EXHIBIT 13
BUSINESS OF DCB FINANCIAL CORP
DCB Financial Corp ("DCB" or the "Corporation") 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 a
wholly-owned subsidiary of DCB.
The Bank conducts business from its main office at 110 Riverbend Avenue in Lewis
Center, Ohio and from its 15 full-service branch offices located in Delaware,
Ohio 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 agent services. Through its information
systems department, the Bank provides data processing, disaster recovery, and
check 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 in these counties
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 3,934,760 common shares outstanding on February 22, 2004, held of record
by approximately 1,600 shareholders. DCB's common stock is not traded on any
established securities market. At times however, various 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. is 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 2003 and 2002 that were not registered under the Securities
Acts.
1
Quarter ended
-------------------------------------------------------
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
--------- -------- ------------- ------------
High $ 19.00 $ 19.00 $ 18.40 $ 20.40
Low 17.75 16.60 16.10 17.40
Dividends per share 0.09 0.10 0.10 0.10
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
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 of DCB 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 CONSOLIDATED 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.
Selected consolidated financial condition data:
At December 31,
--------------------------------------------------------------
(In thousands) 2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Total assets $ 553,297 $ 522,998 $ 519,380 $ 497,250 $ 430,005
Cash and cash equivalents 20,349 32,503 17,945 18,496 16,838
Securities available for sale 108,547 96,477 84,021 101,955 91,909
Securities held to maturity -- -- 34,718 29,843 35,245
Net loans and leases 400,616 366,487 358,960 327,184 274,675
Deposits 442,352 438,623 430,714 418,946 371,799
Borrowed funds 54,312 29,802 37,336 30,422 16,889
Shareholders' equity 49,689 52,528 49,121 44,899 40,387
2
Year ended December 31,
--------------------------------------------------------------
Selected Operating Data: 2003 2002 2001 2000 1999
(In thousands, except per share data) ---------- ---------- ---------- ---------- ----------
Interest and dividend income $ 26,776 $ 30,882 $ 35,736 $ 36,717 $ 30,483
Interest expense 7,998 10,142 16,369 19,607 14,322
---------- ---------- ---------- ---------- ----------
Net interest income 18,778 20,740 19,367 17,110 16,161
Provision for loan and lease losses 1,418 2,950 872 908 1,495
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan and lease losses 17,360 17,790 18,495 16,202 14,666
Noninterest income 7,094 6,259 5,625 4,030 4,233
Noninterest expense 17,138 18,010 17,377 13,134 11,963
---------- ---------- ---------- ---------- ----------
Income before income tax 7,316 6,039 6,743 6,831 6,936
Income tax expense 2,287 2,036 2,245 2,206 2,154
---------- ---------- ---------- ---------- ----------
Net income $ 5,029 $ 4,003 $ 4,498 $ 4,625 $ 4,782
========== ========== ========== ========== ==========
Per Share Data:
Basic and diluted earnings per share $ 1.26 $ .96 $ 1.08 $ 1.11 $ 1.14
========== ========== ========== ========== ==========
Dividends declared per share $ 0.39 $ 0.34 $ 0.30 $ 0.28 $ 0.25
========== ========== ========== ========== ==========
At or for the year ended December 31,
--------------------------------------------------------------
Selected Financial Ratios: 2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Interest rate spread 3.52% 3.79% 3.42% 2.92% 3.20%
Net interest margin 3.78 4.24 4.10 3.83 4.07
Return on average equity 10.11 7.82 9.40 11.12 12.18
Return on average assets 0.91 0.76 0.89 0.97 1.13
Average equity to average assets 8.96 9.78 9.43 8.74 9.31
Dividend payout ratio 30.95 35.42 27.78 25.23 21.93
Allowance for loan and lease losses as
a percentage of nonperforming loans 151.18 114.55 100.17 224.81 444.75
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 consolidated
financial condition and results of operations as of and for the year ended
December 31, 2003, 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, the 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.
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 procedures for assessing the adequacy of the allowance for loan losses
reflect our evaluation of credit risk after careful consideration of all
information available to us. In developing this assessment, we must rely on
estimates and exercise judgment regarding matters where the ultimate outcome is
unknown such as economic factors, developments affecting companies in specific
industries and issues with respect to single borrowers. Depending on changes in
circumstances, future assessments of credit risk may yield materially different
results, which may require an increase or a decrease in the allowance for loan
losses.
The allowance is regularly reviewed by management to determine whether the
amount is considered adequate to absorb probable losses. This evaluation
includes specific loss estimates on certain individually reviewed loans,
statistical loss estimates for loan pools that are based on historical loss
experience, and general loss estimates that are based upon the size, quality,
and concentration characteristics of the various loan portfolios, adverse
situations that may affect a borrower's ability to repay, and current economic
and industry conditions. Also considered as part of that judgment is a
4
review of the Bank's trends in delinquencies and loan losses, as well as trends
in delinquencies and losses for the region and nationally, and economic factors.
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the loan portfolio.
Management's evaluation of the adequacy of the allowance is an estimate based on
management's current judgment about the credit quality of the loan portfolio.
While the Corporation strives to reflect all known risk factors in its
evaluations, judgment errors may occur.
ANALYSIS OF FINANCIAL CONDITION
DCB's assets totaled $553,297 at year-end 2003 compared to $522,998 at year-end
2002, an increase of $30,299, or 5.8%. The growth in assets was mainly
attributed to the loan growth the Corporation experienced within its normal
markets, particularly in the residential real estate market. Additionally during
2003, management aligned its balance sheet by reducing the Corporation's
liquidity to fund loan and investment growth. Additional financing was supplied
through increased borrowed funds, consisting mainly of Federal Home Loan Bank
advances. The liquidity risk associated with reduced cash and cash equivalent
balances were offset with by increased borrowings capability through
correspondent bank relationships.
Total securities increased to $108,547 at year-end 2003, compared to $96,477 at
year-end 2002. The increase in securities was the result of applying proceeds
from maturities, calls and principal repayments to fund additional investment
securities and by reducing short term cash equivalents and using the proceeds to
purchase higher yielding securities. DCB invests primarily in U.S. Treasury
notes, obligations of U.S. government agencies, 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 $38,201 at year-end 2003,
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. DCB held no derivative securities
or structured notes during any period presented.
