UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number
0-24501
BLUE RIVER BANCSHARES, INC.
(Exact name of small business issuer as specified in its charter)
Indiana 35-2016637
----------------------------------------- ----------------------
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification Number)
29 East Washington Street
Shelbyville, Indiana 46176
----------------------------------------- ----------------------
(Address of principal executive office) (Zip Code)
Issuer's telephone number, including area code:
(317) 398-9721
As of November 15, 2004, there were 3,406,150 shares of the Registrant's Common
Stock issued and outstanding.
Transitional Small Business Disclosure Format.
(Check one): Yes [ ] No [X]
BLUE RIVER BANCSHARES, INC.
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements:
Consolidated Statements of Financial Condition (Unaudited)
as of September 30, 2004 and December 31, 2003 3
Consolidated Statements of Operations and Comprehensive Income
(Unaudited) for the three months ended September 30, 2004 and 2003 4
Consolidated Statements of Operations and Comprehensive Income
(Unaudited) for the nine months ended September 30, 2004 and 2003 5
Consolidated Statements of Cash Flows (Unaudited) for the
nine months ended September 30, 2004 and 2003 6
Notes to Consolidated Financial Statements (Unaudited) 7-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12-25
Item 3. Controls and Procedures 26
PART II. OTHER INFORMATION: 27
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other information
Item 6. Exhibits
SIGNATURE PAGE 28
EXHIBIT INDEX 29
PART I FINANCIAL STATEMENTS
ITEM 1. FINANCIAL STATEMENTS
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
SEPTEMBER 30, DECEMBER 31,
2004 2003
ASSETS
Cash and due from banks $ 5,492,903 $ 6,609,803
Interest-bearing deposits with banks 9,726,845 1,192,500
------------- -------------
Cash and cash equivalents 15,219,748 7,802,303
------------- -------------
Investment securities available for sale 33,774,985 48,825,911
Investment securities held to maturity 19,887 134,663
Loans receivable, net of allowance for loan losses 150,166,849 126,985,289
of $1,797,302 and $1,681,005
Stock of FHLB 2,866,000 2,765,500
Accrued interest receivable 952,513 1,008,822
Deferred income taxes 2,569,710 2,749,610
Premises and equipment, net 2,164,400 2,288,022
Real estate owned 1,979,357 2,052,223
Prepaid expenses and other assets 386,434 798,306
Core deposit intangible, net 396,547 427,066
Goodwill 3,145,176 2,972,743
------------- -------------
TOTAL ASSETS $ 213,641,606 $ 198,810,458
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits 176,486,276 160,685,890
FHLB advances and other borrowings 15,663,269 16,878,276
Term debt 4,000,000 4,000,000
Accrued expenses and other liabilities 609,284 715,253
Accrued interest payable 620,624 302,745
------------- -------------
Total liabilities 197,379,453 182,582,164
------------- -------------
SHAREHOLDERS' EQUITY:
Common stock, without par value: 3,406,150 shares issued and
outstanding 24,621,287 24,647,617
Accumulated deficit (8,421,968) (8,499,910)
Unrealized gain on securities available for sale, net of tax 62,834 80,587
------------- -------------
Total shareholders' equity 16,262,153 16,228,294
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 213,641,606 $ 198,810,458
============= =============
See notes to consolidated financial statements (unaudited).
- 3 -
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE THREE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
2004 2003
INTEREST INCOME:
Loans receivable $ 2,215,757 $ 1,033,733
Securities 355,329 339,687
Interest-bearing deposits 21,536 6,711
Dividends from FHLB 32,875 27,112
----------- -----------
Total interest income 2,625,497 1,407,243
----------- -----------
INTEREST EXPENSE:
Interest expense on deposits 866,730 490,743
Interest expense on borrowings 190,675 90,618
----------- -----------
Total interest expense 1,057,405 581,361
----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES 1,568,092 825,882
PROVISION FOR LOAN LOSSES 175,000 60,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,393,092 765,882
----------- -----------
NON-INTEREST INCOME:
Service charges and fees 77,767 57,635
Gain on sale of securities 16,563 68,789
Secondary market mortgage fees 139,168 -
Other 51,154 51,092
----------- -----------
Total non-interest income 284,652 177,516
----------- -----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 715,630 392,191
Premises and equipment 215,247 116,153
Federal deposit insurance 12,770 35,602
Data processing 147,696 98,834
Advertising and promotion 39,626 8,688
Bank fees and charges 27,382 13,423
Directors fees 57,150 33,450
Professional fees 92,313 75,152
Stationery, supplies and printing 29,401 14,733
Core deposit intangible 17,241 -
Merger costs 152,853 -
Other 262,641 112,739
----------- -----------
Total non-interest expense 1,769,950 900,965
----------- -----------
NET BEFORE INCOME TAX (92,206) 42,433
INCOME TAX EXPENSE (BENEFIT) - -
----------- -----------
NET INCOME (LOSS) $ (92,206) $ 42,433
=========== ===========
COMPREHENSIVE INCOME (LOSS) $ 226,564 $ (224,111)
=========== ===========
Basic and diluted earnings (loss) per share $ (0.03) $ 0.02
=========== ===========
See notes to consolidated financial statements (unaudited).
- 4 -
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
2004 2003
----------- -----------
INTEREST INCOME:
Loans receivable $ 6,100,322 $ 3,075,350
Securities 1,142,286 857,590
Interest-bearing deposits 38,573 42,672
Dividends from FHLB 93,951 83,340
----------- -----------
Total interest income 7,375,132 4,058,952
----------- -----------
INTEREST EXPENSE:
Interest expense on deposits 2,301,778 1,456,819
Interest expense on FHLB and other borrowings 560,239 259,702
----------- -----------
Total interest expense 2,862,017 1,716,521
----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN
LOSSES 4,513,115 2,342,431
PROVISION FOR LOAN LOSSES 370,000 180,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES 4,143,115 2,162,431
----------- -----------
NON-INTEREST INCOME:
Service charges and fees 227,488 157,087
Gain on sale of securities 121,731 229,407
Secondary market mortgage fees 286,105 15,268
Other 241,070 177,697
----------- -----------
Total non-interest income 876,394 579,459
----------- -----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,047,359 1,190,924
Premises and equipment 646,365 348,008
Federal deposit insurance 37,689 112,567
Data processing 446,587 333,705
Advertising and promotion 78,502 30,174
Bank fees and charges 76,012 40,079
Directors fees 174,650 100,350
Professional fees 335,105 258,527
Stationery, supplies and printing 103,667 39,308
Core deposit intangible 52,267 -
Merger Costs 152,853 -
Other 790,510 319,869
----------- -----------
Total non-interest expense 4,941,566 2,773,511
----------- -----------
NET INCOME (LOSS) BEFORE INCOME TAX 77,943 (31,621)
INCOME TAX EXPENSE (BENEFIT) - -
----------- -----------
NET INCOME (LOSS) $ 77,943 $ (31,621)
=========== ===========
COMPREHENSIVE INCOME (LOSS) $ 60,190 $ (382,972)
=========== ===========
Basic and diluted earnings (loss) per share $ 0.02 $ (0.01)
=========== ===========
See notes to consolidated financial statements (unaudited).
- 5 -
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 77,943 $ (31,621)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Depreciation and amortization 1,332,094 406,010
Provision for loan losses 370,000 180,000
FHLB stock dividend (100,500) (55,600)
(Gain) on sales of securities (121,731) (229,407)
(Gain) on sales other real estate owned (35,849) (46,541)
(Gain) on sales of loans (9,922) -
Changes in assets and liabilities:
Accrued interest receivable 56,309 (195,642)
Other assets 395,325 (655,360)
Accrued interest payable and other liabilities 211,910 1,495,523
------------ ------------
Net cash from operating activities 2,175,579 867,362
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan funded, net of collections (23,708,541) (9,332,406)
Principal maturities collected on securities available for sale 9,212,046 6,534,467
Principal maturities collected on securities held to maturity 114,605 -
Proceeds from sales of real estate owned 108,715 512,671
Purchase of premises and equipment (61,884) (19,789)
Proceeds from sales of securities available-for-sale 19,573,584 9,482,230
Purchases of securities available-for-sale (13,893,204) (20,963,669)
------------ ------------
Net cash from investing activities (8,654,679) (13,786,496)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock, net of offering costs of $101,110 - 2,483,116
Additional offering costs from proceeds of rights offering (26,331) -
Repayment of FHLB advances and other borrowings (82,319,450) (4,000,000)
Proceeds from FHLB advances and other borrowings 81,104,443 4,000,000
Net increase in deposits 15,137,883 11,710,589
------------ ------------
Net cash from financing activities 13,896,545 14,193,705
------------ ------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 7,417,445 1,274,571
CASH AND EQUIVALENTS, Beginning of period 7,802,303 3,439,078
------------ ------------
CASH AND EQUIVALENTS, End of period $ 15,219,748 $ 4,713,649
============ ============
See notes to consolidated financial statements (unaudited).
