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, 2006
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
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
---- ----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
---- ----
As of August 10, 2006 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
PAGE
NUMBER
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements:
Consolidated Balance Sheets (Unaudited)
as of June 30, 2006 and December 31, 2005 3
Consolidated Statements of Income and Comprehensive Income
(Unaudited) for the three months ended June 30, 2006 and 2005 4
Consolidated Statements of Income and Comprehensive Income
(Unaudited) for the six months ended June 30, 2006 and 2005 5
Consolidated Statements of Cash Flows (Unaudited) for the 6
six months ended June 30, 2006 and 2005
Notes to Consolidated Financial Statements (Unaudited) 7-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12-24
Item 3. Controls and Procedures 25
PART II. OTHER INFORMATION: 26
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 26
Item 5. Other information
Item 6. Exhibits 26
SIGNATURE PAGE 27
EXHIBIT INDEX 28
PART 1 FINANCIAL STATEMENTS
ITEM 1. FINANCIAL STATEMENTS
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
AS OF JUNE 30, 2006 AND DECEMBER 31, 2005
- --------------------------------------------------------------------------------
JUNE 30, DECEMBER 31,
ASSETS 2006 2005
ASSETS:
Cash and cash equivalents:
Cash and due from banks $ 4,940,517 $ 7,955,266
Interest-bearing deposits 717,601 12,221,600
------------- -------------
Total cash and cash equivalents 5,658,118 20,176,866
Securities available for sale 22,750,720 24,720,805
Securities held to maturity 14,589 16,019
Loans receivable, net of allowance for loan losses of $1,726,246 and
$1,575,511 171,878,534 162,416,186
Stock in FHLB, at cost 2,990,800 2,974,100
Restricted stock, at cost 37,500 37,500
Deferred income taxes, net 3,323,783 3,312,203
Premises and equipment, net 2,200,200 1,970,992
Other real estate owned 168,430 468,666
Accrued interest receivable and other assets 1,838,110 1,678,703
Core deposit intangible 275,860 310,342
Goodwill 3,159,051 3,159,051
------------- -------------
TOTAL ASSETS $ 214,295,695 $ 221,241,433
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Interest bearing deposits $ 154,483,548 $ 154,367,308
Non-interest bearing deposits 20,955,777 24,391,830
Fed funds purchased 1,541,000 -
Advances from FHLB 11,566,106 17,826,422
Note payable - 6,000,000
Subordinated debt 7,217,000 -
Accrued interest and other liabilities 1,068,310 1,185,898
------------- -------------
Total liabilities 196,831,741 203,771,458
------------- -------------
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
shares issued and outstanding 25,143,278 25,129,517
Accumulated deficit (6,869,241) (7,209,062)
Accumulated other comprehensive (loss) (810,083) (450,480)
------------- -------------
Total shareholders' equity 17,463,954 17,469,975
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 214,295,695 $ 221,241,433
============= =============
See accompanying notes to consolidated financial statements (unaudited).
-3-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE THREE MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
- --------------------------------------------------------------------------------
2006 2005
INTEREST INCOME:
Loans receivable $ 3,261,374 $ 2,497,542
Securities 262,561 319,332
Interest-bearing deposits 37,845 60,830
Dividends from FHLB and other 42,758 31,382
----------- -----------
Total interest income 3,604,538 2,909,086
----------- -----------
INTEREST EXPENSE:
Interest expense on deposits 1,324,225 978,911
Interest expense on FHLB and other borrowings 270,335 224,773
----------- -----------
Total interest expense 1,594,560 1,203,684
----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES 2,009,978 1,705,402
PROVISION FOR LOAN LOSSES 214,987 52,500
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,794,991 1,652,902
----------- -----------
NON-INTEREST INCOME:
Service charges and fees 150,001 118,422
Secondary market mortgage fees 67,182 146,391
(Loss) on sale and impairment of other real estate owned and other assets (83,295) (76,156)
Other 76,167 58,103
----------- -----------
Total non-interest income 210,055 246,760
----------- -----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 959,268 944,151
Premises and equipment 205,619 200,839
Federal deposit insurance 12,882 13,162
Data processing 175,477 155,280
Advertising and promotion 44,969 40,156
Bank fees and charges 27,553 27,594
Directors fees 27,600 28,750
Professional fees 150,636 184,835
Stationery, supplies and printing 35,479 28,077
Merger expense - 3,836
Core deposit intangible 17,241 17,241
Other 169,832 192,362
----------- -----------
Total non-interest expense 1,826,556 1,836,283
----------- -----------
INCOME BEFORE INCOME TAX 178,490 63,379
INCOME TAX EXPENSE 66,888 -
----------- -----------
NET INCOME $ 111,602 $ 63,379
=========== ===========
COMPREHENSIVE INCOME (LOSS) $ (105,451) $ 432,001
=========== ===========
Basic and diluted earnings per share $ 0.03 $ 0.02
=========== ===========
See accompanying notes to consolidated financial statements (unaudited).
-4-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
- --------------------------------------------------------------------------------
2006 2005
INTEREST INCOME:
Loans receivable $ 6,258,261 $ 4,845,384
Securities 525,475 654,413
Interest-bearing deposits 122,861 93,222
Dividends from FHLB and other 78,155 62,500
----------- -----------
Total interest income 6,984,752 5,655,519
----------- -----------
INTEREST EXPENSE:
Interest expense on deposits 2,496,282 1,893,671
Interest expense on FHLB and other borrowings 561,410 401,324
----------- -----------
Total interest expense 3,057,692 2,294,995
----------- -----------
NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES 3,927,060 3,360,524
PROVISION FOR LOAN LOSSES 282,987 105,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,644,073 3,255,524
----------- -----------
NON-INTEREST INCOME:
Service charges and fees 313,112 219,448
Secondary market mortgage fees 167,321 271,719
(Loss) on sale and impairment of other real estate owned and other assets (96,053) (69,280)
Other 133,212 88,938
----------- -----------
Total non-interest income 517,592 510,825
----------- -----------
NON-INTEREST EXPENSE:
Salaries and employee benefits 1,936,412 1,780,024
Premises and equipment 402,944 389,359
Federal deposit insurance 27,548 29,404
Data processing 338,367 310,066
Advertising and promotion 96,592 80,690
Bank fees and charges 53,918 53,417
Directors fees 54,000 82,600
Professional fees 284,759 278,805
Stationery, supplies and printing 63,775 55,467
Merger expense - 73,171
Core deposit intangible 34,482 34,482
Other 321,273 331,751
----------- -----------
Total non-interest expense 3,614,070 3,499,236
----------- -----------
INCOME BEFORE INCOME TAX 547,595 267,113
INCOME TAX EXPENSE 207,774 -
----------- -----------
NET INCOME $ 339,821 $ 267,113
=========== ===========
COMPREHENSIVE INCOME (LOSS) $ (19,785) $ 286,709
=========== ===========
Basic and diluted earnings per share $ 0.10 $ 0.08
=========== ===========
See accompanying notes to consolidated financial statements (unaudited).