Total loans increased $34,366, or 9.3%, from $370,581 at year-end 2002 to
$404,947 at year-end 2003. The growth in the overall loan portfolio was
attributed to large increases in residential real estate and home equity,
commercial and industrial, and commercial real estate loans offset by declines
in the real estate construction, consumer and credit card and lease financing
portfolios. Commercial real estate loans increased $12,190, or 8.4%, from
$144,646 at year-end 2002 to $156,836 at year-end 2003. Residential real estate
and home equity loans increased $29,550, or 33.8%, from $87,548 at year-end 2002
to $117,098 at year-end 2003. The increase in residential real estate loans is
attributed to the advantageous refinancing market that existed during 2003,
coupled with the strong economic growth in Delaware County.
Premises and equipment decreased $2,668 in 2003 from $12,615 at year-end 2002 to
$9,947 at year-end 2003. The decrease is mainly attributable to the sale of real
estate and branch buildings, and to a lesser extent, the retiring of various
pieces of equipment. During 2003, the Corporation sold a branch office that
management deemed unnecessary due to the geographic proximity of other area
branch locations.
Total deposits increased $3,729 or .9%, from $438,623 at year-end 2002 to
$442,352 at year-end 2003. Noninterest-bearing deposits increased $4,946, or
6.7%, while interest-bearing deposits decreased $1,217, or 0.3%.
Interest-bearing demand and money market deposits decreased from 39.4% of total
interest-bearing deposits at year-end 2002 to 43.9% of total interest-bearing
deposits at year-end 2003, as DCB
5
experienced a $15,921, or 11.1%, increase in volume of such accounts. The
increase in such deposits has been primarily due to economic trends resulting in
the shift of customer funds from other reinvestment alternatives to liquid
savings products. DCB experienced a decrease of $9,176 in savings deposits while
such accounts decreased from 19.1% of total interest-bearing deposits at
year-end 2002 to 16.7% of total interest-bearing deposits at year-end 2003.
Certificates of deposit decreased $7,962, or 5.3%, comprising 39.4% of total
interest-bearing deposits at year-end 2003 compared to 41.5% at year-end 2002.
Management attributes these trends to the rate structure of the Corporation's
deposit products and their relationship to the economic conditions under which
DCB operated during 2003. The lack of normal deposit growth is somewhat
attributed to the competition in the Bank's geographic area, where the increase
of competitors' branch locations has made it increasingly difficult to obtain
deposits. Management intends to continue to develop new products, and to monitor
the rate structure of its deposit products to encourage the growth within its
deposit liabilities.
Borrowed funds totaled $54,312 at year-end 2003 compared to $29,802 at year-end
2002. During 2003, management utilized the FHLB to fund loan growth to take
advantage of low borrowing costs due to the current economic environment. The
borrowings mainly consisted of long term FHLB advances that were used to fund
loan growth for commercial and residential loans.
Shareholders' equity declined by $2,839 during 2003, as treasury share
repurchases totaling $5,464, dividend payments of $1,557, and an $847 after tax
reduction in the fair value of securities designated as available for sale more
than offset period earnings of $5,029.
During 2003, the Board entered into an agreement with certain shareholders (the
"shareholder group") whereby the Corporation acquired 237,274 of its common
shares at an approximate total cost of $6,135 including approximately $427 of
legal and other pre-tax period costs charged to operations. Pursuant to the
agreement, the shareholder group also withdrew from a proxy contest and agreed
to withdraw now and in the future from offering various proposals to change
control of the Corporation through sale or otherwise. The Corporation recorded
the acquired treasury shares at fair value.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND
DECEMBER 31, 2002
NET INCOME. Net income for 2003 totaled $5,029, compared to net income for 2002
of $4,003. Basic and diluted earnings per share totaled $1.26 for 2003 and $.96
for 2002. Return on average assets was 0.91% and 0.76% for 2003 and 2002, while
return on average equity was 10.11% and 7.82% over the same two years. Net
income and fee income both increased during 2003 in comparison to 2002. The
increase in net income was related principally to growth in earning assets, the
allocation of funds from lower yielding to higher yielding asset categories,
reduced loan charge-offs and increased emphasis on operating expense cost
control.
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, the volume and the composition of
interest-earning assets and interest-bearing liabilities.
Net interest income was $18,778 for 2003 compared to $20,740 for 2002. The
decrease of $1,962 is attributed to reduced margins due to the overall decline
in interest rates experienced in 2003. Though DCB was able to reduce its overall
cost of funds through strategic initiatives developed through its
Asset/Liability Committee (ALCO), a significant portion of the Corporation's
loan portfolio is variable rate. This has caused assets to reprice downward at a
faster pace than liabilities. 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
6
average interest-earning assets, decreased from 4.24% in 2002 to 3.78% in 2003.
Additionally, because of the increased competition in the Bank's primary
marketplace, management has recognized the importance of offering special rates
on certain deposit products. These special deposit rates tend to negatively
effect the Corporation's net interest margin. It is likely that these offerings
will continue to be offered to gain a market share.
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. Management further
evaluates these reserve levels through an ongoing credit quality process, which
in addition to evaluating the current credit quality of the lending portfolios,
examines other economic indicators and trends, which could affect the overall
loss rates associated with the lending process.
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 the allowance for loan and lease losses totaled
$1,418 in 2003, compared to $2,950 in 2002. Net charge-offs for 2003 were
$1,181, which represents 0.31% of average loans, compared to net charge-offs of
$2,452, or 0.66% of average loans in 2002.
The allowance for loan and lease losses increased by $237 to $4,331 at year-end
2003 from $4,094 at year-end 2002. As a percent of gross loans and leases, the
allowance decreased to 1.07% at year-end 2003 from 1.10% at year-end 2002. 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.
Improved exposure to credit losses in the commercial loan portfolio required a
more normalized provision compared to the prior year. This decrease in
charge-offs during 2003 was mainly attributed to the improved economic
conditions that affected the commercial loan portfolio in the current year, and
to management's increased activities related to monetary, collection, and
workout of delinquent loans. Management continues to monitor exposure to
industry segments, and believes that the loan portfolio remains adequately
diversified.
To assist in identifying and managing potential loan and lease losses,
management maintains a methodology for establishing appropriate loan and lease
loss values. The Board of Directors has 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 involves identifying
both specific and non-specific components. The specific allowance allocation is
determined from information provided through the Bank's watch list, loan review
function and loan grade status applied to specific credits. The allocated
allowance 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, and
evaluates economic conditions as they relate to potential credit risk within its
portfolios on a quarterly basis.
