIN 46R is required in financial
statements of public enterprises that have interests in structures that are
commonly referred to as special-purpose entities, or SPE's, for periods ending
after December 15, 2003. Application by public enterprises, other than small
business issuers, for all other types of VIE's (i.e., non-SPE's) is required in
financial statements for periods ending after March 15, 2004, with earIier
adoption permitted. Adoption of this Interpretation did not have a material
effect on Fidelity's Consolidated Financial Statements.
Asset/Liability Management
Fidelity is subject to interest rate risk to the degree that its
interest-bearing liabilities, primarily deposits with short and medium term
maturities, mature or reprice at different rates than its interest-earning
assets. Although having liabilities that mature or reprice less frequently than
average assets will be beneficial in times of rising interest rates, such an
asset/liability structure will result in lower net income during periods of
declining interest rates such as those experienced in 2003 and 2002, unless
offset by other factors.
The OTS utilizes a model, the "Office of Thrift Supervision Net Portfolio Value"
("NPV") model, which uses a net market value methodology to measure the interest
rate risk exposure of savings associations. Under this model, an institution's
"normal" level of interest rate risk in the event of an assumed change in
interest rates is a decrease in the institution's NPV in an amount not exceeding
2% of the present value of its assets. Savings associations with over $300
million in assets or less than a 12% risk-based capital ratio are required to
file OTS Schedule CMR. Data from Schedule CMR is used by the OTS to calculate
changes in NPV (and the related "normal" level of interest rate risk) based upon
certain interest rate changes (discussed below). Associations which do not meet
either of the filing requirements are not required to file OTS Schedule CMR, but
may do so voluntarily. United is not required to file a CMR since it exceeds the
risk-based capital requirement and its assets are less than $300 million, but
does so on a voluntary basis. Under the regulation, associations, which must
file are required to take a deduction (the interest rate risk capital component)
from their total capital available to calculate their risk based capital
requirement if their interest rate exposure is greater than "normal". The amount
of that deduction is one-half of the difference between (a) the institution's
actual calculated exposure to a 200 basis point interest rate increase or
decrease (whichever results in the greater pro forma decrease in NPV) and (b)
its "normal" level of exposure which is 2% of the present value of its assets.
During the current historically low interest rate environment a 200 basis point
decrease is not meaningful, therefore a 100 basis point decrease is currently
used by the OTS.
Presented below, at December 31, 2003 and December 31, 2002, is an analysis
performed by the OTS of United's interest rate risk as measured by 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. On
December 31, 2003, the yield on the three month Treasury bill was 0.93%. As a
result, the NPV model did not produce results for the minus 200 or 300 basis
points scenarios for the quarter ending December 31, 2003. At December 31, 2003
and December 31, 2002, 2% of the present value of United's assets was
approximately $3.5 million and $2.5 million respectively. Because the interest
rate risk of a 200 basis point increase in 2003 and 2002 (which was greater than
the interest rate risk of a 100 basis point decrease) was $4.1 million at
December 31, 2003, United would have been required to make a deduction from its
total capital available to calculate its risk based capital requirement.
However, United is not required to file a CMR, therefore no deduction is
required for the interest rate capital component. United is continuing to change
its balance sheet mix and anticipates its interest rate sensitivity will
decrease in 2004. The increase in interest rate risk from December 31, 2002 to
December 31, 2003 is due to interest rate changes and a change in United's
balance sheet mix.
21
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Interest Rate Risk as of December 31, 2003
Net Portfolio Value NPV as Percent of Present
(Dollars In Thousands) Value of Assets
--------------------------------------------------------------------------------------------
Change Dollar Dollar Percentage
in Rates Amount Change Change NPV Ratio Change
- -----------------------------------------------------------------------------------------------------------
+ 300 bp $9,118 $(7,038) (44)% 5.51% - 373 bp
+ 200 bp 12,006 (4,151) (26) 7.10 - 214 bp
+ 100 bp 14,432 (1,724) (11) 8.38 - 86 bp
0 bp 16,156 9.24
- 100 bp 17,114 958 6 9.68 44 bp
Interest Rate Risk as of December 31, 2002
Net Portfolio Value NPV as Percent of Present
(Dollars In Thousands) Value of Assets
--------------------------------------------------------------------------------------------
Change Dollar Dollar Percentage
in Rates Amount Change Change NPV Ratio Change
- -----------------------------------------------------------------------------------------------------------
+ 300 bp $9,677 $(2,304) (19)% 7.87% - 151 bp
+ 200 bp 10,812 (1,169) (10) 8.66 - 73 bp
+ 100 bp 11,676 (305) (3) 9.23 - 16 bp
0 bp 11,981 9.38
- 100 bp 11,969 (12) 0 9.31 - 7 bp
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the methods of analysis presented above. For example, although
certain assets and liabilities may have similar maturities or periods to
repricing, they may react in different degrees to changes in market 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 market rates. Additionally, certain assets, such as
adjustable-rate loans, have features, which restrict changes in interest rates
on a short-term basis and over the life of the assets. Further, in the event of
a change in interest rates, expected rates of prepayments on loans and early
withdrawals from certificates could likely deviate significantly from those
assumptions used in calculating the table.
Results of Operations
General
Fidelity recorded net income of $214,000 for the year ended December 31, 2003,
an increase in net income of $4.6 million over the previous year. Net interest
income decreased slightly and provision for loan losses increased slightly,
while being offset by higher noninterest income and a significant decrease in
noninterest expense. Nonrecurring losses were incurred during 2002 from the sale
of two subsidiaries, impairment charges and changes in useful lives of
Fidelity's intangible assets. Also, valuation allowances were established in
connection with the retained interest in a securitization transaction due to a
increase in prepayment speeds. Finally, a valuation allowance was established
against the deferred tax asset due to uncertainties regarding the future
utilization of income tax carryforwards.
Income
o Fidelity generates two sources of pre-tax income. The first is net
interest income. Net interest income is the difference between interest
income - which is the income that Fidelity earns on its loans and
investments - and interest expense - which is the interest that
Fidelity pays on its deposits and borrowings.
o Fidelity's second source of pre-tax income is noninterest income. This
includes fee income - the compensation we receive from providing
products and services - and gains on sales of loans. Most of Fidelity's
fee income comes from loan sales, letter of credit fees, service
charges and overdraft fees.
22
Management's Discussion and Analysis
of Results of Operations and Financial Condition
o Fidelity may occasionally recognize a gain or loss as a result of the
sale of investment securities or foreclosed real estate. These gains
and losses are not a regular part of Fidelity's income.
Expenses
o The expenses Fidelity incurs in operating its business consist of
salaries and employee benefits, occupancy and equipment expenses,
deposit insurance premiums, data processing fees and other
miscellaneous expenses.
o Salaries and employee benefits consist primarily of the salaries and
wages paid to our employees, as well as expenses for retirement and
other employee benefits.
o Occupancy and equipment expenses, the fixed and variable costs of
building and equipment, consist primarily of depreciation of property
and equipment, real estate taxes, maintenance and insurance.
o Deposit insurance premiums are calculated as a percentage of assessable
deposits.
o Data processing fees depend on the number of accounts and transaction
volume.
o Other expenses consist of professional fees, advertising and
promotions, printing, supplies, postage and other miscellaneous
operating expenses.
o Legal and professional fees incurred over the past three years have
primarily been related to workout activities with respect to various
classified assets and expenses associated with the sale of certain real
estate assets, in addition to the securitization transaction and sale
of subsidiaries in 2002.
o In addition to operating expenses noted above, Fidelity also
occasionally recognizes expense that is not anticipated by management
to be recurring. Such expenses that occurred in 2002 were changes in
estimated useful lives of intangible assets, prepayment fees on FHLB
advances, start up costs associated with United's first securitization
transaction and other expenses incurred in connection with the sale of
two of its subsidiaries.
Net Interest Income
Net interest income, Fidelity's largest component of income, represents the
difference between interest and fees earned on loans, investments and other
interest-earning assets, and interest paid on interest-bearing liabilities. It
also measures how effectively management has balanced and allocated Fidelity's
interest rate-sensitive assets and liabilities. In addition, certain external
factors such as the overall condition of the economy, credit demand strength,
Federal Reserve Board monetary policy, changes in tax laws, and the Supervisory
Agreement that United currently operates under can also have significant effects
on changes in net interest income from one period to another.
The net interest margin is determined by dividing net interest income by average
interest-earning assets. The net interest spread is the difference between the
average yield earned on interest-earning assets and the average rate paid on
interest-bearing liabilities.
23
The following table details average balances, interest income/expense and
average rates/yield for Fidelity's earning assets and interest bearing
liabilities for the years ended December 31, 2003, 2002 and 2001.
Average Balance Sheet and Net Interest Analysis
(Dollars In Thousands on Fully Taxable Equivalent Basis)
December 2003 December 2002 December 2001
------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Year Ended: Balances Interest Rates Balances Interest Rates Balances Interest Rates
- ----------------------------------------------------------------------------------------------------------------------------
Assets
Federal funds sold and
other short-term
investments $ 3,542 $ 47 1.33% $ 6,371 $ 114 1.79% $ 12,173 $ 481 3.95%
Investment securities
available for
sale-taxable 41,658 1,421 3.41 32,191 1,427 4.43 18,977 1,220 6.43
Loans held for sale 572 39 6.82 2,016 137 6.80
Federal Home Loan Bank
Stock 2,755 141 5.12 2,634 160 6.07 2,620 195 7.44
Loans (1) (2)
Commercial loans 2,478 130 5.25 2,223 133 5.98 2,076 166 8.00
Multi-family loans 9,097 592 6.51 8,733 799 9.15 11,097 972 8.76
Home equity loans 4,795 224 4.67 4,563 245 5.37 4,879 381 7.81
Real estate mortgages 39,553 2,266 5.73 40,700 2,852 7.01 47,619 3,716 7.80
Consumer loans 26,630 1,790 6.72 38,602 3,167 8.20 45,901 4,324 9.42
---------------------- ---------------------- -----------------------
Total loans 82,553 5,002 6.06 94,821 7,196 7.59 111,572 9,559 8.57
---------------------- ---------------------- -----------------------
Total earning assets 131,080 6,650 5.07 138,033 9,034 6.54 145,342 11,455 7.88
------------ ------------ ------------
Allowance for loan
losses (775) (1,135) (1,702)
Cash and due from banks 2,191 2,435 3,794
Premises and equipment 4,774 5,810 5,903
Other assets 12,307 14,482 12,255
------------ ------------ ------------
Total assets $149,577 $159,625 $165,592
============ ============ ============
Liabilities
Interest-bearing
deposits
Interest-bearing
checking $ 13,792 $ 67 0.49 $ 12,720 $ 115 0.90 $ 11,009 $ 196 1.78%
Money market accounts 6,743 58 0.86 9,664 137 1.42 13,808 496 3.59
Savings accounts 5,470 34 0.62 4,958 37 0.75 4,497 72 1.60
Certificates of
deposit 80,319 2,727 3.40 86,779 4,096 4.72 93,885 5,730 6.10
---------------------- ---------------------- -----------------------
Total
interest-bearing
deposits 106,324 2,886 2.71 114,121 4,385 3.84 123,199 6,494 5.27
Federal funds purchased 156 3 1.92 32
Other borrowings 7,611 659 8.66 11,842 1,096 9.26 13,493 1,335 9.89
Federal Home Loan Bank
advances 15,172 282 1.86 13,561 538 3.97 10,926 672 6.15
---------------------- ---------------------- -----------------------
Total
interest-bearing
liabilities 129,107 3,827 2.96 139,680 6,022 4.31 147,650 8,501 5.76
------------ ------------ ------------
Non-interest bearing
demand deposits 5,564 4,964 2,654
Advances by borrowers for
taxes and insurance 285 309 369
Other liabilities 1,953 2,736 4,631
------------ ------------ ------------
Total liabilities 136,909 147,689 155,304
Stockholders' Equity 12,668 11,936 10,288
------------ ------------ ------------
Total liabilities and
stockholders' equity $149,577 $159,625 $165,592
============ ============ ============
Recap: (3)
Interest income 6,650 5.07 9,034 6.54% 11,455 7.88%
Interest expense 3,827 2.92 6,022 4.36 8,501 5.85
-------------------- ---------------------- ----------------------
Net interest
Income/margin $2,823 2.15% $3,012 2.18% $ 2,954 2.03%
==================== ====================== ======================
Interest rate spread 2.11% 2.23% 2.12%
Average interest-bearing
assets to average
interest-bearing
liabilities 101.53% 98.82% 98.44%
(1) Nonaccrual loans have been included in the average balances.
(2) Loan income includes interest and fees on loans.
(3) Interest rate spread is calculated by subtracting combined weighted
average interest rate cost from combined weighted average interest rate
earned for the period indicated.
24
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Net interest income decreased $189,000 for the year ended December 31, 2003,
compared to December 31, 2002. The net interest margin decreased slightly from
2.18% at December 31, 2002 to 2.15% at December 31, 2003. Lower interest rates
in 2003 impacted the margin negatively by approximately $199,000, while the
change in volume during 2003 impacted the margin favorably by approximately
$10,000, resulting in a net decrease of $189,000.
United completed a $49.5 consumer loan securitization transaction at the end of
the fourth quarter of 2002. The elimination of these higher earning assets and
replacement with lower earning assets in 2003 negatively impacted interest
income on a year-to-year comparison. Consumer loan interest income decreased
$982,000 due to the decrease in average loans and an additional $395,000 due to
a decrease in the overall yield on the consumer loan portfolio. The yield on
consumer loans decreased from 8.20% at December 31, 2002 to 6.72% due to the
completion of the securitization transaction and replacement of the sold loans
with other loans at lower rates.
