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 June 30, 2005
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 August 15, 2005 there were 3,507,150 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
<Table>
<Caption>
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements:
Consolidated Statements of Financial Condition
(Unaudited) as of June 30, 2005 and December 31, 2004 3
Consolidated Statements of Operations and Comprehensive
Income (Unaudited) for the three months ended
June 30, 2005 and 2004 4
Consolidated Statements of Operations and Comprehensive
Income (Unaudited) for the six months ended
June 30, 2005 and 2004 5
Consolidated Statements of Cash Flows (Unaudited) for the
six months ended June 30, 2005 and 2004 6
Notes to Consolidated Financial Statements (Unaudited) 7-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-24
Item 3. Controls and Procedures 25
PART II. OTHER INFORMATION: 26-27
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
</Table>
PART 1 FINANCIAL STATEMENTS
ITEM 1. FINANCIAL STATEMENTS
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF JUNE 30, 2005 AND DECEMBER 31, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
JUNE 30, DECEMBER 31,
ASSETS 2005 2004
(UNAUDITED)
ASSETS:
Cash and cash equivalents:
Cash and due from banks $ 4,256,969 $ 3,572,243
Interest-bearing deposits 10,125,993 1,542,765
------------- -------------
Total cash and cash equivalents 14,382,962 5,115,008
Securities available for sale 29,528,882 32,361,376
Securities held to maturity 17,935 19,073
Loans receivable, net of allowance for loan losses
of $1,768,449 and $1,919,193 153,382,224 155,508,075
Stock in FHLB, at cost 2,958,900 2,896,400
Deferred income taxes, net 2,638,854 2,650,679
Premises and equipment, net 1,928,711 1,992,349
Other real estate owned 1,040,093 1,415,351
Accrued interest receivable and other assets 1,532,069 1,128,719
Core deposit intangible 344,824 379,306
Goodwill 3,159,051 3,159,051
------------- -------------
TOTAL ASSETS $ 210,914,505 $ 206,625,387
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Interest bearing deposits $ 144,333,559 $ 151,358,006
Non-interest bearing deposits 25,482,274 18,972,486
Fed funds purchased -- 427,000
Advances from FHLB 17,429,483 15,091,393
Note payable 6,000,000 4,000,000
Accrued interest and other liabilities 1,101,360 992,237
------------- -------------
Total liabilities 194,346,676 190,841,122
------------- -------------
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 2,000,000 shares
authorized, none issued -- --
Common stock, no par value, 15,000,000 shares authorized,
3,507,150 and 3,406,150 shares issued and outstanding 25,132,017 24,635,162
Accumulated deficit (8,515,309) (8,782,422)
Accumulated other comprehensive (loss) (48,879) (68,475)
------------- -------------
Total shareholders' equity 16,567,829 15,784,265
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 210,914,505 $ 206,625,387
============= =============
</Table>
See accompanying notes to consolidated financial statements.
-3-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE THREE MONTH PERIODS ENDED JUNE 30, 2005 AND 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
2005 2004
INTEREST INCOME:
Loans receivable $ 2,497,542 $ 2,002,092
Securities 319,332 340,196
Interest-bearing deposits 60,830 11,182
Dividends from FHLB 31,382 27,625
----------- -----------
Total interest income 2,909,086 2,381,095
----------- -----------
INTEREST EXPENSE:
Interest expense on deposits 978,911 808,851
Interest expense on FHLB and other borrowings 224,773 180,990
----------- -----------
Total interest expense 1,203,684 989,841
----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES 1,705,402 1,391,254
PROVISION FOR LOAN LOSSES 52,500 97,500
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,652,902 1,293,754
----------- -----------
NON-INTEREST INCOME:
Service charges and fees 118,422 72,777
Secondary market mortgage fees 146,391 113,848
Gain (loss) on sale of other real estate owned and other assets (76,156) 16,957
Gain on sale of securities -- 7,605
Other 58,103 59,090
----------- -----------
Total non-interest income 246,760 270,277
----------- -----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 944,151 793,394
Premises and equipment 200,839 223,986
Federal deposit insurance 13,162 12,407
Data processing 155,280 148,247
Advertising and promotion 40,156 21,079
Bank fees and charges 27,594 24,972
Directors fees 28,750 59,050
Professional fees 184,835 130,229
Stationery, supplies and printing 28,077 43,284
Merger expense 3,836 --
Core deposit intangible 17,241 18,601
Other 192,362 201,099
----------- -----------
Total non-interest expense 1,836,283 1,676,348
----------- -----------
INCOME BEFORE INCOME TAX 63,379 (112,317)
INCOME TAX EXPENSE (BENEFIT) -- --
----------- -----------
NET INCOME (LOSS) $ 63,379 $ (112,317)
=========== ===========
COMPREHENSIVE INCOME (LOSS) $ 432,001 $ (614,851)
=========== ===========
Basic earnings per share $ 0.02 $ (0.03)
=========== ===========
Diluted earnings per share $ 0.02 $ (0.03)
=========== ===========
</Table>
See accompanying notes to consolidated financial statements.
-4-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 2005 AND 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
2005 2004
INTEREST INCOME:
Loans receivable $ 4,845,384 $ 3,870,313
Securities 654,413 786,954
Interest-bearing deposits 93,222 17,040
Dividends from FHLB 62,500 61,076
----------- -----------
Total interest income 5,655,519 4,735,383
----------- -----------
INTEREST EXPENSE:
Interest expense on deposits 1,893,671 1,435,045
Interest expense on FHLB and other borrowings 401,324 369,564
----------- -----------
Total interest expense 2,294,995 1,804,609
----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES 3,360,524 2,930,774
PROVISION FOR LOAN LOSSES 105,000 195,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,255,524 2,735,774
----------- -----------
NON-INTEREST INCOME:
Service charges and fees 219,448 149,721
Secondary market mortgage fees 271,719 176,965
Gain (loss) on the sale of other real estate owned and other assets (69,280) 149,496
Gain on sale of securities -- 105,167
Other 88,938 10,392
----------- -----------
Total non-interest income 510,825 591,741
----------- -----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,780,024 1,520,802
Premises and equipment 389,359 431,118
Federal deposit insurance 29,404 24,919
Data processing 310,066 298,892
Advertising and promotion 80,690 38,876
Bank fees and charges 53,417 48,632
Directors fees 82,600 117,500
Professional fees 278,805 242,789
Stationery, supplies and printing 55,467 74,265
Merger expense 73,171 --
Core deposit intangible 34,482 35,026
Other 331,751 421,170
----------- -----------
Total non-interest expense 3,499,236 3,253,989
----------- -----------
INCOME BEFORE INCOME TAX 267,113 73,526
INCOME TAX EXPENSE (BENEFIT) -- --
----------- -----------
NET INCOME $ 267,113 $ 73,526
=========== ===========
COMPREHENSIVE INCOME (LOSS) $ 286,709 $ (262,995)
=========== ===========
Basic earnings per share $ 0.08 $ 0.02
=========== ===========
Diluted earnings per share $ 0.08 $ 0.02
=========== ===========
</Table>
See accompanying notes to consolidated financial statements.
