EXHIBIT 13
36.
BUSINESS OF DCB FINANCIAL CORP
DCB Financial Corp ("DCB") was incorporated under the laws of the State of Ohio
on March 14, 1997, at the direction of management and approval of the
shareholders of The Delaware County Bank and Trust Company (the "Bank") for the
purpose of becoming a bank holding company by acquiring all outstanding shares
of the Bank. The Bank is a commercial bank, chartered under the laws of the
State of Ohio, and was organized in 1950. The Bank is the wholly-owned
subsidiary of DCB.
The Bank conducts business from its main office at 110 Riverbend Avenue in Lewis
Center, and from its 16 full-service branch offices located in Delaware and
surrounding communities. The Bank provides customary retail and commercial
banking services to its customers, including checking and savings accounts, time
deposits, IRAs, safe deposit facilities, personal loans, commercial loans, real
estate mortgage loans, installment loans, night depository facilities and trust
services. The Bank also provides cash management, bond registrar and payment
services. Through its information systems department, the Bank provides data
processing services to other financial institutions; however, such services are
not a significant part of operations or revenue.
DCB, through the Bank, grants residential real estate, commercial real estate,
consumer and commercial loans to customers located primarily in Delaware,
Franklin, and Union Counties, Ohio. Unemployment statistics have historically
been among the lowest in the State of Ohio, and real estate values have been
stable to rising. DCB also invests in U.S. Government and agency obligations,
obligations of states and political subdivisions, corporate obligations,
mortgage-backed securities, commercial paper and other investments permitted by
applicable law. Funds for lending and other investment activities come primarily
from customer deposits, borrowed funds, and loan and security sales and
principal repayments.
As a financial holding company, DCB is subject to regulation, supervision and
examination by the Federal Reserve Board. As a commercial bank chartered under
the laws of the State of Ohio, the Bank is subject to regulation, supervision
and examination by the State of Ohio Division of Financial Institutions and the
Federal Deposit Insurance Corporation (the "FDIC"). The FDIC insures deposits in
the Bank up to applicable limits. The Bank is also a member of the Federal Home
Loan Bank (the "FHLB") of Cincinnati.
COMMON STOCK AND SHAREHOLDER MATTERS
DCB had 4,168,234 common shares outstanding on February 22, 2003, held of record
by approximately 1,537 shareholders. DCB's common stock is not traded on any
established securities market. However, several central Ohio brokerage firms
maintain daily bid and ask prices for DCB's common stock. The range of high and
low transactions as reported by Sweney, Cartwright & Co. are reported below.
These transactions are without retail mark-up, mark-down or commissions.
Management does not have knowledge of the prices in all transactions and has not
verified the accuracy of those prices that have been reported. Because of the
lack of an established market for DCB's stock, these prices may not reflect the
prices at which the stock would trade in a more active market. DCB sold no
securities during 2002 and 2001 that were not registered under the Securities
Acts.
1
----------------------------Quarter ended------------------------
March 31, June 30, September 30, December 31,
2002 2002 2002 2002
----------- ---------- ------------- ------------
High $ 16.00 $ 21.00 $ 19.85 $ 20.50
Low 12.75 15.10 16.15 18.00
Dividends per share 0.08 0.08 0.09 0.09
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
----------- ---------- ------------- ------------
High $ 11.75 $ 14.00 $ 14.50 $ 14.30
Low 10.25 11.25 13.25 11.50
Dividends per share 0.07 0.07 0.08 0.08
Income of DCB primarily consists of dividends, which are periodically declared
and paid by the Board of Directors of the Bank on common shares of the Bank held
by DCB. While management expects to maintain the organization's policy of paying
regular cash dividends in the future, no assurances can be given that any
dividends will be declared or, if declared, what the amount of any such
dividends will be. See Note 11 to the consolidated financial statements for a
description of dividend restrictions.
SELECTED FINANCIAL INFORMATION AND OTHER DATA
The following tables set forth certain information concerning the consolidated
financial condition, earnings and other data regarding DCB at the dates and for
the periods indicated.
At December 31,
Selected financial --------------------------------------------------------------------------
condition data: 2002 2001 2000 1999 1998
(In thousands) ------------ ------------- ------------ ------------ ------------
Total assets $ 522,998 $ 519,380 $ 497,250 $ 430,005 $ 418,540
Cash and cash equivalents 32,503 17,945 18,496 16,838 15,492
Securities available for sale 96,477 84,021 101,955 91,909 90,399
Securities held to maturity -- 34,718 29,843 35,245 49,184
Net loans and leases 366,487 358,960 327,184 274,675 253,341
Deposits 438,623 430,714 418,946 371,799 368,918
Borrowed funds 29,802 37,336 30,422 16,889 9,450
Shareholders' equity 52,528 49,121 44,899 40,387 38,309
2
Year ended December 31,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
Selected Operating Data: ------------ ------------- ------------ ------------ ------------
(In thousands, except per share data)
Interest and dividend income $ 31,566 $ 36,409 $ 36,717 $ 30,483 $ 28,928
Interest expense 10,142 16,369 19,607 14,322 14,323
------------ ------------- ------------ ------------ ------------
Net interest income 21,424 20,040 17,110 16,161 14,605
Provision for loan and lease losses 2,950 872 908 1,495 469
------------ ------------- ------------ ------------ ------------
Net interest income after
provision for loan and lease losses 18,474 19,168 16,202 14,666 14,136
Noninterest income 5,867 5,119 4,030 4,233 4,139
Noninterest expense 18,302 17,544 13,134 11,963 11,373
------------ ------------- ------------ ------------ ------------
Income before income tax 6,039 6,743 6,831 6,936 6,902
Income tax expense 2,036 2,245 2,206 2,154 2,168
------------ ------------- ------------ ------------ ------------
Net income $ 4,003 $ 4,498 $ 4,625 $ 4,782 $ 4,734
============ ============= ============ ============ ============
Per Share Data:
Basic and diluted earnings per share $ 0.96 $ 1.08 $ 1.11 $ 1.14 $ 1.13
============ ============= ============ ============ ============
Dividends declared per share $ 0.34 $ 0.30 $ 0.28 $ 0.25 $ 0.27
============ ============= ============ ============ ============
At or for the year ended December 31,
--------------------------------------------------------------------------
Selected Financial Ratios: 2002 2001 2000 1999 1998
------------ ------------- ------------ ------------ ------------
Interest rate spread 3.93% 3.56% 2.92% 3.20% 3.01%
Net interest margin 4.38 4.24 3.83 4.07 3.95
Return on average equity 7.82 9.40 11.12 12.18 13.64
Return on average assets 0.76 0.89 0.97 1.13 1.21
Average equity to average assets 9.78 9.43 8.74 9.31 8.89
Dividend payout ratio 35.42 27.78 25.23 21.93 18.58
Allowance for loan and lease losses as
a percentage of nonperforming loans 114.55 100.17 224.81 444.75 180.71
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(Dollars in thousands, except per share amounts)
INTRODUCTION
In the following pages, management presents an analysis of DCB's financial
condition and results of operations as of and for the year ended December 31,
2002, compared to prior years. This discussion is designed to provide
shareholders with a more comprehensive review of the operating results and
financial position than could be obtained from an examination of the financial
statements alone. This analysis should be read in conjunction with the financial
statements and related footnotes and the selected financial data included
elsewhere in this report.
3
FORWARD-LOOKING STATEMENTS
Certain statements in this report constitute "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995, such as
statements relating to the financial condition and prospects, lending risks,
plans for future business development and marketing activities, capital spending
and financing sources, capital structure, the effects of regulation and
competition, and the prospective business of both the Corporation and its
wholly-owned subsidiary The Delaware County Bank & Trust Company (the "Bank").
Where used in this report, the word "anticipate," "believe," "estimate,"
"expect," "intend," and similar words and expressions, as they relate to the
Corporation or the Bank or their respective management, identify forward-looking
statements. Such forward-looking statements reflect the current views of the
Corporation and are based on information currently available to the management
of the Corporation and the Bank and upon current expectations, estimates, and
projections about the Corporation and its industry, management's belief with
respect thereto, and certain assumptions made by management. These
forward-looking statements are not guarantees of future performance and are
subject to risks, uncertainties, and other factors that could cause actual
results to differ materially from those expressed or implied by such
forward-looking statements. Potential risks and uncertainties include, but are
not limited to: (i) significant increases in competitive pressure in the banking
and financial services industries; (ii) changes in the interest rate environment
which could reduce anticipated or actual margins; (iii) changes in political
conditions or the legislative or regulatory environment; (iv) general economic
conditions, either nationally or regionally (especially in central Ohio),
becoming less favorable than expected resulting in, among other things, a
deterioration in credit quality of assets; (v) changes occurring in business
conditions and inflation; (vi) changes in technology; (vii) changes in monetary
and tax policies; (viii) changes in the securities markets; and (ix) other risks
and uncertainties detailed from time to time in the filings of the Corporation
with the Commission.
The Corporation does not undertake, and specifically disclaims any obligation,
to publicly revise any forward-looking statements to reflect events or
circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
DCB's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and follow general
practices within the financial services industry. The application of these
principles requires management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and accompanying
notes. These estimates, assumptions, and judgments are based on information
available as of the date of the financial statements; as this information
changes, the financial statements could reflect different estimates,
assumptions, and judgments.
The most significant accounting policies followed by the Corporation are
presented in Note 1 to the consolidated financial statements. These policies,
along with the disclosures presented in the other financial statement notes and
in this financial review, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined.
ANALYSIS OF FINANCIAL CONDITION
DCB's assets totaled $522,998 at year-end 2002 compared to $519,380 at year-end
2001, an increase of $3,618, or .7%. The growth in assets was mainly attributed
to the investment of funds provided by deposit growth into loans. During the
year, management aligned its balance sheet by allowing the securities portfolio
to decline, using the proceeds to reduce borrowings and increase cash and cash
equivalents. The increase in cash and cash equivalents will allow management to
more actively pursue business initiatives, while increasing liquidity resources
during the current economic climate.