The yield on average mortgage loans decreased from 7.01% to 5.73% during 2003
due to refinancing activity in the portfolio and growth of the adjustable-rate
mortgage (ARM) portfolio, which carried a lower yield in 2003. This resulted in
a $586,000 decrease in mortgage loan interest income, of which $506,000 was due
to lower rates in 2003.
During 2003, the Company sold $2.6 million in classified multifamily loans
bearing an interest rate that was higher than market. These loans were
effectively replaced with higher-quality, but lower yielding commercial real
estate loans, resulting in a decrease in interest income of $207,000 from 2002.
Average investment securities increased $9.5 million during 2003 which
attributed to additional interest income of $420,000. However this interest
income was offset by a decrease in the yield on the investment portfolio
resulting in a $426,000 decrease in interest income. Sales and increased
prepayment speeds on United's mortgage-backed portfolio and a lower interest
rate environment contributed to a lower reinvestment yield in 2003.
Interest expense decreased $2.2 million at December 31, 2003 when compared to
December 31, 2002. Average interest-bearing liabilities decreased $10.6 million
from December 31, 2002 to $129.1 million at December 31, 2003. This decrease
accounted for $663,000 of the $2.2 million decrease in interest expense. Other
factors in the decrease of interest expense were:
o Average certificates of deposit decreased $6.5 million and the
corresponding interest expense associated with the volume change
decreased $305,000.
o Average other borrowings decreased $4.2 million during 2003 which
accounted for $392,000 of the $437,000 decrease in other borrowings
interest expense.
The yield on interest-bearing liabilities decreased from 4.31% in 2002 to 2.96%
in 2003. The change in rate accounted for $1.5 million of the $2.2 million
decrease in interest expense. Other factors in the decrease of interest due to
the yield on interest-bearing liabilities were:
o The average rate on certificates of deposit decreased from 4.72% at
December 31, 2002 to 3.40% at December 31, 2003. This decrease
accounted for $1.1 million of the decrease in interest expense.
o The average yield on FHLB advances decreased from 3.97% to 1.86% in
2003 due to repricing opportunities in a lower interest rate
environment and the prepayment of higher interest-bearing advances in
2002. This decrease in yield accounted for approximately $320,000
reduction in interest expense.
Net interest income increased $58,000 for the year ended December 31, 2002
compared to the same period last year. The net interest margin increased to
2.18% at December 31, 2002 from 2.03% at December 31, 2001. United reduced its
liquid assets during 2003 by utilizing available liquidity in investments,
consumer loans and increased commercial lending activities.
25
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Average mortgage loans decreased $6.9 million from the prior year, primarily due
to refinancing activity in the portfolio, resulting in an $864,000 decrease in
mortgage loan interest income. Average commercial and multifamily loans
decreased $2.2 million, resulting in a $206,000 decrease in interest income.
Total average loans decreased $16.8 million resulting in a decrease of $1.4
million in interest income. The overall decline in interest rates for total
loans accounted for an additional $928,000 decrease in interest income.
The increase in Fidelity's average investment portfolio of $13.2 million
contributed an additional $850,000 in interest income, but was offset partially
by a $643,000 decrease due to lower rates and increased prepayment speeds on the
investment portfolio over the prior year. Due to the historical low interest
rate environment and increased prepayment speeds, United reduced the premium
associated with the mortgage-backed securities by approximately $303,000 to
reflect the projected remaining life of the instruments based on current
prepayment speeds.
Interest expense decreased $2.5 million at December 31, 2002 when compared to
December 31, 2001. Average interest-bearing liabilities decreased $8.0 million
from December 31, 2001 to $139.7 million at December 31, 2002. This decrease
accounted for $547,000 of the $2.5 million decrease in interest expense. The
remaining $1.9 million was rate-associated, with $1.2 million of the decrease
due to declines in certificates of deposits rates. The average rate on
interest-bearing deposits decreased to 3.84% from 5.27% in 2001, primarily due
to the continued reduction in market interest rates in 2002 and repricing
opportunities with higher fixed rate certificates maturing in 2002.
Rate/Volume Analysis
The following table sets forth an analysis of volume and rate changes in
interest income and interest expense of Fidelity's average earning assets and
average interest-bearing liabilities. The table distinguishes between the
changes related to average outstanding balances of assets and liabilities
(changes in volume holding the initial interest rate constant) and the changes
related to average interest rates (changes in average rate holding the initial
outstanding balance constant). The change in interest due to both volume and
rate has been allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each.
December 31, 2003 December 31, 2002
Compared to December 31, 2002 Compared to December 31, 2001
Increase (Decrease) Due To Increase (Decrease) Due To
--------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
--------------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Interest income on average earning assets:
Loans $(931) $(1,263) $(2,194) $ (1,435) $ (928) $ (2,363)
Investment securities 420 (426) (6) 850 (643) 207
Loans held for sale (98) - (98) 137 137
Federal Home Loan Bank stock 7 (26) (19) 1 (36) (35)
Federal funds sold and other
short-term investments (51) (16) (67) (229) (138) (367)
-------------------------------------------------------------------------------
Total interest income (653) (1,731) (2,384) (813) (1,608) (2,421)
-------------------------------------------------------------------------------
Interest expense on average interest- bearing liabilities:
Now accounts 10 (58) (48) 30 (111) (81)
Money market deposit accounts (41) (38) (79) (149) (210) (359)
Savings accounts 4 (7) (3) 7 (42) (35)
Certificates of deposit (305) (1,064) (1,369) (434) (1,200) (1,634)
Federal funds purchased (3) - (3)
Other borrowings (392) (45) (437) (163) (73) (236)
Federal Home Loan Bank advances 64 (320) (256) 162 (296) (134)
-------------------------------------------------------------------------------
Total interest expense (663) (1,532) (2,195) (547) (1,932) (2,479)
-------------------------------------------------------------------------------
Changes in net interest income $ 10 $ (199) $ (189) $ (266) $ 324 $ 58
===============================================================================
Provision for Loan Losses and Letter of Credit Reserves
Fidelity makes provisions for loan losses in amounts estimated to be sufficient
to maintain the allowance for loan losses at a level considered necessary by
management to absorb losses in the loan portfolios. Specific reserves are
assigned to certain credits. The reserves are determined by management's
evaluation of those credits, which include evaluations of borrower's ability to
repay outstanding debt, as well as the value of supporting collateral.
26
Management's Discussion and Analysis
of Results of Operations and Financial Condition
The results of internal loan reviews, previous regulatory reviews, and past
events assist Fidelity in making that evaluation. The independent support for
the allowance for loan losses and letter of credit valuation reserve includes
documentation that supports the amount of recorded reserves for these credits.
General reserves for loans and letters of credit not specifically reserved are
also determined. Fidelity computes general reserves for the commercial,
commercial mortgage, residential mortgage and consumer loan portfolios by
utilizing historical information and information currently available about the
loans within those portfolios that provides information as to the likelihood of
loss. The potential effect of current economic conditions is also considered
with respect to establishing general reserve amounts.
The provision for loan losses for the year ended December 31, 2003 was $13,000
compared to a credit of $360,000 for the year ended December 2002, an increase
of $373,000.
During 2003, United recognized provision for loan losses of $492,000 compared to
$204,000 in 2002. The provision for loan loss in 2003 was primarily offset by a
reduction of allocated reserves previously set aside for consumer loans as a
result of completing consumer loan sales in 2003, in addition to the sale of two
large classified multifamily loans during the second quarter of 2003.
During 2002, Fidelity completed a securitization of automobile loans in addition
to a loan sale which created $564,000 in excess allocated consumer loan
reserves. These excess reserves were removed from the allowance for loan losses
and credited against the 2002 provision for a net credit result of $360,000.
During 2003 a credit of $170,000 reduced the letter of credit valuation
provision due to improvements in the underlying credits. At December 31, 2003
the balance of the letter of credit valuation allowance was $291,000 compared to
$445,000 at December 31, 2002. This reduction was offset by additional provision
for loan losses for the same amount during the year, and is included in the
overall provision of $492,000.
United expects to increase the allowance for loan losses in conjunction with
projected loan growth in 2004. As a result, the provision for loan losses is
also expected to increase in 2004.
The ratio of allowance for loan losses to non-performing loans was 49.3% at
December 31, 2003 compared to 91.5% at December 31, 2002. The primary reason for
the increase in non-performing loans was due to one residential real estate loan
totaling $451,000. Subsequent to year-end, this credit was paid off in full. The
largest remaining non-accrual loan has a balance of $233,000 and is a purchased
participation. Management believes that the reserves for the loan are adequate
at December 31, 2003.
Non-Interest Income
Non-interest income for the year ended December 31, 2003 increased by $371,000
or 10.6% compared to December 31, 2002.
Net gains on the sale of loans decreased $558,000 from the prior year due
primarily to a decrease in volume of automobile loans sold. Fidelity recorded
$353,000 in gains on sales of available for sale securities in 2003 compared to
$73,000 in 2002. Declining interest rates and increased prepayment speeds made
it advantageous to sell certain securities in 2003. Servicing fees on loans sold
increased $131,000 over the prior year due to the increased size of the mortgage
and consumer loan servicing portfolios. Gain on sales of assets was $15,000 for
2003 compared to $574,000 in 2002. A non recurring gain of $574,000 was
recognized in the fourth quarter of 2002 in connection with the sale of certain
affordable housing assets to a related party. During 2002, Fidelity liquidated a
$500,000 senior note for $360,000 and recorded a gain of $140,000. A gain of
$359,000 was recognized on the sale of three foreclosed properties during 2003,
or substantially all of the real estate owned portfolio. An increase in early
payoffs on automobile loans previously sold resulted in the repayment of dealer
interest totaling $299,000 from auto dealers, compared to $66,000 in 2002.
Income of $182,000 was recognized on the retained interests in securitized
assets compared to $90,000 in 2002.
27
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Non-Interest Expense
Non-interest expense decreased $3.2 million or 32.6% for the year ended December
31, 2003, compared to December 31, 2002.
Salaries and employee benefits decreased $289,000 during 2003 when compared to
2002, due to a reduction in full-time equivalent employees. Data processing
expense increased $100,000 over 2002 due to increased volume of mortgage and
consumer loans serviced when compared to the same period in 2002, in addition to
the introduction of internet banking in 2003. Legal and professional fees
decreased $48,000 from the prior year due to a decrease in loan workout
activities. Dealer promotional expenses decreased $60,000 in 2003 due primarily
to a decrease in automobile originations in the current year. Professional
liability insurance expense increased $108,000 over the prior year due to market
rate increases.
During 2003, the valuation allowance for letters of credit was reduced by
$170,000 compared to none in 2002 and $1.5 million in 2001 to reflect a
reduction in loss exposure achieved. The $170,000 in 2003 was effectively
reclassified between the letter of credit valuation and allowance for loan
losses offsetting the impact on net income.
Fidelity records its percentage share of losses for its limited partner
investments in various affordable housing partnerships under the equity method
of accounting. These losses were $40,000, $160,000, and $304,000 for 2003, 2002
and 2001, respectively. During the fourth quarter of 2002, Fidelity completed
the sale of a subsidiary that held general partnership interests in seventeen
affordable housing projects. See "Related Party" footnote for additional
details.
Other real estate owned expenses of $247,000 were recognized in 2002 compared to
only $34,000 in 2003 due to a foreclosure on one large commercial real estate
loan in 2002.
Non-recurring expenses were incurred during 2002 for various reasons, the
following non-recurring items are included in non-interest expense: Changes in
the estimated useful lives of intangible assets created additional expense of
$864,000 and are discussed in the "Related Party" footnote. Prepayment fees on
FHLB advances of $504,000 were recognized in 2002 compared to none in 2003 or
2001. United repaid long-term FHLB advances that had substantially higher
interest rates than the current market. The completion of the securitization
transaction created liquidity which was used to payoff these higher interest
bearing liabilities. It is expected that these higher cost borrowings will be
replaced with deposits and borrowings at a much lower rate. This is expected to
result in a much lower overall cost of funds for the Company in the future.
During 2002, United completed a securitization transaction and recognized a
loss. In addition, a valuation allowance of $455,000 was recorded due to lower
than expected market interest rates, which resulted in United securitizing loans
at lower interest rates than originally estimated, plus experiencing faster than
expected prepayment speeds on the seasoned portion of the securitized loans.
These losses were partially offset by a reversal of $360,000 in consumer loan
loss provision.
Income Tax Expense (Benefit)
Fidelity reported a pretax loss of $6,000 compared to the prior year pretax loss
of $3.0 million. An income tax benefit of $220,000 was recorded on the net loss
which was primarily generated by the current year tax credits. In 2002, an
income tax benefit of approximately $1.2 million was recorded on the $3.0
million pretax loss but was reduced by additional tax expense resulting from a
capital gain, which reduced the benefit to $641,000. The additional tax expense
was primarily the result of the capital gain for tax purposes on the sale of
Fidelity's subsidiaries and the additional $600,000 tax valuation allowance
established in connection with Fidelity's deferred tax asset. Included in the
tax benefit are tax credits for 2003 of $222,000 compared to $185,000 in the
prior year. The 2003 credits were received from Fidelity's remaining investment
as a limited partner in affordable housing properties and are a component of the
overall return on these investments.