NONINTEREST INCOME AND NONINTEREST EXPENSE. Total noninterest income increased
$835, or 13.3% to $7,094 in 2003 compared to $6,259 in 2002. The increase was
primarily attributed to the increased revenue generated by selling residential
mortgages in the secondary market and the sale of a branch location. During
2003, favorable economic interest rates created a large increase in mortgage
refinancing. Additionally, the Corporation experienced 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.
7
Total noninterest expense decreased $872, or 4.8%, in 2003 compared to 2002. The
decrease was primarily the result of decreases in salaries and employee
benefits, outside professional services, and various operating costs due to
management's new expense control initiatives. The decrease in outside
professional services is attributed to decreased consulting and legal fees. The
decrease in compensation and employee benefits were planned decreases relating
to management's human resource efficiency initiatives implemented during 2003.
INCOME TAXES. The change in income tax expense is primarily attributable to the
increase in tax exempt earnings offset by the growth in income before income
taxes. See Note 9 to the Consolidated Financial Statements for additional
information regarding income taxes. The provision for income taxes totaled
$2,287 in 2003 and $2,036 in 2002 resulting in effective tax rates of 31.3% and
33.7%.
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. Basic and diluted earnings per share totaled $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 equity was 7.82% and 9.40% over the comparable two-year
period. Net interest income and fee income both increased during 2002 in
comparison to 2001. The decline in net income in 2002 related principally to an
increase in the allowance for loan and lease losses, as a result of 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 $20,740 for 2002 compared to $19,367 for 2001. The
increase of $1,373 is attributed to the higher level of interest-bearing assets
and the decrease in the Corporation'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 overall ability of management to control costs
on savings, checking and other deposit accounts. The culmination of the these
shifts in the components of interest-earning assets and interest-bearing
liabilities, as well as movements in overall market interest rates, resulted in
a modest decline in net interest margin from 4.24% in 2001 to 4.10% 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.
As stated previously, 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.
Exposure to credit losses in the commercial loan portfolio required the
recognition of an additional provision compared to the 2001. This increase in
the provision was due to a number of factors
8
including deteriorating economic conditions related to specific credits in the
commercial loan portfolio and management's decision to accelerate its workout
strategies for certain borrowers.
Specifically, 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 declining economic prospects. The net charge-offs
associated with these four loans were approximately $1.7 million or 69% of the
total net charge-offs for the year. Management continues to monitor exposure to
industry segments, and believes that the loan portfolios remain adequately
diversified.
NONINTEREST INCOME AND NONINTEREST EXPENSE. Total noninterest income increased
$634, or 11.27% to $6,259 in 2002 compared to $5,625 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 Corporation 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 $633, or 3.6%, 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. The increases in these fees was mainly attributable
to legal and consulting fees associated with the aforementioned 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. Income taxes totaled $2,036 for 2002, as compared to $2,245 in
2001. The 9.3% decline in income tax expense is primarily attributable to the
10.5% reduction in income before income taxes. See Note 9 to the Consolidated
Financial Statements for additional information regarding income taxes. The
provision for income taxes resulted in effective tax rates of 33.7% and 33.3%
for 2002 and 2001.
9
Year ended December 31,
---------------------------------------------------------------------------
2003 2002
------------------------------------- ----------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
----------- ---------- -------- ----------- ---------- -------
Interest-earning assets:
Federal funds sold $ 14,082 $ 143 1.02% $ 4,974 $ 74 1.49%
Taxable securities 77,882 2,874 3.69 99,746 5,378 5.39
Tax-exempt securities (1) 17,049 702 4.12 12,950 596 4.60
Loans and leases (2) 387,627 23,057 5.95 371,507 24,834 6.68
----------- ---------- -------- ----------- ---------- -------
Total interest-earning assets 496,640 26,776 5.39 489,177 30,882 6.31
Noninterest-earning assets 58,209 34,685
----------- -----------
Total assets $ 554,849 $ 523,862
=========== ===========
Interest-bearing liabilities:
Demand and money market deposits $ 171,045 $ 2,148 1.26% $ 161,950 $ 2,635 1.63%
Savings deposits 62,792 420 0.67 57,131 905 1.58
Certificates of deposit 141,650 4,100 2.89 145,647 5,331 3.66
----------- ---------- -------- ----------- ---------- -------
Total deposits 375,486 6,668 1.78 364,728 8,871 2.43
Borrowed funds 51,146 1,330 2.60 38,375 1,271 3.31
----------- ---------- -------- ----------- ---------- -------
Total interest-bearing liabilities 426,633 7,998 1.87 403,103 10,142 2.52
---------- ----------
Noninterest-bearing liabilities 78,480 69,547
----------- -----------
Total liabilities 505,113 472,650
Shareholders' equity 49,736 51,212
----------- -----------
Total liabilities & shareholders'
equity $ 554,849 $ 523,862
=========== ===========
Net interest income; interest rate spread $ 18,778 3.52% $ 20,740 3.79%
========== ======== ========== =======
Net interest margin (net interest income
as a percent of average interest-earning
assets) 3.78% 4.24%
======== =======
Average interest-earning assets to average
interest-bearing liabilities 116.41% 121.35%
======== =======
Year ended December 31,
-------------------------------------
2001
-------------------------------------
Average Interest
outstanding earned/ Yield/
balance paid rate
----------- ---------- --------
Interest-earning assets:
Federal funds sold $ 6,576 $ 275 4.18%
Taxable securities 111,476 7,082 6.35
Tax-exempt securities (1) 11,508 533 4.63
Loans and leases (2) 342,809 27,846 8.12
----------- ---------- --------
Total interest-earning assets 472,369 35,736 7.57
Noninterest-earning assets 35,505
-----------
Total assets $ 507,874
===========
Interest-bearing liabilities:
Demand and money market deposits $ 195,416 $ 6,869 3.52%
Savings deposits 45,570 1,141 2.50
Certificates of deposit 120,250 6,384 5.31
----------- ---------- --------
Total deposits 361,236 14,394 3.98
Borrowed funds 33,297 1,975 5.93
----------- ---------- --------
Total interest-bearing liabilities 394,533 16,369 4.15
----------
Noninterest-bearing liabilities 65,473
-----------
Total liabilities 460,006
Shareholders' equity 47,868
-----------
Total liabilities & shareholders'
equity $ 507,874
===========
Net interest income; interest rate spread $ 19,367 3.42%
========== ========
Net interest margin (net interest income
as a percent of average interest-earning
assets) 4.10%
========
Average interest-earning assets to average
interest-bearing liabilities 119.73%
========
- ------------------------
(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 $1,064 in 2003, $903 in 2002, and $808 in 2001.