4
Total securities decreased to $96,477 at year-end 2002 compared to $118,739 at
year-end 2001. The decrease in securities was the result of the majority of
proceeds from maturities, calls and principal repayments being used to fund
higher yielding loans. DCB invests primarily in U.S. Treasury notes, obligations
of U.S. government agencies and corporations, municipal bonds, corporate
obligations and mortgage-backed securities. Mortgage-backed securities include
Federal Home Loan Mortgage Corporation ("FHLMC"), Government National Mortgage
Association ("GNMA"), Federal National Mortgage Association ("FNMA")
participation certificates and collateralized mortgage obligations ("CMOs"). The
mortgage-backed securities portfolio, totaling $49,448 at year-end 2002,
provides DCB with a constant cash flow stream from principal repayments, that is
utilized by management to fund other areas of the balance sheet. Management
classifies securities as available for sale to provide DCB with the flexibility
to move funds into loans as demand warrants. During 2002, management sold a
security classified held to maturity as was deemed appropriate by management, as
the security's attributes no longer met the Corporation's asset/liability
guidelines. Subsequent to that decision, the entire held to maturity portfolio
was reclassified to available for sale. DCB held no derivative securities or
structured notes during any period presented.
Total loans increased $8,025, or 2.2%, from $362,556 at year-end 2001 to
$370,581 at year-end 2002. The growth in the overall loan portfolio was
attributed to large increases in commercial real estate loans and land
development loans offset by declines in the commercial, consumer and credit card
and lease financing portfolios. Commercial real estate loans increased $20,109,
or 16.2%, from $124,537 at year-end 2001 to $144,646 at year-end 2002.
Residential real estate and home equity loans decreased $1,249, or 1.4%, from
$88,797 at year-end 2001 to $87,548 at year-end 2002.
Premises and equipment increased $295 in 2002 from $12,320 at year-end 2001 to
$12,615 at year-end 2002. During 2002, the Corporation developed a new branch
location in a local area community, replacing previously leased space. Also
during the year, the Corporation invested in new software and equipment in order
to upgrade its check imaging system. This system allows DCB the ability to
create electronic images of customer items in order to improve customer service
and create internal efficiencies within the organization.
Total deposits increased $7,909 or 1.8%, from $430,714 at year-end 2001 to
$438,623 at year-end 2002. Noninterest-bearing deposits increased $3,672, or
5.3%, while interest-bearing deposits increased $4,237, or 1.2%.
Interest-bearing demand and money market deposits decreased from 49.4% of total
interest-bearing deposits at year-end 2001 to 39.4% of total interest-bearing
deposits at year-end 2002, as DCB experienced a $34,468, or 19.3%, decrease in
volume of such accounts. The decrease in such deposits has been primarily due to
economic trends resulting in the shift of customer funds from lower yielding
deposit accounts to certificates of deposit. At the same time, DCB's trends
indicate that customers were also shifting funds into savings accounts, which,
during 2002, were yielding higher returns than some other transactional
accounts. DCB experienced an increase of $19,287 in savings deposits while such
accounts increased from 14.0% of total interest-bearing deposits at year-end
2001 to 19.1% of total interest-bearing deposits at year-end 2002. Certificates
of deposit increased $19,418, or 14.7%, comprising 41.5% of total
interest-bearing deposits at year-end 2002 compared to 36.6% at year-end 2001.
Management attributes these trends to the rate structure of the organization's
deposit products and their relationship to the economic conditions under which
DCB operated during 2002. Though deposits may continue to grow to varying
degrees, there is no assurance that deposit growth in future periods will be
similar to those experienced in 2002.
Borrowed funds totaled $29,802 at year-end 2002 compared to $37,336 at year-end
2001. During 2002, management primarily utilized the cash flow from security
maturities and paydowns to reduce debt. This debt mainly consisted of FHLB loans
that were used to fund loan growth in previous operating periods.
5
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND
DECEMBER 31, 2001
NET INCOME. Net income for 2002 totaled $4,003, compared to net income for 2001
of $4,498. Earnings per share were $0.96 for 2002 and $1.08 for 2001. Return on
average assets was 0.76% and 0.89% for 2002 and 2001, while return on average
shareholders' equity was 7.82% and 9.40% over the same two years. Net interest
income and fee income both increased during 2002 in comparison to 2001. The
decline in net income related principally to an increase in the allowance for
loan and lease losses and the charge off of four large commercial loans, as
noted below.
NET INTEREST INCOME. Net interest income represents the amount by which interest
income on interest-earning assets exceeds interest paid on interest-bearing
liabilities. Net interest income is the largest component of DCB's income and is
affected by the interest rate environment and the volume and composition of
interest-earning assets and interest-bearing liabilities.
Net interest income was $21,424 for 2002 compared to $20,040 for 2001. The
increase of $1,384 is attributed to the higher level of interest-bearing assets
and the decrease in the organization's overall funding costs. The significant
decrease in DCB's cost of funds resulted from higher yielding certificates of
deposit repricing in 2002 and the ability of management to control costs on
savings, checking and other deposit accounts. As a result of the these shifts in
the components of interest-earning assets and interest-bearing liabilities, as
well as movements in market interest rates, DCB's net interest margin, which is
calculated by dividing net interest income by average interest-earning assets,
increased from 4.24% in 2001 to 4.38% in 2002.
PROVISION AND ALLOWANCE FOR LOAN AND LEASE LOSSES. The provision for loan and
lease losses represents the charge to income necessary to adjust the allowance
for loan and lease losses to an amount that represents management's assessment
of the losses inherent in the Bank's loan portfolio. All lending activity
contains associated risks of loan losses and the Bank recognizes these credit
risks as a necessary element of its business activity. To assist in identifying
and managing potential loan losses, the Bank maintains a credit administration
function that regularly evaluates lending relationships as well as overall loan
portfolio conditions. One of the primary objectives of this credit
administration function is to make recommendations to management as to both
specific loss reserves and overall portfolio loss reserves.
DCB's provision is determined based upon management's estimate of the overall
collectibility of loans within the portfolio as determined by ongoing credit
reviews. The provision for loan and lease losses totaled $2,950 in 2002 compared
to $872 in 2001. Net charge-offs for 2002 were $2,452, which represents 0.66% of
average loans, compared to net charge-offs of $610, or 0.18% of average loans in
2001.
The allowance for loan and lease losses increased from $3,596 at year-end 2001
to $4,094 at year-end 2002. As a percent of gross loans and leases, the
allowance increased to 1.10% at year-end 2002 from 0.99% at year-end 2001. DCB
maintains an allowance for loan and lease losses at a level to absorb
management's estimate of probable incurred credit losses in its portfolio.
Exposure to credit losses in the commercial loan portfolio required the
recognition of additional provision compared to the prior year. This increase in
charge-offs was due to a number of factors including deteriorating economic
conditions that affected the commercial loan portfolio and management's decision
to accelerate its workout strategies for certain borrowers.
The increase in net charge-offs was mainly attributed to four large commercial
loans. These loans were in the areas of agricultural production, parts
manufacturing, medical equipment production, and supply chain software
development. The individual companies that participated in these industry
segments were not able to overcome the change to their operating environments
brought on by deteriorating economic conditions. The net charge-offs associated
with these four loans were approximately $1.7 million or 69% of the entire net
charge-offs for the entire 2002 fiscal year. Management continues to monitor
exposure to industry segments, and believes that the loan portfolios remain
adequately diversified.
6
To assist in identifying and managing potential loan and lease losses,
management reviewed its methodology for establishing appropriate loan and lease
loss values. Subsequent to the review process, the Board of Directors approved a
policy that directs management to "develop and maintain an appropriate,
systematic, and consistently applied process to determine the amounts of the
Allowance for Loan and Lease Losses (ALLL)." The methodology that management
adopted during the fourth quarter 2002 involves identifying both specific and
non-specific reserves. The specific reserve portion is determined from
information provided through the bank's watch list, loan review function and
loan grade status. The non-specific reserve portion is developed by utilizing
historical net loss components for each identified segment of the loan
portfolio. Additionally, current economic condition factors are used to adjust
the historical net loss components. Management performs analysis of the loan
portfolio on a monthly basis. Upon implementation of this approved methodology,
management increased the allowance for loan and lease losses during the fourth
quarter 2002, to a level commensurate with management's estimate of probable
losses in the portfolio.
NONINTEREST INCOME AND NONINTEREST EXPENSE. Total noninterest income increased
$748, or 14.6% to $5,867 in 2002 compared to $5,119 in 2001. The increase was
primarily attributed to the increased revenue generated by selling residential
mortgages in the secondary market. During 2002, favorable economic interest
rates created a large increase in mortgage refinancing. DCB generated $1.0
million of revenues associated with this activity, an increase of $398, or 64%.
Additionally, the organization experienced general increases on account service
charges, trust activities and cash management service fees. These increases are
generally attributed to a high number of accounts and customers served by the
Corporation.
Total noninterest expense increased $758, or 4.3%, in 2002 compared to 2001. The
increase was primarily the result of increases in salaries and employee
benefits, occupancy and equipment and outside professional services. The
increase in outside professional services is attributed to increased audit,
consulting and legal fees. These increase in these fees was mainly attributable
to legal and consulting fees associated with a legal action filed on behalf of
shareholders, for which no resolution was reached at year-end 2002. The increase
in compensation and employee benefits were planned increases relating to
increased staffing in order to initiate business objectives aimed at capturing a
larger portion of the consumer market in Delaware County. With its broad line of
products and services, DCB expects to be able to meet the needs of the market
and obtain the business needed to sustain the additional overhead expenses
associated with the new corporate headquarters and new branch operations.