28
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Consideration of the need for a valuation allowance for the deferred tax asset
was made at December 31, 2003 after projecting the reversal of the deferred
items. These analyses were based on projected operating income in future years,
action plans developed and partially implemented included in Fidelity's business
plan and cost reductions. These analyses showed that not all carryforwards would
be utilized within the carryforward periods (federal and state) and a valuation
allowance would be necessary. The analyses assume that Fidelity will execute
approximately 50% of the initiatives included within its current business plan
and then achieve 10% growth in annual earnings thereafter. The conservative
level of earnings contemplated by these analyses, if achieved, will constitute
for the majority of the carryforward periods, earnings levels that are below
other thrift holding companies included within Fidelity's peer group. Due to a
level of projected profitability for 2002 being less than originally
anticipated, Fidelity established a valuation allowance of $600,000 until such
time that Fidelity meets its future period profitability forecasts. Fidelity has
set forth reasonable plans, and exceeded its 2003 strategic plan indicating that
future period profitability will increase and be more in line with its recently
approved strategic plan, the ultimate outcome of this uncertainty on net income
or earnings per share, if any, is unknown.
The assumptions used to help consider the need for a valuation allowance for the
deferred tax asset are subject to certain risks and uncertainties that could
impact the final determination regarding the amount of the valuation allowance.
These risks include the failure to implement the business plan targets for
increased revenues, cost reductions, the potential loss of key employees,
ability to maintain projected interest rate margins, and the potential
disruption of activities in key income-producing areas.
Loss on Discontinued Operations
During the fourth quarter of 2002, Fidelity completed the sale of the assets
connected to their affordable housing activities that began in the mid-1990's to
Pedcor Funding Corporation ("Funding"). The assets consisted of the stock of
Village Housing Corporation (a wholly-owned subsidiary of United Fidelity Bank),
the stock of Village Affordable Housing Corporation (a wholly-owned subsidiary
of Fidelity Federal), an interest rate swap, and notes from affordable housing
limited partnerships in which Village Housing Corporation is the general
partner.
The Company determined to pursue the sale of these assets in order to further
focus on its community banking activities. It also determined that the
elimination of the contingent liabilities associated with the ownership of the
affordable housing general partnerships interests would improve its overall risk
profile.
The purchaser, Funding, is a company controlled by Bruce A. Cordingley, Gerald
K. Pedigo, and Phillip J. Stoffregen, directors of Fidelity Federal and members
of a group which beneficially owns, including stock options and warrants,
approximately 69.9% of Fidelity Federal's issued and outstanding stock. Because
of the relationship between Funding and Fidelity Federal, Messrs. Cordingley,
Pedigo, and Stoffregen did not participate in either the discussion or the vote
by the boards of directors of Fidelity Federal and United Fidelity Bank
regarding the sale. The sale was unanimously approved by all other members of
the respective Boards of Directors of Fidelity Federal and United Fidelity Bank
and was completed following receipt of all necessary regulatory approvals and a
fairness opinion. The fairness opinion was rendered by Crowe Chizek & Co., an
independent, non-affiliated entity which has not performed services for Messrs.
Cordingley, Pedigo, or Stoffregen or any entity they control (other than
Fidelity Federal or United Fidelity Bank), and has not performed services for
the companies within the last five years.
The sale price for the all-cash transaction was approximately $1.7 million, thus
the sale provided the Company with additional liquidity. Because a portion of
the assets sold had been previously eliminated from regulatory capital, the sale
resulted in an increase in the regulatory capital of United Fidelity Bank.
Additional regulatory capital provides the Bank future capacity to increase
earning assets, which could then increase net interest income.
Net loss on operations from these subsidiaries totaled $2.0 million of which
$1.5 million was associated with the completion of the sale and $451,000
associated with the income tax expense impact. Net income or loss from prior
years were immaterial and not included as a separate component. See the
"Discontinued Operations" footnote for additional details.
29
Management's Discussion and Analysis
of Results of Operations and Financial Condition
Quarterly Results of Operations (Dollars In Thousands)
March 31 June 30 September 30 December 31 Total
----------------------------------------------------------------------------------------------------------------------------
December 31, 2003
Interest income $1,602 $1,596 $ 1,616 $ 1,836 $ 6,650
Interest expense 1,158 980 833 856 3,827
-----------------------------------------------------------------------------------
Net interest income 444 616 783 980 2,823
Provision for loan losses (104) (18) 99 36 13
Non-interest income 1,218 1,106 914 640 3,878
Non-interest expense 1,761 1,658 1,662 1,613 6,694
-----------------------------------------------------------------------------------
Income (loss) before income tax 5 82 (64) (29) (6)
Income tax expense (benefit) (50) (21) (90) (59) (220)
-----------------------------------------------------------------------------------
Net income (loss) $ 55 $ 103 $ 26 $ 30 $ 214
===================================================================================
Net income (loss) per share
Diluted net income (loss) $ 0.01 $ 0.01 $ - $ - $ 0.02
Basic net income (loss) 0.01 0.01 - - 0.02
Cash dividends*
December 31, 2002
Interest income $2,573 $2,510 $ 2,426 $ 1,525 $ 9,034
Interest expense 1,602 1,630 1,509 1,281 6,022
-----------------------------------------------------------------------------------
Net interest income 971 880 917 244 3,012
Provision for loan losses (400) 40 (360)
Non-interest income 930 820 580 1,177 3,507
Non-interest expense 1,886 1,754 3,351 2,936 9,927
-----------------------------------------------------------------------------------
Loss before income tax 15 (54) (1,454) (1,555) (3,048)
Income tax expense benefit (71) (98) 562 (1,034) (641)
-----------------------------------------------------------------------------------
Income (loss) from continuing
operations 86 44 (2,016) (521) (2,407)
-----------------------------------------------------------------------------------
Loss on discontinued operations
before tax (762) (775) (1,537)
Income tax expense (229) 680 451
-----------------------------------------------------------------------------------
Loss on discontinued operations (533) (1,455) (1,988)
-----------------------------------------------------------------------------------
Net income (loss) $ 86 $ 44 $(2,549) $(1,976) $(4,395)
===================================================================================
Net income (loss) per share
Diluted net income (loss) from
continuing operations $ 0.01 $ 0.01 $ (0.33) $ (0.08) $ (0.39)
Diluted net income (loss) from
discontinued operations (0.09) (0.22) (0.32)
Diluted net income (loss) 0.01 0.01 (0.41) (0.30) (0.71)
Basic net income (loss) from
continuing 0.01 0.01 (0.33) (0.08) (0.39)
Operations
Basic net income (loss) from
discontinued operations (0.09) (0.22) (0.32)
Basic net income (loss) 0.01 0.01 (0.41) (0.30) (0.71)
Cash Dividends*
*No cash dividends were paid for the years ended December 31, 2003 and 2002.
30
Independent Accountants' Report
Stockholders and Board of Directors
Fidelity Federal Bancorp
Evansville, Indiana
We have audited the accompanying consolidated balance sheets of Fidelity Federal
Bancorp and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 described above present
fairly, in all material respects, the consolidated financial position of
Fidelity Federal Bancorp and subsidiaries as of December 31, 2003 and 2002, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
/s/ BKD. LLP
Evansville, Indiana
January 16, 2004
FIDELITY FEDERAL BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands, Except Share Data)
December 31 2003 2002
----------------------------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 1,705 $ 1,454
Interest-bearing demand deposits 1,263 2,369
-------------------------------------
Cash and cash equivalents 2,968 3,823
Investment securities available for sale 52,208 34,912
Loans, net of allowance for loan losses of $737 and $837
(also includes loans to related parties, net of allowance for
loan losses of $177 and $2,654) 100,437 73,087
Premises and equipment 4,620 4,935
Federal Home Loan Bank of Indianapolis stock 3,466 2,674
Deferred income tax 6,093 5,615
Foreclosed assets held for sale, net of allowance of $0 and $100 30 2,145
Interest receivable and other assets 5,568 5,099
-------------------------------------
Total assets $175,390 $132,290
=====================================
Liabilities
Deposits
Non-interest bearing (includes related party deposits
of $854 and $619) $ 6,903 $ 3,209
Interest bearing 113,777 103,582
-------------------------------------
Total deposits 120,680 106,791
Federal Home Loan Bank advances 31,550 3,000
Borrowings (includes borrowings from a related party
of $1,000 and $0) 8,077 10,586
Valuation allowance for letters of credit 291 445
Other liabilities 1,425 1,880
-------------------------------------
Total liabilities 162,023 122,702
-------------------------------------
Stockholders' Equity
Preferred stock, no par or stated value
Authorized and unissued--5,000,000 shares
Common stock, $1 stated value
Authorized--15,000,000 shares
Issued and outstanding--9,618,658 and 6,740,883 shares 9,619 6,741
Additional paid-in capital 16,634 15,359
Stock warrants 261 261
Accumulated deficit (12,938) (13,152)
Accumulated other comprehensive income (loss) (209) 379
-------------------------------------
Total stockholders' equity 13,367 9,588
-------------------------------------
Total liabilities and stockholders' equity $175,390 $132,290
=====================================
See notes to consolidated financial statements.
32
FIDELITY FEDERAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Income
(In Thousands, Except Share Data)
Year Ended December 31 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------
Interest Income
Loans receivable $5,002 $7,196 $9,559
Loans held for sale 39 137
Investment securities--taxable 1,421 1,427 1,220
Deposits with financial institutions 47 114 481
Other dividend income 141 160 195
--------------------------------------------------------
Total interest income 6,650 9,034 11,455
--------------------------------------------------------
Interest Expense
Deposits 2,886 4,385 6,494
Short-term borrowings 18 64
Long-term debt 923 1,573 2,007
--------------------------------------------------------
Total interest expense 3,827 6,022 8,501
--------------------------------------------------------
Net Interest Income 2,823 3,012 2,954
Provision for loan losses 13 (360) 1,349
--------------------------------------------------------
Net Interest Income After Provision for
Loan Losses 2,810 3,372 1,605
--------------------------------------------------------
Other Income
Service charges on deposit accounts 436 439 364
Net gains on loan sales (includes a $223 gain on sale
to a related party in 2002) 725 1,283 2,051
Net gains on sales of securities available for sale 353 73
Letter of credit fees 491 501 506
Servicing fees on loans sold 292 161 125
Gain on sale of assets 15 574
Gain on early extinguishment of debt 140 325
Gain on sale of foreclosed assets 359 75
Dealer interest recovery 299 66 18
Income from I/O STRIP 182 90
Other income (includes a $72 gain on sale of interest
rate swap to a related party in 2002) 726 180 469
--------------------------------------------------------
Total non-interest income $3,878 $3,507 $3,933
--------------------------------------------------------
33
FIDELITY FEDERAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Income
(In Thousands, Except Share Data)
(Continued)
Year Ended December 31 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------
Other Expenses
Salaries and employee benefits $3,327 $ 3,616 $ 3,258
Net occupancy expenses 343 371 368
Equipment expenses 393 350 282
Data processing fees 437 337 348
Deposit insurance expense 51 57 248
Legal and professional fees 250 298 243
Advertising 156 142 144
Promotional expense 158 218 183
Printing, postage, and office supplies expenses 205 229 237
Professional liability insurance expense 284 176 211
Fee on prepayment of FHLB advances 504
Letter of credit valuation provision (170) (1,450)
Loss on investment in partnerships 40 160 304
Amortization of intangible assets 917 209
Correspondent bank charges 147 132 155
Loss on securitization 976
Other real estate owned expenses 34 247
Bond issuance expense 110 63 58
Other expense 929 1,134 900
------------------------------------------------------
Total non-interest expense 6,694 9,927 5,698
------------------------------------------------------
Loss From Continuing Operations Before Income Tax (6) (3,048) (160)
Income tax benefit (220) (641) (384)
------------------------------------------------------
Income (Loss) From Continuing Operations 214 (2,407) 224
------------------------------------------------------
Discontinued Operations
Loss from operations of VHC and VAHC (including
loss on sale of $1,517 to a related party) (1,537)
Income tax expense 451
------------------------------------------------------
Loss on discontinued operations (1,988)
Net Income (Loss) $ 214 $(4,395) $ 224
======================================================
Basic Earnings (Loss) Per Share From Continuing Operations $ 0.02 $ (0.39) $ 0.04
Basic Loss Per Share from Discontinued Operations $ (0.32)
Basic Earnings (Loss) Per Share $ 0.02 $ (0.71) $ 0.04
Diluted Earnings (Loss) Per Share From Continuing Operations $ 0.02 $ (0.39) $ 0.04
Diluted Loss Per Share from Discontinued Operations $ (0.32)
Diluted Earnings (Loss) Per Share $ 0.02 $ (0.71) $ 0.04
See notes to consolidated financial statements.
34
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands, Except Share Data)
Accumulated
Common Stock Comprehensive Other
------------------- Paid-in Stock Income Accumulated Comprehensive
Shares Amount Capital Warrants (Loss) Deficit Income (Loss) Total
--------------------------------------------------------------------------------------
Balances, January 1, 2001 4,607,658 $4,607 $13,674 $ 11 $ (8,981) $(536) $ 8,775
Comprehensive income
Net income $224 224 224
Other comprehensive income, net of tax
Unrealized gain on securities 498 498 498
-------------
Comprehensive income $722
=============
Sale of stock 1,379,353 1,380 1,018 2,398
Purchase of stock (2)
-------------------------------------- ------------------------------------
Balances, December 31, 2001 5,987,009 5,987 14,692 11 (8,757) (38) 11,895
Comprehensive loss
Net loss $(4,395) (4,395) (4,395)
Other comprehensive income, net of tax
Unrealized gain on securities 417 417 417
-------------
Comprehensive loss $(3,978)
=============
Sale of stock 753,874 754 667 1,421
Issuance of stock warrants 250 250
-------------------------------------- ------------------------------------
Balances, December 31, 2002 6,740,883 6,741 15,359 261 (13,152) 379 9,588
Comprehensive income
Net income $ 214 214 214
Other comprehensive loss, net of tax
Unrealized loss on securities (588) (588) (588)
-------------
Comprehensive loss $(374)
=============
Sale of stock 2,877,777 2,878 1,275 4,153
Issuance of stock warrants
Purchase of stock (2)
-------------------------------------- ------------------------------------
Balances, December 31, 2003 9,618,658 $9,619 $16,634 $261 $(12,938) $(209) $13,367
====================================== ====================================
See notes to consolidated financial statements.