- 6 -
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
AS OF AND FOR THE THREE MONTH AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004
AND 2003
1. BASIS OF CONSOLIDATION AND PRESENTATION
The unaudited consolidated financial statements include the accounts of
Blue River Bancshares, Inc. (the "Company") and its wholly owned
subsidiaries Shelby County Bank and Unified Banking Company (collectively
the "Banks") and the wholly owned subsidiaries of Shelby County Bank. A
summary of significant accounting policies is set forth in Note 1 of the
Notes to the Consolidated Financial Statements of the Company included in
the December 31, 2003 Annual Report to Shareholders.
The accompanying consolidated interim financial statements at September
30, 2004, and for the three months ended September 30, 2004 and 2003, and
the nine month periods ended September 30, 2004 and 2003 are unaudited and
have been prepared in accordance with instructions to Form 10-QSB. In the
opinion of management, the financial statements include all adjustments
(which include only normal recurring adjustments) necessary to present
fairly the financial position, results of operations and cash flows for
such periods.
In accordance with SFAS No. 131, the Company has disclosed all required
information relating to its one operating segment, community banking.
2. DESCRIPTION OF BUSINESS
The Banks provide financial services to south central Indiana through
Shelby County Bank's main office in Shelbyville and three other full
service branches in Shelbyville, Morristown, and St. Paul, Indiana and to
the city of Lexington, and Fayette County, Kentucky through Unified
Banking Company's one office located in Lexington, Kentucky.
The Banks are subject to competition from other financial institutions and
other financial services providers and are regulated by certain federal
agencies and undergo periodic examinations by those regulatory
authorities.
On September 22, 2003, the Office of Thrift Supervision (the "OTS") issued
a letter to Shelby County Bank indicating their "troubled condition"
status (previously imposed by the OTS on July 10, 2000) had been lifted,
and that restrictions associated with the "troubled condition" status had
been removed. In a separate letter dated September 22, 2003, the OTS
informed the Company that its "troubled condition" status (previously
imposed by the OTS on February 7, 2001) had been lifted, and associated
restrictions no longer applied.
3. ACQUISITION
On November 17, 2003, the Company acquired 100% of the issued and
outstanding shares of stock of Unified Banking Company, a federal savings
association with its principal office in Lexington, Kentucky from Unified
Financial Services, Inc. The results of operations and financial position
of Unified Banking Company were included in the Company's consolidated
financial statements beginning November 1, 2003 as if the transaction was
effective November 1, 2003.
In connection with the acquisition, the Company paid cash of $8,200,000 to
Unified Financial Services and $344,863 in acquisition related costs. As a
condition of the acquisition, Unified Financial Services
- 7 -
and certain of its affiliates are required to maintain an aggregate
minimum amount of $8.5 million in non-interest bearing deposits at Unified
Banking Company through November 2006.
The acquisition was accounted for under the purchase method of accounting,
and accordingly, the net assets were recorded at their estimated fair
values at the date of acquisition. Fair value adjustments on the assets
acquired and liabilities assumed are being amortized over the estimated
useful lives of the related assets and liabilities. The original excess of
the purchase price over the estimated fair value of the underlying net
assets of $2,972,743 was allocated to goodwill and is not deductible for
tax purposes. Additionally, a core deposit intangible of $438,016 was
recognized and is being amortized over approximately seven years. The fair
value of the net assets acquired was based on preliminary estimates and
was revised on June 30, 2004. Adjustments noted in the course of refining
the purchase accounting to increase goodwill and the core deposit
intangible of $172,433 and $21,748 respectively were made on June 30,
2004. The offset to these increased adjustments was a decrease to the
deferred tax asset.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition and is
reflective of the subsequent revisions to goodwill, the core deposit
intangible and other assets.
Cash and cash equivalents $ 1,757,709
Investments 22,124,689
Loans receivable, net of allowance of $633,297 57,382,493
Other assets 1,345,471
Core deposit intangible 459,764
Goodwill 3,145,176
-----------
Total assets acquired $86,215,302
-----------
Deposits $73,364,574
Borrowed funds 3,931,924
Other liabilities 373,941
-----------
Total liabilities acquired $77,670,439
-----------
Net assets acquired $ 8,544,863
===========
4. COMMON SHARE INFORMATION
Earnings (loss) per share of common stock is based on the weighted average
number of basic shares and dilutive shares outstanding.
- 8 -
The following is a reconciliation of the weighted average common shares
for the basic and diluted earnings (loss) per share computations:
FOR THE THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2004 2003
Basic earnings per share:
Weighted average common shares 3,406,150 2,406,150
=========== ===========
Diluted earnings per share:
Weighted average common shares 3,406,150 2,406,150
Dilutive effect of stock options -- 427
----------- -----------
Weighted average common shares and incremental shares 3,406,150 2,406,577
=========== ===========
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2004 2003
Basic earnings per share:
Weighted average common shares 3,406,150 2,336,552
=========== ===========
Diluted earnings per share:
Weighted average common shares 3,406,150 2,336,552
Dilutive effect of stock options 32,812 -
----------- -----------
Weighted average common shares and incremental shares 3,438,962 2,336,552
=========== ===========
During the three months ended September 30, 2004 and the nine months ended
September 30, 2003, there were no incremental shares relating to the
dilutive effect of stock options. For the three months ended September 30,
2003 and the nine months ended September 30, 2004, respectively 198,350,
and 122,350 stock options were not considered in the calculation of the
dilutive effect of stock options as they were anti-dilutive.
5. STOCK BASED COMPENSATION
At September 30, 2004, the Company had stock-based employee compensation
plans. The Company accounts for those 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 (loss), as all options
granted under those plans had an exercise price equal to the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net income (loss) and earnings (loss) per share
if the company had applied the fair value recognition provisions of SFAS
123, "Accounting for Stock-Based Compensation," to stock-based employee
compensation.
- 9 -
SEPTEMBER 30,
-------------------------
2004 2003
Net income (loss):
Net income (loss) as reported $ (92,206) $ 42,433
Deduct total stock based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (8,175) (33,884)
----------- ----------
Pro forma, net income (loss) $ (100,381) $ 8,549
=========== ==========
Net earnings (loss) per share:
Basic earnings (loss) per share $ (0.03) $ 0.02
Diluted earnings (loss) per share $ (0.03) $ 0.02
Pro forma earnings (loss) per share:
Basic earnings (loss) per share $ (0.03) $ 0.00
Diluted earnings (loss) per share $ (0.03) $ 0.00
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2004 2003
Net income (loss):
Net income (loss) as reported $ 77,943 $ (31,621)
Deduct total stock based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (24,525) (101,652)
------------- -------------
Pro forma, net income (loss) $ 53,418 $ (133,273)
============= =============
Net earnings (loss) per share:
Basic earnings (loss) per share $ 0.02 $ (0.01)
Diluted earnings (loss) per share $ 0.02 $ (0.01)
Pro forma earnings (loss) per share:
Basic earnings (loss) per share $ 0.02 $ (0.06)
Diluted earnings (loss) per share $ 0.02 $ (0.06)
6. INCOME TAXES
During the fourth quarter of 2002, the Company recorded a valuation
allowance against a portion of the deferred tax assets because management
believed it was more likely than not that a portion of the benefit
associated with the deferred tax asset would not be realized. The Company
recorded a reduction in its valuation allowance to offset a decline in the
deferred tax assets, resulting in no income tax expense for the nine
months ended September 30, 2004. The Company has generated federal and
state operating losses carryforwards totaling $4.5 million. The net
operating loss carryforwards, if unused will begin to expire in 2020
through 2023.
7. AFFILIATION AND MERGER WITH HEARTLAND BANCSHARES, INC.
On August 31, 2004, the Company and Heartland Bancshares, Inc.