-5-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 2005 AND 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
2005 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 267,113 $ 73,526
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and purchase accounting amortization 77,897 782,070
Net amortization (accretion) of securities 19,932 205,468
Provision for loan losses 105,000 195,000
FHLB stock dividends (62,500) (69,200)
(Gain) on sale of securities available for sale -- (105,167)
(Gain) loss on sale of other real estate owned 51,045 (35,849)
Changes in assets and liabilities:
Accrued interest receivable 91,581 99,640
Other assets (494,463) 518,920
Accrued interest payable and other liabilities 109,122 (62,159)
------------ ------------
Net cash from operating activities 164,727 1,602,249
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan funded, net of collections 1,761,745 (22,846,154)
Maturities and paydowns of securities available for sale 2,843,983 7,624,573
Maturities and paydowns of securities held to maturity 1,138 110,354
Proceeds from sales of securities available-for-sale -- 11,137,667
Purchases of securities available-for-sale -- (6,453,242)
Purchase of premises and equipment (62,335) (52,647)
Proceeds from sale of real estate owned 398,713 469,280
------------ ------------
Net cash from investing activities 4,943,244 (10,010,169)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock, net of offering costs of $8,145 496,855 --
Additional offering costs from proceeds of rights offering -- (26,331)
Proceeds from note payable 2,000,000 --
Net change in fed funds purchased (427,000) --
Repayment of FHLB advances (12,222,553) (61,265,321)
Proceeds from FHLB advances 14,569,409 68,813,000
Net (decrease) in deposits (256,728) (2,120,849)
------------ ------------
Net cash from financing activities 4,159,983 5,400,499
------------ ------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 9,267,954 (3,007,421)
CASH AND EQUIVALENTS, Beginning of period 5,115,008 7,802,303
------------ ------------
CASH AND EQUIVALENTS, End of period $ 14,382,962 $ 4,794,882
============ ============
</Table>
See accompanying notes to consolidated financial statements.
-6-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
AS OF AND FOR THE PERIODS ENDED JUNE 30, 2005 AND 2004
- --------------------------------------------------------------------------------
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 Paramount Bank (formally known as
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, 2004 Annual Report to Shareholders.
The accompanying consolidated interim financial statements at June 30,
2005, and for the three and six months ended June 30, 2005 and 2004 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
Paramount Bank'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.
3. RESTATEMENT OF DEFERRED LOAN COSTS AND FEES ON HOME EQUITY LOANS
During the 2004 year end audit of the financial statements, it was
determined that the Company was incorrectly accounting for deferred
loan fees and costs on home equity loans. This resulted in a $178,000
reduction in 2004 net income. Subsequently, the Company determined that
it needed to restate its 2004 quarterly financials to reflect the
$178,000 reduction in net income to properly document the full effect
of the accounting error on each of the quarters in 2004. The Company
has determined that the earnings reported during 2004 will be reduced
by $41,000 for the first quarter, $55,000 for the second quarter and
$52,000 for the third quarter. This information is provided in detail
in the following tables for the three months ended March 31, 2004, June
30, 2004 and September 30, 2004 and for the six months ended June 30,
2004 and for the nine months ended September 30, 2004.
-7-
<Table>
<Caption>
THREE MONTHS ENDED THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2004 JUNE 30, 2004 SEPTEMBER 30, 2004
-----------------------------------------------------------------------------------------------
AS PREVIOUSLY AS PREVIOUSLY AS AS PREVIOUSLY
REPORTED AS RESTATED REPORTED RESTATED REPORTED AS RESTATED
------------- ----------- ------------- ----------- ------------- -----------
Net Income (Loss) $ 227,025 $ 185,843 $ (56,877) $ (112,317) $ (92,206) $ (144,119)
Interest Income 2,358,966 2,354,288 2,390,671 2,381,095 2,625,497 2,609,620
Net Interest Income before
the Provision for Loan Losses 1,544,198 1,539,520 1,400,830 1,391,254 1,568,092 1,552,215
Non Interest Expense 1,541,137 1,577,641 1,630,484 1,676,348 1,769,950 1,805,986
Basic earnings (loss) per share 0.07 0.05 (0.02) (0.03) (0.03) (0.04)
Diluted earnings (loss) per share 0.07 0.05 (0.02) (0.03) (0.03) (0.04)
</Table>
<Table>
<Caption>
SIX MONTHS ENDED NINE MONTHS ENDED
JUNE 30, 2004 SEPTEMBER 30, 2004
------------------------------------------------------------
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
Net Income (Loss) $ 170,148 $ 73,526 $ 77,943 $ (70,593)
Interest Income 4,749,637 4,735,383 7,375,132 7,345,001
Net Interest Income before
the Provision for Loan Losses 2,945,028 2,930,774 4,513,115 4,482,984
Non Interest Expense 3,171,621 3,253,989 4,941,566 5,059,971
Basic earnings (loss) per share 0.05 0.02 0.02 (0.02)
Diluted earnings (loss) per share 0.05 0.02 0.02 (0.02)
</Table>
4. COMMON SHARE INFORMATION
Earnings per share of common stock is based on the weighted average
number of basic shares and dilutive shares outstanding.
The following is a reconciliation of the weighted average common shares
for the basic and diluted earnings per share computations:
<Table>
<Caption>
FOR THE THREE MONTHS ENDED
JUNE 30,
---------------------------
2005 2004
Basic earnings per share:
Weighted average common shares 3,468,304 3,406,150
========= =========
Diluted earnings per share:
Weighted average common shares 3,468,304 3,406,150
Dilutive effect of stock options 681 --
--------- ---------
Weighted average common shares and incremental shares 3,468,985 3,406,150
========= =========
</Table>
-8-
<Table>
<Caption>
FOR THE SIX MONTHS ENDED
JUNE 30,
-------------------------
2005 2004
Basic earnings per share:
Weighted average common shares 3,437,399 3,406,150
========= =========
Diluted earnings per share:
Weighted average common shares 3,437,399 3,406,150
Dilutive effect of stock options 891 34,199
--------- ---------
Weighted average common shares and incremental shares 3,438,290 3,440,349
========= =========
</Table>
For the three month and six month periods ended June 30, 2005, and the
six month period ended June 30, 2004, 163,850, and 122,350 stock
options were not considered in the calculation of the dilutive effect
of stock options as they were anti-dilutive. During the three months
ended June 30, 2004, there were no incremental shares relating to the
dilutive effect of stock options due to a net loss.
5. STOCK BASED COMPENSATION
At June 30, 2005, 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, 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 and earnings 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.