-5-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
- --------------------------------------------------------------------------------
2006 2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 339,821 $ 267,113
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and purchase accounting amortization 289,931 77,897
Net amortization (accretion) of securities 18,559 19,932
Provision for loan losses 282,987 105,000
FHLB stock dividends (16,700) (62,500)
Loss on sale and impairment of other real estate owned and other assets 96,053 69,280
Stock compensation expense 13,761 -
Changes in assets and liabilities:
Accrued interest receivable (51,419) 91,581
Other assets 16,490 (512,698)
Accrued interest payable and other liabilities (117,589) 109,122
------------ ------------
Net cash from operating activities 871,894 164,727
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan funded, net of collections (9,932,394) 1,761,745
Maturities and paydowns of securities available for sale 1,372,571 2,843,983
Maturities and paydowns of securities held to maturity 1,430 1,138
Purchase of premises and equipment (361,081) (62,335)
Proceeds from sale of premises and equipment 3,047 -
Proceeds from sale of real estate owned 298,970 398,713
------------ ------------
Net cash from investing activities (8,617,457) 4,943,244
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock, net of offering costs of $8,145 - 496,855
Proceeds from note payable - 2,000,000
Repayment of note payable (6,000,000) -
Proceeds from subordinated debt 7,217,000 -
Net change in fed funds purchased 1,541,000 (427,000)
Net change in short term FHLB advances (6,251,550) 2,346,856
Net increase (decrease) in deposits (3,279,635) (256,728)
------------ ------------
Net cash from financing activities (6,773,185) 4,159,983
------------ ------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (14,518,748) 9,267,954
CASH AND EQUIVALENTS, Beginning of period 20,176,866 5,115,008
------------ ------------
CASH AND EQUIVALENTS, End of period $ 5,658,118 $ 14,382,962
============ ============
See accompanying notes to consolidated financial statements (unaudited).
-6-
BLUE RIVER BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
AS OF AND FOR THE PERIODS ENDED JUNE 30, 2006 AND 2005
- --------------------------------------------------------------------------------
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 (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, 2005 Annual Report to Shareholders.
The accompanying consolidated interim financial statements at June 30,
2006, and for the three and six months ended June 30, 2006 and 2005 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. 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,
--------------------------
2006 2005
Basic earnings per share:
Weighted average common shares 3,507,150 3,468,304
========= =========
Diluted earnings per share:
Weighted average common shares
3,507,150 3,468,304
Dilutive effect of stock options 8,976 681
--------- ---------
Weighted average common shares and incremental shares 3,516,126 3,468,985
========= =========
</Table>
-7-
<Table>
<Caption>
FOR THE SIX MONTHS ENDED
JUNE 30,
--------------------------
2006 2005
Basic earnings per share:
Weighted average common shares 3,507,150 3,437,399
Diluted earnings per share:
Weighted average common shares 3,507,150 3,437,399
Dilutive effect of stock options 5,849 891
-------- ---------
Weighted average common shares and incremental shares 3,512,999 3,438,290
========= =========
</Table>
For the three and six months ended June 30, 2006, 89,450 and 112,950 stock
options were not considered in the calculation of the dilutive effect of
stock options as they were anti-dilutive. For the three and six months
ended June 30, 2005, 163,850 stock options were not considered in the
calculation of the dilutive effect of stock options as they were
anti-dilutive.
4. STOCK BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 123R, "Share Based Payment." The Company
elected to use the modified prospective transition method; therefore,
prior period results were not restated. Prior to the adoption of SFAS
123R, stock-based compensation expense related to stock options was not
recognized in the results of operations if the exercise price was at least
equal to the market value of the common stock on the grant date, in
accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees". Prior to 2006, stock-based employee
compensation cost is not 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
Net income:
Net income as reported $ 63,379
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)
-----------
Pro forma, net income $ 59,114
===========
Net earnings per share:
Basic earnings per share $ 0.02
Diluted earnings per share $ 0.02
Pro forma earnings per share:
Basic earnings per share $ 0.02
Diluted earnings per share $ 0.02
-8-
<Table>
<Caption>
FOR THE SIX MONTHS
ENDED
JUNE 30, 2005
Net income:
Net income as reported $ 267,113
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
19,441
-----------
Pro forma, net income $ 286,554
===========
Net earnings per share:
Basic earnings per share $ 0.08
Diluted earnings per share $ 0.08
Pro forma earnings per share:
Basic earnings per share $ 0.08
Diluted earnings per share $ 0.08
</Table>
SFAS 123R requires all share-based payments to employees, including grants
of employee stock options, to be recognized as compensation expense over
the service period (generally the vesting period) in the consolidated
financial statements based on their fair values. Under the modified
prospective method, awards that were granted, modified, or settled on or
after January 1, 2006 are measured and accounted for in accordance with
SFAS 123R. Unvested stock options that were granted prior to January 1,
2006 will continue to be accounted for in accordance with SFAS 123, except
that all options are recognized in the results of operations over the
remaining vesting periods. The impact of forfeitures that may occur prior
to vesting is also estimated and considered in the amount recognized.
As of June 30, 2006, the Company expensed approximately $14,000 pre-tax in
stock based employee compensation and anticipates an additional
compensation expense of $14,000 during 2006. During the three months ended
June 30, 2006 the Company expensed approximately $7,000 pre-tax in stock
based employee compensation.