(Heartland), Franklin, Indiana, entered into an Agreement of Affiliation
and Merger which provides for Heartland to merge with and into to the
Company. The banking subsidiaries, of the Company and Heartland, Shelby
County Bank and Heartland Community Bank, respectively, will also merge
their operations pursuant to the merger agreement. Under the terms of the
agreement, a stock-for-stock merger will occur in which 2.54 shares
- 10 -
of the Company's common stock will be exchanged, on a tax-free basis, for
each share of Heartland common stock. The Company and Heartland also
entered into reciprocal option agreements providing the other party with
an option to purchase up to 19.9% of its presently outstanding common
stock in certain events. The merger is subject to approval by the
shareholders of the Company and Heartland as well as federal and state
regulatory authorities and other conditions customary for transactions of
this nature. Based primarily on the relative ownership of Heartland and
Blue River shareholders in the merged entity, as well as the composition
of the Board of Directors of the merged entity, it is expected that
Heartland will be considered the acquiring entity for accounting purposes.
During the third quarter of 2004, the Company incurred costs of $153,000
related to the merger with Heartland Bancshares, Inc. These costs were
expensed by the Company since it is expected that Heartland will be the
acquiring entity in the merger.
8. DEPARTURE OF DIRECTORS OR PRINCIPAL OFFICERS; ELECTION OF DIRECTORS;
APPOINTMENT OF PRINCIPAL OFFICERS
On October 4, 2004, the Company entered into a Severance Agreement and
Release with Lawrence T. Toombs pursuant to which Mr. Toombs resigned as
the President and a director of the Company and as the President and Chief
Executive Officer and a director of the Company's wholly-owned subsidiary,
Shelby County Bank. Under the terms of such agreement, Mr. Toombs will
receive his base compensation until August 2, 2005 in addition to other
benefits. Subsequently, the Board of Directors appointed Russell Breeden,
III, the Company's Chairman and CEO, as the President of the Company and
Randy Collier, the Company's current Executive Vice President, as the
acting President and Chief Executive Officer of Shelby County Bank.
9. NEW ACCOUNTING PRONOUNCEMENTS
EITF Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments, contains accounting guidance regarding
other-than-temporary impairment on securities that was to take effect for
the quarter ended September 30, 2004. However, the effective date of
portions of this guidance has been delayed, and more interpretive guidance
is to be issued in the near future. The effect of this new and pending
guidance on the Company's financial statements is not known, but it is
possible this guidance could change management's assessment of
other-than-temporary impairment in future periods.
- 11 -
PART I - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 the Company. The information contained in this
discussion should be read in conjunction with the unaudited condensed
consolidated financial statements and accompanying notes thereto.
FORWARD LOOKING STATEMENTS
Further, this Quarterly Report on Form 10-QSB may contain certain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Statements in this report which express "belief",
"intention", "expectation", "prospects", as well as other statements which are
not historical fact, are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve risk and uncertainties which may cause actual results to
differ materially from those in such statements. Some of the factors that may
generally cause actual results to differ materially from projection, forecasts,
estimates and expectations include, but are not limited to (i) changes in the
interest rate environment, (ii) competitive pressures among financial
institutions, (iii) general economic conditions on local or national levels,
(iv) political developments, wars or other hostilities that may disrupt or
increase volatility in securities markets, (v) legislative or regulatory
changes, (vi) changes in prepayment speeds of loans or securities, (vii) changes
in loan sale volumes, charge-offs and loan loss provisions, (viii) changes in
legal or regulatory proceedings, and (ix) the impact of reputation risk created
by these developments on such matters as business generation or retention. Such
statements reflect the current view of the Company and the Banks with respect to
future events and are subject to these and other risks, uncertainties and
assumptions relating to the operations, results of operations, growth strategy
and liquidity of the Company and the Banks.
COMPANY OVERVIEW
The Company is a holding company for its principal banking subsidiaries, Shelby
County Bank and Unified Banking Company. The Company's net income is derived
principally from the operating results of its banking subsidiaries. The
principal sources of the Company's revenue are interest and fees on loans;
deposit service charges; interest on security investments; and, origination fees
on mortgage loans brokered. The Banks' lending activity consists of
short-to-medium-term consumer and commercial loans, including home equity lines
of credit; personal loans for home improvement, autos and other consumer goods;
residential real estate loans; and, commercial real estate and operating loans.
Funding activities at the subsidiary Banks include a full range of deposit
accounts, including demand deposits; NOW accounts; money market accounts; and
certificates of deposit. Also, funding is supplemented with deposits gathered
from local and state governments and through borrowings from the Federal Home
Loan Banks. The Company maintains a $4,000,000 loan from a commercial bank.
Shelby County Bank is a federally chartered savings bank located in Shelbyville,
Indiana and Unified Banking Company is a federally chartered savings bank
located in Lexington, Kentucky. The Banks provide full-service banking to
businesses and residents within their communities and surrounding areas. The
Banks place particular emphasis on serving its clients with a broad range of
services delivered by experienced professionals concerned with building strong
and long-term relationships.
- 12 -
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. The
estimate most susceptible to change in the near term is the allowance for loan
losses.
The Company's critical accounting policies include the following:
An analysis of the allowance for loan losses is performed monthly by the Banks'
management to assess the appropriate levels of allowance for loan losses. This
analysis is performed to recognize specific reserves allocated to classified
assets, to monitor trends in loan delinquencies and charge-offs and to consider
portfolio composition. Specific reserves are established based upon review of
individual borrowers identified in the classified loan list, establishing the
probable incurred losses associated with such borrowers, including comparison of
loan balances versus estimated liquidation values of collateral based upon
independent information sources or appraisals performed by board-approved
licensed appraisers. The remaining pool of loans, excluding those classified or
delinquent is the source for the general loan loss reserve. Management evaluates
this general reserve using loan loss statistics by various types of loans, as
published periodically by the OTS, or the Banks' historical losses and
multiplying such loss percentages to the Banks' distribution of portfolio
balances. The calculated reserve is compared to the Banks' existing reserve to
establish the provision necessary to bring the actual reserve balance in
compliance with the findings of the allowance analysis.
The Company establishes valuation allowances in accordance with the provisions
of SFAS 109, "Accounting for Income Taxes". The Company continually reviews the
adequacy of the valuation allowance and will recognize the benefits only as
reassessment indicates that it is more likely than not that the benefits will be
realized.
MANAGEMENT OVERVIEW
Overview of Financial Condition at September 30, 2004 and December 31, 2003
On a consolidated basis, the Company's total assets as of September 30, 2004
were $213,642,000 compared to total assets of $198,810,000 at December 31, 2003.
As of September 30, 2004, gross loans were $151,964,000 compared to gross loans
of $128,666,000 at December 31, 2003. Deposits were $176,486,000 at September
30, 2004 compared to $160,686,000 at December 31, 2003. Total capital was
$16,262,000 at September 30, 2004 compared to $16,228,000 at December 31, 2003.
Outstanding shares of common stock were 3,406,150 as of September 30, 2004 and
December 31, 2003.
Overview of Results of Operations for the Three Months Ended September 30, 2004
and 2003
For the quarter ended September 30, 2004, the Company's net consolidated loss
was ($92,000). This compares to consolidated net income of $42,000 for the same
period of 2003. Basic loss per share was ($0.03) for the quarter ended September
30, 2004 compared to $0.02 earnings per share for the quarter ended September
30, 2003. Weighted average outstanding shares (basic) for the third quarter of
2004 were 3,406,150 compared to 2,406,150 for the third quarter of 2003. The
Company previously recorded a valuation allowance against its deferred tax asset
in 2002. The Company increased its valuation allowance to offset an increase in
deferred tax assets, resulting in no income tax benefit for the quarter ended
September 30, 2004. Additionally, the Company benefited from recognizing
required purchase accounting treatment based on the acquisition of Unified
Banking Company. The benefit of the accounting treatment for the three months
ended September 30, 2004 was $58,000. However, this benefit will be decreasing
in the future. The next quarter will be the first quarter in which we have
comparative financial information which includes Unified Banking Company.
- 13 -
Interest income for the three months ended September 30, 2004 was $2,625,000
compared to $1,407,000 for the three months ended September 30, 2003. Interest
expense increased to $1,057,000 for the period ended September 30, 2004 compared
to total interest expense of $581,000 for the same period in 2003. The third
quarter of 2004 was the third full quarter of consolidated reporting including
Unified Banking Company.