INCOME TAXES. The change of income tax expense is primarily attributable to the
change in income before income taxes. See Note 9 to the consolidated financial
statements. The provision for income taxes totaled $2,036 in 2002 and $2,245 in
2001 resulting in effective tax rates of 33.7% and 33.3%.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND
DECEMBER 31, 2000
NET INCOME. Net income for 2001 totaled $4,498, decreasing slightly compared to
net income for 2000 of $4,625. Earnings per share were $1.08 for 2001 and $1.11
for 2000. Return on average assets was 0.89% and 0.97% for 2001 and 2000, while
return on average shareholders' equity was 9.40% and 11.12% over the same two
years.
NET INTEREST INCOME. Net interest income represents the amount by which interest
income on interest-earning assets exceeds interest paid on interest-bearing
liabilities. Net interest income is the largest component of the DCB's income
and is affected by the interest rate environment and the volume and composition
of interest-earning assets and interest-bearing liabilities.
7
Net interest income was $20,040 for 2001 compared to $17,110 for 2000. The
$2,930 increase in 2001 over 2000 was the result of an increase in DCB's net
interest margin in 2001. The significant decrease in DCB's cost of funds
resulted from higher yielding certificates of deposit repricing in 2001 and
slightly offset by the reduction in DCB's yield earned on interest-earning
assets. As a result of these shifts in the components of interest-earning assets
and interest-bearing liabilities, as well as movements in market interest rates,
DCB's net interest margin, which is calculated by dividing net interest income
by average interest-earning assets, increased from 3.83% in 2000 to 4.24% in
2001.
PROVISION AND ALLOWANCE FOR LOAN AND LEASE LOSSES. The provision for loan and
lease losses represents the charge to income necessary to adjust the allowance
for loan and lease losses to an amount that represents management's assessment
of the losses inherent in the Bank's loan portfolio. All lending activity
contains associated risks of loan losses and the Bank recognizes these credit
risks as a necessary element of its business activity. To assist in identifying
and managing potential loan losses, the Bank maintains a credit administration
function that regularly evaluates lending relationships as well as overall loan
portfolio conditions. One of the primary objectives of this credit
administration function is to make recommendations to management as to both
specific loss reserves and overall portfolio loss reserves.
The provision for loan and lease losses totaled $872 in 2001 compared to $908 in
2000. Net charge-offs for 2001 were $610, which represents 0.18% of average
loans, compared to net charge-offs of $367, or 0.11% of average loans in 2000.
DCB's provision is determined based upon management's estimate of the overall
collectibility of loans within the portfolio as determined by ongoing credit
reviews.
The allowance for loan and lease losses increased from $3,334 at year-end 2000
to $3,596 at year-end 2001. As a percent of gross loans and leases, the
allowance decreased slightly to 0.99% at year-end 2001 from 1.01% at year-end
2000. DCB maintains an allowance for loan and lease losses at a level to absorb
management's estimate of probable incurred credit losses in its portfolio.
Management performs an analysis of the loan portfolio on a monthly basis to
assess the adequacy of the allowance for loan and lease losses. The allowance
balance and the provision charged to expense are determined by management based
upon past loan loss experience, economic conditions and various other
circumstances that are subject to change over time. The collectibility of
certain specific loans is evaluated based upon various factors including the
financial position of the borrower and estimated collateral values. Historical
loss information of DCB is considered in establishing allowances on its
remaining portfolio.
NONINTEREST INCOME AND NONINTEREST EXPENSE. Total noninterest income increased
$1,089, or 27.0% to $5,119 in 2001 compared to $4,030 in 2000. The increase was
due primarily to increased gains from sales of loans, service charges on deposit
accounts due to increased volume and higher revenues from the trust department.
Total noninterest expense increased $4,410, or 33.6%, in 2001 compared to 2000.
The increase was primarily the result of increases in salaries and employee
benefits, occupancy and other expenses, which comprised $3,950 of the total
increase. The increase in compensation and employee benefits and occupancy
expense were planned increases relating to increased staffing and increased
operating costs associated with DCB's overall growth and its move into its new
corporate headquarters in the second quarter of 2001. In addition, the increase
in other expenses resulted from a one-time charge to expense of approximately
$1,440 relating to the disposal of several obsolete fixed assets from DCB's move
to the new corporate headquarters and re-assessment of the useful lives of
certain prepaid expenses and other assets. With its broad line of products and
services, DCB expects to be able to meet the needs of the market and obtain the
business needed to sustain the additional overhead expenses associated with the
new corporate headquarters and new branch operations.
INCOME TAXES. The change of income tax expense is primarily attributable to the
change in income before income taxes. See Note 9 to the consolidated financial
statements. The provision for income taxes totaled $2,245 in 2001 and $2,206 in
2000 resulting in effective tax rates of 33.3% and 32.3%.
8
Year ended December 31,
--------------------------------------------------------------------
2002 2001
--------------------------------- ---------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
----------- ---------- ------ ----------- ---------- ------
Interest-earning assets:
Federal funds sold $ 4,974 $ 74 1.49% $ 6,576 $ 275 4.18%
Taxable securities 99,746 5,378 5.39 111,476 7,135 6.40
Tax-exempt securities (1) 12,950 596 4.60 11,508 533 4.63
Loans and leases (2) 371,507 25,518 6.87 342,809 28,466 8.30
----------- ---------- ----- ----------- ---------- ------
Total interest-earning assets 489,177 31,566 6.45 472,369 36,409 7.71
Noninterest-earning assets 34,685 35,505
----------- -----------
Total assets $ 523,862 $ 507,874
=========== ===========
Interest-bearing liabilities:
Demand and money market deposits $ 161,950 $ 2,635 1.63% $ 195,416 $ 6,869 3.52%
Savings deposits 57,131 905 1.58 45,570 1,141 2.50
Certificates of deposit 145,647 5,331 3.66 120,250 6,384 5.31
----------- ---------- ----- ----------- ---------- ------
Total deposits 364,728 8,871 2.43 361,236 14,394 3.98
Borrowed funds 38,375 1,271 3.31 33,297 1,975 5.93
----------- ---------- ----- ----------- ---------- ------
Total interest-bearing liabilities 403,103 10,142 2.52 394,533 16,369 4.15
---------- ----------
Year ended December 31,
-----------------------------------
2000
-----------------------------------
Average Interest
outstanding earned/ Yield/
balance paid rate
----------- -------- ------
Interest-earning assets:
Federal funds sold $ 4,894 297 6.07%
Taxable securities 117,666 7,900 6.71%
Tax-exempt securities (1) 11,621 556 4.78
Loans and leases (2) 312,482 27,964 8.95
----------- --------- -----
Total interest-earning assets 446,663 36,717 8.22
Noninterest-earning assets 29,240
-----------
Total assets $ 475,903
===========
Interest-bearing liabilities:
Demand and money market deposits $ 193,699 $ 10,496 5.42%
Savings deposits 42,950 1,168 2.72
Certificates of deposit 108,985 6,374 5.85
----------- --------- -----
Total deposits 345,634 18,038 5.22
Borrowed funds 24,298 1,569 6.46
----------- --------- -----
Total interest-bearing liabilities 369,932 19,607 5.30
---------
(Continued on next page)
9
(Continued)
Year ended December 31,
---------------------------------------------------------------------
2002 2001
------------------------------------- ---------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
------------ --------- ------ ----------- --------- ------
Noninterest-bearing liabilities 69,547 65,473
------------ ---------
Total liabilities 472,650 460,006
Shareholders' equity 51,212 47,868
------------ ---------
Total liabilities & shareholders'
equity $ 523,862 $ 507,874
============ =========
Net interest income; interest rate spread $ 21,424 3.93% $ 20,040 3.56%
========= ====== ======== ======
Net interest margin (net interest income
as a percent of average interest-earning
assets) 4.38% 4.24%
====== ======
Average interest-earning assets to average
interest-bearing liabilities 121.35% 119.73%
====== ======
Year ended December 31,
----------------------------------------
2000
----------------------------------------
Average Interest
outstanding earned/ Yield/
balance paid rate
----------- ---------- -------
Noninterest-bearing liabilities 64,366
---------
Total liabilities 434,298
Shareholders' equity 41,605
---------
Total liabilities & shareholders'
equity $ 475,903
=========
Net interest income; interest rate spread $ 17,110 2.92%
========== ======
Net interest margin (net interest income
as a percent of average interest-earning
assets) 3.83%
======
Average interest-earning assets to average
interest-bearing liabilities 120.74%
======
- ------------------------
(1) Interest on tax-exempt securities is reported on a historical basis
without tax-equivalent adjustment. Interest on tax-exempt securities on
a tax equivalent basis was $903 in 2002, $808 in 2001, and $844 in
2000.
(2) Includes nonaccrual loans.