-9-
5. INCOME TAXES
In the year ended December 31, 2002, the Company recorded a valuation
allowance against a portion of the deferred tax asset because at that time
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 changes in its valuation allowance to offset changes in
the deferred tax asset, resulting in no income tax expense through the
period ended September 30, 2005. In the fourth quarter 2005, management
concluded that the valuation allowance on the deferred tax asset was no
longer necessary given the Company's sustained income and growth through
the year and projected net income in the future, and the remaining
valuation allowance was fully reversed. The Company has generated federal
net operating loss carryforwards of approximately $4.5 million. The net
operating loss carryforwards, if unused will expire in 2020 through 2024.
The Company has generated net state operating loss carryforwards of
approximately $4.4 million which, if unused, will expire in 2015 through
2019.
6. 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, 2006 were $10,645. The private placement closed on May 6, 2005.
7. SUBORDINATED DEBENTURES
The Company established a new Delaware trust subsidiary, Blue River
Bancshares Trust I, which completed the sale of $7 million of trust
preferred securities on April 20, 2006. Blue River Bancshares Trust I
issued the trust preferred securities at a rate equal to the three-month
LIBOR rate plus 1.55%. The trust preferred securities mature in 30 years
and may be called without penalty on or after June 30, 2011. Blue River
Bancshares Trust I simultaneously issued 217 of the trust's common
securities to the Company for a purchase price of $217,000, which,
together with the trust preferred securities, constitutes all of the
issued and outstanding securities of the trust. Blue River Bancshares
Trust I used the proceeds from the sale of the trust preferred securities
to purchase the Company's unsecured junior subordinated deferrable
interest notes due June 30, 2036 (the "Debenture"). The net proceeds from
the offering were used by the Company to pay all amounts due under and
terminated, its $6 million credit facility with Union Federal Bank of
Indianapolis, under the Credit Agreement dated as of November 19, 2003, as
amended December 30, 2004 by the First Amendment to Credit Agreement, June
30, 2005 by the Second Amendment to Credit Agreement and June 30, 2005 by
the Third Amendment to Credit Agreement. The obligations evidenced by the
Credit Agreement were scheduled to mature on June 30, 2008. In conjunction
with the termination of the Credit Agreement, all collateral securing the
obligations under the Credit Agreement, including the capital stock of
Shelby County Bank and Paramount Bank was released. The additional
proceeds will be used for general corporate purposes.
The Debenture was issued pursuant to a Junior Subordinated Indenture
between the Company and Wilmington Trust Company dated April 20, 2006,
(the "Indenture"). The interest payments by the Company will be used by
the trust to pay the quarterly distributions to the holders of the trust
preferred securities. The Indenture permits the Company to redeem the
Debenture after June 30, 2011.
The terms of the trust preferred securities are governed by an Amended and
Restated Trust Agreement, dated April 20, 2006 between the Company, as
Depositor, Wilmington Trust Company, as property trustee, Wilmington Trust
Company, as Delaware trustee, and the Administrators named therein.
-10-
Pursuant to a Guarantee Agreement dated April 20, 2006, between the
Company and Wilmington Trust Company, the Company has guaranteed the
payment of distributions and payments on liquidation or redemption of the
trust preferred securities. The obligations of the Company under the
Guarantee Agreement are unsecured and subordinate to all of the Company's
senior debt.
The offering of the trust preferred securities was conducted pursuant to a
Placement Agreement dated April 20, 2006 between the Company, Blue River
Bancshares Trust I, and J. P. Morgan Securities, Inc. The Company did not
pay any fees or commissions to the placement agent.
In accordance with FASB Interpretation No. 46 (as revised in December
2003), the trust will not be consolidated with the Company. Accordingly,
the Company will not report the securities issued by the trust as
liabilities, and instead will report as liabilities the subordinated
debentures issued by the Company and held by the trust.
8. NEW ACCOUNTING PRONOUNCEMENTS BUT NOT YET EFFECTIVE
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48 ("FIN" 48), "Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109." FIN 48 requires that
realization of an uncertain income tax position be "more likely than not"
before it can be recognized in the financial statements. Further, FIN 48
prescribes a comprehensive model for how a company should recognize,
measure, present and disclose in its financial statements uncertain tax
positions that the company has taken or expects to take on a tax return
(including a decision whether to file or not to file a return in a
particular jurisdiction). FIN 48 also clarifies the financial statement
classification of tax-related penalties and interest and sets forth new
disclosures regarding unrecognized tax benefits. The accounting provisions
of FIN No. 48 are effective for fiscal years beginning after December 15,
2006. The Company is currently evaluating the requirements of FIN 48 and
the impact this interpretation may have on its financial statements.
9. SUBSEQUENT EVENTS
On July 25, 2006 a quarterly dividend of $.015 per share was declared by
the Board of Directors, payable September 1, 2006, to the shareholders of
record as of August 15, 2006.
-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
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. Shelby County Bank and Paramount Bank are
collectively referred to as the "Banks". 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. At June 30, 2006, the Company maintains $7,217,000 of Subordinated
Debentures. On April 20, 2006, the Company paid off its $6,000,000 loan in its
entirety to a commercial bank with the proceeds of the Subordinated Debentures
(see Note 7 to the Consolidated Financial Statements included herein).
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 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 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.
Specific allocations 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 pools of loans, excluding those classified or
delinquent are analyzed for the general loan loss allowance. Management
evaluates this general allowance using loan loss statistics by various types of
loans, including statistics published periodically by the OTS and FDIC, the
Banks' historical losses and recommendations by the Chief Credit Officer.
Appropriate loss percentages are applied to the Banks' distribution of portfolio
balances since management believes this will be representative of losses
inherent in the portfolio. The calculated allocations are compared to the Banks'
existing allocations to establish the provision necessary to bring the actual
allowance 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. In the
past, the Company maintained a valuation allowance against a portion of its
deferred tax asset, however in the fourth quarter of 2005, management concluded
that the remaining valuation allowance on the deferred tax assets was no longer
necessary given the Company's sustained income and growth through the year and
projected net income in the future. A net tax benefit of $430,000 was recognized
on December 31, 2005 as a result of the reversal of the tax valuation allowance.