(2) Includes nonaccrual loans.
10
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,
------------------------------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001
--------------------------------------- ----------------------------------------
Increase Increase
(decrease) (decrease)
due to due to
------------------------ -------------------------
Volume Rate Total Volume Rate Total
---------- ---------- ---------- ---------- ---------- ----------
Interest income attributable to:
Federal funds sold $ 136 $ (67) $ 69 $ (55) $ (146) $ (201)
Taxable securities (1,179) (1,325) (2,504) (703) (1,001) (1,704)
Tax-exempt securities 189 (83) 106 66 (3) 63
Loans and leases 1,071 (2,848) (1,777) 2,249 (5,261) (3,012)
---------- ---------- ---------- ---------- ---------- ----------
Total interest income 217 (4,323) (4,106) 1,557 (6,411) (4,854)
---------- ---------- ---------- ---------- ---------- ----------
Interest expense attributable to:
Demand and money market deposits 148 (636) (488) (1,024) (3,210) (4,234)
Savings deposits 90 (574) (484) 246 (482) (236)
Certificates of deposit (146) (1,085) (1,231) 1,179 (2,232) (1,053)
Borrowed funds 422 (363) 59 267 (971) (704)
---------- ---------- ---------- ---------- ---------- ----------
Total interest expense 514 (2,658) (2,144) 668 (6,895) (6,227)
---------- ---------- ---------- ---------- ---------- ----------
Increase (decrease) in net
interest income $ (297) $ (1,665) $ (1,962) $ 889 $ 484 $ 1,373
========== ========== ========== ========== ========== ==========
ASSET AND LIABILITY MANAGEMENT AND MARKET RISK
The ALCO of DCB Financial Corp 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
11
Presented below is an analysis depicting the changes in DCB's interest rate risk
as of December 31, 2003, and December 31, 2002, 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 2003 to 2002 are mainly attributed to
three factors. First, there was a substantial decline in floating rate
liabilities coupled with an increase in fixed rate time deposits. Second,
throughout 2003 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 the
potential impairment of NPV in a +300 increasing interest rate environment.
These favorable trends were more than offset by the effect of a reduction in the
Corporation's capital during 2003.
December 31, 2003 December 31, 2002
Change in ------------------------------------ ------------------------------
Interest Rate $ Change % Change NPV $ Change % Change NPV
(Basis Points) In NPV In NPV Ratio In NPV In NPV Ratio
- -------------- -------- -------- ----- -------- -------- -----
+300 $(15,668) (42)% 4.14% $(12,029) (32)% 5.15%
+200 (10,709) (29) 4.99 (8,189) (22) 5.83
+100 (5,489) (15) 5.85 (4,188) (11) 6.51
Base - - 6.71 - - 7.21
- -100 4,163 11.26 7.31 4,284 11 7.90
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.
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
12
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 decreased $12,154, or 37.4%, from $32,503 at year-end
2002 to $20,349 at year-end 2003. Cash and cash equivalents at year-end 2003
represented 3.7% of total assets compared to 6.2% of total assets at year-end
2002. 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
securities portfolio as available for sale following the sale of a held to
maturity security for liquidity purposes. The change in the available for sale
designation 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 Corporation. The Corporation did not enter into
any derivative contracts during 2003. 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 2003 were securities purchases of $87,391; the net
increase in loans of $34,568; the net increase in deposits of $3,729; securities
sales of $27,866; net proceeds from FHLB advances and other short-term
borrowings totaling $24,510; and the receipt of proceeds from maturities and
repayments of securities of $44,961.
13
CAPITAL RESOURCES
As previously stated, total shareholders' equity decreased $2,839, primarily due
to the purchase of treasury stock totaling $5,464 and a an $847 after tax
decrease in the fair value of securities available for sale, both of which were
partially offset by period earnings of $5,029. The reduction of shareholders'
equity was also attributable to cash dividends of $1,557. 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 net 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
consolidated ratio of total capital to risk-weighted assets was 11.50% at
year-end 2003, while the Tier 1 risk-based consolidated capital ratio was
10.56%. Regulatory minimums call for a total risk-based capital ratio of 8%, at
least half of which must be Tier 1 capital. DCB's consolidated leverage ratio,
defined as Tier 1 capital divided by average assets, of 8.82% at year-end 2003
exceeded the regulatory minimum for capital adequacy purposes of 4.0%.
The following table sets forth the Corporation's obligations and commitments to
make future payments under contract as of December 31, 2003.
PAYMENT DUE BY YEAR
CONTRACTUAL OBLIGATIONS
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
Long-Term Debt Obligations $ 49,693 $ 4,000 $7,000 $ - $38,693
Capital Lease Obligations - - - - -
Operating Lease Obligations 5,650 744 817 652 3,437
Loan and Line of Credit
Commitments 81,384 81,384 - - -
Other Long-Term Liabilities
Reflected on the Corporations's
Balance Sheet under GAAP - - - - -
-------- ------- ------ ---- -------
Total Contractual Obligations $136,727 $86,128 $7,817 $652 $42,130
======== ======= ====== ==== =======
14
DCB FINANCIAL CORP
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
(Dollars in thousands, except share amounts)
2003 2002
---- ----
ASSETS
Cash and due from financial institutions $ 20,349 $ 28,622
Federal funds sold -- 3,881
----------- -----------
Total cash and cash equivalents 20,349 32,503
Securities available for sale 108,547 96,477
Loans held for sale -- 6,442
Loans and leases 404,947 370,581
Less allowance for loan and lease losses (4,331) (4,094)
----------- -----------
Net loans and leases 400,616 366,487
Premises and equipment, net 9,947 12,615
Investment in unconsolidated affiliate 1,951 1,951
Accrued interest receivable and other assets 11,887 6,523
----------- -----------
Total assets $ 553,297 $ 522,998
=========== ===========
LIABILITIES
Deposits
Noninterest-bearing $ 78,477 $ 73,531
Interest-bearing 363,875 365,092
----------- -----------
Total deposits 442,352 438,623
Federal funds purchased and other short-term borrowings 4,619 2,000
Federal Home Loan Bank advances 49,693 27,802
Accrued interest payable and other liabilities 6,944 2,045
----------- -----------
Total liabilities 503,608 470,470
SHAREHOLDERS' EQUITY
Common stock, no par value, 7,500,000 shares authorized,
4,273,200 issued 3,780 3,780
Retained earnings 52,775 49,303
Treasury stock, at cost, 338,440 and 104,966
shares at December 31, 2003 and 2002 (7,616) (2,152)
Accumulated other comprehensive income 750 1,597
----------- -----------
Total shareholders' equity 49,689 52,528
----------- -----------
Total liabilities and shareholders' equity $ 553,297 $ 522,998
=========== ===========
See accompanying notes to consolidated financial statements.