<Table>
<Caption>
FOR THE THREE MONTHS ENDED
JUNE 30,
-----------------------------
2005 2004
Net income (loss):
Net income (loss) as reported $ 63,379 $ (112,317)
Deduct total stock based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects and reversals of
prior period expense due to forfeitures (4,265) (8,175)
----------- -----------
Pro forma, net income (loss) $ 59,114 $ (120,492)
=========== ===========
Net earnings (loss) per share:
Basic earnings (loss) per share $ 0.02 $ (0.03)
Diluted earnings (loss) per share $ 0.02 $ (0.03)
Pro forma earnings (loss) per share:
Basic earnings (loss) per share $ 0.02 $ (0.04)
Diluted earnings (loss) per share $ 0.02 $ (0.04)
</Table>
-9-
<Table>
<Caption>
FOR THE SIX MONTHS ENDED
JUNE 30,
--------------------------
2005 2004
Net income:
Net income as reported $ 267,113 $ 73,526
Deduct total stock based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects 19,441 (16,350)
----------- -----------
Pro forma, net income $ 286,554 $ 57,176
=========== ===========
Net earnings per share:
Basic earnings per share $ 0.08 $ 0.02
Diluted earnings per share $ 0.08 $ 0.02
Pro forma earnings per share:
Basic earnings per share $ 0.08 $ 0.02
Diluted earnings per share $ 0.08 $ 0.02
</Table>
6. INCOME TAXES
The Company maintains a valuation allowance against a portion of the
deferred tax assets because management believes it is more likely than
not that a portion of the benefit associated with the deferred tax
asset will not be realized. During 2005 and 2004, management's estimate
of the deferred tax asset realization did not change significantly and
the Company recorded changes in its valuation allowance to offset
changes in the deferred tax assets, resulting in no income tax expense
for 2005 or 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 2024.
7. NEW ACCOUNTING PRONOUNCEMENTS BUT NOT YET EFFECTIVE
FAS 123, Revised, requires all public companies to record compensation
cost for stock options provided to employees in return for employee
service. The cost is measured at the fair value of the options when
granted, and this cost is expensed over the employee service period,
which is normally the vesting period of the options. This will apply to
awards granted or modified after the first quarter or year beginning
after December 15, 2005. Compensation cost will also be recorded for
prior option grants that vest after the date of adoption. The effect on
results of operations will depend on the level of future option grants
and the calculation of the fair value of the options granted at such
future date, as well as the vesting periods provided, and cannot
currently be predicted. Existing options that will vest after adoption
date are expected to result in additional compensation expense of
approximately $27,000 in 2006. There will be no significant effect on
financial position as total equity will not change.
8. PRIVATE PLACEMENT
On April 26, 2005, the Board of Directors of the Company approved the
offer and sale of up to $600,000 worth of its common stock to certain
accredited investors, including, without limitation, the officers and
directors of the Company in a private placement under Section 4(2) of
the Securities Act of 1933 and Rule 506 of Regulation D promulgated
thereunder. On April 29, 2005, the price of $5.00 per share was
determined by the Executive Committee of the Board of Directors of the
Company. Subsequently, the Company sold 101,000 shares of common stock
at a price of $5.00 per share, or $505,000 in gross proceeds. Offerings
costs as of June 30, 2005 are $8,145. The private placement closed on
May 6, 2005.
-10-
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
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. The Company undertakes no duty to
update any forward looking statement to reflect events or circumstances after
the date on which the forward looking statement is made or to reflect the
occurrence of unanticipated events.
COMPANY OVERVIEW
The Company is a holding company for its principal banking subsidiaries, Shelby
County Bank and Paramount Bank. 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 $6,000,000 loan from a commercial bank.
Shelby County Bank is a federally chartered savings bank located in Shelbyville,
Indiana and Paramount Bank 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 their clients with a broad range of services
delivered by experienced professionals concerned with building strong and
long-term relationships.
-11-
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 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, FDIC, the Banks' historical losses or by the
Chief Credit Officer's recommendations and by multiplying such loss percentages
to the Banks' distribution of portfolio balances since management believes this
will be representative of 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.
A valuation allowance reduces deferred tax assets to the amount management
believes is more likely than not to be realized. In evaluating the realization
of deferred tax assets, management considers the likelihood that sufficient
taxable income of appropriate character will be generated within carry forward
periods, including consideration of available tax planning strategies. During
2005 and 2004, management's estimate of deferred tax asset realization did not
change significantly, and the valuation allowance was adjusted to offset the net
change in deferred tax assets during the periods.
MANAGEMENT OVERVIEW
Overview of Financial Condition at June 30, 2005 and December 31, 2004
On a consolidated basis, the Company's total assets as of June 30, 2005 were
$210,915,000 compared to total assets of $206,625,000 at December 31, 2004. As
of June 30, 2005, gross loans were $155,151,000 compared to gross loans of
$157,427,000 at December 31, 2004. Deposits were $169,816,000 at June 30, 2005
compared to $170,330,000 at December 31, 2004. Total capital was $16,568,000 at
June 30, 2005 compared to $15,784,000 at December 31, 2004. Outstanding shares
of common stock were 3,507,150 as of June 30, 2005 and 3,406,150 as of December
31, 2004.
The Company has continued to be asset sensitive, with a large amount of variable
rate loans tied to prime, and the Company is benefiting from the prime rate
increases. During the quarter ended June 30, 2005, the Company raised $505,000
in gross proceeds through the sale of its common stock, borrowed an additional
$2,000,000 from Union Federal Bank of Indianapolis and invested $1,800,000 into
Shelby County Bank. The remaining monies will be held by the Company as
additional working capital. This additional capital will allow Shelby County
Bank to maintain its momentum of growing quality loans and improving net
interest income. During the remainder of 2005, the Company believes loan
balances will continue to increase net interest income, without reducing credit
quality. Management and staff at both Shelby County Bank and Paramount Bank will
continue to work diligently at implementing growth plans and strategies as the
Company expects meaningful results from these actions this year.
-12-
Overview of Results of Operations for the Three Months Ended June 30, 2005 and
2004
For the quarter ended June 30, 2005, the Company's net consolidated income was
$63,000. This compares to a consolidated net loss of $112,000 for the same
period of 2004. Basic earnings per share was $0.02 for the quarter ended June
30, 2005 compared to a loss of $0.03 earnings per share for the quarter ended
June 30, 2004. Weighted average outstanding shares (basic) for the second
quarter of 2005 were 3,468,304 and 3,406,150 the second quarter of 2004. The
Company benefited from amortization of purchase accounting adjustments from the
acquisition of Paramount Bank. For the three month period ended June 30, 2005,
income has been increased $54,000 as a result of net accretion of purchase
accounting adjustments on loans, deposits and borrowings. However, this benefit
will be decreasing in the future.
Net interest income before the provision for loan losses for the three months
ended June 30, 2005 increased approximately 22.5% from the period ended June 30,
2004. This increase can be attributed to a rising interest rate environment with
the prime lending rate increasing from 4.00% to 6.00%. The Banks will continue
to benefit from the increases in the prime interest rate as a large amount of
the loan portfolio has variable rates. Another factor contributing to the
increase was increased loan growth at Shelby County Bank during 2004.