MANAGEMENT OVERVIEW
OVERVIEW OF FINANCIAL CONDITION AT JUNE 30, 2006 AND DECEMBER 31, 2005
On a consolidated basis, the Company's total assets as of June 30, 2006 were
$214,296,000 compared to total assets of $221,241,000 at December 31, 2005. As
of June 30, 2006, gross loans were $173,605,000 compared to gross loans of
$163,992,000 at December 31, 2005. Deposits were $175,439,000 at June 30, 2006
compared to $178,759,000 at December 31, 2005. Total capital was $17,464,000 at
June 30, 2006 compared to $17,470,000 at December 31, 2005. Outstanding shares
of common stock were 3,507,150 as of June 30, 2006 and December 31, 2005. The
book value per share was $4.98 at June 30, 2006 and at December 31, 2005.
The Company benefited from the past increases in the prime lending rate.
However, the Banks have reduced their asset sensitivity. As a result, the
Company would no longer gain as much benefit if the prime lending rate would
increase as in the past. With the issuance of the subordinated debentures in
April 2006 (see Note 7 to the Consolidated Financial Statements included
herein), the Company fully retired $6,000,000 of bank debt with the remaining
balance of the proceeds of the issuance to be used for general corporate
purposes. The initial interest rate on the subordinated debt is 6.63%, which
will float for five years with 3 month LIBOR plus a margin of 155 basis points.
The interest rate on the retired bank debt was equal to the prime interest rate
plus a margin, which varied, but was recently prime plus 50 basis points. The
Company continues to focus on maintaining its momentum of growing quality loans
and improving net interest income. During 2006, the Company believes increasing
loan balances will continue to increase net interest income, without reducing
credit quality. The Company continues to focus on achieving a 10 - 12% pretax
return on
-13-
shareholders' equity during 2006 or 2007, by concentrating on the growth of
quality loans, and lowering net non interest expense.
Management believes it can continue to improve return on equity by following
this strategy and prudently managing non interest expenses. The Banks are
strategically maintaining their "well capitalized" status while continuing to
concentrate on improving net interest income and overall profitability, without
taking undue interest rate risk. Management and staff at both Shelby County Bank
and Paramount Bank will continue to work diligently at implementing loan growth
plans and strategies; emphasizing the benefits of gathering non-certificate
depository funding as means of decreasing the Banks' overall funding costs;
improving levels of fee income derived from depository relationships and
encouraging a stronger relationship with their customer base. The issuance of
the subordinated debt will allow additional liquidity at the holding company
level, and together with improved profitability, the Company has subsequently
announced the commencement of a dividend payment to its shareholders. In July
2006, a quarterly dividend of $.015 per share was declared by the Board of
Directors, payable on September 1, 2006 to the shareholders of record as of
August 15, 2006. The Company will continue to review the possibility of future
dividend payments to its shareholders during the remainder of 2006 and in the
year 2007.
OVERVIEW OF RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30,
2006 AND 2005
For the three months ended June 30, 2006, the Company's net income was $112,000.
This compares to a net income of $63,000 for the same period of 2005. The 2005
results had no federal or state income tax expense and the 2006 results included
federal and state tax expense of $67,000. The Company had an increase in pretax
income of 182% for the quarter ended June 30, 2006 compared to the three month
period ended June 30, 2005. Basic and fully diluted earnings per share were
$0.03 for the quarter ended June 30, 2006 compared to $0.02 per share for the
quarter ended June 30, 2005. Weighted average outstanding shares (basic) for the
second quarter of 2006 were 3,507,150 and 3,507,150 for the second quarter of
2005.
For the six months ended June 30, 2006, the Company's net income was $340,000.
This compares to a net income of $267,000 for the same period of 2005. The 2005
results had no federal or state income tax expense and the 2006 results included
federal and state tax expense of $208,000. The Company had an increase in pretax
income of 105% for the six months ended June 30, 2006 compared to the six month
period ended June 30, 2005. Basic and fully diluted earnings per share were
$0.10 for the six months ended June 30, 2006 compared to $0.08 per share for the
six months ended June 30, 2005. Weighted average outstanding shares (basic) for
the first six months of 2006 were 3,507,150 and 3,507,150 for the first six
months of 2005.
The income tax provision for the three and six months ended June 30, 2006 was
$67,000 and $208,000 respectively with effective rates of 37.5% and 38%
respectively compared to no income tax expense for the three and sixth months
ended June 30, 2005. Prior year's changes in the valuation allowance offset tax
expense; however with last year's decision to reverse the valuation allowance on
the Company's deferred tax asset, the Company has now recognized tax expense
against current earnings.
FINANCIAL CONDITION
The Company's total assets at June 30, 2006 were $214,296,000, a decrease of
$6,946,000 from December 31, 2005. This decrease is primarily the result of a
decrease in cash equivalents and was the result of a decrease in deposits offset
by an increase in loans. Cash and cash equivalents declined $14,519,000 to
$5,658,000 at June 30 2006 compared to $20,177,000 at year-end 2005. Securities
available-for-sale and held-to-maturity decreased $1,972,000 to $22,765,000 at
June 30, 2006 compared to $24,737,000 at year-end 2005. Loans, net of the
allowance for loan losses increased $9,463,000 to $171,879,000 at June 30, 2006
compared to $162,416,000 at December 31, 2005. Other real estate owned declined
$300,000 to $168,000 at June 30, 2005 compared to $468,000 at year-end 2005.
Total deposits at June 30, 2006 decreased $3,320,000 to $175,439,000 compared to
$178,759,000 in total deposits at December 31, 2005. This decrease is primarily
the result of a decrease of one large deposit account at Paramount Bank which
has significant volatility in the amount of overnight deposits maintained.
Demand accounts decreased $3,436,000 while NOW, savings, money market and
certificates of deposits increased modestly. FHLB advances and fed funds
-14-
purchased decreased $4,719,000 to $13,107,000 at June 30, 2006 compared to
$17,826,000 at December 31, 2005. With the issuance of the subordinated
debentures in April 2006 of $7,217,000 (see Note 7 to the Consolidated Financial
Statements included herein), the Company fully retired $6,000,000 of bank debt.