15
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share amounts)
2003 2002 2001
---- ---- ----
Interest and dividend income
Loans, including fees $ 23,057 $ 24,834 $ 27,846
Taxable securities 2,874 5,378 7,082
Tax-exempt securities 702 596 533
Federal funds sold and other 143 74 275
---------- --------- ----------
Total 26,776 30,882 35,736
Interest expense
Deposits 6,668 8,871 14,394
Borrowings 1,330 1,271 1,975
---------- --------- ----------
Total 7,998 10,142 16,369
---------- --------- ----------
Net interest income 18,778 20,740 19,367
Provision for loan and lease losses 1,418 2,950 872
---------- --------- ----------
Net interest income after provision for loan and lease losses 17,360 17,790 18,495
Noninterest income
Service charges 3,060 2,996 2,935
Trust department income 609 538 466
Net gains on sales of securities 51 26 4
Net gains on sale of property 649 -- --
Net gains on sales of loans 979 1,019 621
Cash management fees 522 519 394
Data processing service fees 366 391 300
Other 858 770 905
---------- --------- ----------
7,094 6,259 5,625
Noninterest expense
Salaries and employee benefits 8,168 8,517 8,163
Occupancy and equipment 4,006 3,877 3,560
Professional services 578 624 418
Advertising 315 386 427
Postage, freight and courier 346 485 444
Supplies 268 316 363
State franchise taxes 484 590 541
Other 2,973 3,215 3,461
---------- --------- ----------
17,138 18,010 17,377
---------- --------- ----------
Income before income taxes 7,316 6,039 6,743
Income tax expense 2,287 2,036 2,245
---------- --------- ----------
Net income $ 5,029 $ 4,003 $ 4,498
========== ========= ==========
Basic and diluted earnings per common share $ 1.26 $ .96 $ 1.08
========== ========= ==========
See accompanying notes to consolidated financial statements.
16
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year ended December 31, 2003, 2002, and 2001
(Dollars in thousands, except per share data)
2003 2002 2001
---- ---- ----
Net income $ 5,029 $ 4,003 $ 4,498
Less reclassification for realized gains on
sale of securities included in operations,
net of tax (34) (17) (3)
Unrealized gains (losses) on securities
available for sale, net of tax (813) 1,014 980
------- ------- -------
Comprehensive income $ 4,182 $ 5,000 $ 5,475
======= ======= =======
See accompanying notes to consolidated financial statements.
17
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Year ended December 31, 2003, 2002 and 2001
(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, 2001 $ 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 through 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
Comprehensive income:
Net income - 5,029 - - 5,029
Other comprehensive loss,
net of tax - - - (847) (847)
---------
Total comprehensive income 4,182
Purchase of treasury stock -
237,274 shares at cost - - (5,536) - (5,536)
Sale of 3,800 shares of treasury stock - - 72 - 72
Cash dividends ($0.39 per share) - (1,557) - - (1,557)
---------- ---------- ---------- ---------- ---------
Balance at December 31, 2003 $ 3,780 $ 52,775 $ (7,616) $ 750 $ 49,689
========== ========== ========== ========== =========
See accompanying notes to consolidated financial statements.
18
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, 2003, 2002 and 2001
(Dollars in thousands)
2003 2002 2001
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,029 $ 4,003 $ 4,498
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Depreciation 1,815 1,682 1,363
Provision for loan and lease losses 1,418 2,950 872
Deferred income taxes 209 (93) (94)
Net gains on sales of securities (51) (26) (4)
Net gains on sales of loans (979) (1,019) (621)
Net gains on sales of property (649) - -
Net securities amortization 1,356 705 143
FHLB stock dividends (92) (102) (138)
Net change in loans held for sale 6,442 (3,854) (1,483)
Net changes in other assets and other liabilities (257) (32) (217)
---------- --------- ----------
Net cash provided by operating activities 14,241 4,214 4,319
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Securities available for sale
Purchases (87,391) (44,059) (42,544)
Maturities, principal payments, and calls 44,961 55,002 56,426
Sales 27,866 4,169 5,658
Securities held to maturity
Purchases - (1,321) (17,115)
Maturities, principal payment, and calls - 8,622 12,109
Sales - 806 -
Purchase of Federal Home Loan Bank stock - (24) -
Net change in loans (33,360) (9,458) (31,406)
Premises and equipment expenditures (281) (2,175) (5,484)
Proceeds from sale of premises and equipment 575 - 77
Investment in unconsolidated affiliate - - (20)
---------- --------- ----------
Net cash provided by (used in) investing activities (47,630) 11,562 (22,299)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Net change in deposits 3,729 7,909 11,768
Net change in federal funds purchased
and other short-term borrowings 2,619 (2,174) 2,287
Proceeds from Federal Home Loan Bank advances 37,746 17,000 5,000
Repayment of Federal Home Loan Bank advances (15,855) (22,360) (373)
Purchase of treasury stock, net (5,464) (201) -
Cash dividends paid (1,540) (1,392) (1,253)
---------- --------- ----------
Net cash provided by (used in) financing activities 21,235 (1,218) 17,429
---------- --------- ----------
Net change in cash and cash equivalents (12,154) 14,558 (551)
Cash and cash equivalents at beginning of year 32,503 17,945 18,496
---------- --------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 20,349 $ 32,503 $ 17,945
========== ========= ==========
See accompanying notes to consolidated financial statements.
19
DCB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, 2003, 2002 and 2001
(Dollars in thousands)
2003 2002 2001
---- ---- ----
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 7,821 $10,482 $16,978
======= ======= =======
Income taxes paid 1,137 2,583 3,108
======= ======= =======
SUPPLEMENTAL NON CASH DISCLOSURES
Non-cash transfer of securities from held to maturity
to available for sale -- 26,490 --
======= ======= =======
Unrealized gains (losses) on securities designated as
available for sale, net of tax $ (847) $ 997 $ 977
======= ======= =======
Loan to finance sale of premises and equipment $ 1,208 $ -- $ --
======= ======= =======
See accompanying notes to consolidated financial statements.
