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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2003
Commission file number 0-11487
LAKELAND FINANCIAL CORPORATION
Indiana 35-1559596
(State of incorporation) (I.R.S. Employer Identification No.)
202 East Center Street, P.O. Box 1387, Warsaw, Indiana 46581-1387
(Address of principal executive offices)
Telephone (574) 267-6144
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to
Section 12(g) of the Act:
Common Stock, no par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such other period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K(Section 229.405 of this chapter) is not contained herein and
will not be contained, to the best of the registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K.[ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes X No___
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant, based on the last sales price quoted on the
Nasdaq Stock Market on June 30, 2003, the last business day of the
registrant's most recently completed second fiscal quarter, was approximately
$159,636,237.
Number of shares of common stock outstanding at February 25, 2004: 5,811,094
DOCUMENTS INCORPORATED BY REFERENCE
Part III - Portions of the Proxy Statement for the Annual Meeting of
Shareholders mailed on March 5, 2004 are incorporated by reference into Part
III hereof.
LAKELAND FINANCIAL CORPORATION
Annual Report on Form 10-K
Table of Contents
Page Number
PART I
Item 1. Business 3
Forward - Looking Statements 4
Supervision and Regulation 7
Industry Segments 12
Guide 3 Information 12
Item 2. Properties 30
Item 3. Legal Proceedings 31
Item 4. Submission of Matters to a Vote of Security Holders 31
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 31
Item 6. Selected Financial Data 32
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 33
Overview 33
Results of Operations 33
Financial Condition 36
Critical Accounting Policies 39
Liquidity 39
Inflation 41
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 41
Item 8. Financial Statements and Supplemental Data 46
Financial Statements 46
Notes to Financial Statements 50
Report of Independent Auditors 77
Management's Responsibility for Financial Statements 78
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 79
Item 9A. Controls and Procedures 79
PART III
Item 10. Directors and Executive Officers of the Registrant 79
Item 11. Executive Compensation 79
Item 12. Security Ownership of Certain Beneficial Owners and Management 79
Item 13. Certain Relationships and Related Transactions 80
Item 14. Principal Accounting Fees and Services 80
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 81
Form 10-K Signature Page 83
Exhibit 21 Subsidiaries 85
2
PART I
ITEM 1. BUSINESS
The Company was incorporated under the laws of the State of Indiana
on February 8, 1983. As used herein, the term "Company" refers to Lakeland
Financial Corporation, or if the context dictates, Lakeland Financial
Corporation and its wholly-owned subsidiary, Lake City Bank, an Indiana state
bank headquartered in Warsaw, Indiana. Also included in the consolidated
financial statements is LCB Investments Limited, a wholly-owned subsidiary of
Lake City Bank which is a Bermuda corporation that manages a portion of the
Bank's investment portfolio. All intercompany transactions and balances are
eliminated in consolidation.
General
Company's Business. The Company is a bank holding company as defined
in the Bank Holding Company Act of 1956, as amended. The Company owns all of
the outstanding stock of Lake City Bank, Warsaw, Indiana, a full service
commercial bank organized under Indiana law (the "Bank"). In trust, the Bank
recognizes a wholly-owned subsidiary, LCB Investments Limited, which manages a
portion of the Bank's investment portfolio. The Company conducts no business
except that incident to its ownership of the outstanding stock of the Bank and
the operation of the Bank.
The Bank's deposits are insured by the Federal Deposit Insurance
Corporation. The Bank's activities cover all phases of commercial banking,
including checking accounts, savings accounts, time deposits, the sale of
securities under agreements to repurchase, commercial and agricultural
lending, direct and indirect consumer lending, real estate mortgage lending,
safe deposit box service and trust and brokerage services.
The Bank's main banking office is located at 202 East Center Street,
Warsaw, Indiana. As of December 31, 2003 the Bank had 43 offices in twelve
counties throughout northern Indiana.
Market Overview. While the Company operates in twelve counties, it
currently defines operations by three primary geographical markets. They are
the South Region, which includes Kosciusko and contiguous counties; the North
Region, which includes Elkhart and St. Joseph Counties; and the East Region,
which includes Allen and DeKalb Counties. The South Region includes the city
of Warsaw and is the location of the Company's headquarters. The Company has
had a presence in this region since 1872 . It has been in the North Region,
which includes the cities of Elkhart, South Bend and Goshen, since 1990, The
Company opened its first office in the East Region, which includes the cities
of Fort Wayne and Auburn, in 1999.
The Company believes that these are well-established, and fairly
diverse economic regions. The Company's markets include a mix of industrial
and service companies with no business or industry concentrations.
Furthermore, no single industry or employer dominates any of the markets. Fort
Wayne represents the largest population center served by the Company with a
population of 206,000, according to 2000 U.S. Census Bureau data. South Bend,
with a 2000 population of 108,000, is the second largest city served by the
Company. Elkhart, with a 2000 population of 52,000, is the third largest city
that the Company currently serves. As a result of the presence of offices in
twelve counties that are widely dispersed, no single city or industry
represents an undue concentration.
Expansion Strategy. The Company's expansion strategy is driven
primarily by the potential for increased penetration in existing markets where
opportunities for market share growth exists. Additionally, the Company
considers growth in new markets with a close geographic proximity to its
current operations. These markets are considered when the Company believes
they would be receptive to its strategic plan to deliver broad based financial
services with a local flavor. The Company has recently focused on growth
through de novo branching in locations that management believes have potential
for creating new market opportunities or for further penetrating existing
markets. In new markets, the Company believes it is critical to attract
experienced local management with a similar philosophy in order to provide a
basis for success.
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The Company also considers opportunities beyond current markets when
the Company's board of directors and management believes that the opportunity
will provide a desirable strategic fit without posing undue risk. The Company
does not currently have any definitive understandings or agreements for any
acquisitions.
Products and Services. The Company is a full service commercial bank
and provides commercial, retail, trust and investment services to its
customers. Commercial products include commercial loans and technology-driven
solutions to commercial customers' cash management needs such as CommerciaLink
Internet business banking and on-line cash management services. Retail banking
clients are provided a wide array of traditional retail banking services,
including lending, deposit and investment services. Retail lending programs
are focused on mortgage loans, home equity lines of credit and traditional
retail installment loans. The Company also has an Honors Private Banking
program that is positioned to serve the more financially sophisticated
customer with a menu including brokerage and trust services, executive
mortgage programs and access to financial planning seminars and programs. The
Bank's Prospero Program is dedicated to serving the expanding financial needs
of the Latino community. The Company provides trust clients with traditional
personal and corporate trust services. The Company also provides retail
brokerage services, including an array of financial and investment products
such as annuities and life insurance.
Forward-looking Statements
This document (including information incorporated by reference)
contains, and future oral and written statements of the Company and its
management may contain, forward-looking statements, within the meaning of such
term in the Private Securities Litigation Reform Act of 1995, with respect to
the financial condition, results of operations, plans, objectives, future
performance and business of the Company. Forward-looking statements, which may
be based upon beliefs, expectations and assumptions of the Company's
management and on information currently available to management, are generally
identifiable by the use of words such as "believe," "expect," "anticipate,"
"plan," "intend," "estimate," "may," "will," "would," "could," "should" or
other similar expressions. Additionally, all statements in this document,
including forward-looking statements, speak only as of the date they are made,
and the Company undertakes no obligation to update any statement in light of
new information or future events.
The Company's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors, which could have
a material adverse effect on the operations and future prospects of the
Company and its subsidiaries include, but are not limited to, the following:
o The strength of the United States economy in general and the
strength of the local economies in which the Company
conducts its operations which may be less favorable than
expected and may result in, among other things, a
deterioration in the credit quality and value of the
Company's assets.
o The economic impact of past and any future terrorist attacks,
acts of war or threats thereof and the response of the United
States to any such threats and attacks.
o The effects of, and changes in, federal, state and local
laws, regulations and policies affecting banking,
securities, insurance and monetary and financial matters.
o The effects of changes in interest rates (including the
effects of changes in the rate of prepayments of the
Company's assets) and the policies of the Board of Governors
of the Federal Reserve System.
o The ability of the Company to compete with other financial
institutions as effectively as the Company currently intends
due to increases in competitive pressures in the financial
services sector.
o The inability of the Company to obtain new customers and to
retain existing customers.
o The timely development and acceptance of products and
services, including products and services offered through
alternative delivery channels such as the Internet.