35
Consolidated Statements of Cash Flows
(In Thousands)
Year Ended December 31 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income (loss) $ 214 $ (4,395) $ 224
Adjustments to reconcile net income (loss) to net cash provided
(used) by operating activities
Provision for loan losses 13 (360) 1,349
Letter of credit valuation provision (170) (1,450)
Gain on early extinguishment of debt (140) (325)
Net gain on sales securities available for sale (353) (73)
Net gain on sale of loans (725)
Net gain on sale of foreclosed assets (359)
Loss on impairment of assets held for sale and changes in
estimated useful lives of intangible assets 1,769
Depreciation and amortization 438 1,334 573
Valuation allowance--affordable housing investments 40 58
Mortgage loans originated for sale (25,827) (22,954) (32,397)
Proceeds from sale of mortgage loans 26,349 23,129 32,516
Consumer loan origination transferred to held for sale (36,829) (5,145)
Proceeds from consumer loan sales 37,032 5,145
Deferred income tax benefit (384)
Changes in
Interest payable and other liabilities (439) (564) 542
Interest receivable and other assets (685) (1,258) 70
Other 64 (78) (136)
--------------------------------------------------------
Net cash provided (used) by operating activities (1,277) (3,550) 640
--------------------------------------------------------
Investing Activities
Purchases of securities available for sale (59,964) (33,633) (2,000)
Proceeds from maturities of securities available for sale 19,456 12,541 5,724
Proceeds from sales of securities available for sale 22,530 5,053
Purchases of FHLB stock (792) (54)
Proceeds from sale of foreclosed assets 2,772
Proceeds from sale of note receivable to a related party (235)
Net change in loans (30,145) 29,510 1,961
Net change in loans to related parties 2,605 166 10
Proceeds from the sale of surplus land to a related party 165
Purchase of premises and equipment (123) (218) (627)
Proceeds from sales of premises and equipment 783 70
Funding on outstanding letters of credit (239) (3,038)
--------------------------------------------------------
Net cash provided (used) by investing activities $(43,661) $ 13,674 $ 2,265
--------------------------------------------------------
36
FIDELITY FEDERAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
(Continued)
Year Ended December 31 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------
Financing Activities
Net change in
Noninterest-bearing, interest-bearing
demand and savings deposits (includes changes to related
party of $235, $30 and $(4)) $ 1,995 $ (3,753) $ 5,015
Certificates of deposit 11,894 (9,611) (11,804)
Proceeds from borrowings 4,275 4,858 2,470
Repayment of borrowings (7,784) (6,449) (3,742)
Proceeds of borrowings from a related party 1,000
Proceeds of FHLB advances 68,500 60,300 9,500
Repayment of FHLB advances (39,950) (69,633) (7,070)
Sale of stock 4,153 1,421 2,398
Sale of stock warrants 250
--------------------------------------------------------
Net cash provided (used) by financing activities 44,083 (22,617) (3,233)
--------------------------------------------------------
Net Change in Cash and Cash Equivalents (855) (12,493) (328)
Cash and Cash Equivalents, Beginning of Period 3,823 16,316 16,644
--------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 2,968 $ 3,823 $16,316
========================================================
Additional Cash Flows Information
Interest paid $ 3,754 $ 6,256 $ 7,941
Income tax refunded (80)
Real estate acquired in settlement of loans 192 2,123
See notes to consolidated financial statements.
37
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Nature of Operations and Summary of Significant Accounting Policies
The accounting and reporting policies of Fidelity Federal Bancorp (Fidelity) and
its wholly-owned subsidiaries conform to accounting principles generally
accepted in the United States of America and reporting practices followed by the
thrift industry. The more significant of the policies are described below.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Fidelity is a registered thrift holding company whose principal activity is the
ownership and management of United Fidelity Bank, fsb (United). United operates
under a national thrift charter and provides full banking services. As a
federally chartered thrift, United is subject to regulation by the Office of
Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation.
Fidelity's other subsidiary was Village Affordable Housing Corporation, which
was formed during 1999 for the purpose of owning interests in real estate
housing. This subsidiary was sold during the fourth quarter of 2002 to a related
party.
United generates mortgage, consumer and commercial loans and receives deposits
from customers located primarily in Vanderburgh County, Indiana and surrounding
counties. Fidelity's loans are generally secured by specific items of collateral
including real property, consumer assets and business assets. United's
subsidiaries, Village Housing Corporation and Village Management Corporation
(Affordable Housing Group) and Village Capital Corporation, had previously been
involved in various aspects of financing, owning, developing and managing
affordable housing projects. During 2003, Village Management was inactive and
merged into Village Capital Corporation. During the fourth quarter of 2002,
Village Housing Corporation was sold to a related party. Village Capital
Corporation earns fees by providing real estate mortgage banking services to
unaffiliated borrowers. Village Capital has not provided any new banking
services for the past three years, but records fee income on transactions
previously completed. Another United subsidiary, Village Insurance Corporation,
is engaged in the business of selling credit life and accident health insurance
in conjunction with United's lending activities. Village Insurance was merged
into Village Capital Corporation during 2003. United formed a new subsidiary,
United Fidelity Finance, LLC, during the fourth quarter of 2001, which was
utilized to complete an auto loan securitization transaction during 2002.
Consolidation-- The consolidated financial statements include the accounts of
Fidelity and its subsidiaries after elimination of all material intercompany
transactions.
Use of estimates-- The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowance for loan losses and
the valuation of foreclosed assets held for sale, management obtains independent
appraisals for significant properties.
38
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Cash equivalents-- Fidelity considers all liquid investments with original
maturities of three months or less to be cash equivalents.
Securities available for sale are carried at fair value, with unrealized gains
and losses reported separately in accumulated other comprehensive income, net of
tax.
Amortization of premiums and accretion of discounts are recorded as interest
income from securities. Realized gains and losses are recorded as net security
gains (losses). Gains and losses of securities are recorded on the
specific-identification method.
Loans held for sale are carried at the lower of aggregate cost or market value.
Market is determined using the aggregate method. Net unrealized losses, if any,
are recognized through a valuation allowance by charges to income, based on the
difference between estimated sales proceeds and aggregate cost.
Loans held for sale at any point in time normally consist of blocks of consumer
loans designated for sale to unrelated financial institutions or individual 1-4
family mortgage loans originated for sale into the secondary market. The amounts
of loans held for sale at December 31, 2003 and 2002, were not significant and
have been included with total loans on the consolidated balance sheets.
Loans are carried at the principal amount outstanding. Interest income is
accrued on the principal balances of loans. The accrual of interest on impaired
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 when considered uncollectible. Interest
income is subsequently recognized only to the extent cash payments are received.
Certain loan fees and related direct costs are being deferred and amortized over
the lives of the loans as an adjustment of yield on the loans.
Allowance for loan losses is maintained for credit losses to absorb losses
inherent in the loan portfolio. The valuation allowance for letters of credit is
maintained for losses related to letters of credit, which are off-balance sheet
instruments. The allowances are based on ongoing quarterly assessments of the
probable estimated losses inherent in the loan and letter of credit portfolios.
The allowance for loan losses is increased by the provision for credit losses,
which is charged against current period operating results and decreased by the
amount of chargeoffs, net of recoveries. The valuation allowance for letters of
credit is maintained in a separate liability account and changes in the
valuation allowance are included in current year operations. Fidelity's
methodology for assessing the appropriateness of the allowance for loan losses
consists of several key elements, which include the formula allowance, specific
allowances for identified problem loans and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans and certain unused commitments, in each case based on the internal risk
grade of such loans, pools of loans or commitments. Changes in risk grades of
both performing and nonperforming loans affect the amount of the formula
allowance. Loss factors are based on historical loss experience and may be
adjusted for significant factors that, in management's judgment, affect the
collectibility of the portfolio as of the evaluation date.
Specific loan and letter of credit valuation reserves are established in cases
where management has identified significant conditions or circumstances related
to a loan or letter of credit that management believes indicate the probability
that a loss has been incurred in excess of the amount determined by the
application of, in the case of the allowance for loan losses, the formula
allowance.
39
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
The unallocated allowance for loan losses is based upon management's evaluation
of various conditions, the effects of which are not directly measured in the
determination of the formula and specific allowances. The evaluation of the
inherent loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific credits. The
conditions evaluated in connection with the unallocated allowance for loan
losses and the letter of credit valuation reserve may include existing general
economic and business conditions affecting Fidelity's key lending areas, credit
quality trends, collateral values, loan volumes and concentrations, seasoning of
the loan and letter of credit portfolios, specific industry conditions within
portfolio segments, recent loss experience in particular segments of the
portfolios, duration of the current business cycle, regulatory examination
results and findings of an independent third party conducting quarterly reviews
of the loan and letter of credit portfolios.
The allowance for loan losses also incorporates the results of measuring
impaired loans as provided in SFAS No. 114 and SFAS No. 118. A loan is
considered impaired when management determines that it is probable that the bank
will be unable to collect all amounts due according to the original contractual
terms of the loan agreement. Impairment is measured by the difference between
the recorded investment in the loan and the estimated present value of total
expected future cash flows, discounted at the loan's effective rate, or the fair
value of the collateral of the loan, if collateral dependent. Impairment is
recognized by adjusting an allocation of the existing allowance for loan losses.
The determination of the adequacy of the allowance for loan losses and the
letter of credit valuation allowance is based on estimates that are particularly
susceptible to significant changes in the economic environment and market
conditions. Management believes that, as of December 31, 2003, the allowance for
loan losses and the letter of credit valuation allowance were adequate based on
information currently available. A worsening or protracted economic decline in
the area within which Fidelity operates could affect the possibility of
additional losses due to credit and market risks and could create the need for
additional loss reserves.
Automobile Loan Securitization-- In 2002, United used the securitization of
automobile loans as a source of funding and as a mechanism to reduce its volume
of automobile loans. Automobile loans were transferred into a qualifying special
purpose entity (SPE) then to a trust in a transaction which is effective under
applicable banking rules and regulations to legally isolate the assets from
United. Where the transferor is a depository institution such as United, legal
isolation is accomplished through compliance with specific rules and regulations
of the relevant regulatory authorities. SFAS 140 requires, for certain
transactions completed after the initial adoption date, a "true sale" analysis
of the treatment of the transfer under state law as if United were a debtor
under the bankruptcy code. A "true sale" legal analysis includes several legally
relevant factors, such as the nature and level of recourse to United and the
nature of retained servicing rights. The analytical conclusion as to a true sale
is never absolute and unconditional, but contains qualifications based on the
inherent equitable powers of a bankruptcy court, as well as the unsettled state
of the common law. Once the legal isolation test has been met under SFAS 140,
other factors concerning the nature and extent of United's control over the
transferred assets are taken into account in order to determine whether
derecognition of assets is warranted, including whether the SPE has complied
with rules concerning qualifying special purpose entities.
40
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
A legal opinion was obtained for the automobile loan securitization transaction
in 2002, which was structured as a two-step securitization. While noting the
transaction fell within the meaning of a "securitization" under the FDIC
regulation, "Treatment by the Federal Deposit Insurance Corporation as
Conservator or Receiver of Financial Assets Transferred by an Insured Depository
Institution in Connection with a Securitization or Participation" (the
"Securitization Rule"), in accordance with accounting guidance, an analysis was
also rendered under state law as if United was a debtor under the bankruptcy
code. The "true sale" opinion provides reasonable assurance the purchased assets
would not be characterized as the property of United's receivership or
conservatorship estate in the event of insolvency and also states United would
not be required to substantively consolidate the assets and liabilities of the
purchaser SPE with those of United upon such event.
In a securitization, the trust issues beneficial interests in the form of senior
and subordinated asset-backed securities backed or collateralized by the assets
sold to the trust. The senior classes of the asset-backed securities typically
receive investment grade credit ratings at the time of issuance. These ratings
are generally achieved through the acquisition of a financial guarantee policy,
the creation of lower-rated subordinated classes of asset-backed securities, as
well as subordinated interests retained by an affiliate of United. In all cases,
United or its affiliate retains interests in the securitized assets, which may
take the form of seller certificates, subordinated tranches, cash reserve
balances, servicing assets and interest-only strips representing the cash flows
generated by the assets in excess of the contractual cash flows required to be
paid to the investors and for other obligations such as servicing fees.
In accordance with SFAS 140, securitized automobile loans are removed from the
balance sheet and a net gain or loss is recognized in income at the time of
initial sale and each subsequent sale when the combined net sales proceeds and,
if applicable, retained interests differ from the loans' allocated carrying
amount. Net gains or losses resulting from securitizations are recorded in
noninterest income or expense.
Retained interests in the subordinated tranches and interest-only strips are
recorded at their fair value and accounted for as available-for-sale securities
with subsequent adjustments to fair value recorded through other comprehensive
income within stockholders' equity or in other noninterest expense in the income
statement if the fair value has declined below the carrying amount and such
decline has been determined to be other than temporary. United uses assumptions
and estimates in determining the fair value allocated to the retained interests
at the time of sale and each subsequent sale in accordance with SFAS 140. These
assumptions and estimates include projections concerning rates charged to
customers, the expected life of the receivables, credit loss experience, loan
repayment rates, the cost of funds and discount rates commensurate with the
risks involved.