11
The table below describes the extent to which changes in interest rates and
changes in volume of interest-earning assets and interest-bearing liabilities
have affected DCB's interest income and expense during the years indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in volume
(multiplied by prior year rate); (2) changes in rate (multiplied by prior year
volume); and, (3) total changes in rate and volume. The combined effects of
changes in both volume and rate, that are not separately identified, have been
allocated proportionately to the change due to volume and change due to rate:
Year ended December 31,
----------------------------------------------------------------------------
2002 vs. 2001 2001 vs. 2000
--------------------------------------- ----------------------------------
Increase Increase
(decrease) (decrease)
due to due to
------------------------- -----------------------
Volume Rate Total Volume Rate Total
------------ ---------- --------- --------- ---------- ------
Interest income attributable to:
Federal funds sold $ (55) $ (146) $ (201) $ 85 $ (107) $ (22)
Taxable securities (703) (1,054) (1,757) (405) (360) (765)
Tax-exempt securities 66 (3) 63 (5) (18) (23)
Loans and leases 2,249 (5,197) (2,948) 2,602 (2,100) 502
----------- ---------- --------- -------- ---------- -------
Total interest income 1,557 (6,400) (4,843) 2,277 (2,585) (308)
----------- ---------- --------- -------- ---------- -------
Interest expense attributable to:
Demand and money market deposits (1,024) (3,210) (4,234) 92 (3,719) (3,627)
Savings deposits 246 (482) (236) 69 (96) (27)
Certificates of deposit 1,179 (2,232) (1,053) 627 (617) 10
Borrowed funds 267 (971) (704) 542 (136) 406
----------- ---------- ---------- -------- ---------- -------
Total interest expense 668 (6,895) (6,227) 1,330 (4,568) (3,238)
----------- ---------- --------- -------- ---------- -------
Increase in net
interest income $ 889 $ 495 $ 1,384 $ 947 $ 1,983 $ 2,930
=========== ========== ========= ======== ========== =======
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK
The Asset/Liability Committee (ALCO) of DCB Financial utilizes a variety of
tools to measure and monitor interest rate risk. This is defined as the risk
that DCB's financial condition will be adversely affected due to movements in
interest rates. To a lesser extent, DCB is also exposed to liquidity risk, or
the risk that changes in cash flows could adversely affect its ability to honor
its financial obligations. The income of financial institutions is primarily
derived from the excess of interest earned on interest-earning assets over the
interest paid on interest-bearing liabilities. Accordingly, the ALCO Committee
places great importance on monitoring and controlling interest rate risk. The
measurement and analysis of the exposure of DCB's primary operating subsidiary,
The Delaware County Bank and Trust Company, to changes in the interest rate
environment are referred to as asset/liability modeling. One method used to
analyze DCB's sensitivity to changes in interest rates is the "net portfolio
value" ("NPV") methodology.
NPV is generally considered to be the present value of the difference between
expected incoming cash flows on interest-earning and other assets and expected
outgoing cash flows on interest-bearing and other liabilities. For example, the
asset/liability model that DCB currently employs attempts to measure the change
in NPV for a variety of interest rate scenarios, typically for parallel shifts
of +/-100 to +/-300 basis points in market rates
12
Presented below is an analysis depicting the changes in DCB's interest rate risk
as of December 31, 2002, and December 31, 2001, as measured by changes in NPV
for instantaneous and sustained parallel shifts of -100 to +300 basis points in
market interest rates. These parallel shifts were used to more accurately
represent the current interest rate environment in which DCB Financial operates.
As illustrated in the tables, the institution's NPV is more sensitive to rising
rates than declining rates. From an overall perspective, such difference in
sensitivity occurs principally because the balance sheet of the bank is
liability sensitive. The liability sensitivity of the balance sheet is due to
the generally short-term nature of the banks liabilities, (checking, savings and
money market accounts) versus the longer-term nature of fixed rate installment
loans and commercial loans. Though the institution does employ variable loan
structures, these structures generally adjust based on annual time frames.
Additionally, as rates rise borrowers are less likely to refinance or payoff
loans prior to contractual maturities, increasing the risk that the institution
may hold below market rate loans in a rising rate environment.
The interest rate environment in which DCB currently operates also affects the
interest rate risk position. As mentioned above, the current interest rate
environment has allowed DCB to price a large portion of its deposit liabilities
under 1.0%, with the majority priced under 2.0%. This results in substantially
all deposits priced at or near 0% in downward shifts of interest rates. The
following table depicts the ALCO's five most likely interest rate scenarios and
their affect on NPV. The analysis presented in the table indicates that the
benefit in a declining rate environment is due to reduced funding costs or
liability sensitive balance sheet accompanied by fixed rate loans and
investments that continue to earn interest at their present levels. In a rising
rate environment, the same liability sensitive balance sheet results in a
decline in NPV.
The dollar and percentage change from 2001 to 2002 are mainly attributed to
two factors. First, there was a substantial decline in floating rate
liabilities coupled with an increase in fixed rate time deposits. Second,
throughout 2002 The Bank reduced its fixed rate investment portfolio and
increased its cash and cash equivalent balances. These two factors reduced the
overall liability-sensitive nature of the balance sheet, and reduced impairment
in an increasing interest rate environment.
December 31, 2002 December 31, 2001
Change in ----------------- -----------------
Interest Rate $ Change % Change NPV $ Change % Change NPV
(Basis Points) In NPV In NPV Ratio In NPV In NPV Ratio
- ------------- -------- -------- ----- -------- -------- -----
+300 $(12,029) (32)% 5.15% $(21,166) (41)% 6.07%
+200 (8,189) (22) 5.83 (9,269) (18) 8.26
+100 (4,188) (11) 6.51 (2,968) (6) 9.35
Base - - 7.21 - - 9.84
(100) 4,284 11 7.90 (4,018) (8) 9.10
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the NPV approach. For example, although certain assets and
liabilities may have similar maturities or periods of repricing, they may react
in different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Further, in the event of a change in interest
rates, expected rates of prepayment on loans and mortgage-backed securities and
early withdrawal levels from certificates of deposit would likely deviate
significantly from those assumed in making risk calculations.
13
In a rising interest rate environment, DCB's net interest income could be
negatively affected. Moreover, rising interest rates could negatively affect
DCB's earnings due to diminished loan demand. As part of its interest rate risk
strategy, DCB has attempted to utilize adjustable-rate and short-term-duration
loans and investments.
If overall rates and loan yields continue to decline, the Bank's ability to
reduce deposits rates will be limited by the zero interest rate floor. This
could negatively affect earnings and future NPV.
DCB intends to limit the addition of unhedged fixed-rate long-duration loans and
securities to its portfolio. In addition to this restructuring, the Bank offers
home equity products that reprice on a monthly basis and has pursued more
aggressively commercial and commercial real estate loans with shorter average
lives and variable interest rates. It is expected that as the size of these
portfolio segments grows, the interest rate risk will be lessened, though not
eliminated.
LIQUIDITY
Liquidity is the ability of DCB to fund customers' needs for borrowing and
deposit withdrawals. The purpose of liquidity management is to assure sufficient
cash flow to meet all of the financial commitments and to capitalize on
opportunities for business expansion. This ability depends on the institution's
financial strength, asset quality and types of deposit and investment
instruments offered by DCB to its customers. DCB's principal sources of funds
are deposits, loan and securities repayments, maturities of securities, sales of
securities available for sale and other funds provided by operations. The Bank
also has the ability to obtain funding from other sources including the FHLB,
Federal Reserve, and through its correspondent bank relationships. While
scheduled loan repayments and maturing investments are relatively predictable,
deposit flows and early loan and mortgage-backed security prepayments are more
influenced by interest rates, general economic conditions and competition. DCB
maintains investments in liquid assets based upon management's assessment of (1)
need for funds, (2) expected deposit flows, (3) yields available on short-term
liquid assets and (4) objectives of the asset/liability management program.
Cash and cash equivalents increased $14,558, or 81%, from $17,945 at year-end
2001 to $32,503 at year-end 2002. Cash and cash equivalents at year-end 2002
represented 6.2% of total assets compared to 3.5% of total assets at year-end
2001. The Bank has the ability to borrow funds from the Federal Home Loan Bank
and has various federal fund sources from correspondent banks, should DCB need
to supplement its future liquidity needs in order to meet loan demand or to fund
investment opportunities. Also during 2002, management designated its entire
held to maturity securities portfolio to available for sale after a held to
maturity security was sold for liquidity purposes. The additional available for
sale securities will provide a larger base from which to generate additional
liquidity as required. In addition to funding maturing deposits and other
deposit liabilities DCB Financial also has off-balance sheet commitments in the
form of lines of credit and letters of credit utilized by customers in the
normal course of business. Financial instruments include off-balance credit
instruments, such as commitments to make loans and standby letters of credit,
issued to meet customer financing needs. The face amount for these items
represents the exposure to loss, before considering customer collateral or
ability to repay. Such financial instruments are recorded when they are funded.
These off-balance sheet commitments are not considered to have a major effect on
the liquidity position of the organization. The Corporation did not enter into
any derivative contracts during 2002. Further, management believes the DCB's
liquidity position is strong based on its high level of cash, cash equivalents,
core deposits, the stability of its other funding sources and the support
provided by its capital base.
As summarized in the Consolidated Statements of Cash Flows, the most significant
transactions which affected the DCB's level of cash and cash equivalents, cash
flows and liquidity during 2002 were securities purchases of $45,380; the net
increase in loans of $9,458; the net increase in deposits of $7,909; securities
sales of $4,975; net repayments of borrowed funds totaling $5,634; and the
receipt of proceeds from maturities and repayments of securities of $63,624.
14
CAPITAL RESOURCES
Total shareholders' equity increased $3,407, primarily due to earnings retained
and the $997 after tax increase in the fair value of securities available for
sale. The increase is net of cash dividends paid of $1,392. In addition, the
Corporation purchased 11,510 shares of its common stock in 2002. Management may
continue to purchase shares in the future, as opportunities arise. The number of
shares to be purchased and the price to be paid will depend upon the
availability of shares, the prevailing market prices and any other
considerations that may, in the opinion of DCB's Board of Directors or
management, affect the advisability of purchasing shares.
Tier 1 capital is shareholders' equity excluding the unrealized gain or loss on
securities classified as available for sale and intangible assets. Total capital
includes Tier 1 capital plus the allowance for loan and lease losses, not to
exceed 1.25% of risk weighted assets. Risk weighted assets are DCB's total
assets after such assets are assessed for risk and assigned a weighting factor
based on their inherent risk.
DCB and its subsidiaries meet all regulatory capital requirements. DCB's ratio
of total capital to risk-weighted assets was 12.8% at year-end 2002, while the
Tier 1 risk-based capital ratio was 11.8%. Regulatory minimums call for a total
risk-based capital ratio of 8%, at least half of which must be Tier 1 capital.
DCB's leverage ratio, defined as Tier 1 capital divided by average assets, of
9.8% at year-end 2002 exceeded the regulatory minimum for capital adequacy
purposes of 4.0%.