Shareholders' equity at June 30, 2006 was $17,464,000, a decrease of $6,000
compared to $17,470,000 at December 31, 2005. The change in equity resulted from
net income of $340,000, stock compensation expense of $14,000 and a decrease of
$360,000 from a temporary decline in the fair value of the Company's
available-for-sale investment portfolio.
LOANS:
The following comparative table shows loans receivable by major categories at
June 30, 2006 and December 31, 2005:
LOANS RECEIVABLE
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2006 2005
Real Estate Mortgage Loans:
One-to-four family $ 50,027,040 $ 47,751,168
Non Residential 43,030,877 39,440,479
Home equity loans 36,511,187 35,027,100
Consumer loans 9,534,525 11,323,347
Commercial loans, including participations 34,501,151 30,449,603
------------- -------------
Total gross loans 173,604,780 163,991,697
Less allowance for loan losses (1,726,246) (1,575,511)
------------- -------------
Total loans receivable, net $ 171,878,534 $ 162,416,186
============= =============
</Table>
NON-PERFORMING LOANS:
The following table is an analysis of the Company's non-performing loans at June
30, 2006 and December 31, 2005.
NON-PERFORMING LOANS
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2006 2005
Non-performing loans consist of the following:
Non-accrual loans $2,088,876 $1,402,768
Ninety (90) days past due 1,763,156 1,265,281
---------- ----------
Total non-performing loans $3,852,032 $2,668,049
========== ==========
Non-performing loans to total loans 2.22% 1.63%
</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, 2006, the Banks reported
approximately $2,089,000 of non-accrual loans and $1,763,000 in loans ninety
days or more past due. This is an increase in non-accrual loans of $686,000 from
December 31, 2005 and an increase in past due loans of $498,000 from December
31, 2005. The increase in non-accrual loans was primarily the result of an
addition of $822,000 in new non-accrual loans and the reclassification of
$293,000 in ninety day past due loans to non-accrual status, offset by $429,000
in charge-offs and repayments. The primary reason for the increase in past due
loans ninety days or more was the result of the $293,000 shift that occurred
-15-
between the ninety day past due loans and non-accrual loans, $215,000 in other
loans that were removed from ninety days past due as a result of renewals and
payoffs, and the addition of $1,006,000 of loans in this category. The majority
of this increase represents one loan in the amount of $735,000 at Shelby County
Bank. The Bank expects this loan to be paid in full by the end of 2006. There
was an increase in the non-performing loans to total gross loans from 1.63% at
December 31, 2005 to 2.22% at June 30, 2006. The Banks maintain an allowance 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:
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
--------------------------------
2006 2005
Balance, beginning of period $ 1,575,511 $ 1,919,193
Add:
Provision for loan losses 282,987 105,000
Recoveries of loans previously charged off 10,873 26,449
Less gross charge-offs:
Residential real estate loans - (17,773)
Consumer/commercial loans (143,125) (264,420)
----------- -----------
Balance, end of period $ 1,726,246 $ 1,768,449
=========== ===========
Net charge-offs to total average loans outstanding (annualized) 0.16% 0.32%
Allowance to total average loans outstanding 1.03% 1.11%
</Table>
The allowance for loan losses at June 30, 2006 was $1,726,000, an increase of
$150,000 from December 31, 2005 and a decrease of $42,000 since June 30, 2005.
The Company's provision for loan losses for the six months ending June 30, 2006
was $283,000 and its net charge-offs were approximately $132,000. 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. The Company reviews
impaired and watch list loans on a case-by-case basis to allocate a specific
dollar amount of allocations based on available repayment sources and
collateral, whereas all other loans are allocated based on assigned allocation
percentages evaluated by loan pools. Allowance percentages for loan pools are
based on the Company's loss history, adjusted for trends and environmental
factors. The loan pools utilized by the Company are construction, residential
real estate, commercial, commercial real estate, home equity, and consumer.
Specific allocations 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 allowance. Management evaluates this general allowance
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 allocations
are compared to the Banks' existing allocations to establish the provision
necessary to bring the actual allowance balance in compliance with the findings
of the allowance analysis performed by management. The decrease in the allowance
since June 30, 2005 was the result of a decline in general allocations on other
loan pools due to improving trends and the Bank's improved historical losses,
including consideration of the composition of loss history by pool.
-16-
The Company experienced a period of extremely high losses in the past, largely
focused in 2001. Since that period, loss experience has improved, and the impact
of this high loss history has gradually reduced the allowance calculation by
increasing subsequent periods of lower loss experience. During 2005, and the six
months ending June 30, 2006, specific allocations were considered adequate based
on the individual analysis of all impaired and watch list loans. The increase in
non-performing loans since December 31, 2005, primarily in non-accruing loans,
was considered in developing the specific allocations to the provision during
the period ended June 30, 2006.
Since December 31 2005, the Company's allowance for loan losses and related
provision expense increased because allocations for both specific loans and loan
pools increased. Specific allocations totaled $996,000 at June 30, 2006 compared
to $853,000 at December 31, 2005, and pooled allocations were $543,000 at June
30, 2006 compared to $492,000 at December 31, 2005. The increase in the specific
allocations is attributable to an increase in the total watch listed loans,
while the increase in the pooled allocations is the result of an increase in
loan balances. Net charge-offs of $132,000 for the period partially offset the
increase in the allowance. While there were increases to the allowance from
December 31, 2005 to June 30, 2006, there is an overall decline in the total
loan loss allowance since June 30, 2005. This is partially attributable to
previous problem loans reaching resolution, some of which resulted in
charge-offs in 2005. A portion of these charge-offs were previously provided for
in the allowance, and the effect on specific allocations from the resolution of
these loans and improvement in other loans has been larger than the effect of
new or increased allocations on other problem loans.
For the six month period ended June 30, 2006, the allowance to total average
loans outstanding decreased to 1.03% compared to 1.11% for the six month period
ended June 30, 2005 and increased four basis points compared to .99% for the
twelve months ended December 31, 2005.