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o Technological changes implemented by the Company and by
other parties, including third party vendors, which may be
more difficult or more expensive than anticipated or which
may have unforeseen consequences to the Company and its
customers.
o The ability of the Company to develop and maintain secure and
reliable electronic systems.
o The ability of the Company to retain key executives and
employees and the difficulty that the Company may experience
in replacing key executives and employees in an effective
manner.
o Consumer spending and saving habits, which may change in a
manner that affects the Company's business adversely.
o Business combinations and the integration of acquired
businesses, which may be more difficult or expensive than
expected.
o The costs, effects and outcomes of existing or future
litigation.
o Changes in accounting policies and practices, as may be
adopted by state and federal regulatory agencies, the
Financial Accounting Standards Board, the Securities and
Exchange Commission and the Public Company Accounting
Oversight Board.
o The ability of the Company to manage the risks associated
with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements. Additional information concerning the Company and its business,
including other factors that could materially affect the Company's financial
results, is included in the Company's filings with the Securities and Exchange
Commission.
Business Developments
The Company conducts no business except that which is incident to its
ownership of the stock of the Bank, the collection of dividends from the Bank,
and the disbursement of dividends to shareholders.
Lakeland Statutory Trust II (the "Trust"), a statutory business
trust, was formed under Connecticut law pursuant to a trust agreement dated
October 1, 2003 and a certificate of trust filed with the Connecticut
Secretary of State on October 1, 2003. Through a private placement, the trust
issued $30.0 million in trust preferred securities. The Trust exists for the
exclusive purposes of (i) issuing the trust securities representing undivided
beneficial interests in the assets of the Trust, (ii) investing the gross
proceeds of the trust securities in the subordinated debentures issued by the
Company, and (iii) engaging in only those activities necessary, advisable, or
incidental thereto. The subordinated debentures are the only assets of the
Trust, and payments under the subordinated debentures are the only revenue of
the Trust. The Trust has a term of 35 years, but may be terminated earlier as
provided in the trust agreement.
Competition
The Bank was originally organized in 1872 and has continuously
operated under the laws of the State of Indiana since its organization. The
Bank's activities cover all phases of commercial banking, including checking
accounts, savings accounts, time deposits, the sale of securities under
agreements to repurchase, commercial and agricultural lending, direct and
indirect consumer lending, real estate mortgage lending, safe deposit box
services and trust and brokerage services. The interest rates for both
deposits and loans, as well as the range of services provided, are nearly the
same for all banks competing within the Bank's service area.
The Bank competes for loans principally through a high degree of
customer contact, timely loan review and approval, market-driven competitive
loan pricing in certain situations and the Bank's reputation throughout the
region. The Bank believes that its convenience, quality service and hometown
5
approach to banking enhances its ability to compete favorably in attracting
and retaining individual and business customers. The Bank actively solicits
deposit-related customers and competes for customers by offering personal
attention, professional service and competitive interest rates.
The Bank's primary service area is northern Indiana. In addition to
the banks located within its service area, the Bank also competes with savings
and loan associations, credit unions, farm credit services, finance companies,
personal loan companies, insurance companies, money market funds, and other
non-depository financial intermediaries. Also, financial intermediaries such
as money market mutual funds and large retailers are not subject to the same
regulations and laws that govern the operation of traditional depository
institutions and accordingly may have an advantage in competing for funds.
The Bank competes with other major banks for large commercial deposit
and loan accounts. The Bank is presently subject to an aggregate maximum loan
limit to any single account pursuant to Indiana law. The Bank currently
enforces an internal limit of $12.0 million, which is less than the amount
permitted by law. This maximum might occasionally limit the Bank from
providing loans to those businesses or personal accounts whose borrowings
periodically exceed this amount. In the event this were to occur, the Bank
maintains correspondent relationships with other financial institutions. The
Bank may participate with other banks in the placement of large borrowings in
excess of its lending limit. The Bank is also a member of the Federal Home
Loan Bank of Indianapolis in order to broaden its mortgage lending and
investment activities and to provide additional funds, if necessary, to
support these activities.
Foreign Operations
The Company has no investments with any foreign entity other than two
nominal demand deposit accounts. One is maintained with a Canadian bank in
order to facilitate the clearing of checks drawn on banks located in other
countries. The other is maintained with a bank in Bermuda for LCB Investments
Limited to be used for administrative expenses. There are no foreign loans.
Employees
At December 31, 2003, the Company, including its subsidiaries, had
426 full-time equivalent employees. Benefit programs include a pension plan,
401(k) plan, group medical insurance, group life insurance and paid vacations.
Effective April 1, 2000, the defined benefit pension plan was frozen and
employees can no longer accrue new benefits under that plan. The Bank is not a
party to any collective bargaining agreement, and employee relations are
considered good. The Company also has a stock option plan under which stock
options may be granted to employees and directors.
Internet Website
The Company maintains an Internet site at www.lakecitybank.com. The
Company makes available free of charge on this site its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after it electronically files such
material with, or furnishes it to, the Securities and Exchange Commission. The
Company's code of conduct and the charters of its various committees of the
Board of Directors are also available on the website.
6
SUPERVISION AND REGULATION
General
Financial institutions, their holding companies and their affiliates
are extensively regulated under federal and state law. As a result, the growth
and earnings performance of the Company may be affected not only by management
decisions and general economic conditions, but also by the requirements of
federal and state statutes and by the regulations and policies of various bank
regulatory authorities, including the Indiana Department of Financial
Institutions (the "DFI"), the Board of Governors of the Federal Reserve System
(the "Federal Reserve") and the Federal Deposit Insurance Corporation (the
"FDIC"). Furthermore, taxation laws administered by the Internal Revenue
Service and state taxing authorities and securities laws administered by the
Securities and Exchange Commission (the "SEC") and state securities
authorities have an impact on the business of the Company. The effect of these
statutes, regulations and regulatory policies may be significant, and cannot
be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to
financial institutions regulate, among other things, the scope of business,
the kinds and amounts of investments, reserve requirements, capital levels
relative to operations, the nature and amount of collateral for loans, the
establishment of branches, mergers and consolidations and the payment of
dividends. This system of supervision and regulation establishes a
comprehensive framework for the respective operations of the Company and its
subsidiaries and is intended primarily for the protection of the FDIC-insured
deposits and depositors of the Bank, rather than shareholders.
The following is a summary of the material elements of the regulatory
framework that applies to the Company and its subsidiaries. It does not
describe all of the statutes, regulations and regulatory policies that apply,
nor does it restate all of the requirements of those that are described. As
such, the following is qualified in its entirety by reference to applicable
law. Any change in statutes, regulations or regulatory policies may have a
material effect on the business of the Company and its subsidiaries.
Recent Regulatory Developments
National Bank Preemption. On January 7, 2004, the Office of the
Comptroller of the Currency (the "OCC") issued two final rules that clarify
the federal character of the national banking system. The first rule provides
that, except where made applicable by federal law, state laws that obstruct,
impair or condition national banks' ability to fully exercise their
deposit-taking, lending and operational powers are not applicable to national
banks. That rule further provides that the following types of state laws apply
to national banks to the extent that they only incidentally affect the
exercise of national banks' deposit-taking, lending and operational powers:
contract, criminal, taxation, tort, zoning and laws relating to certain
homestead rights, rights to collect debts, acquisitions and transfers of
property and other laws as determined to apply to national banks by the OCC.
The second rule affirms that, under federal law, with some exceptions, the OCC
has exclusive visitorial authority (the power to inspect, examine, supervise
and regulate) with respect to the content and conduct of activities authorized
for national banks. These controversial rules give national banks, especially
those that operate in multiple states, a significant competitive advantage
over state-chartered banks and are therefore likely to be challenged by
individuals and organizations that represent the interests of individual
states and state-chartered banks. Both the U.S. House Committee on Financial
Services and the New York Attorney General have already initiated such
challenges.
FACT Act. On December 4, 2003, President Bush signed into law the
Fair and Accurate Credit Transactions Act of 2003 (the "FACT Act"), which
contains numerous amendments to the Fair Credit Reporting Act relating to
matters including identity theft and privacy. Among its other provisions, the
FACT Act requires financial institutions: (i) to establish an identity theft
prevention program; (ii) to enhance the accuracy and integrity of information
furnished to consumer reporting agencies; and (iii) to allow customers to
prevent financial institution affiliates from using, for marketing
solicitation purposes, transaction and experience information about the
customers received from the financial institution. The FACT Act also requires
the federal banking regulators, and certain other agencies, to promulgate
regulations to implement its provisions. The various provisions of the FACT
Act contain different effective dates including March 31, 2004, for those
7
provisions of the FACT Act that do not require significant changes to business
procedures and December 1, 2004, for certain other provisions that will
require significant business procedure changes.
The Company
General. The Company, as the sole shareholder of the Bank, is a bank
holding company. As a bank holding company, the Company is registered with,
and is subject to regulation by, the Federal Reserve under the Bank Holding
Company Act of 1956, as amended (the "BHCA"). In accordance with Federal
Reserve policy, the Company is expected to act as a source of financial
strength to the Bank and to commit resources to support the Bank in
circumstances where the Company might not otherwise do so. Under the BHCA, the
Company is subject to periodic examination by the Federal Reserve. The Company
is required to file with the Federal Reserve periodic reports of the Company's
operations and such additional information regarding the Company and its
subsidiaries as the Federal Reserve may require. The Company is also subject
to regulation by the DFI under Indiana law.