Overall non-interest income decreased 9.5% for the three month period ended June
30, 2005 compared to the three month period ended June 30, 2004. Primarily this
reduction was comprised of net losses on the sale of other real estate and other
assets. This decrease was partially offset by increases in secondary market
mortgage loan fees and in service charges and fees on deposit accounts.
Non-interest expense increased 9.5% for the three months ended June 30, 2005
compared to the same period of 2004. This increase was primarily due to
additional professional expenses incurred in the second quarter of 2005 related
to the costs to manage and reduce real estate owned and pursue litigation on
past due loans. The Company reduced this non-earning asset category by $288,000
during the second quarter of 2005 and expects to further reduce this category by
approximately $550,000 during the third quarter of 2005. Salaries and benefits
have increased for the three months ended June 30, 2005 compared to the same
period of 2004 due to staffing additions at both Shelby County Bank and
Paramount Bank, and the inclusion of salary expense for the Chief Executive
Officer of the Company and for the Chairman of the Board of Directors of Shelby
County Bank. These salary increases were accompanied by a reduction in director
fees for these two individuals over the periods. Paramount Bank incurred
increased expenses in advertising and promotion for the three months ended June
30, 2005 compared to the three months ended June 30, 2004. These additional
costs were the result of increased efforts to promote and advertise the Bank in
its local market area. In the fourth quarter of 2004, the Banks formally
negotiated enhanced, more cost effective insurance contracts. This benefit
reduced other non-interest expense.
-13-
Overview of Results of Operations for the Six Months Ended June 30, 2005 and
2004
For the six month period ended June 30, 2005, the Company's net consolidated
income was $267,000. This compares to a net consolidated income of $74,000 for
the same period of 2004. Basic earnings per share were $0.08 for the six months
ended June 30, 2005 compared to $0.02 per share for the six months ended June
30, 2004. Weighted average outstanding shares (basic) for the first half of 2005
were 3,437,399 compared to 3,406,150 for the first half of 2004. The Company
benefited from amortization of purchase accounting adjustments from the
acquisition of Paramount Bank. For the six month period ended June 30, 2005,
income has been increased $141,000 as a result of net accretion of purchase
accounting adjustments on loans, deposits and borrowings. However, this benefit
will be decreasing in the future quarters as it declined from $87,000 for the
period ended March 31, 2005 to $54,000 for the period ended June 30, 2005.
Net interest income before loan loss provision for the six months ended June 30,
2005 was $3,361,000 as compared to $2,931,000 for the same period in 2004, or a
14.7% increase. The increase in net interest income for the six month period
ending June 30, 2005, when compared to the same period of 2004 can be attributed
to a rising interest rate environment with the prime lending rate increasing
from 4.00% to 6.00%. The Banks will continue to benefit from the increases in
the prime interest rate as a large amount of the loan portfolio has variable
rates.
Non-interest income for the six months ended June 30, 2005 was $511,000 as
compared to $592,000 for the same period in 2004, or a 16% decrease comprised
primarily of decreases on gains of securities available-for-sale, losses on
sales of other real estate owned and other assets, partially offset by increases
in secondary market mortgage loan fees and service charges on deposit accounts.
Non-interest expense increased to $3,499,000 for the six months ended June 30,
2005 from $3,254,000 for the same period of 2004. This increase was primarily
due to additional professional expenses incurred in 2005 related to the costs to
manage and reduce real estate owned and pursue litigation on past due loans. The
Company reduced this non-earning asset category by $375,000 since December 31,
2004 and expects to further reduce this category during the remainder of 2005.
Salaries and benefits have increased for the six months ended June 30, 2005
compared to the same period of 2004 due to staffing additions at both Shelby
County Bank and Paramount Bank, and the inclusion of salary expense for the
Chief Executive Officer of the Company and for the Chairman of the Board of
Directors of Shelby County Bank during the second quarter of 2005. These salary
increases were accompanied by a reduction in director fees for these two
individuals over the periods. Paramount Bank incurred increased expenses in
advertising and promotion for the six months ended June 30, 2005 compared to the
six months ended June 30, 2004. These additional costs were the result of
increased efforts to promote and advertise the bank in its local market area. In
the fourth quarter of 2004, the Banks formally negotiated enhanced, more cost
effective insurance contracts. This benefit to reduced other non-interest
expense.
-14-
FINANCIAL CONDITION
The Company's total assets at June 30, 2005 were $210,915,000, an increase of
$4,290,000 from December 31, 2004. Primarily the change consists of an increase
in cash and cash equivalents of $9,268,000, offset by a decrease in securities
available-for-sale of $2,832,000, a decrease in net loans of $2,126,000 and a
decrease in other real estate owned of $375,000. During 2005, Shelby County Bank
continues to focus its efforts on maintaining its "well capitalized" status,
therefore loan growth has slowed. However, the Banks do foresee the loan
balances growing during the remainder of this year. During the quarter ended
June 30, 2005 the Company raised $505,000 in gross proceeds through the sale of
its common stock and borrowed an additional $2,000,000 from Union Federal Bank
of Indianapolis. The Company then invested $1,800,000 into Shelby County Bank.
The remaining monies will be held by the Company as additional working capital.
During 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 continue 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. With the additional capital, Shelby County Bank will
be able to resume and maintain its momentum of growing quality loans and
improving net interest income.
The investment portfolio balances have decreased to $29,547,000 at June 30, 2005
from $32,380,000 at December 31, 2004. There was a $1,000,000 call of a U.S.
Agency available-for-sale security which contributed to the decline in
investments. Additional decreases in the investments were due to average
repayments of approximately $310,000 per month on the
mortgage-backed-securities. These decreases were offset by an increase in the
market value of securities available-for-sale of $31,000. The call and
repayments were replaced by liquid funds to help improve "well capitalized"
ratios. In the future the Banks will continue 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 $8,583,000 to
$10,126,000 from $1,543,000 at December 31, 2004. The large amount of
interest-bearing deposits within other banks is primarily the result of one
large account at Paramount Bank which has significant volatility in the amount
of overnight deposits which they maintain. The Company's liquidity position is
the primary source of additional capital for infusion into its banking
subsidiaries. During the year ended December 31, 2004, the Banks had
significantly increased their use of borrowed funds as a result of increased
loan demand and maturities of higher interest rate certificates of deposit. Due
to the Company's liquidity needs, the Company borrowed an additional $2,000,000
in external funding in order to resume loan growth at Shelby County Bank. In
addition, a private placement was authorized by the Board of Directors in April
2005 and completed in May 2005 in order to increase the Company's capital. The
private placement raised gross proceeds of $505,000 of capital, the offering
costs were $8,145.