Net interest income before loan loss provision for the three months ended
September 30, 2004 was $1,568,000 as compared to $826,000 for the same period in
2003, or a 90% increase. Non-interest income for the three months ended
September 30, 2004 was $285,000 as compared to $178,000 for the same period in
2003, or a 60% increase. The two increases in the prime lending rate also
increased our net interest income for the three months ended September 30, 2004.
Non-interest expense increased to $1,770,000 for the three months ended
September 30, 2004 from $901,000 for the same period of 2003. There were
professional costs of $153,000 related to the proposed merger with Heartland
Bancshares, Inc. occurring in the third quarter of 2004. In addition, the costs
to manage and remove real estate owned remains very high. The Company expects to
materially reduce this non-earning asset category during the fourth quarter of
2004.
The increase in interest income in the three month period ending September 30,
2004, when compared to the same period of 2003, is attributed to an increase of
$979,000 in interest income from Unified Banking Company, which was acquired in
November, 2003. The additional increase in interest income of $239,000 is the
result of loan growth offset by declining yields at Shelby County Bank.
The increase in interest expense for the three month period ended September 30,
2004, when compared to the same period of 2003, included interest expense of
$350,000 associated with the addition of Unified Banking Company. There was also
an increase in interest expense of $126,000 due to increased volume of deposits
and borrowings at Shelby County Bank, partially offset by reductions in interest
rates.
The increase in non-interest income of $107,000 for the three month period ended
September 30, 2004 compared to the three month period ended September 30, 2003
was comprised of $79,000 in secondary market mortgage loan fees; $9,000 in
service charges and fees on deposit accounts and $25,000 in other fees. This
positive impact was offset by a net loss of ($2,000) on sales of
available-for-sale securities at Unified Banking Company. Fees on deposit
accounts and other fees for Blue River and Shelby County Bank increased $11,000.
Additionally, there were $30,000 in secondary market mortgage loan fees and an
increase of $5,000 in other income offset by a decrease of $50,000 in net gains
on sales of securities at Shelby County Bank when comparing the two periods.
The increase in non-interest expense of $869,000 for the three month period
ended September 30, 2004 compared to same period ended September 30, 2003,
primarily included non-interest expense of $622,000 associated with Unified
Banking Company and $153,000 in merger related costs associated with the
proposed merger with Heartland Bancshares, Inc.
Overview of Results of Operations for the Nine Months Ended September 30, 2004
and 2003
For the nine month period ended September 30, 2004, the Company's net
consolidated income was $78,000. This compares to a consolidated net loss of
($32,000) for the same period of 2003. Basic earnings per share were $0.02 for
the nine months ended September 30, 2004 compared to ($0.01) loss per share for
the nine months ended September 30, 2003. Weighted average outstanding shares
(basic) for the first three quarters of 2004 were 3,406,150 compared to
2,336,552 for the first three quarters of 2003. The Company previously recorded
a valuation allowance against its deferred tax asset in 2002. The Company
recorded a reduction in its valuation allowance to offset a decline in deferred
tax assets, resulting in no income tax expense for the nine month period ended
September 30, 2004. Additionally, the Company benefited from recognizing
required purchase accounting treatment based on the acquisition of Unified
Banking Company. The benefit of the accounting treatment for the nine months
ended September 30, 2004 was $244,000. However, this benefit will be decreasing
in the future quarters.
- 14 -
Interest income for the nine months ended September 30, 2004 was $7,375,000
compared to $4,059,000 for the nine months ended September 30, 2003. Interest
expense increased to $2,862,000 for the nine month period ended September 30,
2004 compared to total interest expense of $1,717,000 for the same period in
2003.
Net interest income before loan loss provision for the nine months ended
September 30, 2004 was $4,513,000 as compared to $2,342,000 for the same period
in 2003, or a 93% increase. Non-interest income for the nine months ended
September 30, 2004 was $877,000 as compared to $579,000 for the same period in
2003, or a 51% increase.
Non-interest expense increased to $4,942,000 for the nine months ended September
30, 2004 from $2,774,000 for the same period of 2003.
The increase in interest income in the nine month period ending September 30,
2004, when compared to the same period of 2003, is attributed to an increase of
$2,705,000 in interest income from Unified Banking Company, which was acquired
in November, 2003, and an interest income increase of $611,000 from loan growth
offset by declining yields at Shelby County Bank.
The increase in interest expense for the nine month period ended September 30,
2004, when compared to the same period of 2003, included interest expense of
$878,000 associated with the addition of Unified Banking Company, and an
increase in interest expense of $267,000 due to increased volume of deposits and
borrowings at Shelby County Bank, partially offset by reductions in interest
rates.
The increase in non-interest income of $297,000 for the nine month period ended
September 30, 2004 compared to September 30, 2003 was comprised of $256,000 in
secondary market mortgage loan fees; $135,000 in net gains on securities
available-for-sale and other assets; and $51,000 in service charges and fees on
deposit accounts at Unified Banking Company. Fees on deposit accounts and other
fees for the stand alone holding company, Blue River, and Shelby County Bank
increased $51,000. There also was an increase of $15,000 in secondary market
mortgage fees at Shelby County Bank. These increases were offset by a decrease
of $206,000 in net gains on sales of available-for-sale securities and net
decreases of $5,000 in other fees and gains on other assets at Shelby County
Bank when comparing the two periods.
The increase in non-interest expense of $2,168,000 for the nine month period
ended September 30, 2004 compared to same period ended September 30, 2003,
primarily included non-interest expense of $1,873,000 associated with Unified
Banking Company and $153,000 in merger related costs associated with the
proposed merger with Heartland Bancshares, Inc.
FINANCIAL CONDITION
On November 17, 2003 the Company completed its acquisition of 100% of the issued
and outstanding shares of common stock of Unified Banking Company, a federal
savings bank with its principal office in Lexington, Kentucky, from Unified
Financial Services, Inc. The aggregate purchase price was $8.2 million. The
Company financed the purchase price through a combination of cash on hand, an
offering of its common stock to its existing shareholders of 1,000,000 shares at
$4.50 per share and a loan from the Union Federal Bank of Indianapolis in the
amount of $4,000,000. The Company operates Unified Banking Company separately
from its other savings bank subsidiary, Shelby County Bank. At the time of the
acquisition, Unified Banking Company had $81 million in assets.
The Company's total assets at September 30, 2004 were $213,642,000, an increase
of $14,831,000 from December 31, 2003. The increase is primarily a result of an
increase in loans due to growth, which was offset by a decline in securities
available-for-sale and cash and due from banks, and a decrease in other real
estate owned. The increase in net loans was $23,182,000, offset by a decrease in
securities available-for-sale of $15,051,000 a decrease in cash and due from
banks of $1,117,000 and a decrease in other real estate owned of $73,000. During
the first three quarters of 2004, the Banks focused their efforts on commercial
loan
- 15 -
production to improve interest income, and in home equity lending in order to
strengthen its Qualified Thrift Lender ("QTL") ratios. However, at the end of
the third quarter 2004, it was necessary for Shelby County Bank to participate
$4,000,000 of its commercial loan and home equity loan portfolios to other
banks. This was accomplished in order to assure its "well capitalized" status.
The Banks are strategically maintaining their "well capitalized" status while
continuing to focus on improving net interest income and overall profitability.
The investment portfolio balances have decreased to $33,795,000 at September 30,
2004 from $48,961,000 at December 31, 2003. In an effort to improve risk-based
capital and manage liquidity, the Banks sold $9,575,000 of their
available-for-sale investment securities during the first quarter of 2004;
$1,563,000 during the second quarter of 2004 and $8,436,000 during the third
quarter 2004. These sales yielded a year to date net gain of $122,000. There
were maturities of securities available for sale and securities held to maturity
of $3,850,000 which also contributed to the decline in investments. Additional
decreases in the investments were due to average repayments of approximately
$609,000 per month on the mortgage-backed-securities. These sales, maturities
and repayments were replaced with $13,893,000 in U.S. government, GNMA and
treasury securities. The Banks have continued to invest primarily in GNMA
mortgage-backed securities. These investment products receive favorable
risk-based capital treatment.