Acquisitions, Activities and Change in Control. The primary purpose
of a bank holding company is to control and manage banks. The BHCA generally
requires the prior approval of the Federal Reserve for any merger involving a
bank holding company or any acquisition by a bank holding company of another
bank or bank holding company. Subject to certain conditions (including deposit
concentration limits established by the BHCA), the Federal Reserve may allow a
bank holding company to acquire banks located in any state of the United
States. In approving interstate acquisitions, the Federal Reserve is required
to give effect to applicable state law limitations on the aggregate amount of
deposits that may be held by the acquiring bank holding company and its
insured depository institution affiliates in the state in which the target
bank is located (provided that those limits do not discriminate against
out-of-state depository institutions or their holding companies) and state
laws that require that the target bank have been in existence for a minimum
period of time (not to exceed five years) before being acquired by an
out-of-state bank holding company.
The BHCA generally prohibits the Company from acquiring direct or
indirect ownership or control of more than 5% of the voting shares of any
company that is not a bank and from engaging in any business other than that
of banking, managing and controlling banks or furnishing services to banks and
their subsidiaries. This general prohibition is subject to a number of
exceptions. The principal exception allows bank holding companies to engage
in, and to own shares of companies engaged in, certain businesses found by the
Federal Reserve to be "so closely related to banking ... as to be a proper
incident thereto." This authority would permit the Company to engage in a
variety of banking-related businesses, including the operation of a thrift,
consumer finance, equipment leasing, the operation of a computer service
bureau (including software development), and mortgage banking and brokerage.
The BHCA generally does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility
requirements prescribed by the BHCA and elect to operate as financial holding
companies may engage in, or own shares in companies engaged in, a wider range
of nonbanking activities, including securities and insurance underwriting and
sales, merchant banking and any other activity that the Federal Reserve, in
consultation with the Secretary of the Treasury, determines by regulation or
order is financial in nature, incidental to any such financial activity or
complementary to any such financial activity and does not pose a substantial
risk to the safety or soundness of depository institutions or the financial
system generally. As of the date of this filing, the Company has neither
applied for nor received approval to operate as a financial holding company.
Federal law also prohibits any person or company from acquiring
"control" of an FDIC-insured depository institution or its holding company
without prior notice to the appropriate federal bank regulator. "Control" is
conclusively presumed to exist upon the acquisition of 25% or more of the
outstanding voting securities of a bank or bank holding company, but may arise
under certain circumstances at 10% ownership.
Capital Requirements. Bank holding companies are required to maintain
minimum levels of capital in accordance with Federal Reserve capital adequacy
guidelines. If capital levels fall below the minimum required levels, a bank
holding company, among other things, may be denied approval to acquire or
establish additional banks or non-bank businesses.
8
The Federal Reserve's capital guidelines establish the following
minimum regulatory capital requirements for bank holding companies: (i) a
risk-based requirement expressed as a percentage of total assets weighted
according to risk; and (ii) a leverage requirement expressed as a percentage
of total assets. The risk-based requirement consists of a minimum ratio of
total capital to total risk-weighted assets of 8% and a minimum ratio of Tier
1 capital to total risk-weighted assets of 4%. The leverage requirement
consists of a minimum ratio of Tier 1 capital to total assets of 3% for the
most highly rated companies, with a minimum requirement of 4% for all others.
For purposes of these capital standards, Tier 1 capital consists primarily of
permanent stockholders' equity less intangible assets (other than certain loan
servicing rights and purchased credit card relationships). Total capital
consists primarily of Tier 1 capital plus certain other debt and equity
instruments that do not qualify as Tier 1 capital and a portion of the
company's allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum
requirements. Higher capital levels will be required if warranted by the
particular circumstances or risk profiles of individual banking organizations.
For example, the Federal Reserve's capital guidelines contemplate that
additional capital may be required to take adequate account of, among other
things, interest rate risk, or the risks posed by concentrations of credit,
nontraditional activities or securities trading activities. Further, any
banking organization experiencing or anticipating significant growth would be
expected to maintain capital ratios, including tangible capital positions
(i.e., Tier 1 capital less all intangible assets), well above the minimum
levels. As of December 31, 2003, the Company had regulatory capital in excess
of the Federal Reserve's minimum requirements.
Dividend Payments. The Company's ability to pay dividends to its
shareholders may be affected by both general corporate law considerations and
policies of the Federal Reserve applicable to bank holding companies. As an
Indiana corporation, the Company is subject to the limitations of the Indiana
General Business Corporation Law, which prohibit the Company from paying
dividends if the Company is, or by payment of the dividend would become,
insolvent, or if the payment of dividends would render the Company unable to
pay its debts as they become due in the usual course of business.
Additionally, policies of the Federal Reserve caution that a bank holding
company should not pay cash dividends that exceed its net income or that can
only be funded in ways that weaken the bank holding company's financial
health, such as by borrowing. The Federal Reserve also possesses enforcement
powers over bank holding companies and their non-bank subsidiaries to prevent
or remedy actions that represent unsafe or unsound practices or violations of
applicable statutes and regulations. Among these powers is the ability to
proscribe the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. The Company's common stock is
registered with the SEC under the Securities Act of 1933, as amended, and the
Securities Exchange Act of 1934, as amended (the "Exchange Act").
Consequently, the Company is subject to the information, proxy solicitation,
insider trading and other restrictions and requirements of the SEC under the
Exchange Act.
The Bank
General. The Bank is an Indiana-chartered bank, the deposit accounts
of which are insured by the FDIC's Bank Insurance Fund ("BIF"). As an
Indiana-chartered bank, the Bank is subject to the examination, supervision,
reporting and enforcement requirements of the DFI, the chartering authority
for Indiana banks, and the FDIC, designated by federal law as the primary
federal regulator of state-chartered, FDIC-insured banks that, like the Bank,
are not members of the Federal Reserve System ("non-member banks").
Deposit Insurance. As an FDIC-insured institution, the Bank is
required to pay deposit insurance premium assessments to the FDIC. The FDIC
has adopted a risk-based assessment system under which all insured depository
institutions are placed into one of nine categories and assessed insurance
premiums based upon their respective levels of capital and results of
supervisory evaluations. Institutions classified as well-capitalized (as
defined by the FDIC) and considered healthy pay the lowest premium while
institutions that are less than adequately capitalized (as defined by the
FDIC) and considered of substantial supervisory concern pay the highest
premium. Risk classification of all insured institutions is made by the FDIC
for each semi-annual assessment period.
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During the year ended December 31, 2003, BIF assessments ranged from
0% of deposits to 0.27% of deposits. For the semi-annual assessment period
beginning January 1, 2004, BIF assessment rates will continue to range from 0%
of deposits to 0.27% of deposits.
FICO Assessments. Since 1987, a portion of the deposit insurance
assessments paid by members of the FDIC's Savings Association Insurance Fund
("SAIF") has been used to cover interest payments due on the outstanding
obligations of the Financing Corporation ("FICO"). FICO was created in 1987 to
finance the recapitalization of the Federal Savings and Loan Insurance
Corporation, the SAIF's predecessor insurance fund. As a result of federal
legislation enacted in 1996, beginning as of January 1, 1997, both SAIF
members and BIF members became subject to assessments to cover the interest
payments on outstanding FICO obligations until the final maturity of such
obligations in 2019. These FICO assessments are in addition to amounts
assessed by the FDIC for deposit insurance. During the year ended December 31,
2003, the FICO assessment rate for BIF and SAIF members was approximately
0.02% of deposits.
Supervisory Assessments. All Indiana banks are required to pay
supervisory assessments to the DFI to fund the operations of the DFI. The
amount of the assessment is calculated on the basis of the bank's total
assets. During the year ended December 31, 2003, the Bank paid supervisory
assessments to the DFI totaling $84,000.
Capital Requirements. Banks are generally required to maintain
capital levels in excess of other businesses. The FDIC has established the
following minimum capital standards for state-chartered FDIC-insured
non-member banks, such as the Bank: (i) a leverage requirement consisting of a
minimum ratio of Tier 1 capital to total assets of 3% for the most
highly-rated banks with a minimum requirement of at least 4% for all others;
and (ii) a risk-based capital requirement consisting of a minimum ratio of
total capital to total risk-weighted assets of 8% and a minimum ratio of Tier
1 capital to total risk-weighted assets of 4%. For purposes of these capital
standards, the components of Tier 1 capital and total capital are the same as
those for bank holding companies discussed above.
The capital requirements described above are minimum requirements.
Higher capital levels will be required if warranted by the particular
circumstances or risk profiles of individual institutions. For example,
regulations of the FDIC provide that additional capital may be required to
take adequate account of, among other things, interest rate risk or the risks
posed by concentrations of credit, nontraditional activities or securities
trading activities.