20
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(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), collectively referred to
hereinafter as the Corporation. All intercompany transactions and balances have
been eliminated in the consolidated financial statements.
During 2000, DCB purchased a 9% interest in ProCentury Corporation, the holding
company for Century Surety Company, a property and casualty insurance company.
DCB does not exert significant influence over ProCentury, and accordingly, the
investment is being carried at cost and is shown as an investment in
unconsolidated affiliate. This investment is reviewed for impairment when events
indicate the carrying amount may not be recoverable from future undiscounted
cash flows. If impaired, the ProCentury investment will be recorded at fair
value.
Nature of Operations: DCB provides financial services through its fifteen
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, engages in mortgage banking operations, and
supplies data processing and business recovery services to other financial
institutions.
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 consolidated 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 for
customer loan and deposit transactions, federal funds purchased and other
short-term borrowings.
Securities: Securities may be classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities may be classified as available for sale as such
securities might be sold before maturity. Securities available for sale are
carried at fair value, with unrealized holding gains and losses reported as a
component of other comprehensive income. Other securities such as Federal Home
Loan Bank stock are carried at cost. The Corporation does not operate a
securities trading account.
Interest income includes premium amortization and accretion of discounts on
securities. Gains and losses on sales are based on the net carrying value of the
security sold. Securities are written down to fair value when a decline in fair
value is not temporary.
(Continued)
21
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(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 the allowance for loan and lease losses. Loans held for sale are
reported at the lower of cost or market, determined in the aggregate.
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 required allowance balance 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. 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 industrial, commercial real estate, and land development 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, such loans are not separately identified for impairment
disclosures.
Concentrations of Credit Risk: The Bank grants commercial, real estate and
consumer loans primarily in Delaware, and the surrounding counties. Loans for
commercial real estate, farmland, construction and land development purposes
comprise 46% of loans at year end 2003. Loans for commercial purposes comprise
13% of loans, and include loans secured by business assets and agricultural
loans. Loans for residential real estate purposes, including home equity loans,
aggregate 29% of loans. Loans and leases for consumer purposes are primarily
secured by consumer assets and represent 12% of total loans.
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 the straight line method. 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)
22
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(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 below such amount, a valuation allowance
is recorded through expense. Holding 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 $147 and $172
at December 31, 2003 and 2002.
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 the 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 4,000,161 for 2003
and 4,171,703 for 2002 and 4,178,200 for 2001. The shareholders approved the
issuance of preferred stock during 2003, though no stock was issued under the
plan. In addition, 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 consists solely of net
unrealized gains on securities available for sale which is recognized as a
separate component of shareholders' equity.
Newly issued but not yet effective Accounting Standards: New accounting
standards on hedging, financial instruments, and variable interest entities were
issued in 2003. Management determined that when the new accounting standards are
adopted they will not have a material impact on the Company's financial
condition or results of operations.
(Continued)
23
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank
of $9,649 and $7,022 was required to meet regulatory reserve and clearing
balance requirements at year-end 2003 and 2002. These balances do not earn
interest.
Dividend Restrictions: 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: Certain amounts in the prior consolidated financial statements
have been reclassified to conform to the current year 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
---------- ---------- ----------
2003
U.S. government agencies $ 38,597 $ 251 $ (47)
States and political subdivisions 21,076 580 (93)
Corporate bonds 8,215 11 (45)
Mortgage-backed and related securities 38,201 621 (170)
---------- ---------- ----------
Total debt securities 106,089 1,463 (355)
Other securities 2,458 28 --
---------- ---------- ----------
Total $ 108,547 $ 1,491 $ (355)
========== ========== ==========
(Continued)
24
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 2 - SECURITIES (Continued)
The table below indicates the length of time individual securities have been in
a continuous unrealized loss position at December 31, 2003:
(Less than 12 months) (12 months or longer) Total
Description of Number of Fair Unrealized Number of Fair Unrealized Number of Fair Unrealized
Securities investments value losses investments value losses investments value losses
- ---------- ----------- ----- ------ ----------- ----- ------ ----------- ----- ------
(Dollars in thousands)
U.S. Government and
agency obligations 6 $ 4,573 $ (47) - $ - $ - 6 $ 4,573 $ (47)
State and municipal
obligations 13 5,649 (94) - - - 13 5,649 (94)
Corporate bonds 1 2,970 (44) - - - 1 2,970 (44)
Mortgage-backed
securities 31 14,356 (170) - - - 31 14,356 (170)
--- -------- ------ --- ---- ---- ---- -------- ------
Total temporarily
impaired securities 51 $ 27,548 $ (355) - $ - $ - 51 $ 27,548 $ (355)
=== ======== ====== === ==== ==== ==== ======== ======
Management has the intent and ability to hold these securities for the
foreseeable future and the decline in the fair value is primarily due to an
increase in market interest rates. The fair values are expected to recover as
securities approach maturity dates.
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 and related securities 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)
25
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 2 - SECURITIES (Continued)
The fair value of debt securities, at year-end 2003 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 $ 2,365
Due from one to five years 15,512
Due from five to ten years 22,945
Due after ten years 27,066
Mortgage-backed securities 38,201
----------
$ 106,089
==========
Sales of securities were as follows.
2003 2002 2001
-------- -------- --------
Proceeds $ 27,866 $ 4,975 $ 5,658
Gross gains 53 30 8
Gross losses (2) (4) (4)
At year-end 2003 and 2002, there were no holdings of securities of any one
issuer, other than the U.S. government and agencies thereof, in an amount
greater than 10% of shareholders' equity.
Securities with a carrying amount of $55,945 and $60,467 at year-end 2003 and
2002 were pledged to secure public deposits and other obligations.
(Continued)
26
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 3 - LOANS AND LEASES
Year-end loans and leases were as follows:
2003 2002
--------- ---------
Commercial and industrial $ 51,709 $ 45,543
Commercial real estate 156,836 144,646
Residential real estate and home equity 117,098 87,548
Real estate construction and land development 30,120 37,603
Consumer and credit card 44,467 48,409
Direct lease financing 3,932 6,412
--------- ---------
404,162 370,161
Net deferred loan origination costs 1,114 1,132
Unearned income on leases (329) (712)
--------- ---------
$ 404,947 $ 370,581
========= =========
Loans to principal officers, directors, and their related affiliates in 2003
were as follows.