The Banks' interest-bearing deposits within other banks increased $8,534,000 to
$9,727,000 from $1,193,000 at December 31, 2003. The large amount of
interest-bearing deposits within other banks is primarily the result of one
large account at Unified Banking Company which has significant volatility in the
amount of overnight deposits which they maintain. The Company's present
liquidity levels are sufficient to meet its operating needs. The Company's
liquidity position is the primary source of additional capital for infusion into
its banking subsidiaries. In 2003, the Company raised additional capital from
stock offerings. The Company then contributed a portion of the additional
capital to Unified Banking Company in an amount equal to $500,000 during the
fourth quarter of 2003 and an additional $400,000 during the first and second
quarters of 2004. Due to the Company's current liquidity sources and its
increased use of funds, the Company does not anticipate the need for any
additional external funding over the next six months.
The Banks' net loans increased $23,182,000 from December 31, 2003 to
$150,167,000 at September 30, 2004. During the nine month period ended September
30, 2004, the Banks sought loan products that provided the opportunity to
continue to improve interest rate sensitivity through shorter maturity terms and
variable rate pricing. However, immediate future growth is expected to
decelerate in the commercial lending market as well as in the home equity market
in order to maintain the banks' "well capitalized" status.
LOANS RECEIVABLE
SEPTEMBER 30, DECEMBER 31,
2004 2003
Residential mortgage loans:
One-to-four family $ 45,169,382 $ 40,826,997
Non Residential 31,841,830 29,624,474
Home equity loans 32,887,986 20,646,169
Consumer loans 8,544,712 9,122,657
Commercial loans, including participations 33,520,241 28,445,997
------------- -------------
Total gross loans 151,964,151 128,666,294
------------- -------------
Less allowance for loan losses (1,797,302) (1,681,005)
------------- -------------
Total loans receivable, net $ 150,166,849 $ 126,985,289
============= =============
- 16 -
NON-PERFORMING LOANS
SEPTEMBER 30 DECEMBER 31,
2004 2003
Non-performing loans consist of the following:
Non-accrual loans $ 785,890 $ 901,298
Ninety (90) days past due 1,495,144 1,094,005
------------- -------------
Total non-performing loans $ 2,281,034 $ 1,995,303
============= =============
Non-performing loans to total loans 1.50% 1.55%
Non-performing assets are defined as: (1) loans in non-accrual status where the
ultimate collection of interest is uncertain; (2) loans past due ninety days or
more as to principal or interest (and where continued accrual has not been
specifically approved); and (3) loans which have been renegotiated to provide a
reduction or deferral of interest or principal because of deterioration in the
financial condition of the borrower. At September 30, 2004, the Banks reported
approximately $786,000 of non-accrual loans, a decrease of $115,000 from
December 31, 2003, and $1,495,000 in loans ninety days past due, an increase of
$401,000 from December 31, 2003. There is a decrease in the non-performing loans
to total gross loans from 1.55% at December 31, 2003 to 1.50% at September 30,
2004. This decrease is directly related to the increase in total loans
outstanding. The Banks maintain a reserve for loan losses to cover losses
incurred when loans default. Loans in all categories are charged-off when a loan
is 180 days past due or when uncollectibility is confirmed.
Activity in the allowance for loan losses consists of the following:
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
2004 2003
Balance, beginning of period $ 1,681,005 $ 1,717,072
Add:
Provision for loan losses 370,000 180,000
Recoveries of loans previously charged off 54,239 80,038
Less gross charge-offs: - -
Residential real estate loans (128,479) (39,028)
Consumer/commercial loans (179,463) (848,940)
------------- -------------
Balance, end of period $ 1,797,302 $ 1,089,142
============= =============
Net charge-offs to total average loans outstanding (annualized) 0.54% 4.02%
Allowance to total average loans outstanding 1.24% 1.81%
Allowance for loan losses at September 30, 2004 was $1,797,000, an increase of
$116,000 from December 31, 2003. The Company's provision for loan losses for the
first three quarters of 2004 was $370,000 and its net charge-offs were
approximately $254,000. An analysis of the allowance for loan losses is
performed monthly by the Banks' management to assess the appropriate levels of
allowance for loan losses. Specific reserves are established based upon review
of individual borrowers identified in the classified loan list, establishing the
probability of loss associated with such borrowers, including comparison of loan
balances versus estimated liquidation values of collateral based upon
independent information sources or appraisals performed by board-approved
licensed appraisers. The remaining pool of loans, excluding those classified
- 17 -
or delinquent is the source for the general loan loss reserve. Management
evaluates this general reserve using loan loss statistics by various types of
loans, as published periodically by the OTS, or the Banks' historical losses and
multiplying such loss percentages to the Banks' distribution of portfolio
balances since management believes this will be representative of future losses
inherent in the portfolio. The calculated reserve is compared to the Banks'
existing reserve to establish the provision necessary to bring the actual
reserve balance in compliance with the findings of the allowance analysis
performed by management. The reason for the increase in the allowance was
primarily due to these monthly assessments resulting in monthly provisions.
These increases were offset by the net-charge-offs for the period. Residential
real estate loan charge-offs consisted of primarily two loans; one at Unified
Banking Company of $91,000 charged-off during the second quarter of 2004 with
more losses anticipated during the fourth quarter of 2004, and one at Shelby
County Bank of $27,000 also occurring during the second quarter of 2004.
Consumer and commercial loan charge-offs consisted primarily of three loans; two
loans at Unified Banking Company of $71,000 charged-off during the second
quarter of 2004, and one loan at Shelby County Bank of $67,000 charged-off
during the first of quarter 2004. The allowance to total average loans
outstanding decreased 57 basis points from 1.81% for the nine month period ended
September 30, 2003 to 1.24% for the nine month period ended September 30, 2004.
This decrease was the result of the addition of Unified Banking Company, and the
general improvement of the loan portfolio, increased volume and the concentrated
effort to reduce problem loans at Shelby County Bank.
Total liabilities at September 30, 2004 were $197,379,000, an increase of
$14,797,000 compared to $182,582,000 at December 31, 2003. Deposits at September
30, 2004 were $176,486,000 compared to $160,686,000 at December 31, 2003, an
increase of $15,800,000. Accordingly, other borrowings have decreased by
$1,215,000 to $15,663,000 at September 30, 2004 from $16,878,000 at December 31,
2003. During the third quarter of 2004, it was necessary for Shelby County Bank
to accept $6,068,000 in brokered certificates of deposits to better position its
asset and liability administration. In addition, management will continue to
emphasize the benefits of gathering non-certificate depository funding as a
means of decreasing the Banks' overall funding costs, improving levels of fee
income derived from depository relationships, and encouraging a stronger
relationship with its customer base. By acquiring primary transaction accounts,
the Banks are less susceptible to loss of accounts during periods of volatile
interest rates.
Shareholders' equity at September 30, 2004 was $16,262,000, an increase of
$34,000 compared to $16,228,000 at December 31, 2003. The change in equity
resulted from net income of $78,000, offset by a decrease of $18,000 from
reductions in the fair value of the Company's available-for-sale investment
portfolio and by $26,000 of additional capital expenses from the rights offering
during the fourth quarter of 2003 related to the acquisition of Unified Banking
Company.
RESULTS OF OPERATIONS: Three Months Ended September 30, 2004
During the three month period ended September 30, 2004, the Company's net loss
was ($92,000) compared to net income of $42,000 reported for the three month
period ended September 30, 2003. The income tax expense/benefit was $0 for the
three month period ended September 30, 2004 and for the three month period ended
September 30, 2003. In December 2002, the Company recognized a valuation
allowance of $760,000 pertaining to the recoverability of its deferred tax
assets. Management concluded that it was more likely than not that a portion of
the benefit associated with the deferred tax asset would not be realized, and no
further tax benefit was recorded in 2003. The Company increased its valuation
allowance to offset an increase in deferred tax assets, resulting in no income
tax benefit for the quarter ended September 30, 2004.
The Company's comparative performance showed an increase in net interest income
before provision for loan losses of $742,000, an increase in the provision for
loan losses of $115,000, an increase in non-interest income of $107,000, and an
increase in non-interest expenses of $869,000.