15
DCB FINANCIAL CORP
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
(Dollars in thousands, except share amounts)
2002 2001
--------- ---------
ASSETS
Cash and due from financial institutions $ 28,622 $ 17,945
Federal funds sold 3,881 -
--------- ---------
Total cash and cash equivalents 32,503 17,945
Securities available for sale 96,477 84,021
Securities held to maturity (fair value of $35,274 in 2001) - 34,718
Loans held for sale 6,442 2,588
Loans and leases 370,581 362,556
Less allowance for loan and lease losses (4,094) (3,596)
--------- ---------
Net loans and leases 366,487 358,960
Premises and equipment, net 12,615 12,320
Investment in unconsolidated affilatae 1,951 1,951
Accrued interest receivable and other assets 6,523 6,877
--------- ---------
Total assets $ 522,998 $ 519,380
========= =========
LIABILITIES
Deposits
Noninterest-bearing $ 73,531 $ 69,859
Interest-bearing 365,092 360,855
--------- ---------
Total deposits 438,623 430,714
Federal funds purchased and other short-term borrowings 2,000 4,174
Federal Home Loan Bank advances 27,802 33,162
Accrued interest payable and other liabilities 2,045 2,209
--------- ---------
Total liabilities 470,470 470,259
SHAREHOLDERS' EQUITY
Common stock, no par value, 7,500,000 shares authorized,
4,273,200 issued 3,780 3,779
Retained earnings 49,303 46,720
Treasury stock, at cost, 104,966 and 95,000
shares in 2002 and 2001 (2,152) (1,978)
Accumulated other comprehensive income 1,597 600
--------- ---------
Total shareholders' equity 52,528 49,121
--------- ---------
Total liabilities and shareholders' equity $ 522,998 $ 519,380
========= =========
See accompanying notes to consolidated financial statements.
16
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2002, 2001 and 2000
(Dollars in thousands, except per share amounts)
2002 2001 2000
-------- -------- --------
Interest and dividend income
Loans, including fees $ 25,518 $ 28,466 $ 27,964
Taxable securities 5,378 7,135 7,900
Tax-exempt securities 596 533 556
Federal funds sold and other 74 275 297
-------- -------- --------
31,566 36,409 36,717
Interest expense
Deposits 8,871 14,394 18,038
Borrowings 1,271 1,975 1,569
-------- -------- --------
10,142 16,369 19,607
-------- -------- --------
Net interest income 21,424 20,040 17,110
Provision for loan and lease losses 2,950 872 908
-------- -------- --------
Net interest income after provision for loan and lease losses 18,474 19,168 16,202
Noninterest income
Service charges on deposit accounts 2,312 2,293 2,074
Trust department income 645 566 383
Net gains (losses) on sales of securities 26 4 (19)
Net gains on sales of loans 1,019 621 337
Cash management fees 519 394 320
Data processing service fees 391 300 267
Other 955 941 668
-------- -------- --------
5,867 5,119 4,030
Noninterest expense
Salaries and employee benefits 8,517 8,163 6,813
Occupancy and equipment 4,061 3,782 2,465
Professional services 624 484 433
Advertising 386 412 415
Postage, freight and courier 485 444 367
Supplies 316 361 320
State franchise taxes 590 541 514
Other 3,323 3,357 2,074
-------- -------- --------
18,302 17,544 13,401
-------- -------- --------
Income before income taxes 6,039 6,743 6,831
Income tax expense 2,036 2,245 2,206
-------- -------- --------
Net income $ 4,003 $ 4,498 $ 4,625
======== ======== ========
Basic and diluted earnings per common share $ .96 $ 1.08 $ 1.11
======== ======== ========
See accompanying notes to consolidated financial statements.
17
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2002, 2001 and 2000
(Dollars in thousands, except per share amounts)
Accumulated
Other Total
Common Retained Treasury Comprehensive Shareholders'
Stock Earnings Stock Income (Loss) Equity
-------- -------- -------- ------------- -------------
Balance at January 1, 2000 $ 3,779 $ 40,020 $ (1,978) $ (1,434) $ 40,387
Comprehensive income:
Net income - 4,625 - - 4,625
Other comprehensive income,
net of tax - - - 1,057 1,057
--------
Total comprehensive income 5,682
Cash dividends ($0.28 per share) - (1,170) - - (1,170)
-------- -------- -------- -------- --------
Balance at December 31, 2000 3,779 43,475 (1,978) (377) 44,899
Comprehensive income:
Net income - 4,498 - - 4,498
Other comprehensive income,
net of tax - - - 977 977
--------
Total comprehensive income 5,475
Cash dividends ($0.30 per share) - (1,253) - - (1,253)
-------- -------- -------- -------- --------
Balance at December 31, 2001 3,779 46,720 (1,978) 600 49,121
Comprehensive income:
Net income - 4,003 - - 4,003
Other comprehensive income,
net of tax - - - 997 997
--------
Total comprehensive income 5,000
Purchase of treasury stock -
11,510 shares at cost - - (201) - (201)
Shares issued in Dividend
Reinvestment Plan - 1,544 shares 1 - 27 - 28
Cash dividends ($0.34 per share) - (1,420) - - (1,420)
-------- -------- -------- -------- --------
Balance at December 31, 2002 $ 3,780 $ 49,303 $ (2,152) $ 1,597 $ 52,528
======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
18
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002, 2001 and 2000
(Dollars in thousands)
2002 2001 2000
------- -------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,003 $ 4,498 $ 4,625
Adjustments to reconcile net income to net cash from
operating activities
Depreciation 1,682 1,363 912
Provision for loan and lease losses 2,950 872 908
Deferred income taxes (93) (94) (51)
Net (gains) losses on sales of securities (26) (4) 19
Net gains on sales of loans (1,019) (621) (337)
Net securities amortization (accretion) 705 143 (226)
FHLB stock dividends (102) (138) (117)
Net change in loans held for sale (3,854) (1,483) (619)
Net changes in other assets and other liabilities (32) (217) 177
------- -------- --------
Net cash from operating activities 4,214 4,319 5,291
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale
Purchases (44,059) (42,544) (58,108)
Maturities, principal payments, and calls 55,002 56,426 18,297
Sales 4,169 5,658 31,765
Securities held to maturity
Purchases (1,321) (17,115) (2,846)
Maturities, principal payment, and calls 8,622 12,109 8,177
Sales 806 - -
Purchase of Federal Home Loan Bank stock (24) - -
Net change in loans (9,458) (31,406) (53,465)
Premises and equipment expenditures (2,175) (5,484) (5,031)
Proceeds from sale of premises and equipment - 77 -
Investment in unconsolidated affiliate - (20) (1,931)
------- -------- --------
Net cash from investing activities 11,562 (22,299) (63,142)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 7,909 11,768 47,146
Net change in federal funds purchased
and other short-term borrowings (2,174) 2,287 (11,113)
Proceeds from Federal Home Loan Bank advances 17,000 5,000 25,000
Repayment of Federal Home Loan Bank advances (22,360) (373) (354)
Purchase of treasury stock (201) - -
Cash dividends paid (1,392) (1,253) (1,170)
------- -------- --------
Net cash from financing activities (1,218) 17,429 59,509
------- -------- --------
Net change in cash and cash equivalents 14,558 (551) 1,658
Cash and cash equivalents at beginning of year 17,945 18,496 16,838
------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $32,503 $ 17,945 $ 18,496
======= ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $10,482 $ 16,978 $ 18,702
Income taxes paid 2,583 3,108 2,032
SUPPLEMENTAL NON CASH DISCLOSURES
Non-cash transfer of securities from held to maturity
to available for sale $26,490 - -
See accompanying notes to consolidated financial statements.
19
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The consolidated financial statements include the
accounts of DCB Financial Corp (DCB) and its wholly-owned subsidiary, The
Delaware County Bank and Trust Company (Bank), together referred to as the
Corporation. The financial statements of the Bank include accounts of its
wholly-owned subsidiaries, D.C.B. Corporation and 362 Corp. Intercompany
transactions and balances are eliminated in consolidation.
During 2000, DCB purchased a 9% interest in ProFinance Holdings Corporation, the
holding company for Century Surety Company, a property and casualty insurance
company. Accordingly, the investment is being carried at cost and is shown as
investment in unconsolidated affiliate on the consolidated balance sheet. The
investment is reviewed for impairment when events indicate the carrying amount
may not be recoverable from future undiscounted cash flows. If impaired, the
investment is recorded at the fair value.
Nature of Operations: DCB provides financial services through its sixteen
banking locations in Delaware, Franklin and Union Counties, Ohio. Its primary
deposit products are checking, savings, and term certificate accounts and its
primary lending products are residential mortgage, commercial and installment
loans. Substantially all loans are secured by specific items of collateral
including business assets, consumer assets, and real estate. Commercial loans
are expected to be repaid from cash flow operations of businesses. Real estate
loans are secured by both residential and commercial real estate. DCB also
operates a trust department and engages in mortgage banking operations.
Business Segments: While DCB's chief decision-makers monitor the revenue streams
of the various products and services, operations are managed and financial
performance is evaluated on a corporation-wide basis. Accordingly, all of DCB's
operations are considered by management to be aggregated in one reportable
operating segment.
Use of Estimates: To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect amounts reported in the financial statements and disclosures
provided, and future results could differ. The allowance for loan and lease
losses, fair value of financial instruments and status of contingencies are
particularly subject to change.
Cash Flows: Cash and cash equivalents include cash on hand, deposits with other
financial institutions and federal funds sold. Net cash flows are reported net
for customer loan and deposit transactions, federal funds purchased and other
short-term borrowings.
Securities: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with unrealized holding gains and losses reported in other comprehensive income.
Other securities such as Federal Home Loan Bank stock are carried at cost.