The Banks' net loans decreased $2,216,000 from December 31, 2004 to $153,382,000
at June 30, 2005. During the six month period ended June 30, 2005, Shelby County
Bank slowed loan growth to maintain their "well capitalized" status. However, as
a result of the additional capital, future growth is expected to accelerate in
the commercial lending market as well as in the home equity market. These loan
products provide the opportunity for increased profitability and continued
improvement in interest rate sensitivity while maintaining the Banks' "well
capitalized" status.
-15-
LOANS RECEIVABLE
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2005 2004
Real Estate Mortgage Loans:
One-to-four family $ 43,391,430 $ 44,643,438
Non Residential 35,723,095 32,578,619
Home equity loans 35,473,850 33,852,662
Consumer loans 8,491,776 9,076,135
Commercial loans, including participations 32,070,522 37,276,414
------------- -------------
Total gross loans 155,150,673 157,427,268
Less allowance for loan losses (1,768,449) (1,919,193)
------------- -------------
Total loans receivable, net $ 153,382,224 $ 155,508,075
============= =============
</Table>
NON-PERFORM ING LOANS
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2005 2004
Non-performing loans consist of the following:
Non-accrual loans $1,595,540 $ 462,473
Ninety (90) days past due 1,018,108 1,445,792
---------- ----------
Total non-performing loans $2,613,648 $1,908,265
========== ==========
Non-performing loans to total loans 1.68% 1.21%
</Table>
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 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 June 30, 2005, the Banks reported
approximately $1,596,000 of non-accrual loans and $1,018,000 in loans ninety
days or more past due. This is an increase in non-accrual loans of $1,133,000
from December 31, 2004 and a decrease in past due loans of $428,000 from
December 31, 2004. The increase in non-accrual loans was the result of moving a
$234,000 ninety day past due loan to non-accrual status and the addition of
several loans of $1,069,000 placed on non-accrual status at Paramount Bank.
These increases were offset by a decrease in non-accrual loans which were
removed from non-accrual, partially charged off and moved to other real estate.
The primary reason for the decrease in past due loans ninety days or more was
the result of moving the one loan of $234,000 from this category to the
non-accrual category. In addition, there were other loans that were removed from
ninety days past due as a result of renewals and payoffs. There is an increase
in the non-performing loans to total gross loans from 1.21% at December 31, 2004
to 1.68% at June 30, 2005. The Banks maintain a reserve for loan losses to cover
losses incurred when loans default. Loans in all categories are charged-off when
they are deemed uncollectible.
Activity in the allowance for loan losses consists of the following:
-16-
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
-----------------------------
2005 2004
Balance, beginning of period $ 1,919,193 $ 1,681,005
Add:
Provision for loan losses 105,000 195,000
Recoveries of loans previously charged off 26,449 4,849
Less gross charge-offs:
Residential real estate loans (17,773) (90,619)
Consumer/commercial loans (264,420) (203,964)
----------- -----------
Balance, end of period $ 1,768,449 $ 1,586,271
=========== ===========
Net charge-offs to total average loans outstanding (annualized) 0.32% 0.42%
Allowance to total average loans outstanding 1.11% 1.14%
</Table>
Allowance for loan losses at June 30, 2005 was $1,768,000, an increase of
$182,000 from December 31, 2004. The Company's provision for loan losses for the
year was $105,000 and its net charge-offs were approximately $256,000. 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 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, FDIC, the Banks' historical losses or by the Chief Credit Officer's
recommendations and by multiplying such loss percentages to the Banks'
distribution of portfolio balances since management believes this will be
representative of 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 decrease in the
allowance was primarily due to the charge off of loans that had been previously
allocated in the allowance and management's analysis of the allowance in
determining the necessity for a monthly provision. The net charge offs for the
period six month ended June 30, 2005 compared to the period ended June 30, 2004
have decreased by $34,000. Shelby County Bank decreased its net charge offs by
$93,000 while Paramount Bank increased its net charge offs by $59,000.
Residential real estate loan charge-offs for the period were $18,000 primarily
one loan at Shelby County Bank. Consumer and commercial loan charge-offs
consisted primarily of four loans at Paramount Bank. There were recoveries of
seven loans previously charged off of $26,000. The allowance to total average
loans outstanding decreased to 1.11% for the six month period ended June 30,
2005 compared to the six month period ended June 30, 2004. For the six month
period ended June 30, 2005, the allowance to total average loans outstanding
decreased 20 basis points from 1.31% at December 31, 2004.
Total liabilities at June 30, 2005 were $194,347,000, an increase of $3,506,000
compared to $190,841,000 at December 31, 2004. Deposits at June 30, 2005 were
$169,816,000 compared to $170,330,000 at December 31, 2004, a decrease of
$514,000. Accordingly, other borrowings have increased by $1,911,000 to
$17,429,000 at June 30, 2005 from $15,518,000 at December 31, 2004. The note
payable increased $2,000,000 to $6,000,000 at June 30, 2005 from $4,000,000 at
December 31, 2004. The additional borrowing was completed during the quarter
ended June 30, 2005 and subsequently $1,800,000 was invested at Shelby County
Bank to improve its regulatory capital ratios. Management continues 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
-17-
relationship with its customer base. By acquiring primarily transaction
accounts, the Banks are less susceptible to loss of accounts during periods of
volatile interest rates.
Shareholders' equity at June 30, 2005 was $16,568,000, an increase of $784,000
compared to $15,784,000 at December 31, 2004. The change in equity resulted from
net income of $267,000, additional capital of $505,000 net of offering costs of
$8,100 as a result of the private placement and an increase of $20,000 from an
improvement in the fair value of the Company's available-for-sale investment
portfolio.
RESULTS OF OPERATIONS: Three Months Ended June 30, 2005
During the three month period ended June 30, 2005, the Company's net income was
$63,000 compared to a net loss of $112,000 reported for the three month period
ended June 30, 2004. There was no income tax expense for the three month period
ended June 30, 2005 and for the three month period ended June 30, 2004. The
Company maintains a valuation allowance on a portion of its deferred tax assets.
During 2005 and 2004, management's estimate of the deferred tax asset
realization did not change significantly and the Company recorded changes in its
valuation allowance to offset a change in the deferred tax assets, resulting in
no income tax expense for 2005 or 2004.
The Company's comparative performance showed an increase in net interest income
before provision for loan losses of $314,000, a decrease in the provision for
loan losses of $45,000, a decrease in non-interest income of $24,000, and an
increase in non-interest expenses of $160,000.
The increase in net interest income before provision for loan losses resulted
from an increase in interest income of $528,000, offset by an increase in
interest expense of $214,000. The increase in loan interest income was primarily
due to loan growth in 2004 and prime interest rate increases in the latter half
of 2004 and in 2005. Increases of $53,000 in interest income on interest bearing
deposits and dividends from FHLB were primarily the effect of interest rate
increases. These increases were offset by decreases of $21,000 in the investment
interest income as a result of decreased volume. The major variance in interest
expense is $170,000 and is attributed to both increases in rates and volume of
primarily certificates of deposit. Additionally, interest expense on borrowings
increased $44,000 and was primarily the result of an increase in the interest
rates of those borrowings.