On a quarterly basis, management reviews the historical performance of the
retained interest and the assumptions used to project future cash flows. If past
performance and future expectations dictate, assumptions are revised and the
present value of future cash flows is recalculated. Refer to the automobile loan
securitization footnote for further analysis of the assumptions used in the
determination of fair value.
The retained interest represents United's maximum loss exposure with respect to
securitization vehicles. The investors in the debt securities issued by the SPEs
have no further recourse against United if cash flows generated by the
securitized automobile loans are inadequate to service the obligations of the
SPEs.
Transaction costs associated with the automobile loan securitization were
recognized as a component of the gain or loss at the time of sale.
41
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Premises and equipment are carried at cost, net of accumulated depreciation.
Depreciation is computed using the straight-line method based principally on the
estimated useful lives of the assets. Maintenance and repairs are expensed as
incurred while major additions and improvements are capitalized. Gains and
losses on dispositions are included in current operations.
Federal Home Loan Bank (FHLB) stock is a required investment for institutions
that are members of the FHLB system. The required investment in the common stock
is based on a predetermined formula.
Foreclosed assets held for sale-- Assets acquired through, or in lieu of, loan
foreclosure are held for sale and are initially recorded at fair value at the
date of foreclosure, establishing a new cost basis. Subsequent to foreclosure,
valuations are periodically performed by management and the assets are carried
at the lower of carrying amount or fair value less cost to sell. Revenue and
expenses from operations and changes in the valuation allowance are included in
net income or expense from foreclosed assets.
Income tax in the consolidated statements of income includes deferred income tax
provisions or benefits for all significant temporary differences in recognizing
income and expenses for financial reporting and income tax purposes. Fidelity
files consolidated income tax returns with its subsidiaries.
Servicing rights on originated loans that have been sold, including those
transferred as part of securitizations, are capitalized by allocating the total
cost of the mortgage or consumer loans between the servicing rights and the
loans based on their relative fair values. Capitalized servicing rights are
amortized in proportion to and over the period of estimated servicing revenues.
Impairment of mortgage and consumer loan-servicing rights is assessed based on
the fair value of those rights. Fair values are estimated using discounted cash
flows based on a current market interest rate. For purposes of measuring
impairment, the rights are stratified based on the predominant risk
characteristics of the underlying loans. The predominant characteristic
currently used for stratification is type of loan. The amount of impairment
recognized is the amount by which the capitalized servicing rights for a stratum
exceed their fair value.
Stock options and Fidelity's stock-based incentive compensation plans are
discussed more fully in the Stock Option Plans footnote. The Company accounts
for these plans under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related Interpretations.
No stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price that was equal to or
greater than the market value of the underlying common stock on the grant date.
The following table illustrates the effect on net income and earnings per share
if Fidelity had applied the fair value provisions of FASB statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
Year Ended December 31 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 214 $(4,395) $ 224
Less: Total stock-based compensation cost determined
under the fair value based method, net of income taxes 31 73 26
-----------------------------------------------
Pro forma net income (loss) $ 183 $(4,468) $ 198
===============================================
Basic earnings (loss) per share - as reported $0.02 $(0.71) $0.04
Basic earnings (loss) per share - pro forma $0.02 $(0.72) $0.04
Diluted earnings (loss) per share - as reported $0.02 $(0.71) $0.04
Diluted earnings (loss) per share - pro forma $0.02 $(0.72) $0.04
42
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Earnings per share have been computed based upon the weighted-average common
shares outstanding during the year. The effect of outstanding options and
warrants are included in diluted earnings per share if they are not
anti-dilutive. At December 31, 2003 and 2002, all outstanding potentially
dilutive instruments were anti-dilutive.
Reclassification of certain amounts in the 2002 and 2001 consolidated financial
statements has been made to conform to the 2003 presentation.
>> Restriction on Cash and Due From Banks
United is required to maintain reserve funds in cash and/or on deposit with the
Federal Reserve Bank. The reserve required at December 31, 2003 was $60.
United maintains cash in bank deposit accounts, which at times, may exceed
federally insured limits. United has not experienced any losses in such
accounts. Management does not believe United is exposed to any significant risk.
>> Investment Securities Available for Sale
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------------
December 31, 2003
Mortgage-backed securities $52,544 $ 50 $(386) $52,208
===============================================================
December 31, 2002
Mortgage-backed securities $34,293 $621 $ (2) $34,912
===============================================================
Securities with a carrying value of $52,207 and $34,909 were pledged at December
31, 2003 and 2002 to secure certain deposits, outstanding Federal Home Loan Bank
advances, secured federal funds purchased line of credit and for other purposes
as permitted or required by law.
Gross gains of $353 and $73 resulting from sales of available-for-sale
securities were realized for 2003 and 2002, respectively. Taxes of $134 and $28
were recorded on the gains, respectively. There were no sales of securities in
2001.
Certain investments in debt securities are reported in the financial statements
at an amount less than their historical cost. Total fair value of these
investments at December 31, 2003, was $34,400, which is approximately 66% of
Fidelity's available-for-sale investment portfolio. These declines primarily
resulted from recent increases in market interest rates.
Based on evaluation of available evidence, including recent changes in market
interest rates and information obtained from regulatory filings, management
believes the declines in fair value for these securities are temporary.
43
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Should the impairment of any of these securities become other than temporary,
the cost basis of the investment will be reduced and the resulting loss
recognized in net income in the period the other-than-temporary impairment is
identified.
The following table shows our investments' gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2003:
Less than 12 Months 12 Months or More Total
----------------------------------------------------------------------------------------------
Description of Securities Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
----------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities $34,281 $(384) $119 $(2) $34,400 $(386)
==============================================================================================
>> Loans and Allowance
December 31 2003 2002
--------------------------------------------------------------------------------------------------------------
Real estate mortgage loans
First mortgage loans
Conventional $ 41,754 $36,157
Construction 2,042 1,909
Commercial 9,144 5,645
Multi-family 213 3,083
Purchased loans 778 627
Home equity loans 5,067 4,586
Commercial loans--other than secured by real estate 3,138 2,210
Consumer loans 39,038 19,707
-------------------------------------
Total loans 101,174 73,924
Allowance for loan losses (737) (837)
-------------------------------------
Total loans, net of the allowance for loan losses $100,437 $73,087
=====================================
Year Ended December 31 2003 2002 2001
--------------------------------------------------------------------------------------------------------------
Allowance for Loan Losses
Balances, beginning of period $ 837 $2,138 $1,921
Provision for losses 492 204 1,349
Loans transferred to held for sale (479) (564)
Recoveries on loans 123 1,013 269
Loans charged off (236) (1,954) (1,401)
---------------------------------------------------
Balances, end of period $ 737 $ 837 $2,138
===================================================
44
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Information on impaired loans is summarized below:
December 31 2003 2002
----------------------------------------------------------------------------------------------------------------------------
Impaired loans with an allowance $765 $3,440
Impaired loans without an allowance 10 13
-------------------------------------
Total impaired loans $775 $3,453
=====================================
Allowance for impaired loans (included in allowance for loan losses) $169 $ 332
=====================================
Year Ended December 31 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------
Average balance of impaired loans $924 $3,656 $5,856
Interest income recognized on impaired loans 13 312 496
Cash-basis interest included above 16 333 492
At December 31, 2003 and 2002, accruing loans delinquent 90 days or more totaled
$287 and $1, respectively. Non-accruing loans at December 31, 2003 and 2002,
were $1,415 and $875, respectively.
>> Letter of Credit Valuation Allowance
Reserves related to letters of credit issued by Fidelity and United relate to
the permanent financing for certain affordable housing projects. Multi-family
housing letters of credit, an off-balance sheet item, carry the same risk
characteristics as conventional loans and totaled $27,774 and $29,674 at
December 31, 2003 and 2002, respectively.
Year Ended December 31 2003 2002 2001
--------------------------------------------------------------------------------------------------
Letter of credit valuation allowance
Balances, beginning of year $ 445 $ 665 $ 5,153
Provision (170) (1,450)
Recoveries 16 19 38
Funding of outstanding letters of credit (239) (3,076)
----------------------------------------------------
Balances, end of year $ 291 $ 445 $ 665
====================================================
>> Automobile Loan Securitization
United completed an automobile loan securitization transaction in 2002. The
transaction resulted in the sale of $49 million of rated class A notes.
Financial Security Assurance (FSA) provided a financial guaranty policy on the
class A notes. The transaction also resulted in the sale of $500,000 in
non-rated class B notes. The transaction was effected through a wholly-owned
subsidiary, United Fidelity Finance, LLC.
45
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
A summary of the components of managed loans, which represents both owned and
securitized loans, follow. The automobile loans presented represent the managed
portfolio of indirect prime automobile loans.
Loans Past
Principal Due Over
As of December 31, 2003 Balance 30 Days
------------------------------------------------------------------------------------------------
Total managed automobile loans $ 93,721 $ 694
Less: Automobile loans securitized (23,715) (219)
Automobile loans serviced (32,420) (168)
------------------------------------
Total automobile loans held in portfolio $ 37,586 $ 307
====================================
Certain cash flows received from (paid to) the securitization trust follow:
Year Ended December 31 2003 2002
-----------------------------------------------------------------------------------------
Proceeds from securitization $48,939
Servicing fees received $ 329 138
United estimates the fair value of the retained interest at the date of the
transfer and during the period of the transaction based on a discounted cash
flow analysis. United receives annual servicing fees based on the loan balances
outstanding, the rights to future cash flows arising after investors in the
securitization trust have received their contractual return and after certain
administrative costs of operating the trust. These cash flows are estimated over
the life of the loans using prepayment, default and interest rate assumptions
that market participants would use for financial instruments subject to similar
levels of prepayment, credit and interest rate risk.
46
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
A summary of the fair values of the interest-only strips and servicing assets
retained, key economic assumptions used to arrive at the fair values and the
sensitivity of the December 31, 2003, fair values to immediate 10% and 20%
adverse changes in those assumptions follows. Actual credit losses experienced
through year end 2003 on the pool of automobile loans securitized have been
consistent with initial projections. As such, the expected static pool loss
assumption would perform consistently with that disclosed in the sensitivity
analysis. The sensitivities are hypothetical. Changes in fair value may not be
linear. Also, the effect of a variation in a particular assumption on the fair
value of the retained interests is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might either magnify or counteract the
sensitivities.
Weighted- Monthly Expected
Average Prepayment Cumulative Annual Weighted-
Fair Life Speed Credit Discount Average
Value (in months) (% ABS) Losses Rate Coupon
-------------------------------------------------------------------------------
Interest-only strip
As of the date of securitization $ 2,707 39 1.50% 1.50% 15.0% 8.75%
As of December 31, 2003 1,623 18 1.41 1.50 15.0 8.56
Decline in fair value of 10%
adverse change $ 25 $ 17 $ 24
Decline in fair value of 20%
adverse change 55 31 47
Servicing asset
As of the date of securitization $ 362 39 1.50% 1.50% 15.0%
As of December 31, 2003 * 108 18 1.41 1.50 15.0
Decline in fair value of 10%
adverse change $ 15 $ 2 $ 1
Decline in fair value of 20%
adverse change 31 2 2
* Carrying value of the assets approximated fair value at December 31, 2003.
>> Foreclosed Assets Held for Sale
Activity in the allowance for losses on foreclosed assets was as follows:
Year Ended December 31 2003 2002
------------------------------------------------------------------------------------------
Balance, beginning of year $ 100
Provision charged to expense $100
Charge-offs, net of recoveries (100)
-------------------------------------
Balance, end of year $ 0 $100
=====================================
There was no activity in the allowance for losses on foreclosed assets in 2001.
47
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Premises and Equipment
December 31 2003 2002
-----------------------------------------------------------------------------------------
Land $ 935 $ 935
Building and land improvements 5,590 5,563
Furniture, fixtures and equipment 2,214 2,119
-------------------------------------
Total cost 8,739 8,617
Accumulated depreciation (4,119) (3,682)
-------------------------------------
Net $ 4,620 $4,935
=====================================
>> Other Assets and Investments in Limited Partnerships
Included in other assets at December 31, 2003 and 2002, are investments of $358
and $397 in limited partnerships which are organized to build, own and operate
apartment complexes. The carrying amounts of these investments approximate
Fidelity's equity in the net assets of the partnerships. The investments at
December 31, 2003 and 2002, were as follows:
Amount of Number of
Investment Partnerships
Percentage and Type of ---------------------------------------------------------------
Partnership Interest 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------
31%--Limited $ 0 $ 13 1 1
26%--Limited 45 54 1 1
10%--Limited 217 235 1 1
10%--Limited 95 95 1 1
99%--Limited 0 0 0 2
Fidelity records income on the equity method in the income and losses of the
limited partnerships, which resulted in losses of $22, $38 and $100 during the
years ended December 31, 2003, 2002 and 2001, respectively. In addition to
recording its equity in the losses of these projects, Fidelity has recorded the
benefit of low-income housing tax credits of $222, $185 and $319 for the years
ended December 31, 2003, 2002 and 2001, respectively. In certain cases, Fidelity
could reduce the carrying value of its investments in and related loans to these
partnerships, should its share of net losses materially exceed the net
investments in and loans to these partnerships. Combined condensed financial
statements as of December 31, 2003 and 2002, have not been presented because the
investments in limited partnerships were not considered material at that date.
48
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Fidelity reduced the recorded value of its investment in limited partnerships,
in addition to the losses recorded, by $18, $122 and $204 during the years ended
December 31, 2003, 2002 and 2001, respectively, based on the performance of the
underlying real estate operations.