Interest income includes premium amortization and accretion of discounts on
securities. Gains and losses on sales are based on the amortized cost of the
security sold. Securities are written down to fair value when a decline in fair
value is not temporary.
(Continued)
20
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans and Leases: Loans and leases that management has the intent and ability to
hold for the foreseeable future or until maturity or payoff are reported at the
principal balance outstanding, net of unearned interest, deferred loan fees and
costs and an allowance for loan and lease losses. Loans held for sale are
reported at the lower of cost or market, on an aggregate basis.
Interest income is reported on the interest method and includes amortization of
net deferred loan fees and costs over the loan term. Interest income on mortgage
and commercial loans is discontinued at the time the loan is 90 days delinquent
unless the credit is well secured and in process of collection. In all cases,
loans are placed on nonaccrual or charged-off at an earlier date if collection
of principal or interest is considered doubtful.
All interest accrued but not received for loans placed on nonaccrual is reversed
against interest income. Interest received on such loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all the principal and interest amount
contractually due are brought current and future payments are reasonably
assured.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is
a valuation allowance for probable incurred credit losses, increased by the
provision for loan and lease losses and decreased by charge-offs less
recoveries. Management estimates the allowance balance required based on past
loan loss experience, the nature and volume of the portfolio, information about
specific borrower situations and estimated collateral values, economic
conditions and other factors. Allocations of the allowance may be made for
specific loans, but the entire allowance is available for any loan that, in
management's judgment, should be charged-off. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed.
A loan is impaired when full payment under the loan terms is not expected.
Commercial and commercial real estate loans are individually evaluated for
impairment. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future value
cash flows using the loan's existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Large groups of smaller
balance homogeneous loans, such as consumer and residential real estate loans,
are collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.
Concentrations of Credit Risk: The Bank grants commercial, real estate and
consumer loans primarily in Delaware, Ohio, and surrounding counties. Loans for
commercial real estate, farmland, construction and land development purposes
comprise 50% of loans at year end 2002. Loans for commercial purposes comprise
12% of loans, and include loans secured by business assets and agricultural
loans. Loans for residential real estate purposes, including home equity loans,
aggregate 24% of loans. Loans and leases for consumer purposes are primarily
secured by consumer assets and represent 14% of total loans. The borrowers'
ability to honor their contracts is not dependent on the economic status of any
single industry.
Premises and Equipment: Land is carried at cost. Premises and equipment are
stated at cost less accumulated depreciation. Depreciation is computed over the
assets' useful lives using straight line. These assets are reviewed for
impairment when events indicate the carrying amount may not be recoverable.
Maintenance and repairs are expensed and major improvements are capitalized.
(Continued)
21
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Foreclosed Assets: Assets acquired through or instead of loan foreclosure are
initially recorded at the lower of cost or market when acquired, establishing a
new cost basis. If fair value declines, a valuation allowance is recorded
through expense. Costs after acquisition are expensed.
Servicing Assets: Servicing assets represent the allocated value of retained
servicing on loans sold. Servicing assets are expensed in proportion to, and
over the period of, estimated net servicing revenues. Impairment is evaluated
based on the fair value of the assets, using groupings of the underlying loans
as to interest rates, and then secondarily as to geographic and prepayment
characteristics. Fair value is determined using prices for similar assets with
similar characteristics, when available, or based upon discounted cash flows
using market-based assumptions. Any impairment of a grouping is reported as a
valuation allowance. The Corporation had net servicing assets of $172 and $184
at December 31, 2002 and 2001.
Bank Owned Life Insurance: The Company has purchased life insurance policies on
certain key executives. Company owned life insurance is recorded at its cash
surrender value, or the amount that can be realized.
Income Taxes: Income tax expense is the sum of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax amounts of temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
Financial Instruments: Financial instruments include off-balance sheet credit
instruments, such as commitments to make loans and standby letters of credit,
issued to meet customer financing needs. The face amount for these items
represents the exposure to loss, before considering customer collateral or
ability to repay. Such financial instruments are recorded when they are funded.
Earnings Per Common Share: Basic earnings per common share is net income divided
by the weighted average number of common shares outstanding during the period.
The weighted average number of common shares outstanding was 4,171,703 for 2002
and 4,178,200 for 2001 and 2000. The Corporation does not have any securities
which could potentially dilute earnings per share.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes the unrealized gains
and losses on securities available for sale, which are also recognized as a
separate component of shareholders' equity.
Newly issued but not yet effective Accounting Standards: New accounting
standards on asset retirement obligations, restructuring activities and exit
costs, operating leases, and early extinguishment of debt were issued in 2002.
Management determined that when the new accounting standards are adopted in 2003
they will not have a material impact on the Company's financial condition or
results of operations.
(Continued)
22
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loss Contingencies: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there now are such matters that will have
a material effect on the financial statements.
Restrictions of Cash: Cash on hand or on deposit with the Federal Reserve Bank
of $7,022 and $6,952 was required to meet regulatory reserve and clearing
balance requirements at year-end 2002 and 2001. These balances do not earn
interest.
Dividend Restriction: Banking regulations require maintaining certain capital
levels and may limit the dividends paid by the Bank to DCB or by DCB to
shareholders. These restrictions pose no practical limit on the ability of the
Bank or DCB to pay dividends at historical levels.
Fair Value of Financial Instruments: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in a separate note. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk,
prepayments and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or market conditions could
significantly affect the estimates.
Reclassification: Some items in prior financial statements have been
reclassified to conform to the current presentation.
NOTE 2 - SECURITIES
The fair value of securities available for sale and the related gains and losses
recognized in accumulated other comprehensive income were as follows.
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
------- ---------- ----------
2002
U.S. government agencies $29,995 $ 735 $ (3)
States and political subdivisions 14,425 390 (6)
Corporate bonds 247 11 --
Mortgage-backed 49,448 1,291 (20)
------- ------- -------
Total debt securities 94,115 2,427 (29)
Other securities 2,362 31 (10)
------- ------- -------
Total $96,477 $ 2,458 $ (39)
======= ======= =======
(Continued)
23
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 2 - SECURITIES (Continued)
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
------- ---------- ----------
2001
U.S. government agencies $43,756 $ 804 $ (52)
States and political subdivisions 7,276 16 (132)
Corporate bonds 208 - (4)
Mortgage-backed 30,587 350 (83)
------- -------- -------
Total debt securities 81,827 1,170 (271)
Other securities 2,194 10 -
------- -------- -------
Total $84,021 $ 1,180 $ (271)
======= ======== =======
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows for 2001
Gross Gross
Carrying Unrecognized Unrecognized Fair
Amount Gains Losses Value
-------- ------------ ------------ -------
2001
States and political subdivisions $ 6,004 $ 134 $ (11) $ 6,127
Corporate bonds 130 - - 130
Mortgage-backed 28,584 498 (65) 29,017
------- ------- ------- -------
Total $34,718 $ 632 $ (76) $35,274
======= ======= ======= =======
During 2002, the Corporation sold a security classified as held to maturity, as
was deemed appropriate by management, as the security's attributes no longer met
asset/liability guidelines. Consequently, the Corporation will classify all
securities as available for sale for the foreseeable future. As a result, the
Corporation transferred $26,490 of securities held to maturity to available for
sale. The unrealized gain at the time the securities were transferred was $990.
The after tax effect of the transfer was to increase shareholders' equity by
$653 and is reflected as a cumulative effect adjustment in other comprehensive
income.
The fair value of debt securities, at year-end 2002 by contractual maturity were
as follows. Securities not due at a single maturity date, primarily
mortgage-backed securities, are shown separately.
Fair
Value
-------
Due in one year or less $ 2,009
Due from one to five years 7,994
Due from five to ten years 20,760
Due after ten years 13,904
Mortgage-backed securities 49,448
-------
$94,115
=======
(Continued)
24
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 2 - SECURITIES (Continued)
Sales of securities were as follows.
2002 2001 2000
-------- -------- --------
Proceeds $ 4,975 $ 5,658 $ 31,765
Gross gains 30 8 22
Gross losses (4) (4) (41)
At year-end 2002 and 2001, there were no holdings of securities of any one
issuer, other than the U.S. government and its agencies, in an amount greater
than 10% of shareholders' equity.
Securities with a carrying amount of $60,467 and $44,946 at year-end 2002 and
2001 were pledged to secure public deposits and other obligations.
NOTE 3 - LOANS AND LEASES
Year-end loans and leases were as follows:
2002 2001
--------- ---------
Commercial and industrial $ 45,543 $ 52,534
Commercial real estate 144,646 124,537
Residential real estate and home equity 87,548 88,797
Real estate construction and land development 37,603 34,212
Consumer and credit card 48,409 52,993
Direct lease financing 6,412 9,520
--------- ---------
370,161 362,593
Net deferred loan fees costs 1,132 1,303
Unearned income on leases (712) (1,340)
--------- ---------
$ 370,581 $ 362,556
========= =========
Loans to principal officers, directors, and their related affiliates in 2002
were as follows.
Beginning balance $ 8,437
New loans 1,970
Repayments (815)
Effect of changes in related parties (14)
-------
Ending balance $ 9,578
=======
(Continued)
25
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 4 - ALLOWANCE FOR LOAN AND LEASE LOSSES
Activity in the allowance for loan and lease losses was as follows.
2002 2001 2000
------- ------- -------
Beginning balance $ 3,596 $ 3,334 $ 2,793
Provision for loan and lease losses 2,950 872 908
Loans charged off (2,650) (765) (506)
Recoveries 198 155 139
------- ------- -------
Ending balance $ 4,094 $ 3,596 $ 3,334
======= ======= =======
Impaired loans were as follows at year-end
2002 2001
------- -------
Year-end loans with no allocated allowance for loan losses $ 464 $ 648
Year-end loans with allocated allowance for loan losses 3,735 2,915
------- -------
Total $ 4,199 $ 3,563
======= =======
Amount of the allowance for loan losses allocated $ 1,088 $ 1,110
======= =======
2002 2001 2000
------- ------- -------
Average of impaired loans during the year $ 5,204 $ 2,998 $ -
Interest income recognized during impairment 259 494 -
Cash basis interest income recognized 234 476 -
Nonperforming loans were as follows at year-end
2002 2001
------- -------
Loans past due over 90 days still accruing interest $ 187 $ 200
Nonaccrual loans 3,387 3,390
Nonperforming loans include both smaller balance homogeneous loans that are
collectively evaluated for impairment and individually classified impaired
loans.