The increase in net interest income before provision for loan losses resulted
from an increase in interest income of $1,218,000, offset by an increase in
interest expense of $476,000. The increase in interest income was primarily due
to the acquisition of Unified Banking Company which accounts for $979,000 of
this
- 18 -
increase, with $239,000 from loan growth and investment portfolio increases at
Shelby County Bank. The major variance in interest expense of $350,000 is
attributed to Unified Banking Company. An increase in interest expense of
$126,000, due to increases in certificates of deposits and borrowings offset by
declining interest rates, attributed to Shelby County Bank.
Interest income and fees from loans increased from $1,034,000 for the three
month period ended September 30, 2003 to $2,216,000 for the three month period
ended September 30, 2004. This increase was comprised of a favorable variance of
$1,553,000 due to higher average loan balances of $92,454,000, of which
$62,000,000 can be attributed to the acquisition Unified Banking Company, and an
unfavorable variance of $371,000 due to a decrease of 96 basis points in the
effective yield on loans. The reduction in yield was largely due to increased
balances in variable rate products, as well as lower yields on new loans
originated during a period of low interest rates. The overall yield on loans
fell to 5.79% for the three month period ended September 30, 2004 from 6.75% for
the three month period ended September 30, 2003.
Interest income from investment securities increased $15,000 to $355,000 for the
three months ended September 30, 2004, when compared to the three month period
ended September 30, 2003. This increase resulted from a favorable variance of
$12,000 from an increase in average investment balances of $1,300,000, of which
$12,083,000 can be attributed to Unified Banking Company offset by a decrease in
the average investment balances at Shelby County Bank of $10,783,000 and an
unfavorable variance of $3,000 due to investment yields being 4 basis points
lower. In order to improve interest rate sensitivity, liquidity and capital
during the third quarter 2004, Shelby County Bank sold $2,234,000 of its
available-for-sale U.S. government agency FNMA securities. During the three
month period ended September 30, 2004, there were also principal payment
reductions in the mortgage backed securities of $556,000 and a $130,000 maturity
of a municipal bond. Shelby County Bank replaced a portion of its
available-for-sale U.S. agency securities with a $1,032,000 GNMA, as this type
of security receives favorable risk-based capital treatment. At Unified Banking
Company there were sales of U.S. agency FNMA securities of $6,185,000 and
payment reductions in the mortgage backed securities of $906,000. The U.S.
agency FNMA securities were replaced with U.S. agency GNMA securities in the
amount of $6,408,000 as this type of security receives favorable risk-based
capital treatment.
Interest expense on deposits increased $376,000 to $867,000 for the three month
period ended September 30, 2004, compared to $491,000 for the three month period
ended September 30, 2003. This increase was comprised of an unfavorable variance
of $582,000 due to an increase in average deposit balances of $72,507,000, of
which $56,995,000 can be attributed to Unified Banking Company and a favorable
variance of $206,000 due to a decrease in average rates on deposits from 2.58%
to 2.34%. This favorable rate variance was created by lower certificate rates on
new and renewed certificates of deposit, as well as reduced rates applied to
core deposit products such as interest-bearing checking, savings, and money
market accounts. The increase in average deposit balances is primarily the
result of the acquisition of Unified Banking Company. Additionally, increases in
certificates of deposits were used as funding sources and to offset maturities
of high rate promotional certificates of deposits.
Interest expense on FHLB advances and other borrowings increased $100,000 from
$91,000 for the three-month period ended September 30, 2003 to $191,000 for the
three month period ended September 30, 2004. This increase was the result of an
unfavorable variance of $90,000 due to an increase in the average borrowing
balance of $12,381,000, of which $4,000,000 can be attributed to the acquisition
of Unified Banking Company in the fourth quarter of 2003. In order to finance a
portion of this acquisition, the Company borrowed $4,000,000 and incurred
$47,000 in interest expense during the third quarter of 2004 related to this
borrowing. An additional volume variance of $5,654,000 can also be attributed to
Unified Banking Company. An unfavorable variance of $10,000 was due to an
increase in interest rates from 2.88% to 3.04%.
For the three month period ended September 30, 2004, the provision for loan
losses was $175,000 compared to $60,000 for the three month period ended
September 30, 2003. The increase of $115,000 is attributed to Unified Banking
Company as there was no variance in the provision for loan losses at Shelby
County Bank
- 19 -
for the three month period ended September 30, 2004 compared to the three month
period ended September 30, 2003.
Total non-interest income was $285,000 for the three-month period ended
September 30, 2004 compared to $178,000 for the three month period ended
September 30, 2003. Of this increase, $111,000 can be attributed to the
acquisition of Unified Banking Company, primarily the result of $79,000 in
secondary market mortgage loan fees; $34,000 from service charges and fees on
deposit accounts and other fees; and a loss of ($2,000) on net losses on
available-for-sale securities. Service charges and fees on deposit accounts,
gains on sales of loans and other assets, and other fees for Blue River and
Shelby County Bank increased $16,000 for the three month period ended September
30, 2004 compared to the three month period ended September 30, 2003. In
addition there were $30,000 in secondary mortgage loan fees. These increases for
the three month period ended September 30, 2004 were offset by a decrease of
$50,000 in net gains on available-for-sale securities at Shelby County Bank when
compared to the three month period ended September 30, 2003.
Non-interest expenses totaled $1,770,000 for the three month period ended
September 30, 2004, compared to $901,000 during the three month period ended
September 30, 2003. Of the increase of $869,000, $622,000 can be attributed to
Unified Banking Company and $247,000 to Shelby County Bank and Blue River, of
which $153,000 can be attributed to the proposed merger with Heartland
Bancshares, Inc.
Changes in non-interest expenses consist of the following:
THREE MONTHS ENDED SHELBY COUNTY UNIFIED
SEPTEMBER 30 BANK BANKING
----------------------------- CHANGE FROM & BLUE RIVER COMPANY
2004 2003 2003 DOLLAR CHANGE DOLLAR CHANGE
------------- -------------
Salaries and employee benefits $ 715,630 $ 392,191 $ 323,439 $ 25,170 $ 298,269
Occupancy 215,247 $ 116,153 99,094 1,737 $ 97,357
Federal deposit insurance 12,770 35,602 (22,832) (25,135) 2,303
Data Processing 147,696 98,834 48,862 16,340 32,522
Advertising and promotion 39,626 8,688 30,938 6,452 24,486
Bank fees and charges 27,382 13,423 13,959 3,957 10,002
Director Fees 57,150 33,450 23,700 (1,800) 25,500
Professional Fees 92,313 75,152 17,161 (7,134) 24,295
Stationery, supplies and printing 29,401 14,733 14,668 8,909 5,759
Core deposit intangible 17,241 - 17,241 - 17,241
Merger costs 152,853 - 152,853 152,853 -
Other Expenses 262,641 112,739 149,902 66,080 83,822
------------- ------------- ------------- ------------- -------------
$ 1,769,950 $ 900,965 $ 868,985 $ 247,429 $ 621,556
============= ============= ============= ============= =============
The major fluctuations in non-interest expense indicate an increase in salaries
and employee benefits of $25,000 due to staffing additions at Shelby County Bank
offset by net deferred salary fees and costs related loan growth. Data
processing charges increased at Shelby County Bank on an average of
approximately $5,400 per month during the quarter ended September 30, 2004
compared with the third quarter ended September 30, 2003. This increase is a
result of increased transactional volume. Federal deposit insurance premiums
decreased $25,000 at Shelby County Bank for the period ended September 30, 2004
due to a decrease in Shelby County Bank's FDIC's risk classification. As a
result of the acquisition of Unified Banking Company and the associated purchase
accounting, Unified Banking Company has a core deposit intangible. The
amortization expense for this core deposit intangible for the three month period
ended September 30, 2004 was $17,000. Merger costs of $153,000 associated with
the proposed merger with Heartland Bancshares, Inc. as discussed in Note 7 were
incurred on the Blue River level during the third quarter of 2004. Other
expenses at Shelby County Bank and Blue River increased $66,000 from the period
ended September 30, 2003. The majority of this increase, $52,000 is related
third party loan costs associated with the growth of the loan portfolio.
- 20 -
RESULTS OF OPERATIONS: Nine Months Ended September 30, 2004
During the nine month period ended September 30, 2004, the Company's net income
was $78,000 compared to a net loss of ($32,000) reported for the nine month
period ended September 30, 2003. The income tax expense/ benefit was $0 for the
nine month period ended September 30, 2004 and for the nine month period ended
September 30, 2003. In December 2002, the Company recognized a valuation
allowance of $760,000 pertaining to the recoverability of its deferred tax
assets. Management concluded that it was more likely than not that a portion of
the benefit associated with the deferred tax asset would not be realized, and no
further tax benefit was recorded in 2003. The Company recorded a reduction in
its valuation allowance to offset a decline in deferred tax assets, resulting in
no income tax expense for the nine months ended September 30, 2004.