Beginning balance $ 9,578
New loans 6,893
Repayments (1,822)
Effect of changes in related parties (38)
--------
Ending balance $ 14,548
========
(Continued)
27
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 4 - ALLOWANCE FOR LOAN AND LEASE LOSSES
Activity in the allowance for loan and lease losses was as follows.
2003 2002 2001
------- ------- -------
Beginning balance $ 4,094 $ 3,596 $ 3,334
Provision for loan and lease losses 1,418 2,950 872
Loans charged off (1,345) (2,650) (765)
Recoveries 164 198 155
------- ------- -------
Ending balance $ 4,331 $ 4,094 $ 3,596
======= ======= =======
Impaired loans were as follows at year-end.
2003 2002
------ ------
Year-end loans with no allocated allowance for loan losses $ -- $ 464
Year-end loans with allocated allowance for loan losses 1,813 3,735
------ ------
Total $1,813 $4,199
====== ======
Amount of the allowance for loan losses allocated $ 580 $1,088
====== ======
2003 2002 2001
--------- ------ ------
Average of impaired loans during the year $ 2,731 $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.
2003 2002
------ ------
Loans past due over 90 days still accruing interest $1,252 $ 187
Nonaccrual loans 1,614 3,387
------ ------
Total $2,866 $3,574
====== ======
Nonperforming loans include both smaller balance homogeneous loans that are
collectively evaluated for impairment and individually classified impaired
loans. Interest income that would have been recognized had nonperforming loans
performed in accordance with contractual terms totaled $163,000, $259,000 and
$97,000 for 2003, 2002 and 2001, respectively.
(Continued)
28
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 5 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
2003 2002
-------- --------
Land $ 667 $ 1,207
Buildings 8,504 9,647
Furniture and equipment 7,680 7,497
-------- --------
16,851 18,351
Accumulated depreciation (6,904) (5,736)
-------- --------
$ 9,947 $ 12,615
======== ========
During 2003, the Corporation sold two parcels of real estate for $1.8 million,
recognizing a gain of $649,000 on the sale.
DCB has entered into operating leases for branch offices and equipment which
expire at various dates through 2023, and provide options for renewals. Rental
expense on lease commitments for 2003, 2002 and 2001 amounted to $834, $784 and
$865. At December 31, 2003, the total future minimum lease commitments under
these leases are summarized as follows.
2004 $ 744
2005 436
2006 381
2007 334
2008 318
Thereafter 3,437
------
$5,650
======
NOTE 6 - INTEREST-BEARING DEPOSITS
Year-end interest-bearing deposits were as follows.
2003 2002
-------- --------
Interest-bearing demand $ 38,987 $ 28,983
Money market 120,852 114,935
Savings 60,626 69,802
Time deposits
In denominations under $100,000 79,142 93,352
In denominations of $100,000 or more 64,268 58,020
-------- --------
$363,875 $365,092
======== ========
(Continued)
29
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 6 - INTEREST-BEARING DEPOSITS (Continued)
Scheduled maturities of time deposits for the next five years were as follows:
2004 $ 114,773
2005 19,363
2006 2,414
2007 5,860
2008 1,000
-----------
$ 143,410
===========
NOTE 7 - BORROWED FUNDS
Federal funds purchased and other short-term borrowings at December 31, 2003 was
comprised of a demand note to the U.S. Treasury totaling $1,419 and federal
funds purchased totaling $3,200. At December 31, 2002, short-term borrowings
consisted solely of a $2,000 demand note from the U.S. Treasury.
Advances from the Federal Home Loan Bank ("FHLB") at year-end were as follows.
2003 2002
Interest Maturing year ------- ----------
rate range ending December 31, (Dollars in Thousands)
1.54% - 2.62% 2003 $ - $ 12,000
3.73% 2004 4,000 4,000
4.52% 2005 4,000 4,000
2.76% 2006 3,000 0
- 2007 - -
2.79% - 5.50% Thereafter 38,693 7,802
------- -----------
$49,693 $ 27,802
======= ==========
Weighted average interest rate 3.71% 3.43%
======= ==========
As a member of the FHLB of Cincinnati, the Bank has the ability to obtain
additional borrowings based on DCB Financial's investment in FHLB stock and
other qualified collateral. FHLB advances are collateralized by a blanket pledge
of the Bank's residential mortgage loan portfolio and all shares of FHLB stock
totaling $67,385 and $2,359, respectively, at December 31, 2003 and $37,492 and
$2,267, respectively, at December 31, 2002.
(Continued)
30
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 7 - BORROWED FUNDS (Continued)
At year-end 2003, required annual principal payments on FHLB advances were as
follows:
2004 $ 4,000
2005 4,000
2006 3,000
2007 --
2008 4,004
Thereafter 34,689
-----------
$ 49,693
===========
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
additional discretionary contributions. Employee voluntary contributions are
vested at all times and Corporation contributions are fully vested after three
years. The 2003, 2002 and 2001 expense related to this plan was $118, $184 and
$125.
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 totaled $227 in 2001.
In 2003 and 2002, a number of covered participants withdrew from the plan,
resulting in recovery of prior accrued costs totaling $136 and $30,
respectively. Total accrued liability under this plan was $269 and $405 at year
end 2003 and 2002.
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)
31
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 9 - INCOME TAXES
Income tax expense was as follows.
2003 2002 2001
------- ------- -------
Current $ 2,078 $ 2,129 $ 2,339
Deferred 209 (93) (94)
------- ------- -------
$ 2,287 $ 2,036 $ 2,245
======= ======= =======
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.
2003 2002 2001
------- ------- -------
Income taxes computed at the statutory federal
income tax rate $ 2,487 $ 2,053 $ 2,293
Tax exempt income (195) (180) (154)
Other (5) 163 106
------- ------- -------
$ 2,287 $ 2,036 $ 2,245
======= ======= =======
Effective tax rate 31.3% 33.7% 33.3%
======= ======= =======
Year-end deferred tax assets and liabilities were due to the following.