(Continued)
26
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 5 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
2002 2001
-------- --------
Land $ 1,207 $ 1,207
Buildings 9,647 8,890
Furniture and equipment 7,497 6,503
-------- --------
18,351 16,600
Accumulated depreciation (5,736) (4,280)
-------- --------
$ 12,615 $ 12,320
======== ========
DCB has long-term operating leases for branch offices and equipment, which
expire at various dates through 2019, and provide options for renewals. Rental
expense on lease commitments for 2002, 2001 and 2000 amounted to $784, $865 and
$771. At December 31, 2002, the total future minimum lease commitments under
these leases are summarized as follows.
2003 $ 760
2004 716
2005 373
2006 352
2007 305
Thereafter 2,577
------
$5,083
======
DCB has entered into three leases for branch facilities with a partnership in
which a director of the Corporation holds a controlling interest. The leases
commenced on April 1, 1997, September 1, 1997 and May 24, 1999 and have original
terms of 20 years with annual rental payments of $84, $71 and $94.
NOTE 6 - INTEREST-BEARING DEPOSITS
Year-end interest-bearing deposits were as follows.
2002 2001
-------- --------
Interest-bearing demand $ 28,983 $ 27,051
Money market 114,935 151,335
Savings 69,802 50,515
Time deposits
In denominations under $100,000 93,352 82,723
In denominations of $100,000 or more 58,020 49,231
-------- --------
$365,092 $360,855
======== ========
(Continued)
27
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 6 - INTEREST-BEARING DEPOSITS (Continued)
Scheduled maturities of time deposits for the next five years were as follows:
2003 $ 90,093
2004 52,567
2005 7,713
2006 999
--------
$151,372
========
NOTE 7 - BORROWED FUNDS
Federal funds purchased and other short-term borrowings at year-end 2002 and
2001 were comprised of a demand note to the U.S. Treasury totaling $2,000 and
$274 respectively. The balance at year-end 2001 also included federal funds
purchased totaling $3,900.
Advances from the Federal Home Loan Bank at year-end were as follows.
2002 2001
------- -------
Fixed-rate FHLB advance, 6,67%, due February 2002 $ - $15,000
Fixed-rate FHLB advance, 2.25%, due May 2002 - 2,500
Fixed-rate FHLB advance, 2.40%, due October 2002 - 2,500
Fixed-rate FHLB advance, 2.62%, due January 2003 2,000 -
Variable-rate FHLB advance, 1.54%, due October 2003 5,000 5,000
Variable-rate FHLB advance, 1.54%, due August 2003 5,000 -
Fixed-rate FHLB advance, 5.50%, due May 2011 5,000 5,000
Fixed-rate FHLB advance, 5.10%, due October, 2008 2,802 3,162
Fixed-rate FHLB advance, 3.73%, due January, 2004 4,000 -
Fixed-rate FHLB advance, 4.52%, due January, 2005 4,000 -
------- -------
$27,802 $33,162
======= =======
As a member of the Federal Home Loan Bank of Cincinnati ("FHLB"), the Bank has
the ability to obtain additional borrowings based on DCB Financial's FHLB stock
investment and its level of qualified collateral. FHLB advances are
collateralized by a blanket pledge of the Bank's residential mortgage loan
portfolio and all shares of FHLB stock of $37,492 and $2,267 at December 31,
2002 and $44,770 and $2,111 at December 31, 2001.
(Continued)
28
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 7 - BORROWED FUNDS (Continued)
At year-end 2002, required annual principal payments on borrowed funds were as
follows:
2003 $12,443
2004 4,433
2005 4,456
2006 480
2007 505
Thereafter 5,485
-------
$27,802
=======
NOTE 8 - RETIREMENT PLANS
The Corporation provides a 401(k) savings plan for all eligible employees. To be
eligible, an individual must have at least 1,000 hours of service during a one
year period and must be 20 or more years of age. Participants are permitted to
make voluntary contributions to the Plan of up to 10% of the individual's
compensation. The Corporation matches 50% of those contributions up to a maximum
match of 3% of the participant's compensation. The Corporation may also provide
an additional discretionary contribution. Employee voluntary contributions are
vested at all times and Corporation contributions are fully vested after three
years. The 2002, 2001 and 2000 expense related to this plan was $184, $125 and
$207.
The Corporation maintains a supplemental post-retirement benefit plan for the
benefit of certain officers. The plan is designed to provide post-retirement
benefits to supplement other sources of retirement income such as social
security and 401(k) benefits. The benefits will be paid for a period of 15 years
after retirement. The amount of each officer's benefit will depend on their
salary at retirement as well as their other sources of retirement income. The
Corporation accrues the cost of these post-retirement benefits during the
working careers of the officers. Expense under this plan was ($30), $227 and
$108 in 2002, 2001 and 2000. The change in expense from 2001 to 2002 is
attributable to the reduction of the number of plan participants. Total accrued
liability under this plan was $405 and $435 at year-end 2002 and 2001.
The Corporation has purchased insurance contracts on the lives of the
participants in the supplemental post-retirement benefit plan and has named the
Corporation as the beneficiary. While no direct connection exists between the
supplemental post-retirement benefit plan and the life insurance contracts, it
is management's current intent that the earnings on the insurance contracts be
used as a funding source for the plan.
(Continued)
29
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 9 - INCOME TAXES
Income tax expense was as follows.
2002 2001 2000
------- ------- -------
Current $ 2,129 $ 2,339 $ 2,257
Deferred (93) (94) (51)
------- ------- -------
$ 2,036 $ 2,245 $ 2,206
======= ======= =======
The difference between financial statement tax provision and amounts computed by
applying the statutory federal income tax rate of 34% to income before income
taxes was as follows.
2002 2001 2000
------- ------- -------
Income taxes computed at the statutory federal
income tax rate $ 2,053 $ 2,293 $ 2,322
Tax exempt income (180) (154) (171)
Other 163 106 55
------- ------- -------
$ 2,036 $ 2,245 $ 2,206
======= ======= =======
Effective tax rate 33.7% 33.3% 32.3%
======= ======= =======
Year-end deferred tax assets and liabilities were due to the following.
2002 2001
------- -------
Deferred tax assets
Allowance for loan and lease losses $ 1,262 $ 1,056
Deferred compensation 137 148
Other 3 4
------- -------
1,402 1,208
Deferred tax liabilities
FHLB stock dividends (215) (181)
Unrealized gain on securities available for sale (822) (309)
Deferred loan fees and costs (144) (207)
Leases (1,073) (1,006)
Accumulated depreciation (366) (297)
Mortgage servicing rights (58) (63)
Other (10) (11)
------- -------
(2,688) (2,074)
------- -------
Net deferred tax liability $(1,286) $ (866)
======= =======
(Continued)
30
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 10 - COMMITMENTS, CONTINGENCIES AND FINANCIAL INSTRUMENTS
WITH OFF-BALANCE-SHEET RISK
Some financial instruments such as loan commitments, credit lines, letters of
credit and overdraft protection are issued to meet customer financing needs.
These are arrangements to provide credit or to support credit of others, as long
as conditions established in the contract are met, and usually have expiration
dates. Commitments may expire without being used. Off-balance-sheet risk to
credit loss exists up to the face amount of these instruments, although material
losses are not anticipated. The same credit policies are used for loans,
including obtaining collateral at exercise of the commitment.
The contractual amount of financing instruments with off-balance-sheet risk was
as follows at year-end.
2002 2001
---- ----
Fixed Variable Fixed Variable
Rate Rate Rate Rate
------- -------- ------- --------
Commitments to extend credit $ 1,711 $34,283 $ 2,642 $46,489
Unused lines of credit and letters of credit -- 39,566 -- 31,947
Commitments to make loans are generally made for periods of 30 days or less. The
fixed rate loan commitments have interest rates ranging from 5.50% to 8.13% for
2002 and 6.75% to 8.38% in 2001. Maturities for these fixed rate commitments
range from 15 to 30 years for both years.
The Corporation has entered into employment agreements with certain officers of
the Bank. The agreements provide for terms of one year that renew automatically
unless prior written notice is provided to the officer.
LEGAL PROCEEDINGS
A shareholder, S. Robert Davis ("Plaintiff"), brought an action (the "Suit") as
a shareholder derivative action in United States District Court for the Southern
District of Ohio, naming the Company, its Board of Directors, the members of the
Board of Directors, and the Company's former Chief Executive Officer as
defendants. He alleges to have sent correspondence constituting a demand under
Ohio law for inspection of the books and records of account of the Company and
its subsidiary, The Delaware County Bank and Trust Company, and that defendants
did not respond to this correspondence prior to the deadline set forth therein.
He alleges that his correspondence is due to inconsistencies in the explanation
of what comprises a certain reduction in earnings announced by the Company in a
press release issued December 12, 2001. Plaintiff claims material
misrepresentation, breach by the Company's directors of fiduciary duty, and
failure to follow proper accounting procedures. Plaintiff seeks among other
remedies an accounting and inspection of books and records of account. Plaintiff
further filed a motion for preliminary injunction on July 2, 2002, to which
defendants filed a response and a motion to dismiss the Suit. If defendants'
motion to dismiss is denied, defendants intend to vigorously oppose the Suit
denying liability.
In the opinion of management, based upon consultation with legal counsel,
although legal proceedings cannot be predicted with certainty, the ultimate
outcome of this Suit is not expected to have a material impact on the Company's
financial position or results of operation.