Included in other assets is interest receivable as follows:
December 31 2003 2002
--------------------------------------------------------------------------------------------------------
Interest receivable on loans $333 $248
Interest receivable on investment securities and other 231 163
-----------------------------------
Total interest receivable $564 $411
===================================
>> Deposits
December 31 2003 2002
-------------------------------------------------------------------------------------------------------
Non-interest bearing transaction accounts $ 6,903 $ 3,209
Interest-bearing transaction accounts 12,981 14,252
Money market deposit accounts 6,798 7,622
Savings accounts 5,533 5,138
Certificates of $100 or more 29,389 15,171
Other certificates and time deposits 59,076 61,399
-------------------------------------
Total deposits $120,680 $106,791
=====================================
Certificates maturing in years ending December 31:
2004 $57,973
2005 22,446
2006 6,729
2007 969
2008 295
Thereafter 53
-----------------
$88,465
=================
Time deposits at December 31, 2003 and 2002, included brokered deposits of
approximately $2,900 and $248, respectively.
49
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Federal Home Loan Bank Advances and Borrowings
December 31 2003 2002
----------------------------------------------------------------------------------------------------------------------------
Note payable, 7.42%, adjusted annually, payable $7 per month, including
interest, due September 2010, secured by specific
multi-family mortgages $ 972
Note payable, 7.42%, adjusted annually, payable $10 per month,
including interest, due September 2010, secured by specific
multi-family mortgages 1,486
Note payable, 10.50%, interest paid quarterly, due June 2003,
secured by United stock 1,500
Junior subordinated notes, 9.00%, interest paid semi-annually,
due February 2009, unsecured $ 1,002 1,002
Junior subordinated notes, 9.25%, interest paid semi-annually,
due January 2002, unsecured
Senior subordinated notes, 10.00%, interest paid semi-annually,
due June 2005, unsecured 1,800 5,500
Federal Home Loan Bank advances, due at various dates through
2004 (weighted-average rates of 2.08% and 2.20% at December 31,
2003 and 2002, respectively) 31,550 3,000
Junior subordinated notes, 12.00%, interest paid semi-annually,
due April 2004, unsecured 126
Note payable, 6.00%, interest paid monthly, due September 2004,
secured by United guarantee 275
Junior subordinated notes, 4.09%, adjusted quarterly, interest paid
quarterly, due September 2033, unsecured, with call option 4,000
Note payable, 9.00%, interest paid quarterly, due June 2004, unsecured 1,000
-------------------------------------
Total long-term debt $39,627 $13,586
=====================================
The terms of a security agreement with the FHLB require United to pledge as
collateral qualifying first mortgage loans in an amount equal to at least 125%
of these advances and all stock in the FHLB or eligible securities with a market
value in an amount equal to at least 110% of these advances. In addition to
first mortgage loans pledged of $32,561. Fidelity had $46,236 of investment
securities pledged at December 31, 2003. Certain advances are subject to
restrictions or penalties in the event of prepayment.
All long-term debt, except for Federal Home Loan Bank advances and the $4,000
note payable noted above, are the debt of the parent company and totals $4,077
at December 31, 2003, as compared to $10,586 at December 31, 2002.
The scheduled principal reduction of borrowings at December 31, 2003, is as
follows: 2004, $14,325; 2005, $12,800; 2006, $6,500; 2007, $0; 2008, $1,000; and
thereafter, $5,002.
50
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage loans
serviced for others totaled $55,413, $57,368 and $54,944 at December 31, 2003,
2002 and 2001, respectively.
The aggregate fair value of capitalized mortgage servicing rights at December
31, 2003 and 2002, approximated $639 and $514, respectively. Comparable market
values and a valuation model that calculates the present value of future cash
flows were used to estimate fair value. For purposes of measuring impairment,
risk characteristics including product type, investor type and interest rates,
were used to stratify the originated mortgage servicing rights.
Year Ended December 31 2003 2002 2001
---------------------------------------------------------------------------------------------
Mortgage servicing rights
Balances, beginning of period $ 514 $ 632 $431
Servicing rights capitalized 258 232 274
Amortization of servicing rights (285) (198) (73)
--------------------------------------------------
487 666 632
Change in valuation allowance 152 (152)
--------------------------------------------------
Balances, end of period $ 639 $ 514 $632
==================================================
The entire valuation allowance of $152 at December 31, 2002, was added in the
fourth quarter of 2002. The valuation allowance was reduced by $152 during 2003
leaving a balance of $0 in the valuation allowance at December 31, 2003.
Consumer loans are also serviced for others and are not included in the
accompanying consolidated balance sheets. The unpaid principal balances of
consumer loans serviced for others totaled $56,136 and $49,610 at December 31,
2003 and 2002, respectively.
The aggregate fair value of capitalized consumer loan servicing rights at
December 31, 2003 and 2002, approximated $223 and $409, respectively. As with
mortgage servicing rights, comparable market values and a valuation model that
calculates the present value of future cash flows were used to estimate fair
value.
Year Ended December 31 2003 2002
---------------------------------------------------------------------------
Consumer loan servicing rights
Balances, beginning of period $ 409 $ 269
Servicing rights capitalized 96 397
Amortization of servicing rights (282) (257)
------------------------------------
Balances, end of period $ 223 $ 409
====================================
51
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Income Tax
Year Ended December 31 2003 2002 2001
--------------------------------------------------------------------------------------------------------------
Income tax benefit
Currently payable
Federal $ (89)
State
Deferred
Federal $(228) $ (513) (261)
State 8 (128) (34)
--------------------------------------------------
Total income tax benefit $(220) $ (641) $(384)
==================================================
Reconciliation of federal statutory to actual tax benefit
Federal statutory income tax at 34% $ (2) $(1,036) $(121)
Effect of state income taxes 5 (53) 4
Nondeductible expenses 8 8 (22)
Changes in the deferred tax asset valuation allowance 600
Affordable housing tax credits and other (211) (222) (319)
Other (20) 62 74
--------------------------------------------------
Actual tax benefit $(220) $ (641) $(384)
==================================================
52
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
The components of the deferred tax asset are as follows:
December 31 2003 2002
---------------------------------------------------------------------------------------------------------
Assets
Allowance for loan losses $ 744 $ 822
Valuation for letters of credit 111 146
Unrealized loss on available-for-sale securities 128
Alternative minimum tax credit 81 81
Low income housing credit carryforward 1,563 1,352
State net operating loss carryforward 1,041 1,028
Federal net operating loss carryforward 3,834 3,726
State income tax 14 7
Other real estate owned 38
Other 8 8
-----------------------------------
Total assets 7,524 7,208
-----------------------------------
Liabilities
Depreciation and amortization (28) (48)
Differences in accounting for certain accrued liabilities (5) (14)
Differences in basis of FHLB stock (117) (64)
Basis differential on certain partnership interests (155) (118)
Differences in accounting for loan servicing rights (328) (351)
Unrealized gain on available-for-sale securities (125)
Other (70)
-----------------------------------
Total liabilities (633) (790)
-----------------------------------
Net deferred tax asset before valuation allowance 6,891 6,418
-----------------------------------
Valuation Allowance
Beginning balance (600) 0
Increase during the period (600)
-----------------------------------
Ending balance (600) (600)
-----------------------------------
Net deferred tax asset $6,291 $5,818
===================================
At December 31, 2003, Fidelity has federal net operating loss carryforwards for
tax purposes totaling $11,277. These loss carryforwards expire in varying
amounts through the year 2022. Fidelity has state net operating loss
carryforwards for tax purposes of $12,250. These loss carryforwards expire in
varying amounts through the year 2016. Fidelity has affordable housing credit
carryforwards of $1,647. These carryforwards expire in varying amounts through
the year 2022. In addition, Fidelity has an alternative minimum tax credit
carryforward of $81.
53
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Retained earnings include approximately $1,138 for which no deferred income tax
liability has been recognized. This amount represents an allocation of income to
bad debt deductions as of December 31, 1987, for tax purposes only. Reduction of
amounts so allocated for purposes other than tax bad debt losses, including
redemption of bank stock or excess dividends, or loss of "bank" status, would
create income for tax purposes only, which income would be subject to the
then-current corporate income tax rate. The unrecorded deferred income tax
liability on the above amount was approximately $387.
Fidelity has recorded a deferred tax asset of $4,875 for the expected benefit to
be realized from the federal and state net operating loss carryovers discussed
above. In addition, a deferred tax asset of $1,563 for low income housing tax
credits is recorded. Realization depends upon the ability of Fidelity to
generate sufficient taxable income before the expiration of the carryover
periods. At December 31, 2003 and 2002, management has established a valuation
allowance of $600 against the deferred tax assets because management believed it
was more likely than not that future earnings will be insufficient to realize
the entire amount of the loss carryforwards and tax credits. The valuation
allowance was established to reduce the deferred tax assets to the amounts
management believe will more likely than not be realized. The amount that
management considers to be realizable is reevaluated at each financial statement
date. That estimate could be reduced in the near term if management lowers its
estimate of future taxable income during the carryover period.
>> Other Comprehensive Income (Loss)
Other comprehensive income components and related taxes were as follows:
Year Ended December 31 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Unrealized gains (losses) on securities available for sale $(602) $755 $824
Reclassification for realized amount included in income (353) (73)
--------------------------------------------------
Other comprehensive income (loss), before tax effect (955) 682 824
Tax expense (benefit) (367) 265 326
--------------------------------------------------
Other comprehensive income (loss) $(588) $417 $498
==================================================
>> Commitments and Contingent Liabilities
In the normal course of business, there are outstanding commitments and
contingent liabilities, such as commitments to extend credit and standby letters
of credit, which are not included in the accompanying consolidated financial
statements. Fidelity's exposure to credit loss in the event of nonperformance by
the other party to the financial instruments for commitments to extend credit
and standby letters of credit is represented by the contractual or notional
amount of those instruments. Fidelity uses the same credit policies in making
such commitments as it does for instruments that are included on the
consolidated balance sheets.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Fidelity evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by Fidelity upon extension of credit, is based on management's credit
evaluation. Collateral held varies, but may include residential real estate,
income-producing commercial properties or other assets of the borrower.
54
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
At December 31, 2003 and 2002, commitments to extend credit, which represent
financial instruments whose contract amount represents credit risk, were $12,099
and $9,038, respectively.
In the past, Fidelity has issued standby letters of credit to affordable housing
developments in which one of Fidelity's subsidiaries previously had partnership
interests until December 2002. The letters of credit secure tax-exempt bond
issues and other permanent financing of limited partnerships in which the
subsidiary previously owned a one percent general partner interest. The amount
outstanding on these letters of credit at December 31, 2003 and 2002, was $0 and
$2,206, respectively.
Fidelity has also issued standby letters of credit on affordable housing
developments in which the borrowers are not affiliated with Fidelity. The
letters of credit secure tax-exempt bond issues and other permanent financing of
limited partnerships. The amount outstanding on the letters of credit at
December 31, 2003 and 2002, was $27,774 and $27,468, respectively.
Fidelity, in its previous role as general partner on various affordable housing
developments through its subsidiaries, was committed to advance certain amounts
to limited partnerships. These previous commitments potentially include
short-term loans to the limited partners or an increase in the general partner's
equity investment. Upon the sale of Village Housing Corporation in the fourth
quarter of 2002, these commitments were extinguished.
Fidelity has entered into change in control agreements with one of its employees
which provide for the continuation of a multiple of the employee's existing
salary and certain benefits for a two-year period of time under certain
conditions following a change in control. The agreement becomes effective if
there is a change in control that is accompanied by a significant change in job
responsibilities and/or compensation.
Fidelity entered into an agreement with another institution in conjunction with
a consumer loan sale that guaranteed to the purchaser that Fidelity would
repurchase any consumer loans that exceeded a 60-day delinquency status. The
original amount of the loans sold was $5.0 million and remaining amount
outstanding totaled $1.5 million at December 31, 2003. Over the past year,
Fidelity has repurchased a total of $217 that exceeded the 60-day delinquency
status.
Fidelity and its subsidiaries are also subject to claims and lawsuits that arise
primarily in the ordinary course of business. It is the opinion of management
that the disposition or ultimate resolution of such claims and lawsuits will not
have a material adverse effect on the consolidated financial position of
Fidelity.
>> Dividend and Capital Restrictions
Fidelity's dividend policy is to pay cash or distribute stock dividends when its
board of directors deems it to be appropriate, taking into account Fidelity's
financial condition and results of operations, economic and market conditions,
industry standards and other factors, including regulatory capital requirements
of its savings bank subsidiary. Fidelity is not subject to any regulatory
restrictions on payments to its stockholders. Fidelity's primary source of
income is dividends from United.
United has entered into a Supervisory Agreement (Agreement) with the OTS. The
Agreement restricts the payments of dividends from United to Fidelity without
prior written OTS approval. The OTS, in 1999, permitted the payment of dividends
to assist Fidelity in meeting interest payments on its outstanding debt, and in
2001, permitted United to transfer, in the form of a dividend, two real estate
properties to Fidelity. There can be no assurance that this approval will be
granted going forward. Fidelity is uncertain when it will pay dividends in the
future and the amount of such dividends, if any.
55
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Regulatory Capital
United is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
United's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, United must meet specific
capital guidelines that involve quantitative measures of the United's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. United's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require United to maintain minimum amounts and ratios (set forth in the table
below). Management believes, as of December 31, 2003 and 2002, that United meets
all capital adequacy requirements to which it is subject.
As of December 31, 2003, the most recent notification from United's federal
regulators categorized United as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, United must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed United's category.
There are no specific targets for capital levels included or agreed to within
the Supervisory Agreement (Agreement) between United and the OTS, only a
requirement that United include capital targets within a strategic plan. At
December 31, 2003, United was in compliance with the targets included within
that plan as illustrated below. The Agreement did set a target level to reduce
its classified assets to 50% or less of core capital plus the allowance for loan
losses and the letter of credit valuation reserves. United's ratio of classified
assets to core capital plus the allowance for loan losses and letter of credit
valuation reserves was 12.7% at December 31, 2003.