Further, federal law and regulations provide various incentives for
financial institutions to maintain regulatory capital at levels in excess of
minimum regulatory requirements. For example, a financial institution that is
"well-capitalized" may qualify for exemptions from prior notice or application
requirements otherwise applicable to certain types of activities and may
qualify for expedited processing of other required notices or applications.
Additionally, one of the criteria that determines a bank holding company's
eligibility to operate as a financial holding company is a requirement that
all of its financial institution subsidiaries be "well-capitalized." Under the
regulations of the FDIC, in order to be "well-capitalized" a financial
institution must maintain a ratio of total capital to total risk-weighted
assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted
assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or
greater.
Federal law also provides the federal banking regulators with broad
power to take prompt corrective action to resolve the problems of
undercapitalized institutions. The extent of the regulators' powers depends on
whether the institution in question is "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized," in each case as defined by regulation. Depending upon the
capital category to which an institution is assigned, the regulators'
corrective powers include: (i) requiring the institution to submit a capital
restoration plan; (ii) limiting the institution's asset growth and restricting
its activities; (iii) requiring the institution to issue additional capital
stock (including additional voting stock) or to be acquired; (iv) restricting
transactions between the institution and its affiliates; (v) restricting the
interest rate the institution may pay on deposits; (vi) ordering a new
election of directors of the institution; (vii) requiring that senior
executive officers or directors be dismissed; (viii) prohibiting the
institution from accepting deposits from correspondent banks; (ix) requiring
the institution to divest certain subsidiaries; (x) prohibiting the payment of
principal or interest on subordinated debt; and (xi) ultimately, appointing a
receiver for the institution.
As of December 31, 2003: (i) the Bank was not subject to a directive
from the FDIC to increase its capital to an amount in excess of the minimum
10
regulatory capital requirements; (ii) the Bank exceeded its minimum regulatory
capital requirements under FDIC capital adequacy guidelines; and (iii) the
Bank was "well-capitalized," as defined by FDIC regulations.
Dividend Payments. The primary source of funds for the Company is
dividends from the Bank. Indiana law prohibits the Bank from paying dividends
in an amount greater than its undivided profits. The Bank is required to
obtain the approval of the DFI for the payment of any dividend if the total of
all dividends declared by the Bank during the calendar year, including the
proposed dividend, would exceed the sum of the Bank's retained net income for
the year to date combined with its retained net income for the previous two
years. Indiana law defines "retained net income" to mean the net income of a
specified period, calculated under the consolidated report of income
instructions, less the total amount of all dividends declared for the
specified period.
The payment of dividends by any financial institution or its holding
company is affected by the requirement to maintain adequate capital pursuant
to applicable capital adequacy guidelines and regulations, and a financial
institution generally is prohibited from paying any dividends if, following
payment thereof, the institution would be undercapitalized. As described
above, the Bank exceeded its minimum capital requirements under applicable
guidelines as of December 31, 2003. As of December 31, 2003, approximately
$19.8 million was available to be paid as dividends by the Bank.
Notwithstanding the availability of funds for dividends, however, the FDIC may
prohibit the payment of any dividends by the Bank if the FDIC determines such
payment would constitute an unsafe or unsound practice.
Insider Transactions. The Bank is subject to certain restrictions
imposed by federal law on extensions of credit to the Company, on investments
in the stock or other securities of the Company and the acceptance of the
stock or other securities of the Company as collateral for loans made by the
Bank. Certain limitations and reporting requirements are also placed on
extensions of credit by the Bank to its directors and officers, to directors
and officers of the Company, to principal shareholders of the Company and to
"related interests" of such directors, officers and principal shareholders. In
addition, federal law and regulations may affect the terms upon which any
person who is a director or officer of the Company or the Bank or a principal
shareholder of the Company may obtain credit from banks with which the Bank
maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have
adopted guidelines that establish operational and managerial standards to
promote the safety and soundness of federally insured depository institutions.
The guidelines set forth standards for internal controls, information systems,
internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, fees and benefits, asset quality and
earnings.
In general, the safety and soundness guidelines prescribe the goals
to be achieved in each area, and each institution is responsible for
establishing its own procedures to achieve those goals. If an institution
fails to comply with any of the standards set forth in the guidelines, the
institution's primary federal regulator may require the institution to submit
a plan for achieving and maintaining compliance. If an institution fails to
submit an acceptable compliance plan, or fails in any material respect to
implement a compliance plan that has been accepted by its primary federal
regulator, the regulator is required to issue an order directing the
institution to cure the deficiency. Until the deficiency cited in the
regulator's order is cured, the regulator may restrict the institution's rate
of growth, require the institution to increase its capital, restrict the rates
the institution pays on deposits or require the institution to take any action
the regulator deems appropriate under the circumstances. Noncompliance with
the standards established by the safety and soundness guidelines may also
constitute grounds for other enforcement action by the federal banking
regulators, including cease and desist orders and civil money penalty
assessments.
Branching Authority. Indiana banks, such as the Bank, have the
authority under Indiana law to establish branches anywhere in the State of
Indiana, subject to receipt of all required regulatory approvals.
Federal law permits state and national banks to merge with banks in
other states subject to: (i) regulatory approval; (ii) federal and state
deposit concentration limits; and (iii) state law limitations requiring the
merging bank to have been in existence for a minimum period of time (not to
exceed five years) prior to the merger. The establishment of new interstate
11
branches or the acquisition of individual branches of a bank in another state
(rather than the acquisition of an out-of-state bank in its entirety) is
permitted only in those few states that authorize such expansion.
State Bank Investments and Activities. The Bank generally is
permitted to make investments and engage in activities directly or through
subsidiaries as authorized by Indiana law. However, under federal law and FDIC
regulations, FDIC insured state banks are prohibited, subject to certain
exceptions, from making or retaining equity investments of a type, or in an
amount, that are not permissible for a national bank. Federal law and FDIC
regulations also prohibit FDIC insured state banks and their subsidiaries,
subject to certain exceptions, from engaging as principal in any activity that
is not permitted for a national bank unless the bank meets, and continues to
meet, its minimum regulatory capital requirements and the FDIC determines the
activity would not pose a significant risk to the deposit insurance fund of
which the bank is a member. These restrictions have not had, and are not
currently expected to have, a material impact on the operations of the Bank.
Federal Reserve System. Federal Reserve regulations, as presently in
effect, require depository institutions to maintain non-interest earning
reserves against their transaction accounts (primarily NOW and regular
checking accounts), as follows: for transaction accounts aggregating $45.4
million or less, the reserve requirement is 3% of total transaction accounts;
and for transaction accounts aggregating in excess of $45.4 million, the
reserve requirement is $1.164 million plus 10% of the aggregate amount of
total transaction accounts in excess of $45.4 million. The first $6.6 million
of otherwise reservable balances are exempted from the reserve requirements.
These reserve requirements are subject to annual adjustment by the Federal
Reserve. The Bank is in compliance with the foregoing requirements.
INDUSTRY SEGMENTS
While the Company's chief decision-makers monitor the revenue streams
of the various Company products and services, the identifiable segments
operations are managed and financial performance is evaluated on a
Company-wide basis. Accordingly, all of the Company's financial service
operations are considered by management to be aggregated in one reportable
operating segment -- commercial banking.
GUIDE 3 INFORMATION
On the pages that follow are tables that set forth selected
statistical information relative to the business of the Company. This data
should be read in conjunction with the consolidated financial statements,
related notes and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" as set forth in Items 7&8, below, herein
incorporated by reference.
12
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
(in thousands of dollars)
2003 2002
---------------------------------------- ----------------------------------------
Average Interest Average Interest
Balance Income Yield (1) Balance Income Yield (1)
------------ ------------ ------------ ------------ ------------ ------------
ASSETS
Earning assets:
Loans:
Taxable (2)(3) $ 839,797 $ 46,861 5.58% $ 766,962 $ 49,083 6.40%
Tax exempt (1) 7,758 430 5.54 3,935 279 7.09
Investments: (1)
Available for sale 271,161 14,118 5.21 274,155 15,677 5.72
Short-term investments 11,882 120 1.01 12,672 191 1.51
Interest bearing deposits 6,134 68 1.11 4,283 70 1.61
------------ ------------ ------------ ------------
Total earning assets 1,136,732 61,597 5.42% 1,062,007 65,300 6.15%
Nonearning assets:
Cash and due from banks 46,394 0 42,904 0
Premises and equipment 25,810 0 24,469 0
Other nonearning assets 40,062 0 28,032 0
Less allowance for loan losses (9,909) 0 (8,662) 0
------------ ------------ ------------ ------------
Total assets $ 1,239,089 $ 61,597 $ 1,148,750 $ 65,300
============ ============ ============ ============
(1) Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2003 and 2002. The tax
equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment
applicable to nondeductible interest expenses.