There is no other pending litigation, other than routine litigation incidental
to the business of the Corporation and Bank, or of a material nature involving
or naming the Corporation or Bank as a defendant. Further, there are no material
legal proceedings in which any director, executive officer, principal
shareholder or affiliate of the Corporation is a party or has a material
interest, which is adverse to the Corporation or Bank. No routine litigation in
which the Corporation or Bank is involved is expected to have a material adverse
impact on the financial position or results of operations of the Corporation or
Bank.
NOTE 11 - REGULATORY MATTERS
Banks and bank holding companies are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and,
additionally for banks, prompt corrective-action regulations involve
quantitative measures of assets, liabilities and certain off-balance-sheet items
calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by regulators. Failure
to meet various capital requirements can initiate regulatory action.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
The Corporation and the Bank met the well-capitalized requirements, as
previously defined, at December 31, 2002. The classification as well capitalized
is made periodically by regulators and is subject to change over time.
Management does not believe any condition or events have occurred since the
latest notification by regulators that would have changed the classification.
(Continued)
31
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 11 - REGULATORY MATTERS (Continued)
Actual and required capital ratios are presented below at year-end.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------ -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- ------- ------- ------- -----
2002
Total capital to risk-weighted assets
Consolidated $55,025 12.8% $34,427 8.0% $43,033 10.0%
Bank 51,435 12.1 33,882 8.0 42,352 10.0
Tier 1 (core) capital to risk
weighted assets
Consolidated 50,931 11.8 17,213 4.0 25,820 6.0
Bank 37,332 8.8 16,941 4.0 25,411 6.0
Tier 1 (core) capital to average assets
Consolidated 50,931 9.8 20,846 4.0 26,057 5.0
Bank 37,332 7.1 20,954 4.0 26,192 5.0
2001
Total capital to risk-weighted assets
Consolidated $52,103 11.8% $35,177 8.0% $43,971 10.0%
Bank 48,133 11.6 33,255 8.0 41,569 10.0
Tier 1 (core) capital to risk
weighted assets
Consolidated 48,503 11.0 17,588 4.0 26,383 6.0
Bank 44,534 10.7 16,627 4.0 24,941 6.0
Tier 1 (core) capital to average assets
Consolidated 48,503 9.4 20,551 4.0 25,689 5.0
Bank 44,534 8.8 20,316 4.0 25,395 5.0
(Continued)
32
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
Banking regulations limit capital distributions by the Bank. Generally, capital
distributions are limited to undistributed net income for the current and prior
two years. In addition, dividends may not reduce capital levels below the
minimum regulatory requirements disclosed above. Currently, the Bank does not
meet the requirements discussed above and must obtain prior regulatory approval
before declaring any proposed distributions.
(Continued)
33
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 12 - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as
follows at year-end.
2002 2001
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- ---------
Financial assets
Cash and cash equivalents $ 32,503 $ 32,503 $ 17,945 $ 17,945
Securities available for sale 96,477 96,477 84,021 84,021
Securities held to maturity -- -- 34,718 35,274
Loans held for sale 6,442 6,458 2,588 2,610
Loans (excluding leases) 364,881 369,008 354,376 357,465
Accrued interest receivable 2,188 2,188 2,912 2,912
Financial liabilities
Noninterest-bearing deposits $ (73,531) $ (73,531) $ (69,859) $ (69,859)
Interest-bearing deposits (365,092) (367,027) (360,855) (362,087)
Federal funds purchased and
other short-term borrowings (2,000) (2,000) (4,174) (4,174)
FHLB advances (27,802) (28,701) (33,162) (33,100)
Accrued interest payable (998) (998) (1,338) (1,338)
The estimated fair value approximates carrying amount for all items except those
described below. Estimated fair value for securities is based on quoted market
values for individual securities or for equivalent securities. For fixed rate
loans or deposits and for variable rate loans or deposits with infrequent
repricing or repricing limits, fair value is based on discounted cash flows
using current market rates applied to the estimated life and credit risk. Fair
values for impaired loans are estimated using discounted cash flow analysis or
underlying collateral values. Fair value of loans held for sale is based on
market quotes. Fair values of long-term borrowed funds are based on current
rates for similar financing. Fair values of off-balance-sheet items are based on
the current fee or cost that would be charged to enter into or terminate such
agreements, which are not material.
(Continued)
34
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 13 - OTHER COMPREHENSIVE INCOME
Other comprehensive income components and related taxes were as follows.
2002 2001 2000
------- ------- -------
Unrealized holding gains and (losses) on
available for sale securities $ 546 $ 1,480 $ 1,586
Reclassification adjustments for (gains) and losses
later recognized in income (26) (4) 19
Cumulative effect adjustment for the transfer
of securities from held to maturity to
available for sale 990 - -
------- ------- -------
Net unrealized gains and losses 1,510 1,476 1,605
Tax effect (513) (499) (548)
------- ------- -------
Other comprehensive income (loss) $ 997 $ 977 $ 1,057
======= ======= =======
(Continued)
35
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 14 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of DCB Financial Corp was as follows.
CONDENSED BALANCE SHEETS
December 31, 2002 and 2001
2002 2001
-------- --------
ASSETS
Cash and cash equivalents $ 58 $ 492
Investment in Bank subsidiary 38,946 45,151
Investment in unconsolidated affiliate 1,951 1,951
Subordinated note from Bank subsidiary 10,000 -
Other assets 1,705 1,547
-------- --------
Total assets $ 52,660 $ 49,141
======== ========
LIABILITIES
Other liabilities $ 132 $ 20
SHAREHOLDERS' EQUITY 52,528 49,121
-------- --------
Total liabilities and shareholders' equity $ 52,660 $ 49,141
======== ========
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
-------- -------- --------
Income
Dividends from Bank subsidiary $ 11,419 $ 1,253 $ 3,101
Other 80 69 42
-------- -------- --------
Total income 11,499 1,322 3,143
Operating expenses 293 64 64
-------- -------- --------
Income before income taxes and equity in
undistributed (distributions in excess of)
earnings of subsidiary 11,206 1,258 3,079
Income tax benefit - (5) (11)
-------- -------- --------
Income before equity in undistributed
earnings of subsidiary 11,206 1,263 3,090
Equity in undistributed (distribution in excess of)
earnings of subsidiary (7,203) 3,235 1,535
-------- -------- --------
NET INCOME $ 4,003 $ 4,498 $ 4,625
======== ======== ========
(Continued)
36
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 14 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,003 $ 4,498 $ 4,625
Adjustments to reconcile net income
to cash provided by operations:
(Equity in undistributed) distribution in
excess of earnings of subsidiary 7,203 (3,235) (1,535)
Net change in other assets and liabilities (47) (1,463) 21
-------- -------- --------
Net cash from operating activities 11,159 (200) 3,111
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in unconsolidated affiliate -- (20) (1,931)
Increase in subordinated note receivable (10,000) -- --
-------- -------- --------
Net cash from investing activities (10,000) (20) (1,931)
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid (1,392) (1,253) (1,170)
Purchase of treasury stock (201) -- --
-------- -------- --------
Net cash from financing activities (1,593) (1,253) (1,170)
-------- -------- --------
Net change in cash and cash equivalents (434) (1,473) 10
Cash and cash equivalents at beginning of period 492 1,965 1,955
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 58 $ 492 $ 1,955
======== ======== ========
NOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest Net Interest Net Earnings
Income Income Income Per Share
-------- ------------ ------ ---------
2002
First quarter $8,041 $5,387 $1,455 $ 0.35
Second quarter 8,022 5,474 1,168 0.28
Third quarter 7,925 5,377 757 0.18
Fourth quarter 7,578 5,186 623 0.15
2001
First quarter $9,470 $4,572 $1,407 $ 0.34
Second quarter 9,115 4,771 1,452 0.35
Third quarter 8,701 4,682 950 0.23
Fourth quarter 9,123 6,015 689 0.16
(Continued)
37
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
(Dollars in thousands)
NOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED)
During the fourth quarter 2002, DCB Financial recognized approximately $623 net
income, or $0.15 quarterly earnings per share. These results were $0.03 less
than the $0.18 quarterly earnings per share recognized in the third quarter
2002. This decline is mainly attributed to a decline in net interest margin and
increased allowance for loan and lease loss expense offset by an increase in
non-interest income and a decline in operating expenses.
Net interest income declined by approximately $190 from the third to fourth
quarters 2002. This is mainly attributed to a decline in the yield of the loan
and investment portfolios, not fully offset by the decrease in deposit rates.
During the fourth quarter DCB Financial recognized $1,250 of allowance for loan
and lease losses, which represents a $350 increase compared to the prior
quarter. This increase was mainly attributed to the increased funding of the
allowance for loan and lease losses after approximately $615 of loans were
charged off. Additionally, the new methodology adopted by the board and
management during the fourth quarter 2002 places more emphasis on current
economic condition components. Therefore, additional provision was recognized in
management's estimate, to account for the probable incurred losses associated
with the loan portfolio.
Also during the quarter non-interest revenue increased by $229, which is mainly
attributed to the increase in profits recognized through the sale of mortgage
loans sold in the secondary market. Due to low mortgage interest rates, DCB
experienced a high volume of mortgage refinancing. These market conditions were
more advantageous than those experienced in the third quarter.
Operating expenses declined by approximately $113, which is mainly attributed to
a decline in salary and benefit expense, offset by increases in other operating
expenses.
(Continued)
38
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
DCB Financial Corp
Lewis Center, Ohio
We have audited the accompanying consolidated balance sheets of DCB Financial
Corp as of December 31, 2002 and 2001, and the related consolidated statements
of income, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 2002. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of DCB Financial Corp
as of December 31, 2002 and 2001, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Crowe, Chizek and Company LLP
Columbus, Ohio
February 21, 2003
39