Interest income and fees from loans increased from $2,002,000 for the three
month period ended June 30, 2004 to $2,498,000 for the three month period ended
June 30, 2005. This increase was comprised of a favorable variance of $180,000
due to higher average loan balances of $12,317,000, and a favorable variance of
$316,000 due to an increase of 77 basis points in the effective yield on loans.
The increase in yield was largely due to increases in the prime interest rate,
increased balances in variable rate products, as well as higher yields on new
loans originated during the period. The overall yield on loans increased to
6.36% for the three month period ended June 30, 2005 from 5.59% for the three
month period ended June 30, 2004.
Interest income from investment securities decreased $21,000 to $319,000 for the
three months ended June 30, 2005, when compared to the three month period ended
June 30, 2004. This decrease resulted from an unfavorable variance of $56,000
from a decrease in average investment balances of $5,400,000. These decreases
were due to maturities, repayments of mortgage-backed-securities and sales
occurring in 2004 and were the result of efforts to improve interest rate
sensitivity, risk-based capital, manage liquidity and concentrate on loan
growth. The unfavorable variance due to volume was offset by an increased
variance of $35,000 due to investment yields being 42 basis points higher over
the prior period ended June 30, 2004. During the three month period ended June
30, 2005, there were principal payment reductions in the
mortgage-backed-securities of $967,000. The Banks will continue to invest
primarily in agency securities and mortgage-backed securities. Both of these
investment products receive favorable risk-based capital treatment.
Interest expense on deposits increased $170,000 to $979,000 for the three month
period ended June 30, 2005, compared to $809,000 for the three month period
ended June 30, 2004. This increase was comprised of an unfavorable variance of
$32,000 due to an increase in average deposit balances of $3,200,000 primarily
in
-18-
certificates of deposit, and an unfavorable variance of $138,000 due to an
increase in average rates on deposits from 2.27% to 2.69%. This unfavorable rate
variance was created by higher certificate rates on new certificates of deposit,
as well as increased rates applied to core deposit products such as savings and
money market accounts. Additionally, increases in certificates of deposit,
specifically at Shelby County Bank were used as funding sources to offset
maturities of high rate promotional certificates of deposits.
Interest expense on FHLB advances and other borrowings increased $44,000 from
$181,000 for the three-month period ended June 30, 2004 to $225,000 for the
three month period ended June 30, 2005. This increase was the result of an
unfavorable variance of $4,000 due to an increase in the average borrowing
balance of $458,000 and an unfavorable variance of $40,000 due to an increase in
interest rates from 3.19% to 3.89%.
For the three month period ended June 30, 2005, the provision for loan losses
was $52,500 compared to $97,500 for the three month period ended June 30, 2004.
The decrease of $45,000 is primarily attributed to Shelby County Bank. There was
no provision for loan losses at Shelby County Bank for the three month period
ended June 30, 2005. Management determined by analysis that the Bank's reserve
was provided for adequately. Please refer to the additional information related
to the allowance for loan losses in the financial condition discussion.
Total non-interest income was $247,000 for the three-month period ended June 30,
2005 compared to $270,000 for the three month period ended June 30, 2004. Of
this decrease, $8,000 can be attributed to the result of net gains on securities
available-for-sale occurring during the period ended June 30, 2004. There are
also net decreases in other income and in other income from sales of other
assets of $94,000. Decreases in other income were in part the result of a sale
of a building owned by the Company during the fourth quarter of 2004 and which
resulted in the reduction of $7,000 in rental income for the three months ended
June 30, 2005, compared to the three months ended June 30, 2004. There were also
net losses on sales of other real estate owned and other assets $93,000. This
was primarily the result of a $72,000 loss on the sale of one other real estate
owned. However, this loss on sale was partially offset by an increase in other
income on other real estate owned of $40,000. Offsetting the decreases, there
was an increase of $33,000 in secondary market mortgage loan fees and a $46,000
increase from service charges and fees on deposit accounts.
Non-interest expenses totaled $1,836,000 for the three month period ended June
30, 2005, compared to $1,676,000 during the three month period ended June 30,
2004.
Changes in non-interest expenses consist of the following:
<Table>
<Caption>
CHANGE FROM
THREE MONTHS ENDED 2004
JUNE 30,
-------------------------
2005 2004
Salaries and employee benefits $ 944,151 $ 793,394 $ 150,757
Occupancy 200,839 223,986 (23,147)
Federal deposit insurance 13,162 12,407 755
Data Processing 155,280 148,247 7,033
Advertising and promotion 40,156 21,079 19,077
Bank fees and charges 27,594 24,972 2,622
Director Fees 28,750 59,050 (30,300)
Professional Fees 184,835 130,229 54,606
Stationery, supplies and printing 28,077 43,284 (15,207)
Core deposit intangible 17,241 18,601 (1,360)
Merger costs 3,836 -- 3,836
Other Expenses 192,362 201,099 (8,737)
---------- ---------- ----------
$1,836,283 $1,676,348 $ 159,935
========== ========== ==========
</Table>
-19-
Major fluctuations in non-interest expense include an increase in salaries and
employee benefits of $151,000. This increase is in part due to decreased loan
growth at Shelby County Bank for the period ended June 30, 2005 and the impact
on salary deferred loan fees and costs related to that slowed growth. Other
increases to salaries were the result of additions to staff, salary increases
and the reclassification of both the Chief Executive of the Company's and the
Chairman of the Board at Shelby County Bank's compensation from director fees to
salaries. Advertising and promotion expenses have increased $19,000 from the
three months ended June 30, 2004 to the three months ended June 30, 2005 due to
an increase of $17,000 in these expenses at Paramount Bank associated with
management's attention to promoting and marketing the Bank in its local area.
Professional fees have increased by $55,000 primarily at Paramount Bank as the
Bank has retained legal counsel to pursue litigation regarding past due loans,
these costs are associated with those efforts. Increases in non-interest expense
were offset by occupancy which decreased $23,000 when comparing the two periods.
A primary reason for the reduction was the result of a sale of a property owned
by the Company in the fourth quarter of 2004 and the $4,000 in occupancy costs
associated with maintaining that property during the three months ended June 30,
2004. Other reductions in occupancy were due to fixed assets becoming fully
depreciated during 2004 and the first quarter ended March 31, 2005. Stationary
and supplies decreased $15,000 as there is a concentrated effort at the Banks to
reduce such expenses as they relate to cost containment. Additionally, director
fees have decreased $30,000 for the period ended June 30, 2005 compared to the
period ended June 30, 2004. This is the result of a change in the role of some
directors who previously served on both Blue River Bancshares' Board of
Directors as well as Shelby County Bank's Board of Directors and who currently
only serve at the bank level. Additionally as stated previously, compensation
for the Chief Executive of the Company and the Chairman of the Board of Shelby
County Bank has changed from directors fees to salaries during the second
quarter ended June 30, 2005. These expenses will be increasing in the future
however, as there are current vacancies on both Banks' Board of Directors as
well as the Company's.