(2) Loan fees, which are immaterial in relation to total taxable loan interest income for the years ended December 31, 2003 and
2002, are included as taxable loan interest income.
(3) Nonaccrual loans are included in the average balance of taxable loans.
13
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)
(in thousands of dollars)
2002 2001
---------------------------------------- ----------------------------------------
Average Interest Average Interest
Balance Income Yield (1) Balance Income Yield (1)
------------ ------------ ------------ ------------ ------------ ------------
ASSETS
Earning assets:
Loans:
Taxable (2)(3) $ 766,962 $ 49,083 6.40% $ 727,330 $ 58,348 8.02%
Tax exempt (1) 3,935 279 7.09 2,420 209 8.64
Investments: (1)
Available for sale 274,155 15,677 5.72 291,901 18,556 6.36
Short-term investments 12,672 191 1.51 9,778 405 4.14
Interest bearing deposits 4,283 70 1.61 2,437 80 3.24
------------ ------------ ------------ ------------
Total earning assets 1,062,007 65,300 6.15% 1,033,866 77,598 7.51%
Nonearning assets:
Cash and due from banks 42,904 0 41,148 0
Premises and equipment 24,469 0 26,423 0
Other nonearning assets 28,032 0 28,743 0
Less allowance for loan losses (8,662) 0 (7,364) 0
------------ ------------ ------------ ------------
Total assets $ 1,148,750 $ 65,300 $ 1,122,816 $ 77,598
============ ============ ============ ============
(1) Tax exempt income was converted to a fully taxable equivalent basis at a 35 and 34 percent tax rate for 2002 and 2001. The
tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA
adjustment applicable to nondeductible interest expenses.
(2) Loan fees, which are immaterial in relation to total taxable loan interest income for the years ended December 31, 2002 and
2001, are included as taxable loan interest income.
(3) Nonaccrual loans are included in the average balance of taxable loans.
14
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)
(in thousands of dollars)
2003 2002
---------------------------------------- ----------------------------------------
Average Interest Average Interest
Balance Expense Yield Balance Expense Yield
------------ ------------ ------------ ------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest bearing liabilities:
Savings deposits $ 61,053 $ 232 0.38% $ 53,792 $ 404 0.75%
Interest bearing checking accounts 301,328 3,214 1.07 231,712 3,592 1.55
Time deposits:
In denominations under $100,000 203,196 6,153 3.03 203,531 7,491 3.68
In denominations over $100,000 230,417 4,480 1.94 224,437 5,604 2.50
Miscellaneous short-term borrowings 118,109 1,110 0.94 146,619 2,552 1.74
Long-term borrowings and
subordinated debentures 53,892 2,948 5.47 46,287 2,915 6.30
------------ ------------ ------------ ------------
Total interest bearing liabilities 967,995 18,137 1.87% 906,378 22,558 2.49%
Noninterest bearing liabilities and
stockholders' equity:
Demand deposits 173,716 0 150,226 0
Other liabilities 10,069 0 13,093 0
Stockholders' equity 87,309 0 79,053 0
Total liabilities and stockholders'
equity ------------ ------------ ------------ ------------
$ 1,239,089 $ 18,137 $ 1,148,750 $ 22,558
============ ============ ============ ============
Net interest differential - yield on
average daily earning assets $ 43,460 3.82% $ 42,742 4.02%
============ ============
15
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)
(in thousands of dollars)
2002 2001
---------------------------------------- ----------------------------------------
Average Interest Average Interest
Balance Expense Yield Balance Expense Yield
------------ ------------ ------------ ------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest bearing liabilities:
Savings deposits $ 53,792 $ 404 0.75% $ 50,513 $ 613 1.21%
Interest bearing checking accounts 231,712 3,592 1.55 230,144 7,447 3.24
Time deposits:
In denominations under $100,000 203,531 7,491 3.68 211,728 11,151 5.27
In denominations over $100,000 224,437 5,604 2.50 203,067 10,639 5.24
Miscellaneous short-term borrowings 146,619 2,552 1.74 178,197 6,904 3.87
Long-term borrowings and
subordinated debentures 46,287 2,915 6.30 32,030 2,476 7.73
------------ ------------ ------------ ------------
Total interest bearing liabilities 906,378 22,558 2.49% 905,679 39,230 4.33%
Noninterest bearing liabilities and
stockholders' equity:
Demand deposits 150,226 0 137,011 0
Other liabilities 13,093 0 10,135 0
Stockholders' equity 79,053 0 69,991 0
Total liabilities and stockholders'
equity ------------ ------------ ------------ ------------
$ 1,148,750 $ 22,558 $ 1,122,816 $ 39,230
============ ============ ============ ============
Net interest differential - yield on
average daily earning assets $ 42,742 4.02% $ 38,368 3.71%
============ ============
16
ANALYSIS OF CHANGES IN INTEREST DIFFERENTIALS
(fully taxable equivalent basis)
(in thousands of dollars)
YEAR ENDED DECEMBER 31,
2003 Over (Under) 2002 (1) 2002 Over (Under) 2001 (1)
---------------------------------------- ----------------------------------------
Volume Rate Total Volume Rate Total
------------ ------------ ------------ ------------ ------------ ------------
INTEREST AND LOAN FEE INCOME (2)
Loans:
Taxable $ 4,407 $ (6,629) $ (2,222) $ 3,043 $ (12,308) $ (9,265)
Tax exempt 223 (72) 151 113 (43) 70
Investments:
Available for sale (170) (1,389) (1,559) (1,085) (1,794) (2,879)
Short-term investments (11) (60) (71) 96 (310) (214)
Interest bearing deposits 25 (27) (2) 42 (52) (10)
------------ ------------ ------------ ------------ ------------ ------------
Total interest income 4,474 (8,177) (3,703) 2,209 (14,507) (12,298)
------------ ------------ ------------ ------------ ------------ ------------
INTEREST EXPENSE
Savings deposits 49 (221) (172) 38 (247) (209)
Interest bearing checking accounts 914 (1,292) (378) 50 (3,905) (3,855)
Time deposits:
In denominations under $100,000 (12) (1,326) (1,338) (417) (3,243) (3,660)
In denominations over $100,000 146 (1,270) (1,124) 1,022 (6,057) (5,035)
Miscellaneous short-term borrowings (428) (1,014) (1,442) (1,059) (3,293) (4,352)
Long-term borrowings and
subordinated debentures 444 (411) 33 958 (519) 439
------------ ------------ ------------ ------------ ------------ ------------
Total interest expense 1,113 (5,534) (4,421) 592 (17,264) (16,672)
------------ ------------ ------------ ------------ ------------ ------------
INCREASE (DECREASE) IN
INTEREST DIFFERENTIALS $ 3,361 $ (2,643) $ 718 $ 1,617 $ 2,757 $ 4,374
============ ============ ============ ============ ============ ============
(1) The earning assets and interest bearing liabilities used to calculate interest differentials are based on average daily
balances for 2003, 2002 and 2001. The changes in volume represent "changes in volume times the old rate". The changes in
rate represent "changes in rate times old volume". The changes in rate/volume were also calculated by "change in rate
times change in volume" and allocated consistently based upon the relative absolute values of the changes in volume and
changes in rate.
(2) Tax exempt income was converted to a fully taxable equivalent basis at a 35, 35 and 34 percent tax rate for 2003, 2002 and
2001. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the
TEFRA adjustment applicable to nondeductible interest expense.
17
ANALYSIS OF SECURITIES
(in thousands of dollars)
The amortized cost and the fair value of securities as of December 31, 2003, 2002 and 2001 were as follows:
2003 2002 2001
------------------------- ------------------------- ---------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
----------- ------------ ------------ ------------ ------------ ------------
Securities available for sale:
U.S. Treasury securities $ 0 $ 0 $ 5,143 $ 5,338 $ 7,630 $ 7,866
U.S. Government agencies and corporations 17,234 17,280 11,371 11,946 11,528 11,574
Mortgage-backed securities 213,071 211,142 216,619 222,036 213,054 216,654
State and municipal securities 51,138 52,945 33,534 34,785 30,085 29,663
Other debt securities 0 0 0 0 5,791 5,882
----------- ------------ ------------ ------------ ------------ ------------
Total debt securities available for sale $ 281,443 $ 281,367 $ 266,667 $ 274,105 $ 268,088 $ 271,639
=========== ============ ============ ============ ============ ============
18
ANALYSIS OF SECURITIES (cont.)