-17-
RESULTS OF OPERATIONS: Three Months Ended June 30, 2006 and June 30, 2005
Net interest income before the provision for loan losses for the three months
ended June 30, 2006 increased approximately 17.9% from the period ended June 30,
2005. This increase can be attributed to a rising interest rate environment with
the prime lending rate increasing from 6.25% to 8.25%. The Banks have benefited
from past increases in the prime lending rate, however they will not benefit as
much in the future if the prime lending rate would increase, as the Banks have
reduced asset sensitivity. Another factor contributing to the increase was
increased loan growth at both Banks.
The following table sets forth, for the three month periods ended June 30, 2006
and June 30, 2005, information regarding the total dollar amount of interest
income of the Company from interest-earning assets and their average yields; the
total dollar amount of interest expense on interest-bearing liabilities and
their average cost; net interest income; interest-rate spread; net interest
margin; and the ratio of average interest-earning assets to average
interest-bearing liabilities.
Three Months Ended June 30, 2006 Three Months Ended June 30, 2005
-------------------------------- --------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
(Dollars in thousands) (Dollars in thousands)
Interest Earning Assets:
Investment securities $ 23,482 $ 263 4.48% $ 29,747 $ 319 4.29%
Interest-bearing deposits 3,353 38 4.53% 8,661 61 2.82%
FHLB & restricted stock 3,020 43 5.70% 2,947 31 4.21%
Loans (1) 170,228 3,261 7.66% 157,072 2,498 6.36%
-------- -------- ---- -------- -------- ----
Total earning assets 200,083 3,605 7.20% 198,427 2,909 5.86%
-------- -------- ---- -------- -------- ----
Interest and Non-Interest Bearing Liabilities:
Savings accounts 12,116 68 2.24% 9,432 32 1.36%
Non-interest bearing demand accounts 22,323 -- 0.00% 25,223 -- 0.00%
NOW accounts 17,171 30 0.70% 16,545 27 0.65%
Money market accounts 35,709 348 3.90% 18,221 93 2.04%
Certificates of deposit 86,086 879 4.08% 101,315 827 3.27%
-------- -------- ---- -------- -------- ----
Total interest bearing deposits 151,082 1,325 3.51% 145,513 979 2.69%
Borrowings 21,379 270 5.05% 23,131 225 3.89%
-------- -------- ---- -------- -------- ----
Total interest bearing liabilities $172,461 1,595 $168,644 1,204
======== -------- ======== --------
Net interest income $ 2,010 $ 1,705
======== ========
Interest-rate spread (2) 3.50% 3.00%
---- ----
Net interest margin (3) 4.01% 3.44%
---- ----
1.16
Ratio of average interest-bearing assets to
average interest-bearing liabilities 1.18
(1) Includes principal balances of non-accruing loans. Interest on non-accruing
loans is not included.
(2) Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average rate of interest-bearing
liabilities.
(3) Net interest margin is net interest income divided by average
interest-earning assets.
For the three month period ended June 30, 2006, the provision for loan losses
was $215,000 compared to $52,500 for the three month period ended June 30, 2005.
Please refer to the additional information related to the allowance for loan
losses in the financial condition discussion.
-18-
Overall non-interest income decreased 14.9% for the three month period ended
June 30, 2006 compared to the three month period ended June 30, 2005. Total
non-interest income was $210,000 for the three month period ended June 30, 2006
compared to $247,000 for the three month period ended June 30, 2005. Primarily
there was a decrease of $79,000 or 54% in secondary market mortgage loan fees
due to the rising interest rate environment. Another factor contributing to the
decrease included net losses of $83,000 on the disposition and impairment of
other assets and other real estate versus net losses of $76,000 of other real
estate and other assets during the period ended June 30, 2005 for a net decrease
of $7,000 in this category. Primarily $79,000 of the net losses of $83,000 on
other assets during the three month period ended June 30, 2006 was related to
the liquidation and total write off of "The Bank's Insurance Agency", a bank
insurance company in which the Company had invested. This three year old joint
venture sold various insurance products and was formed by several Indiana
community banks. These decreases were offset by an increase of $31,000 in
service charges and fees as the Banks raised their service charges on deposit
accounts during the third quarter of 2005. There were also net increases in
other income of $18,000.
Non-interest expenses totaled $1,827,000 for the three month period ended June
30, 2006, compared to $1,836,000 during the three month period ended June 30,
2005. Overall non-interest expense decreased less than 1.0% for the three months
ended June 30, 2006 compared to the same period of 2005.
Changes in non-interest expenses consist of the following:
Three Months Ended Change from
June 30, 2005
-----------------------------------------
2006 2005
Salaries and employee benefits 959,268 $ 944,151 $ 15,117
Occupancy 205,619 200,839 4,780
Federal deposit insurance 12,882 13,162 (280)
Data Processing 175,477 155,280 20,197
Advertising and promotion 44,969 40,156 4,813
Bank fees and charges 27,553 27,594 (41)
Director Fees 27,600 28,750 (1,150)
Professional Fees 150,636 184,835 (34,199)
Stationery, supplies and printing 35,479 28,077 7,402
Core deposit intangible 17,241 17,241 --
Merger costs -- 3,836 (3,836)
Other Expenses 169,832 192,362 (22,530)
----------- ----------- -----------
$ 1,826,556 $ 1,836,283 $ (9,727)
=========== =========== ===========
Major fluctuations in non-interest expense from the three months ended June 30,
2005 to the three months ended June 30, 2006 include an increase in data
processing charges of $20,000 due to increases in deposit and loan volumes and
the related servicing of those products. Advertising and promotion expenses have
increased $5,000 due to an increase in these expenses at Paramount Bank
associated with management's attention to promoting and marketing the Bank in
its local area. Stationary, supplies and printing expenses increased $7,000 due
to additional printing costs related to customer privacy information. Increases
in non-interest expense were offset by a decrease of $34,000 in professional
fees. As a result of a significant decrease in other real estate owned from the
three month period ended June 30, 2005 to the three month period ended June 30,
2006, professional expenses decreased as these expenses were primarily related
to the costs to pursue litigation and manage these properties. The Company
reduced this non-earning asset category by $872,000 since the second quarter of
2005. Other non-interest expenses were also reduced by $23,000 primarily the
result of a reduction in collection expenses associated with other real estate
owned.