RESULTS OF OPERATIONS: Six Months Ended June 30, 2005
During the six month period ended June 30, 2005, the Company's net income was
$267,000 compared to net income of $74,000 reported for the three month period
ended June 30, 2004. There was no income tax expense for the six month period
ended June 30, 2005 and for the six month period ended June 30, 2004. The
Company maintains a valuation allowance on a portion of its deferred tax assets.
During 2005 and 2004, management's estimate of the deferred tax asset
realization did not change significantly and the Company recorded changes in its
valuation allowance to offset a change in the deferred tax assets, resulting in
no income tax expense for 2005 or 2004.
The Company's comparative performance showed an increase in net interest income
before provision for loan losses of $429,000, a decrease in the provision for
loan losses of $90,000, a decrease in non-interest income of $81,000, and an
increase in non-interest expenses of $245,000.
The increase in net interest income before provision for loan losses resulted
from an increase in interest income of $919,000, offset by an increase in
interest expense of $490,000. The increase in loan interest income was primarily
due to loan growth in 2004 and prime interest rate increases in the latter half
of 2004 and in 2005. Increases of $78,000 in interest income on interest bearing
deposits and dividends from FHLB were primarily the effect of interest rate.
These increases were offset by decreases of $133,000 in the investment interest
income primarily the result of decreased volume. The total variance in interest
expense of $490,000 is attributed primarily to increased rates on certificates
of deposit. Additionally, interest expense on borrowings increased by a net
$31,000 and was predominantly the result of an increase in the interest rates of
those borrowings as volume actually decreased.
Interest income and fees from loans increased from $3,870,000 for the six month
period ended June 30, 2004 to $4,845,000 for the six month period ended June 30,
2005. This increase was comprised of a favorable variance of $522,000 due to
higher average loan balances of $17,696,000, and a favorable variance of
$452,000 due to an increase of 62 basis points in the effective yield on loans.
The increase in yield was largely due to increases in the prime interest rate,
increased balances in variable rate products, as well as higher yields on new
loans originated during the period. The overall yield on loans increased to
6.19% for the six month period ended June 30, 2005 from 5.57% for the six month
period ended June 30, 2004.
-20-
Interest income from investment securities decreased $133,000 to $654,000 for
the six months ended June 30, 2005, when compared to the six month period ended
June 30, 2004. This decrease resulted from an unfavorable variance of $232,000
from a decrease in average investment balances of $11,254,000. These decreases
were due to maturities, repayments of mortgage-backed-securities and sales
occurring in 2004 and were the result of efforts to improve interest rate
sensitivity, risk-based capital, manage liquidity and concentrate on loan
growth. The unfavorable variance due to volume was offset by an increased
variance of $99,000 due to investment yields being 52 basis points higher over
the prior period ended June 30, 2004. During the six month period ended June 30,
2005, there were principal payment reductions in the mortgage-backed-securities
of $1,844,000 and a $1,000,000 call of a U.S Agency available for sale security.
The Banks will continue to invest primarily in agency securities and
mortgage-backed securities. Both of these investment products receive favorable
risk-based capital treatment.
Interest expense on deposits increased $459,000 to $1,894,000 for the six month
period ended June 30, 2005, compared to $1,435,000 for the six month period
ended June 30, 2004. This increase was comprised of an unfavorable variance of
$97,000 due to an increase in the average deposit balances of $6,383,000
primarily in certificates of deposit, and an unfavorable variance of $363,000
due to an increase in average rates on deposits from 2.03% to 2.56%. This
unfavorable rate variance was created by higher certificate rates on new
certificates of deposit, as well as increased rates applied to core deposit
products such as savings and money market accounts. Additionally, increases in
certificates of deposit, specifically at Shelby County Bank were used as funding
sources to offset maturities of high rate promotional certificates of deposits.
Interest expense on FHLB advances and other borrowings increased $32,000 from
$370,000 for the six month period ended June 30, 2004 to $401,000 for the six
month period ended June 30, 2005. This increase was the result of a favorable
variance of $34,000 due to a decreased volume of the average borrowing balance
of $1,980,000 and an unfavorable variance of $65,000 due to an increase in
interest rates from 3.24% to 3.85%.
For the six month period ended June 30, 2005, the provision for loan losses was
$105,000 compared to $195,000 for the six month period ended June 30, 2004. The
decrease of $90,000 is primarily attributed to Shelby County Bank. There was no
provision for loan losses at Shelby County Bank for the six month period ended
June 30, 2005. Management determined by analysis that the Company's reserve was
provided for adequately. Another factor contributing to this decision was due to
the net decrease of $34,000 in charge-offs for the six month period ended June
30, 2005 compared to the six month period ended June 30, 2004. Please refer to
the additional information related to the allowance for loan losses in the
financial condition discussion.
Total non-interest income was $511,000 for the six month period ended June 30,
2005 compared to $592,000 for the six month period ended June 30, 2004. Of this
decrease, $105,000 can be attributed to the result of net gains on securities
available-for-sale occurring during the six month period ended June 30, 2004.
There are also net decreases in other income, other income from sales of other
real estate owned and other assets of $140,000. Decreases in other income were
in part the result of a sale of a building owned by the Company during the
fourth quarter of 2004 and which resulted in the reduction of $15,000 in rental
income for the six months ended June 30, 2005, compared to the six months ended
June 30, 2004. In addition, there were net losses on sales of other real estate
owned and other assets of $219,000. This was primarily the result of a $72,000
loss on the sale of one other real estate owned, however, this loss on sale was
partially offset by an increase in other income on other real estate owned of
$40,000. Offsetting the decreases, there was an increase of $95,000 in secondary
market mortgage loan fees and a $69,000 increase from service charges and fees
on deposit accounts.
Non-interest expenses totaled $3,499,000 for the six month period ended June 30,
2005, compared to $3,254,000 during the six month period ended June 30, 2004. Of
the increase, $73,000 can be attributed to the terminated merger with Heartland
Bancshares, Inc.
-21-
Changes in non-interest expenses consist of the following:
<Table>
<Caption>
CHANGE FROM
SIX MONTHS ENDED 2004
JUNE 30,
-------------------------
2005 2004
Salaries and employee benefits $1,780,024 $1,520,802 $ 259,222
Occupancy 389,359 431,118 (41,759)
Federal deposit insurance 29,404 24,919 4,485
Data Processing 310,066 298,892 11,174
Advertising and promotion 80,690 38,876 41,814
Bank fees and charges 53,417 48,632 4,785
Director Fees 82,600 117,500 (34,900)
Professional Fees 278,805 242,789 36,016
Stationery, supplies and printing 55,467 74,265 (18,798)
Core deposit intangible 34,482 35,026 (544)
Merger costs 73,171 - 73,171
Other Expenses 331,751 421,170 (89,419)
---------- ---------- ----------
$3,499,236 $3,253,989 $ 245,247
========== ========== ==========
</Table>
Other major fluctuations in non-interest expense include an increase in salaries
and employee benefits of $259,000. This increase is in part due to decreased
loan growth at Shelby County Bank for the period ended June 30, 2005 and the
impact on salary deferred loan fees and costs related to that slowed growth.