(fully tax equivalent basis)
(in thousands of dollars)
The weighted average yields (1) and maturity distribution (2) for debt securities portfolio at
December 31, 2003, were as follows:
After One After five
Within Year Years Over
One Within Within Ten Ten
Year Five Years Years Years
------------ ------------ ------------ ------------
Securities available for sale:
Government agencies and corporations
Book value $ 0 $ 11,799 $ 5,481 $ 0
Yield 0.00% 3.36% 5.25% 0.00%
Mortgage-backed securities
Book value 0 16,229 64,112 130,801
Yield 0.00% 5.74% 5.35% 5.45%
State and municipal securities
Book value 100 865 3,922 48,058
Yield 6.85% 3.34% 4.24% 4.63%
------------ ------------ ------------ ------------
Total debt securities available for sale:
Book value $ 100 $ 28,893 $ 73,515 $ 178,859
Yield 6.85% 4.69% 5.05% 5.23%
============ ============ ============ ============
(1) Tax exempt income was converted to a fully taxable equivalent basis at a 35% rate.
(2) The maturity distribution of mortgage-backed securities was based upon anticipated payments as computed by using the
historic average payment speed from date of issue.
There were no investments in securities of any one issuer, other than the U.S. Government and its agencies that exceeded
10% of stockholders' equity at December 31, 2003.
19
ANALYSIS OF LOAN PORTFOLIO
Analysis of Loans Outstanding
(in thousands of dollars)
The Company segregates its loan portfolio into four basic segments: commercial (including agri-business and agricultural
loans), real estate mortgages, installment and personal line of credit loans (including credit card loans). The loan portfolio as
of December 31, 2003, 2002, 2001, 2000 and 1999 was as follows:
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Commercial loans:
Taxable $ 667,672 $ 619,963 $ 534,645 $ 487,125 $ 419,034
Tax exempt 7,785 4,974 2,544 2,374 3,048
------------ ------------ ------------ ------------ ------------
Total commercial loans 675,457 624,937 537,189 489,499 422,082
Real estate mortgage loans 44,050 47,184 47,252 52,731 46,872
Installment loans 58,567 75,692 95,592 129,729 146,711
Line of credit and credit card loans 92,808 74,863 58,190 46,917 38,233
------------ ------------ ------------ ----------- ------------
Total loans 870,882 822,676 738,223 718,876 653,898
Less allowance for loan losses 10,234 9,533 7,946 7,124 6,522
------------ ------------ ------------ ----------- ------------
Net loans $ 860,648 $ 813,143 $ 730,277 $ 711,752 $ 647,376
============ ============ ============ =========== ============
The real estate mortgage loan portfolio included construction loans totaling $3,932, $2,540, $2,354, $3,626 and $4,488 as
of December 31, 2003, 2002, 2001, 2000 and 1999. The loan classifications are based on the nature of the loans as of the loan
origination date. There were no foreign loans included in the loan portfolio for the periods presented.
20
ANALYSIS OF LOAN PORTFOLIO (cont.)
Analysis of Loans Outstanding (cont.)
(in thousands of dollars)
Repricing opportunities of the loan portfolio occur either according to predetermined adjustable rate schedules included
in the related loan agreements or upon maturity of each principal payment. The following table indicates the scheduled maturities
of the loan portfolio as of December 31, 2003.
Line of
Real Credit and
Commercial Estate Installment Credit Card Total Percent
------------ ------------ ------------ ------------ ------------ ------------
Original maturity of one day $ 410,909 $ 0 $ 419 $ 90,006 $ 501,334 57.6%
Other within one year 94,472 6,256 23,420 0 124,148 14.2
After one year, within five years 158,334 5,632 32,671 0 196,637 22.6
Over five years 11,290 32,061 2,057 2,802 48,210 5.5
Nonaccrual loans 452 101 0 0 553 0.1
------------ ------------ ------------ ------------ ------------ ------------
Total loans $ 675,457 $ 44,050 $ 58,567 $ 92,808 $ 870,882 100.0%
============ ============ ============ ============ ============ ============
A portion of the loans is short-term maturities. At maturity, credits are reviewed and, if renewed, are renewed at rates
and conditions that prevail at the time of maturity.
Loans due after one year which have a predetermined interest rate and loans due after one year which have floating or
adjustable interest rates as of December 31, 2003 amounted to $207,387 and $37,460.
21
ANALYSIS OF LOAN PORTFOLIO (cont.)
Review of Nonperforming Loans
(in thousands of dollars)
The following is a summary of nonperforming loans as of December 31, 2003, 2002, 2001, 2000 and 1999.
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
PART A - PAST DUE ACCRUING LOANS (90 DAYS OR MORE)
Real estate mortgage loans $ 160 $ 0 $ 170 $ 398 $ 0
Commercial and industrial loans 2,912 3,245 0 7,635 20
Loans to individuals for household, family and
other personal expenditures 119 142 94 171 151
Loans to finance agriculture production and
other loans to farmers 0 0 0 0 0
------------ ------------ ------------ ------------ ------------
Total past due loans 3,191 3,387 264 8,204 171
------------ ------------ ------------ ------------ ------------
PART B - NONACCRUAL LOANS
Real estate mortgage loans 101 106 59 37 0
Commercial and industrial loans 452 4,110 2,175 169 329
Loans to individuals for household, family and
other personal expenditures 0 0 0 0 0
Loans to finance agriculture production and
other loans to farmers 0 0 0 0 0
----------- ------------ ------------ ------------ ------------
Total past due loans 553 4,216 2,234 206 329
----------- ------------ ------------ ------------ ------------
PART C - TROUBLED DEBT RESTRUCTURED LOANS 0 0 0 1,127 1,179
----------- ------------ ------------ ------------ ------------
Total nonperforming loans $ 3,744 $ 7,603 $ 2,498 $ 9,537 $ 1,679
=========== ============ ============ ============ ============
Nonearning assets of the Company include nonperforming loans (as indicated above), nonaccrual investments, other real
estate and repossessions, which amounted to $4,328 at December 31, 2003.
22
ANALYSIS OF LOAN PORTFOLIO (cont.)
Comments Regarding Nonperforming Assets
PART A - CONSUMER LOANS
Consumer installment loans, except those loans that are secured by
real estate, are not placed on nonaccrual status since these loans are
charged-off when they have been delinquent from 90 to 180 days, and when the
related collateral, if any, is not sufficient to offset the indebtedness.
Advances under Mastercard and Visa programs, as well as advances under all
other consumer line of credit programs, are charged-off when collection
appears doubtful.
PART B - NONPERFORMING LOANS
When a loan is classified as a nonaccrual loan, interest on the loan
is no longer accrued and all accrued interest receivable is charged off. It is
the policy of the Bank that all loans for which the collateral is insufficient
to cover all principal and accrued interest will be reclassified as
nonperforming loans to the extent they are unsecured, on or before the date
when the loan becomes 90 days delinquent. Thereafter, interest is recognized
and included in income only when received. Interest not recorded on nonaccrual
loans is referenced in Footnote 4 in Item 8 below.
As of December 31, 2003, there were $553,000 of loans on nonaccrual
status, some of which were also on impaired status. There were $3.0 million of
loans classified as impaired.
PART C - TROUBLED DEBT RESTRUCTURED LOANS
Loans renegotiated as troubled debt restructurings are those loans
for which either the contractual interest rate has been reduced and/or other
concessions are granted to the borrower because of a deterioration in the
financial condition of the borrower which results in the inability of the
borrower to meet the terms of the loan.
As of December 31, 2003 and 2002, there were no loans renegotiated as
troubled debt restructurings.
PART D - OTHER NONPERFORMING ASSETS
Management is of the opinion that there are no significant
foreseeable losses relating to nonperforming assets, as defined in the
preceding table, or classified loans, except as discussed above in Part B -
Nonperforming Loans and Part C - Troubled Debt Restructured Loans.
PART E - LOAN CONCENTRATIONS
There were no loan concentrations within industries, which exceeded
ten percent of total assets. It is estimated that over 90% of all the Bank's
commercial, industrial, agri-business and agricultural real estate mortgage,
real estate construction mortgage and consumer loans are made within its basic
service area.
23
Basis For Determining Allowance For Loan Losses:
Management is responsible for determining the adequacy of the
allowance for loan losses. This responsibility is fulfilled by management in a
number of ways, including the following:
1. Management reviews the larger individual loans (primarily in the
commercial loan portfolio) for unfavorable collectibility factors and assesses
the requirement for specific reserves on such credits. For those loans not
subject to specific reviews, management reviews previous loan loss experience
to establish historical ratios and trends in charge-offs by loan category. The
ratios of net charge-offs to particular types of loans enable management to
estimate charge-offs by loan category and thereby establish appropriate
reserves for loans not specifically reviewed.
2. Management reviews the current economic conditions of its lending
market to determine the effects on loan charge-offs by loan category, in
addition to the effects on the loan portfolio as a whole.
3. Management reviews delinquent loan reports to determine risk of
loan charge-offs. High delinquencies are generally indicative of an increase
in future loan charge-offs.
Based upon these policies and objectives, $2.3 million, $3.1 million
and $2.2 million were charged to the provision for loan losses and added to
the allowance for loan losses in 2003, 2002 and 2001.