United's actual and required capital amounts and ratios were as follows:
Required for To Be Well Required per
Actual Adequate Capital Capitalized Strategic Plan
---------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------------------------------
As of December 31, 2003
Total risk-based capital (to risk-
weighted assets) $15,294 13.6% $8,984 8.0% $11,230 10.0% $12,353 11.0%
Tier 1 capital (to risk-weighted assets) 10,292 9.2 4,492 4.0 6,738 6.0 9,265 8.3
Core capital (to adjusted total assets) 11,869 7.0 6,787 4.0 8,484 5.0 10,605 6.3
Core capital (to adjusted tangible
assets) 11,869 7.0 3,394 2.0 N/A N/A N/A N/A
Tangible capital (to adjusted total
assets) 11,646 6.9 2,542 1.5 N/A N/A N/A N/A
As of December 31, 2002
Total risk-based capital (to risk-
weighted assets) $11,107 12.5% $7,093 8.0% $ 8,866 10.0% $11,082 12.5%
Tier 1 capital (to risk-weighted assets) 8,823 10.0 3,546 4.0 5,319 6.0 8,798 10.0
Core capital (to adjusted total assets) 10,929 8.8 4,958 4.0 6,197 5.0 9,296 7.5
Core capital (to adjusted tangible
assets) 10,929 8.8 2,479 2.0 N/A N/A N/A N/A
Tangible capital (to adjusted total
assets) 10,520 8.5 1,853 1.5 N/A N/A N/A N/A
56
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Other Restrictions
United entered into a supervisory agreement with the OTS on February 3, 1999.
The supervisory agreement, as amended on November 18, 2003, currently requires
United to:
o Refrain from paying dividends without OTS approval.
o Continue to comply with its strategic plan, including its
capital targets, as noted in the "Regulatory Capital" note,
consistent with United's business plan as approved by the OTS.
o Refrain from engaging in any transaction with or distribution
of funds to Fidelity or its subsidiaries or selling any assets
to an affiliate without OTS approval.
o Not engage in new activities not included in its strategic
plan without OTS approval.
United believes that it currently is in compliance with all provisions of the
supervisory agreement.
>> Stockholders' Equity and Capital Infusion
In April 2003, Fidelity issued 2,777,777 shares of common stock for $4.0 million
in cash through the exercise of an option held by Pedcor Holdings and affiliates
(Pedcor). The exercise price per share was $1.44, and was determined under a
formula included in the shareholder-approved stock purchase agreement effective
May 19, 2000. The proceeds of the option exercise were utilized to reduce
Fidelity's long-term debt outstanding. The remaining options expired on May 19,
2003.
Pedcor is a member of a group of companies which is controlled by Bruce A.
Cordingley, Gerald K. Pedigo and Phillip J. Stoffregen, directors of Fidelity.
Following the option exercise, Pedcor beneficially owns approximately 67.75% of
Fidelity's issued and outstanding stock.
In July 2002, Fidelity filed a registration statement for a stockholder rights
offering with the Securities and Exchange Commission. A total of 750,000 shares
were registered in this filing. For every 8.1 shares of Fidelity held on the
record date, shareholders could subscribe to purchase one share of Fidelity at
$2.00. The rights offering was completed in September 2002. Fidelity raised $770
net of costs associated with the offering. The shares purchased by shareholders
with these funds were issued in September 2002.
During the third quarter of 2002, Pedcor Investments, LLC (Investments)
exercised a portion of its option that was granted under the stock purchase
agreement in May 2000, and purchased $259 in common stock resulting in 137,765
shares being issued.
In December 2001, Fidelity filed a registration statement for a debt and equity
rights offering with the Securities and Exchange Commission. Subscription rights
were distributed to persons who owned common stock as of the close of business
on December 19, 2001, to purchase $1.5 million of 9.00% unsecured junior
subordinated notes due February 28, 2009, and 500,000 warrants representing the
right to purchase shares of common stock at $3.00 per share, less the purchase
price of $0.50 per warrant. The offering was completed on February 28, 2002.
Fidelity issued approximately $1.0 million in 9% notes and all of the 500,000
warrants, raising an additional $250.
57
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
In September 2001, Fidelity filed a registration statement for a stockholder
rights offering with the Securities and Exchange Commission. A total of 650,000
shares were registered in this filing. For every 8.6 shares of Fidelity held on
the record date, shareholders could subscribe to purchase one share of Fidelity
at $2.50. The rights offering was completed in November 2001. Fidelity raised
$888, net of costs associated with the offering. The shares purchased by
shareholders with these funds were issued in December 2001.
In January 2001, Fidelity filed a registration statement for a stockholder
rights offering with the Securities and Exchange Commission. A total of
1,000,000 shares were registered in this filing. For every 4.6 shares of
Fidelity held on the record date, shareholders could subscribe to purchase one
share of Fidelity at $1.55. The rights offering was oversubscribed and completed
in June 2001. Fidelity raised $1.5 million net of costs associated with the
offering. The shares purchased by shareholders with these funds were issued in
July 2001.
In connection with Fidelity's first debt and equity rights offering completed
April 30, 1994, Fidelity reserved 415,500 shares of its common stock for
issuance upon exercise of 1,500 outstanding warrants. Each warrant represents
the right to purchase 277 shares of common stock. The warrants were valued at
$100 per warrant, carrying an exercise price of $6.22 per share, and expire on
April 30, 2004. At December 31, 2003, a total of 397,218 of the shares
originally reserved had been issued and 18,282 remained reserved and unissued.
In connection with Fidelity's second debt and equity offering completed on
January 31, 1995, Fidelity reserved 346,500 shares of its common stock for
issuance upon exercise of 1,500 outstanding warrants. Each warrant represents
the right to purchase 231 shares of common stock. The warrants were valued at
$100 per warrant, carrying an exercise price of $8.93 per share, and expire on
January 31, 2005. At December 31, 2003, a total of 337,029 of the shares
originally reserved had been issued and 9,471 remained reserved and unissued.
>> Discontinued Operations, Including Fourth Quarter Charges
On September 30, 2002, Fidelity signed a definitive agreement to sell the stock
of its wholly owned affordable housing subsidiary, Village Affordable Housing
Corporation and the stock of United's wholly owned affordable housing
subsidiary, Village Housing Corporation and certain other related affordable
housing assets to Pedcor Funding Corporation (Funding). Funding is a company
controlled by three directors of Fidelity and are members of a group that
beneficially owns approximately 60.7% of Fidelity's issued and outstanding
stock.
The sale price was approximately $1.7 million in cash and was consummated during
the fourth quarter of 2002. The sale resulted in a consolidated pre-tax loss
under generally accepted accounting principles of approximately $201, which
consists of a gain from the sale of the affordable housing assets held by
Fidelity and United of $574 offset by a loss from the sale of the subsidiaries
of $775. The gain is recorded as gain on sale of assets in the other income
section of the consolidated statements of income.
The subsidiaries were sold as part of Fidelity's plan to end its active
involvement in the affordable housing business. Accordingly, the results of
operations for the two subsidiaries, which include impairment charges recorded
upon signing the definitive agreement of $742, has been classified as
discontinued operations in Fidelity's consolidated statement of income for
December 31, 2002. The $742 combined with the $775 loss noted in the paragraph
above total the $1,517 listed in the income statement as the loss on sale of
discontinued operations. The results of operations of the two subsidiaries for
the years ended December 31, 2001 and 2000, were not material and have,
therefore, not been segregated.
58
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
The sale was consummated in the fourth quarter of 2002. Certain charges were
recorded in the third quarter because it was determined that some of the assets
held for sale were impaired or their estimated useful lives had changed. Third
quarter charges totaled approximately $1,000, net of tax, including
approximately $860 in write-downs of intangible assets whose useful lives were
reduced. In the fourth quarter, in addition to recording the amounts discussed
in the second paragraph of this note, tax provisions of approximately $800 were
recorded to account for the basis difference on the stock that was sold.
>> Benefit Plans
Fidelity is a participant in the Financial Institutions Retirement Fund (FIRF).
This defined-benefit plan is a multi-employer plan; separate actuarial
valuations are not made with respect to each participating employer. Effective
January 1, 2004, the plan was frozen to reduce future cash outlay and expense.
An estimated normal cost on an ongoing basis for a frozen plan is $14 per year.
According to FIRF administrators, the market value of the fund's assets did not
exceed the value of vested benefits in the aggregate as of June 30, 2003, the
date of the latest actuarial valuation. Plan expense of $0 was recognized during
2003, compared to $110 in 2002 and $54 in 2001. The plan provides pension
benefits for substantially all of Fidelity's employees.
Fidelity has a retirement savings 401(k) plan in which substantially all
employees may participate. Fidelity matches employees' contributions at the rate
of 25% up to 6% of the participant's salary. Fidelity's expense for the plan was
$20, $21 and $16 for the years ended December 31, 2003, 2002 and 2001,
respectively.
>> Related Party Transactions
Fidelity has entered into transactions with certain directors, executive
officers, significant stockholders and limited partnerships in which Fidelity is
an investor and their affiliates and associates. Such transactions were made in
the ordinary course of business on substantially the same terms and conditions,
including interest rates and collateral, as those prevailing at the same time
for comparable transactions with other customers, and did not, in the opinion of
management, involve more than normal credit risk or present other unfavorable
features.
The aggregate amount of loans, as defined, to such related parties was as
follows:
December 31 2003 2002
-----------------------------------------------------------------------------------------------
Balances, beginning of year $ 2,782 $2,948
Composition change (33)
Loans charged off (376)
Recoveries 1,084
New loans, including renewals 1,075
Payments, etc., including renewals (2,572) (1,949)
------------------------------------
Balances, end of year $ 177 $2,782
====================================
Total internally classified related party loans included in the total related
party loans at December 31, 2003 and 2002, were $0 and $2,567, respectively.
Reserves for these classified related party loans totaled $0 and $128 at
December 31, 2003 and 2002, respectively, and are included in the allowance for
loan losses.
59
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Deposits from related parties held by Fidelity at December 31, 2003 and 2002,
totaled $854 and $619. During the second quarter of 2003, Fidelity sold two
classified notes totaling $2.6 million in connection with two first mortgages
held by Fidelity on certain multi-family housing partnerships to a related
party. The instruments were acquired by Pedcor Bancorp at par and assisted
Fidelity in reducing its classified assets.
During the fourth quarter of 2003, Fidelity entered into a $1.0 million
unsecured term loan note with Pedcor Bancorp which matures on June 30, 2004.
These funds were contributed to United's capital prior to the end of the year.
This note will be paid off upon the expected completion of the debt offering
early in the second quarter 2004.
During the first quarter of 2002, Fidelity sold two notes held in conjunction
with advances made by Fidelity to certain multi-family housing partnerships to a
related party. The advances were made to facilitate refinancing activities and
resulted in loans subordinated to the first mortgage loans. The advances had
been previously charged off and had no value on Fidelity's books. The gain on
the note sale totaled $223. Fidelity also sold a position in an interest rate
swap for a $72 gain. These gains are included in gains on sales of loans in the
consolidated statements of income. The instruments were acquired by Pedcor
Funding Corporation and the purchase price consisted of a 20% down payment with
the remainder financed by a 10 year note totaling $235 at a rate of 5.25% for
five years and 6.50% for the last five years with principal paid annually and
interest paid quarterly.
As noted in the discontinued operations footnote, Village Housing Corporation
and Village Affordable Housing Corporation, along with certain affordable
housing assets, were sold to Pedcor Funding Corporation in the fourth quarter of
2002.
Pedcor had also been providing management services to the partnerships in which
Fidelity was a general partner at no cost since May 2000, in accordance with the
provisions of the sale of stock to Pedcor in May 2000. Upon completion of the
Village Housing Corporation sale noted in the discontinued operations note,
these services were no longer necessary.
>> Stock Option Plans
Under Fidelity's stock option plans, Fidelity grants stock option awards which
vest and become exercisable at various dates. During the years ended December
31, 2002 and 2001, Fidelity authorized the grant of options for up to 99,500 and
10,000, shares, respectively, of its common stock. No options were granted in
2003. The exercise price of each option, which has a 10-year life, was greater
than the market price of Fidelity's stock on the date of grant; therefore, no
compensation expense was recognized.
Although Fidelity has elected to follow APB No. 25, SFAS No. 123 requires pro
forma disclosures of net income and earnings per share as if Fidelity had
accounted for its employee stock options under that Statement. The fair value of
each option grant was estimated on the grant date using an option-pricing model
with the following assumptions:
Year Ended December 31 2003 2002 2001
---------------------------------------------------------------------------------------------------------------
Risk-free interest rates 4.2% 5.1% 5.3%
Dividend yields 0.0% 0.0% 0.0%
Volatility factors of expected market price of common stock 39.7% 40.3% 28.1%
Weighted-average expected life of the options 10 years 10 years 10 years
60
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
The following is a summary of the status of the Fidelity's stock option plans
and changes in the plans as of and for the years ended December 31, 2003, 2002
and 2001.
Directors' Plan
Fidelity has a non-qualified stock option plan (Directors' Plan) which provides
for the grant of non-qualified stock options to individuals who are directors of
Fidelity, or any of its subsidiaries. The Directors' Plan provides for the grant
of non-qualified stock options to acquire shares of common stock of Fidelity for
the price of not less than $2 above the average of the high and low bid
quotations, as reported by NASDAQ, for the common stock of Fidelity for the five
trading days immediately preceding the date the option is granted. The plan has
expired, however, as of December 31, 2003, there were options for 198,573 shares
outstanding.