The Company's comparative performance showed an increase in net interest income
before provision for loan losses of $2,171,000, an increase in the provision for
loan losses of $190,000, an increase in non-interest income of $297,000, and an
increase in non-interest expenses of $2,169,000.
The increase in net interest income before provision for loan losses resulted
from an increase in interest income of $3,316,000, offset by an increase in
interest expense of $1,145,000. The increase in interest income was primarily
due to the acquisition of Unified Banking Company which accounts for $2,705,000
of this increase. Loan growth at Shelby County Bank represents $700,000 of the
total increase offset by decreases in the investment portfolio and
interest-bearing deposits of $83,000 as a result of decreased volume and by a
decrease in interest bearing and FHLB dividends of $6,000. Of the increase in
interest expense of $1,145,000, the major variance of $878,000 can be attributed
to Unified Banking Company. An increase in interest expense of $267,000, due to
increases in certificates of deposits and borrowings offset by declining
interest rates can be attributed to Shelby County Bank.
Interest income and fees from loans increased from $3,075,000 for the nine month
period ended September 30, 2003 to $6,100,000 for the nine month period ended
September 30, 2004. This increase was comprised of a favorable variance of
$3,533,000 due to higher average loan balances of $85,693,000 of which
$61,617,000 can be attributed to the acquisition Unified Banking Company and an
unfavorable variance of ($508,000) due to a decrease of 141 basis points in the
effective yield on loans. The reduction in yield was largely due to increased
balances in variable rate products, as well as lower yields on new loans
originated during a period of low interest rates. The overall yield on loans
fell to 5.66% for the nine month period ended September 30, 2004 from 7.07% for
the nine month period ended September 30, 2003.
Interest income from investment securities increased $285,000 to $1,142,000 for
the nine months ended September 30, 2004, when compared to the nine month period
ended September 30, 2003. This increase resulted from a favorable variance of
$294,000 from an increase in average investment balances of $11,003,000, of
which $14,098,000 can be attributed to Unified Banking Company and a decrease in
the average investment balances at Shelby County Bank and Blue River of
$3,095,000 offset by an unfavorable variance of $9,000 due to investment yields
being 3 basis points lower. The rate variance was the result of decreasing
interest rates, a high rate of turnover due to increased prepayments on
mortgage-backed securities, and incremental portfolio growth and replacement of
portfolio runoff with lower rate bonds. In order to improve interest rate
sensitivity, liquidity and capital during the nine month period ended September
30, 2004, Unified Banking Company sold $14,726,000 of its available-for-sale
U.S. government agency securities. These were replaced in part with $12,861,000
in available-for-sale U.S. government agency GNMA securities, and a U.S.
Treasury Bill as these receive favorable risk-based capital treatment.
Additionally, at Unified Banking Company there were payment reductions in the
mortgage backed securities of $3,413,000, and a maturity of a U.S. government
Treasury Bill of $3,500,000. Shelby County Bank sold $4,848,000 of its
available-for-sale U.S. government agency and corporate securities. During the
nine month period ended September 30, 2004, there were also principal payment
reductions in the mortgage backed securities of $2,164,000 and municipal bond
maturities of $250,000. These sales and maturities were offset in part with a
purchase of a $1,032,000 U.S. government agency GNMA security as this type of
security receives a favorable risk-based capital treatment.
- 21 -
Interest expense on deposits increased $845,000 to $2,302,000 for the nine month
period ended September 30, 2004, compared to $1,457,000 for the nine month
period ended September 30, 2003. This increase was comprised of an unfavorable
variance of $1,007,000 due to an increase in average deposit balances of
$70,660,000, of which $56,335,000 can be attributed to Unified Banking Company,
this was offset by a favorable variance of $162,000 due to a decrease in average
rates on deposits from 2.69% to 2.15%. This favorable rate variance was created
by lower certificate rates on new and renewed certificates of deposit, as well
as reduced rates applied to core deposit products such as interest-bearing
checking, savings, and money market accounts. The increase in average deposit
balances is primarily the result of the acquisition of Unified Banking Company.
Additionally, increases in certificates of deposits and brokered certificates of
deposits at Shelby County Bank were used as funding sources and to offset
maturities of high rate promotional certificates of deposits and increased loan
growth.
Interest expense on FHLB advances and other borrowings increased $300,000 from
$260,000 for the nine month period ended September 30, 2003 to $560,000 for the
nine month period ended September 30, 2004. This increase was the result of an
unfavorable variance of $273,000 due to an increase in the average borrowing
balance of $12,020,000, of which $4,000,000 can be attributed to the acquisition
of Unified Banking Company in the fourth quarter of 2003. In order to finance a
portion of this acquisition, the Company borrowed $4,000,000 and incurred
$147,000 in interest expense related to this borrowing during the nine month
period ended September 30, 2004. An additional volume variance of $5,158,000 can
also be attributed to Unified Banking Company. An unfavorable variance of
$27,000 was due to an increase in interest rates from 2.98% to 3.13%.
For the nine month period ended September 30, 2004, the provision for loan
losses was $370,000 compared to $180,000 for the nine month period ended
September 30, 2003. Of the increase, $220,000 is directly related to the
acquisition of Unified Banking Company, offset by a decrease at Shelby County
Bank of $30,000 as a result of decreases in non-performing assets.
Total non-interest income was $876,000 for the nine month period ended September
30, 2004 compared to $579,000 for the nine month period ended September 30,
2003. Of this increase, $442,000 can be attributed to the acquisition of Unified
Banking Company, primarily the result of $256,000 in secondary market mortgage
loan fees, $98,000 in net gains on available-for sale securities, $19,000 from
service charges and fees on deposit accounts and $69,000 from other fees and
gains/losses on other assets. These increases, due to the acquisition of Unified
Banking Company, were offset by a decrease of $145,000 at Shelby County Bank and
Blue River. Service charges and fees on deposit accounts at Shelby County Bank
increased $51,000 for the nine month period ended September 30, 2004 compared to
the nine month period ended September 30, 2003. Shelby County Bank's
non-interest income also reflects an increase of $30,000 in secondary market
mortgage loan fees for the period ended September 30, 2004. These increases were
offset by a decrease of $206,000 in net gains on available-for-sale securities
at Shelby County Bank as Shelby County Bank sold $9,480,000 of its
available-for-sale investments and recognized a gain of $229,000 from these
sales during the nine month period ended September 30, 2003. There was also a
net decrease of $20,000 in other fees and gains/losses on other assets during
the nine month period ended September 30, 2004 when compared to the nine month
period ended September 30, 2003.
Non-interest expenses totaled $4,942,000 for the nine month period ended
September 30, 2004, compared to $2,774,000 during the nine month period ended
September 30, 2003. Of the increase of $2,168,000, $1,873,000 can be attributed
to Unified Banking Company and $295,000 to Shelby County Bank and Blue River, of
which $153,000 can be attributed to the proposed merger with Heartland
Bancshares, Inc.
- 22 -
Changes in non-interest expense consist of the following:
NINE MONTHS ENDED SHELBY COUNTY UNIFIED
SEPTEMBER 30 BANK BANKING
----------------------------- CHANGE FROM & BLUE RIVER COMPANY
2004 2003 2003 DOLLAR CHANGE DOLLAR CHANGE
------------- -------------
Salaries and employee benefits $ 2,047,359 $ 1,190,924 $ 856,435 $ (59,205) $ 915,640
Occupancy 646,365 $ 348,008 298,357 11,332 $ 287,025
Federal deposit insurance 37,689 112,567 (74,878) (82,296) 7,418
Data Processing 446,587 333,705 112,882 7,233 105,649
Advertising and promotion 78,502 30,174 48,328 1,710 46,618
Bank fees and charges 76,012 40,079 35,933 9,024 26,909
Director Fees 174,650 100,350 74,300 (1,200) 75,500
Professional Fees 335,105 258,527 76,578 (11,282) 87,860
Stationery, supplies and printing 103,667 39,308 64,359 44,293 20,066
Core deposit intangible 52,267 - 52,267 - 52,267
Merger costs 152,853 - 152,853 152,853 -
Other Expenses 790,510 319,869 470,641 222,869 247,772
------------- ------------- ------------- ------------- -------------
$ 4,941,566 $ 2,773,511 $ 2,168,055 $ 295,331 $ 1,872,724
============= ============= ============= ============= =============
The major fluctuations in non-interest expense at Shelby County Bank and Blue
River indicate a decrease in salaries and employee benefits of $59,000 due to
net deferred salary fees and costs related loan growth offset by staff
additions. Costs associated with stationery, supplies and printing at Shelby
County Bank and Blue River increased by $44,000 for the nine month period ended
September 30, 2004 compared to the nine month period ended September 30, 2003.