The allocation of the allowance for loan losses to the various
lending areas is performed by management in relation to perceived exposure to
loss in the various loan portfolios. However, the allowance for loan losses is
available in its entirety to absorb losses in any particular loan category.
24
ANALYSIS OF LOAN PORTFOLIO (cont.)
Summary of Loan Loss
(in thousands of dollars)
The following is a summary of the loan loss experience for the years ended December 31, 2003, 2002, 2001, 2000 and 1999.
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Amount of loans outstanding, December 31, $ 870,882 $ 822,676 $ 738,223 $ 718,876 $ 653,898
============ ============ ============ ============ ============
Average daily loans outstanding during the year
ended December 31, $ 847,555 $ 770,897 $ 729,750 $ 679,198 $ 605,170
============ ============ ============ ============ ============
Allowance for loan losses, January 1, $ 9,533 $ 7,946 $ 7,124 $ 6,522 $ 5,510
------------ ------------ ------------ ------------ ------------
Loans charged-off
Commercial 1,261 1,268 569 200 147
Real estate 47 0 0 30 6
Installment 353 509 868 483 252
Credit cards and personal credit lines 113 98 103 35 30
------------ ------------ ------------ ------------ ------------
Total loans charged-off 1,774 1,875 1,540 748 435
------------ ------------ ------------ ------------ ------------
Recoveries of loans previously charged-off
Commercial 21 270 3 45 10
Real estate 0 0 16 0 0
Installment 188 128 113 93 114
Credit cards and personal credit lines 12 8 5 6 13
------------ ------------ ------------ ------------ ------------
Total recoveries 221 406 137 144 137
------------ ------------ ------------ ------------ ------------
Net loans charged-off 1,553 1,469 1,403 604 298
Provision for loan loss charged to expense 2,254 3,056 2,225 1,206 1,310
------------ ------------ ------------ ------------ ------------
Balance, December 31, $ 10,234 $ 9,533 $ 7,946 $ 7,124 $ 6,522
============ ============ ============ ============ ============
Ratio of net charge-offs during the period to
average daily loans outstanding
Commercial 0.15% 0.13% 0.08% 0.02% 0.02%
Real estate 0.00 0.00 0.00 0.00 0.00
Installment 0.02 0.05 0.10 0.06 0.02
Credit cards and personal credit lines 0.01 0.01 0.01 0.01 0.01
------------ ------------ ------------ ------------ ------------
Total 0.18% 0.19% 0.19% 0.09% 0.05%
============ ============ ============ ============ ============
Ratio of allowance for loan losses to
nonperforming assets 236.46% 123.15% 192.58% 73.83% 368.06%
============ ============ ============ ============ ============
25
ANALYSIS OF LOAN PORTFOLIO (cont.)
Allocation of Allowance for Loan Losses
(in thousands of dollars)
The following is a summary of the allocation for loan losses as of December 31, 2003, 2002, 2001, 2000 and 1999.
2003 2002 2001
-------------------------- -------------------------- --------------------------
Allowance Loans as Allowance Loans as Allowance Loans as
For Percentage For Percentage For Percentage
Loan of Gross Loan of Gross Loan of Gross
Losses Loans Losses Loans Losses Loans
------------ ------------ ------------ ------------ ------------ ------------
Allocated allowance for loan losses
Commercial $ 8,634 77.56% $ 7,824 75.96% $ 6,412 72.77%
Real estate 110 5.06 123 5.74 127 6.40
Installment 440 6.72 573 9.20 728 12.95
Credit cards and personal credit lines 696 10.66 563 9.10 431 7.88
------------ ------------ ------------ ----------- ------------ ------------
Total allocated allowance for loan losses 9,880 100.00% 9,083 100.00% 7,698 100.00%
============ =========== ============
Unallocated allowance for loan losses 354 450 248
------------ ------------ ------------
Total allowance for loan losses $ 10,234 $ 9,533 $ 7,946
============ ============ ============
2000 1999
-------------------------- ---------------------------
Allowance Loans as Allowance Loans as
For Percentage For Percentage
Loan of Gross Loan of Gross
Losses Loans Losses Loans
------------ ------------ ------------ ------------
Allocated allowance for loan losses
Commercial $ 5,205 68.09% $ 4,750 64.55%
Real estate 132 7.34 120 7.17
Installment 974 18.04 1,202 22.43
Credit cards and personal credit lines 352 6.53 185 5.85
------------ ------------ ------------ ------------
Total allocated allowance for loan losses 6,663 100.00% 6,257 100.00%
============ ============
Unallocated allowance for loan losses 461 265
------------ ------------
Total allowance for loan losses $ 7,124 $ 6,522
============ ============
In 2001 and 1999, the Company reviewed and revised the allocation process for the Allowance for Loan Losses. These changes
primarily affected the allocations as they pertain to the commercial loans classified in the Company's internal watch list. These
changes also brought the Company's methodology into closer conformity with regulatory guidance. The Company continues to review the
allocation process and the documentation for the Allowance for Loan Losses, therefore future changes may occur.
26
ANALYSIS OF DEPOSITS
(in thousands of dollars)
The average daily deposits for the years ended December 31, 2003, 2002 and 2001, and the average rates paid on those
deposits are summarized in the following table:
2003 2002 2001
-------------------------- -------------------------- --------------------------
Average Average Average Average Average Average
Daily Rate Daily Rate Daily Rate
Balance Paid Balance Paid Balance Paid
------------ ------------ ------------ ------------ ------------ ------------
Demand deposits $ 173,716 0.00% $ 150,226 0.00% $ 137,011 0.00%
Savings and transaction accounts:
Regular savings 61,053 0.38 53,792 0.75 50,513 1.21
Interest bearing checking 301,328 1.07 231,712 1.55 230,144 3.24
Time deposits:
Deposits of $100,000 or more 230,417 1.94 224,437 2.50 203,067 5.24
Other time deposits 203,196 3.03 203,531 3.68 211,728 5.27
------------ ------------ -----------
Total deposits $ 969,710 1.45% $ 863,698 1.98% $ 832,463 3.59%
============ ============ ===========
As of December 31, 2003, time certificates of deposit in denominations of $100,000 or more will mature as follows:
Within three months $ 45,842
Over three months, within six months 17,847
Over six months, within twelve months 10,208
Over twelve months 32,471
------------
Total time certificates of deposit in
denominations of $100,000 or more $ 106,368
============
27
QUALITATIVE MARKET RISK DISCLOSURE
Management's market risk disclosure appears under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7, below, and is incorporated herein by reference in
response to this item. The Company's primary market risk exposure is interest
rate risk. The Company does not have a material exposure to foreign currency
exchange rate risk, does not own any material derivative financial instruments
and does not maintain a trading portfolio.
RETURN ON EQUITY AND OTHER RATIOS
The rates of return on average daily assets and stockholders'
equity, the dividend payout ratio, and the average daily stockholders' equity
to average daily assets for the years ended December 31, 2003, 2002 and 2001
were as follows:
2003 2002 2001
----------- ----------- -----------
Percent of net income to:
Average daily total assets 1.12% 1.08% 0.90%
Average daily stockholders' equity 15.88% 15.64% 14.45%
Percentage of dividends declared per
common share to basic earnings per
weighted average number of common
shares outstanding (5,819,916 shares
in 2003 and 5,813,984 shares in 2002
and 2001) 31.93% 31.92% 34.48%
Percentage of average daily
stockholders' equity to average
daily total assets 7.05% 6.88% 6.23%
28
SHORT-TERM BORROWINGS
(in thousands of dollars)
The following is a schedule, at the end of the year indicated, of
statistical information relating to securities sold under agreement to
repurchase maturing within one year and secured by either U.S. Government
agency securities or mortgage-backed securities classified as other debt
securities. There were no other categories of short-term borrowings for which
the average balance outstanding during the period was 30 percent or more of
stockholders' equity at the end of each period.
2003 2002 2001
------------ ------------ ------------
Outstanding at year end $ 102,601 $ 124,969 $ 149,117
Approximate average interest rate at
year end 0.79% 1.03% 1.91%
Highest amount outstanding as of any
month end during the year $ 108,270 $ 139,857 $ 160,628
Approximate average outstanding
during the year $ 97,808 $ 116,214 $ 140,277
Approximate average interest rate
during the year 0.83% 1.49% 3.72%
Securities sold under agreement to repurchase include fixed rate, term
transactions initiated by the investment department of the Bank, as well as
corporate sweep accounts.