-19-
RESULTS OF OPERATIONS: Six Months Ended June 30, 2006 and June 30, 2005
Net interest income before the provision for loan losses for six months ended
June 30, 2006 increased approximately 16.9% from the period ended June 30, 2005.
This increase can be attributed to a rising interest rate environment with the
prime lending rate increasing from 6.25% to 8.25%. The Banks have benefited from
past increases in the prime lending rate, however they will not benefit as much
in the future if the prime lending rate would increase, as the Banks have
reduced asset sensitivity. Another factor contributing to the increase was
increased loan growth at both Banks.
The following table sets forth, for the six month periods ended June 30, 2006
and June 30, 2005, information regarding the total dollar amount of interest
income of the Company from interest-earning assets and their average yields; the
total dollar amount of interest expense on interest-bearing liabilities and
their average cost; net interest income; interest-rate spread; net interest
margin; and the ratio of average interest-earning assets to average
interest-bearing liabilities.
<Table>
<Caption>
Six Months Ended June 30, 2006 Six Months Ended June 30, 2005
--------------------------------------- ------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
(Dollars in thousands) (Dollars in thousands)
Interest Earning Assets:
Investment securities 23,877 526 4.41% 30,494 655 4.30%
Interest-bearing deposits 5,720 123 4.30% 7,296 93 2.55%
FHLB & restricted stock 3,016 78 5.17% 2,931 63 4.30%
Loans (1) 167,574 6,258 7.47% 156,658 4,845 6.19%
-------- -------- ------- -------- -------- --------
Total earning assets 200,187 6,985 6.98% 197,379 5,656 5.73%
-------- -------- ------- -------- -------- --------
Interest and Non-Interest Bearing Liabilities:
Savings accounts 12,339 136 2.20% 8,938 57 1.28%
Non-interest bearing demand accounts 22,829 -- 0.00% -- -- 0.00%
NOW accounts 16,941 59 0.70% 16,180 52 0.64%
Money market accounts 35,234 641 3.64% 19,091 174 1.82%
Certificates of deposit 78,994 1,660 4.20% 103,476 1,611 3.11%
-------- -------- ------- -------- -------- --------
Total interest bearing deposits
143,508 2,496 3.48% 147,685 1,894 2.56%
Borrowings 22,052 562 5.10% 20,827 401 3.85%
-------- -------- ------- -------- -------- --------
Total interest bearing liabilities $165,560 3,058 $168,512 2,295
======== -------- ======== --------
Net interest income $ 3,927 $ 3,361
======== ========
Interest-rate spread (2) 3.29% 3.01%
------- --------
Net interest margin (3) 3.92 3.41%
------- --------
Ratio of average interest-bearing assets to
average interest-bearing liabilities 1.21 1.17
</Table>
(1) Includes principal balances of non-accruing loans. Interest on non-accruing
loans is not included.
(2) Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average rate of interest-bearing
liabilities.
(3) Net interest margin is net interest income divided by average
interest-earning assets.
For the six month period ended June 30, 2006, the provision for loan losses was
$283,000 compared to $105,000 for the six month period ended June 30, 2005.
Please refer to the additional information related to the allowance for loan
losses in the financial condition discussion.
-20-
Overall non-interest income increased slightly for the six month period ended
June 30, 2006 compared to the six month period ended June 30, 2005. Total
non-interest income was $518,000 for the six month period ended June 30, 2006
compared to $511,000 for the six month period ended June 30, 2005. Primarily
there was an increase of $94,000 or 43% in service charges and other fees, as
the Banks increased their fee structures during the third quarter of 2005 on
deposit accounts. There were also net increases in other income of $44,000.
Offsetting these increases there was a decrease in secondary market mortgage
fees of $104,000 or 38% due to the rising interest rate environment. Another
factor contributing to the decrease included net losses of $96,000 or a 39%
increase in the disposition and impairment of other assets and other real estate
versus net losses of $69,000 of other real estate and other assets during the
six month period ended June 30, 2005. Primarily $79,000 of the net losses of
$96,000 on other assets during the six month period ended June 30, 2006 was
related to the liquidation and total write off of "The Bank's Insurance Agency",
a bank insurance company in which the Company had invested. This three year old
joint venture sold various insurance products and was formed by several Indiana
community banks.
Overall non-interest expense increased by approximately 3% for the six months
ended June 30, 2006 compared to the same period of 2005. Non-interest expenses
totaled $3,614,000 for the six month period ended June 30, 2006, compared to
$3,499,000 during the six month period ended June 30, 2005.
Changes in non-interest expenses consist of the following:
<Table>
<Caption>
SIX MONTHS ENDED CHANGE FROM
JUNE 30, 2005
-------------------------------------------------
2006 2005
Salaries and employee benefits $ 1,936,412 $ 1,780,024 $ 156,388
Occupancy 402,944 389,359 13,585
Federal deposit insurance 27,548 29,404 (1,856)
Data Processing 338,367 310,066 28,301
Advertising and promotion 96,592 80,690 15,902
Bank fees and charges 53,918 53,417 501
Director Fees 54,000 82,600 (28,600)
Professional Fees 284,759 278,805 5,954
Stationery, supplies and printing 63,775 55,467 8,308
Core deposit intangible 34,482 34,482 -
Merger costs - 73,171 (73,171)
Other Expenses 321,273 331,751 (10,478)
----------- ----------- -----------
$ 3,614,070 $ 3,499,236 $ 114,834
=========== =========== ===========
</Table>
-21-
Major fluctuations in non-interest expense include an increase in salaries and
employee benefits of $156,000. This increase is primarily the reclassification
of the director fees during the second quarter of 2005 of both the Chief
Executive of the Company and the Chairman of the Board at Shelby County Bank to
salaries. Advertising and promotion expenses have increased $16,000 from the six
months ended June 30, 2005 to the six months ended June 30, 2006 due to an
increase of $15,000 in these expenses at Paramount Bank associated with
management's attention to promoting and marketing the Bank in its local area.