Other increases to salaries were the result of additions to staff, salary
increases and the reclassification of both the Chief Executive of the Company's
and the Chairman of the Board at Shelby County Bank's compensation from director
fees to salaries. Advertising and promotion expenses have increased $42,000 from
the six months ended June 30, 2004 to the six months ended June 30, 2005 due to
an increase of $34,000 in these expenses at Paramount Bank associated with
management's attention to promoting and marketing the Bank in its local area.
Professional fees have increased by $36,000 primarily at Paramount Bank as the
Bank has retained legal counsel to pursue litigation regarding past due loans,
these costs are associated with those efforts. Increases in non-interest expense
were offset by other expenses which decreased $89,000, primarily the result of
decreases in the Banks' insurance premiums. Occupancy decreased $42,000 when
comparing the two periods. A primary reason for this reduction was the result of
a sale of a property owned by the Company in the fourth quarter of 2004 and the
$11,000 in occupancy costs associated with maintaining that property during the
six months ended June 30, 2004. Other reductions in occupancy were due to fixed
assets becoming fully depreciated during 2004 and the first quarter ended March
31, 2005. Stationary and supplies as well decreased $19,000 as there is a
concentrated effort at the Banks to reduce such expenses as they relate to cost
containment. Additionally, director fees have decreased $35,000 for the six
month period ended June 30, 2005 compared to the six month period ended June 30,
2004. This is the result of a change in the role of some directors who
previously served on both Blue River Bancshares' Board of Directors as well as
Shelby County Bank's Board of Directors and who currently only serve at the bank
level. Additionally as stated previously, compensation for the Chief Executive
of the Company and Chairman of the Board of Shelby County Bank has changed from
directors fees to salaries during the second quarter ended June 30, 2005.
Director's fees will be increasing in the future however, as there are current
vacancies on both Banks' Board of Directors as well as the Company's.
CAPITAL RESOURCES AND LIQUIDITY
The Company and 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 due to these primary
factors: increased loan growth at Shelby County Bank during 2004, continued
operating losses and the disallowance of the Banks' deferred tax assets in
determining regulatory capital ratios.
-22-
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.
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 June 30,
2005, the Banks satisfied all capital requirements. 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 June 30, 2005:
<Table>
<Caption>
SHELBY COUNTY BANK
For Capital Adequacy Purposes: TOTAL
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
--------- --------- ----------
(DOLLARS IN THOUSANDS)
Bank Amount $ 10,079 $ 10,079 $ 11,134
Required Amount 1,907 3,814 7,290
--------- --------- ---------
Excess $ 8,172 $ 6,265 $ 3,844
========= ========= =========
Bank Ratio 7.93% 7.93% 12.22%
Required Ratio 1.50% 3.00% 8.00%
--------- --------- ---------
Ratio Excess 6.43% 4.93% 4.22%
========= ========= =========
</Table>
The following table sets forth the actual and minimum capital amounts to be
adequately capitalized and ratios of Paramount as of June 30, 2005:
<Table>
<Caption>
PARAMOUNT BANK
For Capital Adequacy Purposes: TOTAL
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
-------- -------- ----------
(DOLLARS IN THOUSANDS)
Bank Amount $ 6,250 $ 6,250 $ 6,963
Required Amount 1,173 2,345 4,717
-------- -------- --------
Excess $ 5,077 $ 3,905 $ 2,246
======== ======== ========
Bank Ratio 8.00% 8.00% 11.81%
Required Ratio 1.50% 3.00% 8.00%
-------- -------- --------
Ratio Excess 6.50% 5.00% 3.81%
======== ======== ========
</Table>
-23-
Liquidity measures the Banks' ability to meet their savings withdrawals and
lending commitments. Management believes that the Banks' liquidity is adequate
to meet current requirements.
The Company's liquidity position is the primary source of additional capital for
infusion into its banking subsidiaries. During the six months ended June 30,
2005, the Banks have significantly increased their use of funds as a result of
loan demand and maturities of higher interest rate certificates of deposit. Due
to the Company's recent liquidity needs, the Company borrowed an additional
$2,000,000 from an external funding source during the quarter ended June 30,
2005 and subsequently contributed $1,800,000 of capital to its subsidiary,
Shelby County Bank to fund growth. The Company does not anticipate the need for
any additional capital over the next twelve months as a result of this borrowing
and the private placement which was authorized by the Board of Directors in
April 2005 and completed in May 2005, and which raised a net aggregate of
$497,000 of capital after offering costs.
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.
-24-
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 quarterly period ended June 30, 2005 that have
materially affected, or reasonably likely to 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.
-25-
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On May 6, 2005 the Company sold an aggregate amount of 101,000 shares
of its common stock to certain accredited investors, including without
limitation, the officers and directors of the Company in a private
placement under Section 4(2) of the Securities Act of 1933 and Rule 506
of Regulation D promulgated thereunder. Offering costs as June 30, 2005
are $8,145. The proceeds of the private placement were used for working
capital for the Company.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the shareholders, held on May 24, 2005, in
addition to the election of three directors to serve a three year term
expiring in 2008, the shareholders voted upon one board proposal
contained in Blue River's Proxy Statement dated April 22, 2005.
Russell Breeden, III, Steven R. Abel, Wendell L. Bernard, Wayne C.
Ramsey John R. Owens and Robert J. Salyers all continue as directors of
the Company.
The Board nominees were elected as directors with the following vote:
<Table>
<Caption>
Nominee For Withheld
------- --------- --------
Peter G. DePrez 2,769,600 97,003
Wayne C. Ramsey 2,794,983 71,621
John Eckart 2,796,383 70,221
</Table>
The Board proposal was approved with the following vote:
<Table>
<Caption>
Abstentions
(Other Than Broker
Broker Non-
Proposal For Against Non-Votes) Votes
-------- --------- ------- ----------- ------
Ratification of the 2,841,527 22,227 2,850 -0-
Appointment of Crowe
Chizek and Company LLC
as the Independent Registered
Public Accounting Firm for the
fiscal year 2005
</Table>
-26-
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: August 15, 2005 By: /s/ Patrice M. Lima
----------------------------------------
Patrice M. Lima, Vice President, Controller
(Principal Financial Officer & Chief
Accounting Officer)
-28-
EXHIBIT INDEX
Document Description
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
10.1 Third Amendment to Credit Agreement, dated as of June 30,
2005, by and between Blue River Bancshares, Inc. and Union
Federal Bank of Indianapolis (Incorporated by reference to
Exhibit 10.04 to the Registrant's Current Report on Form 8-K
filed with the SEC on July 5, 2005).
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
</Table>
-29-