29
ITEM 2. PROPERTIES
The Company conducts its operations from the following locations:
Branches/Headquarters
Main/Headquarters 202 East Center St. Warsaw IN
Warsaw Drive-up East Center St. Warsaw IN
Akron 102 East Rochester Akron IN
Argos 100 North Michigan Argos IN
Auburn 1220 East 7th St. Auburn IN
Bremen 1600 Indiana State Road 331 Bremen IN
Columbia City 601 Countryside Dr. Columbia City IN
Concord 4202 Elkhart Rd. Goshen IN
Cromwell 111 North Jefferson St. Cromwell IN
Elkhart Beardsley 864 East Beardsley St. Elkhart IN
Elkhart East 22050 State Road 120 Elkhart IN
Elkhart Hubbard Hill 58404 State Road 19 Elkhart IN
Elkhart Northwest 1208 North Nappanee St. Elkhart IN
Fort Wayne North 302 East DuPont Rd. Fort Wayne IN
Fort Wayne Northeast 10411 Maysville Rd. Fort Wayne IN
Fort Wayne Southwest 10429 Illinois Rd. Fort Wayne IN
Fort Wayne Downtown 200 East Main St., Suite 600 Fort Wayne IN
Goshen Downtown 102 North Main St. Goshen IN
Goshen South 2513 South Main St. Goshen IN
Granger 12830 State Road 23 Granger IN
Huntington 1501 North Jefferson St. Huntington IN
Kendallville East 631 Professional Way Kendallville IN
LaGrange 901 South Detroit LaGrange IN
Ligonier Downtown 222 South Cavin St. Ligonier IN
Ligonier South 1470 U.S. Highway 33 South Ligonier IN
Medaryville Main St. Medaryville IN
Mentone 202 East Main St. Mentone IN
Middlebury 712 Wayne Ave. Middlebury IN
Milford Indiana State Road 15 North Milford IN
Mishawaka 5015 North Main St. Mishawaka IN
Nappanee 202 West Market St. Nappanee IN
North Webster 644 North Main St. North Webster IN
Pierceton 202 South First St. Pierceton IN
Plymouth 862 East Jefferson St. Plymouth IN
Rochester 507 East 9th St. Rochester IN
Shipshewana 895 North Van Buren St. Shipshewana IN
Silver Lake 102 Main St. Silver Lake IN
South Bend Northwest 21113 Cleveland Rd. South Bend IN
Syracuse 502 South Huntington Syracuse IN
Warsaw East 3601 Commerce Dr. Warsaw IN
Warsaw North 420 Chevy Way Warsaw IN
Warsaw West 1221 West Lake St. Warsaw IN
Winona Lake 99 Chestnut St. Winona Lake IN
Winona Lake East 1324 Wooster Rd. Winona Lake IN
The Company leases from third parties the real estate and buildings
for its Milford and Winona Lake East branches, and for its Fort Wayne Downtown
office. In addition, the Company leases the real estate for its freestanding
ATMs. All the other branch facilities are owned by the Company. The Company
also owns parking lots in downtown Warsaw for the use and convenience of
Company employees and customers, as well as leasehold improvements, equipment,
furniture and fixtures necessary to operate the banking facilities.
30
In addition, the Company owns buildings at 110 South High St.,
Warsaw, Indiana, and 114-118 East Market St., Warsaw, Indiana, which it uses
for various offices, a building at 113 East Market St., Warsaw, Indiana, which
it uses for office and computer facilities, and a building at 109 South
Buffalo St., Warsaw, Indiana, which it uses for training and development. The
Company also leases from third parties facilities in Warsaw, Indiana, for the
storage of supplies and in Elkhart, Indiana, for computer facilities.
None of the Company's assets are the subject of any material
encumbrances.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings other than ordinary
routine litigation incidental to the business to which the Company and the
Bank are a party or of which any of their property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the
fourth quarter of 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter
------- ------- ------- -------
2003
Trading range (per share)*
Low $33.510 $29.510 $24.400 $23.000
High $37.469 $34.400 $31.220 $25.750
Dividends declared (per share) $ 0.19 $ 0.19 $ 0.19 $ 0.19
2002
Trading range (per share)*
Low $22.220 $23.570 $20.100 $17.410
High $24.995 $29.760 $28.840 $20.450
Dividends declared (per share) $ 0.17 $ 0.17 $ 0.17 $ 0.17
* The trading ranges are the high and low as obtained from the Nasdaq Stock
market.
The common stock of the Company began being quoted on The Nasdaq
Stock Market under the symbol LKFN in August, 1997. On December 31, 2003, the
Company had approximately 513 shareholders of record and estimates that is has
approximately 2,000 shareholders in total.
The Company paid dividends as set forth in the table above. The
Company's ability to pay dividends to shareholders is largely dependent upon
the dividends it receives from the Bank, and the Bank is subject to regulatory
limitations on the amount of cash dividends it may pay. See "Business -
Supervision and Regulation - The Company - Dividend Payments" and "Business -
Supervision and Regulation - The Bank - Dividend Payments" for a more detailed
description of these limitations.
31
ITEM 6. SELECTED FINANCIAL DATA
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
(in thousands except share and per share data)
Interest income $ 60,336 $ 64,335 $ 76,615 $ 80,050 $ 69,395
Interest expense 18,137 22,558 39,230 45,030 37,122
------------ ------------ ------------ ------------ ------------
Net interest income . . . . . . . . . . . . . . . . . . . . . 42,199 41,777 37,385 35,020 32,273
Provision for loan losses 2,254 3,056 2,225 1,206 1,310
------------ ------------ ------------ ------------- ------------
Net interest income after provision
for loan losses 39,945 38,721 35,160 33,814 30,963
Other noninterest income 14,909 12,894 11,449 10,469 9,841
Net gain on sale of branches 0 0 753 0 0
Net gains on sale of real estate
mortgages held for sale 3,018 1,914 1,232 504 1,302
Net securities gains (losses) 500 55 120 0 1,340
Noninterest expense (37,679) (34,698) (33,857) (31,349) (31,042)
------------ ------------ ------------ ------------ ------------
Income before income tax expense . . . . . . . . . . . . . . . 20,693 18,886 14,857 13,438 12,404
Income tax expense 6,828 6,520 4,744 4,116 4,085
------------ ------------ ------------ ------------ ------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . .$ 13,865 $ 12,366 $ 10,113 $ 9,322 $ 8,319
============ ============ ============ ============ ============
Basic weighted average common shares
outstanding 5,819,916 5,813,984 5,813,984 5,813,984 5,813,984
============ ============ ============ ============ ============
Basic earnings per common share $ 2.38 $ 2.13 $ 1.74 $ 1.60 $ 1.43
============ ============ ============ ============ ============
Diluted weighted average common shares
outstanding 6,001,449 5,958,386 5,841,196 5,813,999 5,813,992
============ ============ ============ ============ ============
Diluted earnings per common share $ 2.31 $ 2.08 $ 1.73 $ 1.60 $ 1.43
============ ============ ============ ============ ============
Cash dividends declared $ 0.76 $ 0.68 $ 0.60 $ 0.52 $ 0.44
============ ============ ============ ============ ============
32
ITEM 6. SELECTED FINANCIAL DATA (continued)
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
(in thousands)
Balances at December 31:
- --------------------------------------
Total assets $ 1,271,414 $ 1,249,060 $ 1,139,013 $ 1,150,485 $ 1,041,198
Total loans $ 870,882 $ 822,676 $ 738,223 $ 718,876 $ 653,898
Total deposits $ 926,391 $ 913,325 $ 793,380 $ 845,329 $ 748,243
Total short-term borrowings $ 184,761 $ 184,968 $ 232,117 $ 200,078 $ 195,374
Long-term borrowings $ 30,047 $ 31,348 $ 11,389 $ 11,433 $ 16,473
Subordinated debentures $ 30,928 $ 20,619 $ 20,619 $ 20,619 $ 20,619
Total stockholders' equity $ 90,022 $ 83,880 $ 73,534 $ 64,973 $ 54,194
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Lakeland Financial Corporation is the holding company for Lake City
Bank. The Company is headquartered in Warsaw, Indiana and operates 43 offices
in twelve counties in northern Indiana. The Company earned $13.9 million for
the year ended 2003 versus $12.4 million for the year ended 2002, an increase
of 12.1%. The increase was driven by a $3.6 million increase in non-interest
income, an $802,000 decrease in the provision for loan losses and a $422,000
increase in net interest income. Offsetting these positive impacts was a $3.0
million increase in non-interest expense, driven by $804,000 expense related
to debt extinguishment costs and an other real estate owned impairment of
$300,000. The Company earned $12.4 million for the year ended 2002 versus
$10.1 million for the year ended 2001, an increase of 22.3%. The increase was
driven by a $4.4 million increase in net interest income and a $1.3 million
increase in non-interest income. Offsetting these positive impacts were
increases of $831,000 in the provision for loan losses and $841,000 in
non-interest expense.
Basic earnings per share for the year ended 2003 was $2.38 per share
versus $2.13 per share for the year ended 2002 and $1.74 for the year ended
2001. Diluted earnings per share reflect the potential dilutive impact of
stock options granted under an employee stock option plan. Diluted earnings
per share for the year ended 2003 was $2.31 per share versus $2.08 per share
for the year ended 2002 and $1.73 for the year ended 2001.
RESULTS OF OPERATIONS