Increases in data processing charges of $28,000 were due to volume increases in
loans and deposits and the related servicing of those products. Occupancy
increased $14,000 due to additional depreciation expense pertaining to a new
computer system implemented at Shelby County Bank. A major offset to the
increases in non-interest expense was the absence of merger related costs of
$73,000 relating to the terminated merger with Heartland Bancshares, Inc., as
the majority of this expense category occurred during the first quarter of 2005.
Additionally, director fees have decreased $29,000 for the period ended June 30,
2006 compared to the period ended June 30, 2005. 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. As stated previously,
compensation for the Chief Executive of the Company and the Chairman of the
Board of Shelby County Bank changed from directors fees to salaries during the
second quarter ended June 30, 2005.
-22-
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".
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, a core capital ratio equal to
4.0 %, and 3.0% for banks with a composite rating of "1" and total risk-based
capital of 8%. Additionally, savings institutions are required to meet a risk
based capital ratio equal to 8.0% for risk-weighted assets. At June 30, 2006,
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, 2006:
<Table>
<Caption>
SHELBY COUNTY BANK
-----------------------------------------------------------------------------------
ACTUAL CAPITAL MINIMUM FOR CAPITAL ADEQUACY FDICIA REGULATIONS
----------------------- ---------------------------- -------------------------
TO BE "WELL CAPITALIZED"
-------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
Tangible capital ratio $11,812,000 9.0% $1,969,000 1.5% $ 6,562,000 N/A
Core capital to average assets 11,812,000 9.0% 5,250,000 4.0% 6,562,000 5.0%
Tier 1 capital to risk weighted assets 11,812,000 11.8% 4,002,000 N/A 6,002,000 6.0%
Total capital to risk weighted assets 12,613,000 12.6% 8,003,000 8.0% 10,004,000 10.0%
</Table>
-23-
The following table sets forth the actual and minimum capital amounts to be
adequately capitalized and ratios of Paramount Bank as of June 30, 2006:
<Table>
<Caption>
PARAMOUNT BANK
-----------------------------------------------------------------------------------
ACTUAL CAPITAL MINIMUM FOR CAPITAL ADEQUACY FDICIA REGULATIONS
------------------------ -------------------------------------------------------
TO BE "WELL CAPITALIZED"
------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
Tangible capital ratio $ 6,702,000 8.6% $ 1,169,000 1.5% $ 3,896,000 N/A
Core capital to average assets 6,702,000 8.6% 3,117,000 4.0% 3,896,000 5.0%
Tier 1 capital to risk weighted assets 6,705,000 10.2% 2,635,000 N/A 3,952,000 6.0%
Total capital to risk weighted assets 7,526,000 11.4% 5,270,000 8.0% 6,587,000 10.0%
</Table>
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 first quarter of 2006,
Paramount Bank had high rate, long term certificates of deposit, which matured.
Rather than match all of their competitor's rates, Paramount Bank temporarily
replaced these certificates with borrowings. During the second quarter of 2006,
Paramount successfully increased certificate of deposit balances through
alternative funding sources and thereby decreased borrowings. Shelby County Bank
has continued to obtain deposits from many local governmental entities. These
deposits are subject to significant volatility and Shelby County Bank must
maintain alternative sources of funding, in order to satisfy large withdrawals.
In an effort to reduce our borrowing costs and provide additional funds, the
Company established a new Delaware trust subsidiary, Blue River Bancshares Trust
I, which completed the sale of $7,000,000 of trust preferred securities on April
20, 2006 (See Note 7 to the Consolidated Financial Statements included herein).
Six million dollars of the net proceeds from the offering were used by the
Company to pay all amounts due under and terminate its $6,000,000 credit
facility with Union Federal Bank of Indianapolis. The additional proceeds will
be used for general corporate purposes. Based upon current projections, the
Company does not anticipate the need for any additional external funding over
the next twelve 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.
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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, our
Disclosure Controls were effective at the Reasonable Assurance level as
described below as of the end of the period covered by this report.
CHANGES IN INTERNAL CONTROLS
There were no changes in the Company's internal control over financial reporting
that occurred during the quarter ended June 30, 2006 that have materially
affected, or reasonably likely to affect, the Company's internal control over
financial reporting.
REASONABLE ASSURANCE LEVEL OF 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 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the shareholders, held on May 26, 2006, in
addition to the election of three directors to serve a three year term
expiring in 2009, the shareholders voted upon one board proposal
contained in Blue River's Proxy Statement dated April 24, 2006.
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
------- --- --------
Steven R. Abel 2,693,155 33,935
Wendell L. Bernard 2,683,314 29,476
Russell Breeden, III 2,683,221 25,569
</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 2,698,521 14,103 166 -0-
Appointment of Crowe
Chizek and Company LLC
as the Independent Registered
Public Accounting Firm for the
fiscal year 2006.
</Table>
Item 6. Exhibits
The exhibits to this Form 10-QSB are listed in the attached Exhibit
Index.
******
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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 10, 2006 By: /s/ Patrice M. Lima
-----------------------------------
Patrice M. Lima, Vice President,
Controller
(Principal Financial Officer &
Chief Accounting Officer)
-27-
EXHIBIT INDEX
Document Description
<Table>
<Caption>
Exhibit No.
10.1 Amended and Restated Declaration of Trust among Blue River
Bancshares, Inc., as Depositor, Wilmington Trust Company, as
property trustee, Wilmington Trust Company, as Delaware trustee, and
the Administrators named therein (Incorporated by reference to the
Registrant's Form 8-K, filed on April 26, 2006)
10.2 Junior Subordinated Indenture between Blue River Bancshares Trust I
and Wilmington Trust Company, as trustee (Incorporated by reference
to the Registrant's Form 8-K, filed on April 26, 2006)
10.3 Guarantee Agreement between Blue River Bancshares, Inc., as
guarantor, and Wilmington Trust Company, as guarantee trustee
(Incorporated by reference to the Registrant's Form 8-K, filed on
April 26, 2006)
10.4 Placement Agreement between Blue River Bancshares, Inc., Blue
River Bancshares Trust I, and J. P. Morgan Securities, Inc.
(Incorporated by reference to the Registrant's Form 8-K, filed on
April 26, 2006)
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>
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