2003 2002
--------- ---------
Deferred tax assets
Allowance for loan and lease losses $ 1,472 $ 1,262
Deferred compensation 95 137
Other - 3
--------- ---------
1,567 1,402
Deferred tax liabilities
FHLB stock dividends (246) (215)
Unrealized gain on securities available for sale (387) (822)
Deferred loan origination fees and costs (38) (144)
Leases (1,020) (1,073)
Accumulated depreciation (876) (366)
Mortgage servicing rights (50) (58)
Other (10) (10)
---------- ----------
(2,627) (2,688)
--------- ---------
Net deferred tax liability $ (1,060) $ (1,286)
========= =========
(Continued)
32
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(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 financing arrangements to provide credit typically have pre-determined
expiration dates, but can be withdrawn if certain conditions are not met. The
commitments may expire without ever having been drawn on by the customer.
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.
2003 2002
---- ----
Fixed Variable Fixed Variable
Rate Rate Rate Rate
---- ---- ---- ----
Commitments to extend credit $ 2,501 $ 36,503 $ 1,711 $ 34,283
Unused lines of credit and letters of credit - 42,380 - 39,566
Commitments to make loans are generally made for periods of 30 days or less. The
fixed rate loan commitments have interest rates ranging from 1.75% to 8.13% for
2003 and 5.50% to 8.13% in 2002. Maturities for these fixed rate commitments
range from 15 to 30 years for both years.
LEGAL PROCEEDINGS
There is no pending litigation, other than routine litigation incidental to the
business of the Corporation and Bank. 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. Finally, there is no litigation in which the
Corporation or Bank is involved which 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.
(Continued)
33
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
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, 2003. 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)
34
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(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
--------- ----- --------- ----- -------- -----
2003
Total capital to risk-weighted assets
Consolidated $ 53,260 11.5% $ 37,047 8.0% $ 46,309 10.0%
Bank 53,565 11.6 36,879 8.0 46,099 10.0
Tier 1 (core) capital to risk
weighted assets
Consolidated 48,921 10.6 18,524 4.0 27,786 6.0
Bank 36,226 7.9 18,440 4.0 27,659 6.0
Tier 1 (core) capital to average assets
Consolidated 48,921 8.8 22,194 4.0 27,742 5.0
Bank 36,226 6.8 22,260 4.0 26,575 5.0
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
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 has
exceeded the requirements discussed above and must obtain prior regulatory
approval before declaring any proposed dividend distributions.
(Continued)
35
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(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.
2003 2002
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ---------- -----------
Financial assets
Cash and cash equivalents $ 20,349 $ 20,349 $ 32,503 $ 32,503
Securities available for sale 108,547 108,547 96,477 96,477
Loans held for sale - - 6,442 6,458
Loans (excluding leases) 401,344 400,989 364,881 369,008
Accrued interest receivable 2,131 2,131 2,188 2,188
Financial liabilities
Noninterest-bearing deposits $ (78,477) $ (78,477) $ (73,531) $ (73,531)
Interest-bearing deposits (363,875) (365,804) (365,092) (367,027)
Federal funds purchased and
other short-term borrowings (4,619) (4,619) (2,000) (2,000)
FHLB advances (49,693) (51,298) (27,802) (28,701)
Accrued interest payable (552) (552) (998) (998)
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 FHLB advances 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)
36
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 13 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of DCB Financial Corp was as follows.
CONDENSED BALANCE SHEETS
December 31, 2003 and 2002
2003 2002
------- -------
ASSETS
Cash and cash equivalents $ 570 $ 58
Investment in Bank subsidiary 36,977 38,946
Investment in unconsolidated affiliate 1,951 1,951
Subordinated note from Bank subsidiary 13,500 10,000
Other assets 1,693 1,705
------- -------
Total assets $54,691 $52,660
======= =======
LIABILITIES
Other liabilities $ 5,002 $ 132
SHAREHOLDERS' EQUITY 49,689 52,528
------- -------
Total liabilities and shareholders' equity $54,691 $52,660
======= =======
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 2003, 2002 and 2001
2003 2002 2001
------- ------- -------
Income
Equity in earnings of Bank subsidiary $ 5,586 $ 4,216 $ 4,488
Other 68 80 69
------- ------- -------
Total income 5,654 4,296 4,557
Operating expenses 625 293 64
------- ------- -------
Income before income taxes 5,029 4,003 4,493
Income tax benefit -- -- (5)
------- ------- -------
NET INCOME $ 5,029 $ 4,003 $ 4,498
======= ======= =======
(Continued)
37
DCB FINANCIAL CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
(Dollars in thousands)
NOTE 14 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 2003, 2002 and 2001
2003 2002 2001
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,029 $ 4,003 $ 4,498
Adjustments to reconcile net income
to cash provided by operations:
(Undistributed earnings of ) excess
distributions from Bank subsidiary 1,102 7,203 (3,235)
Net change in other assets and liabilities 4,885 (47) (1,463)
-------- -------- --------
Net cash from operating activities 11,016 11,159 (200)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in unconsolidated affiliate - - (20)
Issuance of subordinated note receivable (3,500) (10,000) -
-------- -------- --------
Net cash from investing activities (3,500) (10,000) (20)
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid (1,540) (1,392) (1,253)
Purchase of treasury stock, net (5,464) (201) -
-------- -------- --------
Net cash from financing activities (7,004) (1,593) (1,253)
-------- -------- --------
Net change in cash and cash equivalents 512 (434) (1,473)
Cash and cash equivalents at beginning of period 58 492 1,965
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 570 $ 58 $ 492
======== ======== ========
(Continued)
38
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
DCB Financial Corp
Lewis Center, Ohio
We have audited the accompanying consolidated balance sheet of DCB Financial
Corp as of December 31, 2003, and the related consolidated statements of income,
changes in shareholders' equity, comprehensive income, and cash flows for the
year then ended. 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 audit. The consolidated financial statements
of DCB Financial Corp as of December 31, 2002, and for each of the two years
then ended, were audited by other auditors who expressed an unqualified opinion
on the consolidated financial statements in their report dated February 21,
2003.
We conducted our audit 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 audit provides a reasonable
basis for our opinion.
In our opinion, the 2003 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of DCB
Financial Corp as of December 31, 2003, and the results of its operations and
its cash flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Grant Thornton LLP
- ----------------------
Grant Thornton LLP
Cincinnati, Ohio
February 20, 2004
39
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
DCB Financial Corp
Lewis Center, Ohio
We have audited the accompanying consolidated balance sheet of DCB Financial
Corp as of December 31, 2002, and the related consolidated statements of income,
changes in shareholders' equity and cash flows for each of the two 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 the results of its operations and its cash flows for
each of the two 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 LLC
- --------------------------------
Crowe Chizek and Company LLC
Columbus, Ohio
February 21, 2003
40