A summary of the stock options activity for the Directors' Plan is as follows:
December 31 2003 2002 2001
---------------------------------------------------------------------------------------------------------
Shares under option
Outstanding at beginning of year 198,573 143,573 152,313
Granted 55,000
Forfeited/expired (8,740)
---------------------------------------------------
Outstanding at end of year 198,573 198,573 143,573
===================================================
Exercisable at end of year 198,573 198,573 143,573
===================================================
Weighted option price per share
Exercisable 6.29 $6.29 $7.00
Granted 4.42
Weighted-average fair value of options granted
during the year $1.05
The following table summarizes information about stock options under the
Directors' Plan outstanding at December 31, 2003:
Options Outstanding Options Exercisable
-------------------------------------------------------------------------------------------------
Weighted-
Average
Range of Exercise Number Remaining Weighted-Average Number Weighted-Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ----------------------------------------------------------------------------------------------------------------------------
$4.31 to $ 6.22 166,032 4.1 years $ 5.29 166,032 $ 5.29
9.74 to 11.81 32,541 3.3 years 11.37 32,541 11.37
1995 Key Employees' Stock Option Plan
The 1995 Key Employees' Stock Option Plan (1995 Plan) provides for the granting
of either incentive stock options (ISOs) pursuant to Section 422A of the
Internal Revenue Code of 1986, as amended (Code), or stock options which do not
qualify as ISOs, or any combination thereof. Options may be granted to key
employees and officers of Fidelity and its subsidiaries.
61
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
The option price per share for ISOs will not be less than the fair market value
of a share on the date the option is granted. The option price per share for
ISOs granted to an employee owning 10 percent or more of the common stock of
Fidelity will be not less than 110 percent of the fair market value of a share
on the date the option is granted. The option price per share for ISOs will be
determined by the compensation committee, but may not be less than 100 percent
of the fair market value on the date of grant. A total of 236,500 shares have
been reserved for issuance under the 1995 Plan.
At December 31, 2003, there were 82,670 options available for grant. A summary
of the stock options activity for the 1995 Plan was as follows:
December 31 2003 2002 2001
------------------------------------------------------------------------------------------------------------
Shares under option
Outstanding at beginning of year 183,423 186,643 139,143
Granted 44,500 47,500
Forfeited/expired (30,000) (45,720)
Exercised (2,000)
----------------------------------------------------
Outstanding at end of year 153,423 183,423 186,643
====================================================
Exercisable at end of year 128,423 128,423 153,343
====================================================
Weighted option price per share
Exercisable $3.84 $3.85 $5.91
Granted 3.17 1.57
Weighted-average fair value of options granted
during the year $1.37 $0.82
The following table summarizes information about stock options under the 1995
Plan outstanding at December 31, 2003:
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------------------------
Weighted-
Average
Range of Exercise Number Remaining Weighted-Average Number Weighted-Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------
$ 1.53 to $ 4.00 144,923 6.98 years $ 3.23 119,723 $ 3.34
10.81 to 10.81 8,500 3.89 years 10.81 8,500 10.81
62
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Earnings Per Share
Earnings per share (EPS) were computed as follows:
Year Ended December 31 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted-
Income Average Per Share Income Average Per Share
Shares Amount Shares Amount
-------------------------------------------------------------------------------------
Income (Loss) from continuing operations $ 214 $(2,407)
=============== ===============
Basic earnings per share
Income (loss) available to common
stockholders $ 214 8,932,084 $ 0.02 $(2,407) 6,175,896 $(0.39)
=============== ===============
Effect of dilutive securities
Stock options
----------------------------- -----------------------------
Diluted earnings per share
Income (loss) available to common
stockholders and assumed
conversions $ 214 8,932,084 $ 0.02 $(2,407) 6,175,896 $(0.39)
=====================================================================================
Options to purchase 351,996 shares of common stock at prices ranging from $1.53
to $11.81 per share, as well as stock warrants representing the right to
purchase 527,753 shares of common stock at prices ranging from $3.00 to $8.93
per share were outstanding at December 31, 2003, but were not included in the
computation of diluted EPS because the options' exercise price was greater than
the average market price of the common shares.
>> Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument:
Cash and Cash Equivalents-- The fair value of cash and cash equivalents
approximates carrying value.
Interest-Bearing Time Deposits-- The fair value of interest-bearing time
deposits approximates carrying value.
Investment Securities-- Fair values are based on quoted market prices.
Loans-- For both short-term loans and variable-rate loans that reprice
frequently and with no significant change in credit risk, fair values are based
on carrying values. The fair values for certain mortgage loans, including
one-to-four family residential, are based on quoted market prices of similar
loans sold in conjunction with securitization transactions, adjusted for
differences in loan characteristics. The fair value for other loans is estimated
using discounted cash flow analyses using interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality.
63
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Interest Receivable/Payable-- The fair values of interest receivable/payable
approximate carrying values.
FHLB Stock-- The fair value is estimated to be the carrying value, which is par.
All transactions in the capital stock of the FHLB of Indianapolis are executed
at par.
Deposits-- The fair values of non-interest-bearing, interest-bearing demand and
savings accounts are equal to the amount payable on demand at the balance sheet
date. The carrying amounts for variable rate, fixed-term certificates of deposit
approximate their fair values at the balance sheet date. Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on certificates
to a schedule of aggregated expected monthly maturities on such time deposits.
Long-Term Debt-- The fair value of these borrowings is estimated using a
discounted cash flow calculation based on current rates for similar debt.
Long-term debt consists of adjustable instruments tied to a variable market
interest rate.
Off-Balance-Sheet Commitments-- Commitments include commitments to purchase and
originate mortgage loans, commitments to sell mortgage loans and standby letters
of credit and are generally of a short-term nature. The fair value of the loan
commitments is based on fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the
counterparties' credit standing. The carrying amounts of the commitments to
purchase and originate mortgage loans and to sell mortgage loans, which are
immaterial, are reasonable estimates of the fair value of these financial
instruments. The carrying amount of the standby letters of credit, which consist
of a letter of credit valuation allowance of $291, is a reasonable estimate of
the fair value of those off-balance sheet items.
The estimated fair values of Fidelity's financial instruments were as follows:
2003 2002
------------------------------------------------------------------------
Carrying Fair Carrying Fair
December 31 Amount Value Amount Value
----------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 2,968 $ 2,968 $ 3,823 $ 3,823
Investment securities available for sale 52,208 52,208 34,912 34,912
Loans, net 100,437 102,462 73,087 74,532
Interest receivable 564 564 411 411
FHLB stock 3,466 3,466 2,674 2,674
Liabilities
Deposits 120,680 121,782 106,791 109,097
FHLB advances and borrowings 39,627 39,723 13,586 14,199
Interest payable 339 339 266 266
Standby letters of credit 291 291 445 445
64
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
>> Condensed Financial Information (Parent Company Only)
Presented below is condensed financial information as to financial position,
results of operations and cash flows of Fidelity:
Condensed Balance Sheets
December 31 2003 2002
----------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 39 $ 123
Investment in common stock of subsidiaries 14,889 13,958
Loans, net 421 2,814
Subordinated debentures and other loan receivables
from subsidiaries 1,500
Income tax receivable 2,063 1,876
Other assets 94 199
-------------------------------------
Total assets $17,506 $20,470
=====================================
Liabilities
Long-term debt $ 4,077 $10,586
Letter of credit valuation allowance 61
Other liabilities 62 235
-------------------------------------
Total liabilities 4,139 10,882
Stockholders' Equity 13,367 9,588
-------------------------------------
Total liabilities and stockholders' equity $17,506 $20,470
=====================================
65
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Condensed Statements of Income
Year Ended December 31 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------
Income
Dividends from subsidiaries
Interest income $ 232 $ 560 $ 652
Other income 102 614 364
-------------------------------------------------------
Total income 334 1,174 1,016
-------------------------------------------------------
Expense
Interest expense 610 1,113 1,375
Provision for loan losses (73) (400) 595
Letter of credit valuation provision (61) (715)
Other expenses 350 1,526 622
-------------------------------------------------------
Total expense 826 2,239 1,877
-------------------------------------------------------
Loss Before Income Tax and Equity in
Undistributed (Distributions in Excess of)
Income of Subsidiaries (492) (1,065) (861)
Income Taxes (Benefit) (187) 976 (344)
-------------------------------------------------------
Loss Before Equity in Undistributed (Distributions in Excess of)
Income of Subsidiaries (305) (2,041) (517)
Equity in Undistributed (Distributions in Excess of) Income of
Subsidiaries 519 (2,354) 741
-------------------------------------------------------
Net Income (Loss) $ 214 $(4,395) $ 224
=======================================================
66
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Data)
Condensed Statements of Cash Flows
Year Ended December 31 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income (loss) $ 214 $(4,395) $ 224
Adjustments to reconcile net income (loss) to net
cash used by operating activities
Depreciation and amortization 5 6 11
Provision for loan losses (73) (400) 595
Letter of credit valuation provision (61) (715)
Funding on outstanding letters of credit (239) (355)
Gain on early extinguishment of debt (140) (325)
Loss on impairment of assets held for sale and changes in
estimated useful lives of intangible assets 1,096
Loss on sale of subsidiary 64
Undistributed net income (loss) of subsidiaries (519) 2,374 (741)
(Increase) decrease in other assets (87) 921 10
(Increase) decrease in other liabilities (173) (498) (149)
--------------------------------------------------------
Net cash used by operating activities (694) (1,211) (1,445)
--------------------------------------------------------
Investing Activities
Capital contributions to subsidiaries (1,000) (8) (193)
Proceeds from sale of subsidiary 461
Principal payments received on notes from subsidiaries 1,500 1,375
Net change in loans 2,466 (97) (460)
--------------------------------------------------------
Net cash provided (used) by investing activities 2,966 1,731 (653)
--------------------------------------------------------
Financing Activities
Repayment of long-term debt (7,784) (3,928) (2,740)
Proceeds from issuance of long-term debt 1,275 1,858 1,471
Sale of common stock 4,153 1,421 2,398
Sale of stock warrants 250
--------------------------------------------------------
Net cash provided (used) by financing activities (2,356) (399) 1,129
--------------------------------------------------------
Change in Cash and Cash Equivalents (84) 121 (969)
Cash and Cash Equivalents, Beginning of Period 123 2 971
--------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 39 $ 123 $ 2
========================================================
>> Subsequent Event
In February of 2004, Fidelity filed a registration statement on Form S-3 for the
registration and issuance of $2.5 million of 9% junior subordinated notes due in
January of 2009. The offering was to existing shareholders.
67
Corporate Information
Shareholder Relations
Inquiries: 1-800-280-8280
If you have inquiries or questions regarding your Fidelity Federal Bancorp
Shareholder account, call shareholder relations at 1-800-280-8280 or
812-424-0921 ext. 2226.
Stock Transfers, Dividend Payments
Dividend Reinvestment
Fidelity Federal Bancorp
Attn: Debbie Merritt, Shareholder Relations
18 NW Fourth St.
PO Box 1347
Evansville, IN 47706-1347
All other requests, including requests for the Annual Report, Form 10-K, Form
10-Q, etc., should be directed to: Debbie Merritt, Shareholder Relations.
Fidelity Federal Bancorp
18 NW Fourth St.
PO Box 1347
Evansville, IN 47706-1347
812-424-0921 ext. 2226
Internet Information on Fidelity Federal Bancorp is available on the Internet
at: http://www.unitedfidelity.com
Common Stock Information
NASDAQ National Market System
Ticker Symbol: FFED
Market Makers as of December 31, 2003
Knight Equity Markets, L.P.
Hill, Thompson, Magid & Co.
National Stock Exchange
Schwab Capital Markets
Boston Stock Exchange
Archipelago Exchange (The)
Goldman, Sachs & Co.
Annual Meeting
Wednesday, April 28, 2004
9:00 am (Central Daylight Time)
Sheraton Inn
8787 Keystone Crossing
Indianapolis, Indiana 46240
Board of Directors
William R. Baugh
Chairman Emeritus, Fidelity Federal Bancorp
Retired President, United Fidelity Bank, fsb
Paul E. Becker
President, Gaither Technologies STC
Director, United Fidelity Bank, fsb
Bruce A. Cordingley
President and CEO, Pedcor Bancorp
President and CEO, Pedcor Financial, LLC
President and CEO, Pedcor Investments, LLC
President and CEO, Village Housing Corporation
Director, International City Bank, N.A. (Long Beach, CA)
Director, United Fidelity Bank, fsb
Jack Cunningham
Chairman of the Board, United Fidelity Bank, fsb
Chairman of the Board, Fidelity Federal Bancorp
Port of Evansville Wharfmaster
Michael A. Elliott
CFO, Treasurer, Anchor Industries, Inc.
Director, United Fidelity Bank, fsb
Donald R. Neel
President and CEO, Fidelity Federal Bancorp
President, CEO and Director, United Fidelity Bank, fsb
Gerald K. Pedigo
Chairman, Pedcor Bancorp
Chairman, Pedcor Investments, LLC
Director, International City Bank, N.A. (Long Beach, CA)
Barry A. Schnakenburg
President, Barry Inc.
President, U.S. Industries Group, Inc.
Director, United Fidelity Bank, fsb
Phillip J. Stoffregen
Executive Vice President and COO,
Pedcor Investments, LLC
Officers
Jack Cunningham
Chairman
Bruce A. Cordingley
Chairman, Executive Committee
Donald R. Neel
President and CEO
Mark A. Isaac
Vice President and CFO
Nancy K. Sweazey
Vice President, Secretary
Debbie L. Merritt
Assistant Vice President, Shareholder Relations