Shelby County Bank and Blue River incurred additional costs associated with
printing of the annual report and proxy statement and these costs were expensed
during the second quarter of 2004. Federal deposit insurance premiums decreased
$82,000 for the nine month period ended September 30, 2004 at Shelby County
Bank. This decrease is the result of a positive FDIC risk classification change
at Shelby County Bank. As a result of the acquisition of Unified Banking Company
and the associated purchase accounting, Unified Banking Company has a core
deposit intangible. The amortization expense for this core deposit intangible
for the nine month period ended September 30, 2004 was $52,000. Merger costs of
$153,000 associated with the proposed merger with Heartland Bancshares, Inc. as
discussed in Note 7 were incurred by Blue River during the third quarter of
2004. Other expenses at Shelby County Bank and Blue River have increased by
$223,000 for the period ended September 30, 2004 compared to the nine month
period ended September 30, 2003. Of the increase at Shelby County Bank, $159,000
is due to related third party loan costs associated with the growth of the loan
portfolio and is offset by the decrease in salaries relating to net deferred
fees and costs for the same period. The additional increase of $63,000 at Shelby
County Bank for the nine month period ended September 30, 2004 is reflective of
net increases in various other expenses and primarily represents an increase of
$14,000 in insurance expenses due to increased premiums and increases of $6,000
relating to expenses of other real estate and repossessed assets.
CAPITAL RESOURCES AND LIQUIDITY
The Banks are subject to various 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
financial statements. The Board of Directors of the Company has set as an
objective to maintain capital levels required for qualification as
"well-capitalized". The capital ratios of the Banks have been diminished due to
two primary factors: accumulated operating losses and the disallowance of the
Bank's deferred tax assets in determining regulatory capital ratios.
Capital amounts and classification are also subject to qualitative judgments by
regulators involving capital components, risk weights and other factors. The
risk weights assigned to various financial instruments are taken into
consideration in setting operating parameters related to the mix of loans and
investments with the objective to maximize earnings attained through the use of
available equity capital.
- 23 -
Current capital regulations require savings institutions to have minimum
tangible capital equal to 1.5% of total assets and a core capital ratio equal to
3.0% of total assets. Additionally, savings institutions are required to meet a
risk based capital ratio equal to 8.0% for risk-weighted assets. At September
30, 2004, the Banks satisfied all capital requirements. Shelby County Bank's
capital ratios have improved due to the private placements of the Company's
common stock during the third quarter of 2002 and the first quarter of 2003 and
the Company's rights offering in the fourth quarter of 2003. The Banks will
continue to monitor closely their risk-weighted assets and risk-based capital to
maximize returns while striving to maintain the "well-capitalized" designation.
The following table sets forth the actual and minimum capital amounts to be
adequately capitalized and ratios of Shelby County Bank as of September 30,
2004:
For Capital Adequacy Purposes:
SHELBY COUNTY BANK
TOTAL
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
(DOLLARS IN THOUSANDS)
Bank Amount $ 7,639 $ 7,639 $ 8,714
Required Amount 1,838 3,677 6,883
------------- ------------- -------------
Excess $ 5,801 $ 3,962 $ 1,831
============= ============= =============
Bank Ratio 6.23% 6.23% 10.13%
Required Ratio 1.50% 3.00% 8.00%
------------- ------------- -------------
Ratio Excess 4.73% 3.23% 2.13%
============= ============= =============
The following table sets forth the actual and minimum capital amounts to be
adequately capitalized and ratios of Unified Banking Company as of September 30,
2004:
For Capital Adequacy Purposes:
UNIFIED BANKING COMPANY
TOTAL
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
(DOLLARS IN THOUSANDS)
Bank Amount $ 6,276 $ 6,276 $ 6,963
Required Amount 1,273 2,546 5,000
------------- ------------- -------------
Excess $ 5,003 $ 3,730 $ 1,963
============= ============= =============
Bank Ratio 7.40% 7.40% 11.14%
Required Ratio 1.50% 3.00% 8.00%
------------- ------------- -------------
Ratio Excess 5.90% 4.40% 3.14%
============= ============= =============
- 24 -
Liquidity measures the Banks' ability to meet its savings withdrawals and
lending commitments. Management believes that the Banks' liquidity is adequate
to meet current requirements. The Banks maintain liquidity of at least 4% of net
withdrawable assets. At September 30, 2004, Shelby County Bank's regulatory
liquidity ratio was 7.89% and Unified Banking Company's regulatory liquidity
ratio was 19.47%.
The Company's liquidity position is the primary source of additional capital for
infusion into its banking subsidiaries. During the nine months ended September
30, 2004, the Banks have significantly increased their use of funds as a result
of increased loan demand and maturities of higher interest rate certificates of
deposit. Due to the Company's current liquidity sources, the private placement
of common stock during the third quarter 2002, a subsequent private placement
which occurred during the first quarter of 2003 and the rights offering and
borrowing related to the acquisition of Unified Banking Company in the fourth
quarter of 2003, the Company does not anticipate the need for any additional
external funding over the next six months.
The primary function of liquidity and interest rate sensitivity management is to
provide for and assure an ongoing flow of funds that is adequate to meet all
current and future financial needs of the Banks. Such financial needs include
funding credit commitments, satisfying deposit withdrawal requests, purchasing
property and equipment and paying operating expenses. The funding sources of
liquidity are principally the maturing assets, payments on loans issued by the
Banks, net deposit growth, and other borrowings. The purpose of liquidity
management is to match sources of funds with anticipated customer borrowings and
withdrawals and other obligations along with ensuring a dependable funding base.
Alternative sources of liquidity include acquiring jumbo certificates resulting
from local government bidding, liquidation of marketable investment securities,
sales and/or securitization of pools of loans, and additional draws against
available credit at the FHLB.
- 25 -
PART I - ITEM 3
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an evaluation
(the "Evaluation"), under the supervision and with the participation of our
Chief Executive Officer ("CEO") and Controller, of the effectiveness of the
design and operation of our disclosure controls and procedures ("Disclosure
Controls"). Based on the Evaluation, our CEO and Controller concluded that,
subject to the limitations noted below, our Disclosure Controls are effective in
timely alerting them to material information required to be included in our
periodic SEC reports.
CHANGES IN INTERNAL CONTROLS
There were no changes in the Company's internal control over financial reporting
that occurred during the quarter ended September 30, 2004 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Our management, including our CEO and Controller, does not expect that our
Disclosure Controls and internal controls will prevent all errors and all fraud.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can only be
reasonable assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
CEO AND CONTROLLER CERTIFICATIONS
Appearing as exhibits to this report there are Certifications of the CEO and
Controller. The Certifications are required in accord with Section 302 of the
Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This Item of this
report, which you are currently reading is the information concerning the
Evaluation referred to in the Section 302 Certifications and this information
should be read in conjunction with the Section 302 Certifications for a more
complete understanding of the topics presented.
- 26 -
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
The exhibits to this Form 10-QSB are listed in the attached
Exhibit Index.
******
- 27 -
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on behalf of the undersigned, thereto duly authorized.
Blue River Bancshares, Inc.
Date: November 15, 2004 By: /s/ Patrice M. Lima
------------------------------------------
Patrice M. Lima, Vice President, Controller
(Principal Financial Officer & Chief
Accounting Officer)
- 28 -
EXHIBIT INDEX
Document Description
Exhibit No.
- -----------
31.1 Certification of Principal Executive Officer pursuant to Rule
15d-14(a) of the 1934 Act.
31.2 Certification of Principal Financial Officer pursuant to Rule
15d-14(a) of the 1934 Act.
32.1 Certification of Principal Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- 29 -